Lecture Script
Good morning everyone. Today we are going to discuss the factors that affect a business’s choice of finance. Every business needs money to operate and grow, but the important question is, where should that money come from? Choosing the right source of finance is not as simple as just picking one option. There are several factors that managers must think about before making that decision.
Let’s start with the first factor, the cost of finance. This means how much it actually costs the business to get the money. Some sources of finance are cheap, while others can be very expensive. For example, if a business uses its retained earnings, there is no direct cost like interest payments. However, there is an opportunity cost because the money could have been used somewhere else. On the other hand, if a business takes a bank loan, it must pay interest, and if it issues shares, it may have to pay dividends to shareholders. A smart business always tries to find the most cost-effective option
The second factor is flexibility. This refers to how easily a business can adjust or manage the finance it has taken. Some sources of finance are more flexible than others. For example, an overdraft allows a business to borrow money quickly and pay it back when cash is available. It’s useful for short-term needs. On the other hand, a long-term loan or a debenture might lock the business into fixed repayments, which can be difficult if sales fall or cash flow becomes tight. A business that deals with seasonal demand, like an ice cream shop that earns more in summer and less in winter, might prefer an overdraft because it offers flexibility to borrow only when needed.
Next, let’s talk about the need to retain control. Some business owners want to keep full control of their company, and this affects how they choose to finance it. If a business sells shares to raise money, it gives away part of its ownership. This means new shareholders can have a say in how the business is run. On the other hand, taking a bank loan allows the owner to keep control, but it increases financial risk because the loan has to be repaid with interest.
The fourth factor is the purpose of the finance. What the business needs the money for will decide which type of finance is most suitable. If the business needs money for short-term needs, like buying stock or paying bills, it may choose short-term finance such as an overdraft or trade credit. However, if it is planning a long-term investment, such as buying new machinery or a building, then long-term finance like a mortgage or debenture is more suitable. For example, if a company is opening a new branch, it might use retained earnings and a long-term loan to fund the expansion.
Finally, the existing level of debt also matters. This is about how much money the business has already borrowed. If a company already has a lot of loans, banks might be hesitant to lend more money because it looks risky. This situation is known as being highly geared, which means having a high level of debt compared to equity. In such cases, the company might decide to raise money by issuing new shares instead of taking on more loans. For example, a company that already owes a lot to banks might look for investors instead, so it doesn’t increase its debt burden.
To wrap things up, the choice of finance depends on many factors such as cost, flexibility, control, purpose, and existing debt. There is no single best source of finance that fits every situation. A good financial manager carefully considers all these factors before making a decision. The goal is to find a balance that supports the business’s growth, maintains control, and keeps the company financially stable.
By the end of this lesson, you should understand that businesses must choose their sources of finance wisely. The best option is the one that fits their needs, keeps costs manageable, and supports long-term success.
