Explain the factors kept in mind before selecting a source of finance?

The following are the six factors that might affect an organisation’s choice of source of finance.

i. Cost of raising funds- Raising finance through different sources involves different levels of costs. These costs primarily include interest obligations, procurement cost and utilisation cost. For instance, issuing equity shares or trade credit involves higher cost than issuing debentures or factoring. Thus, the company should consider the costs involved and opt for the cheapest source of finance.

ii. Payment obligations- A business needs to honour the payment obligations of capital as well as the return on investment. For instance, in case of borrowed funds, the firm is legally bound to make interest payments at regular intervals. However, in case of equity, the capital is repaid only at the time of dissolution. Thus, a company should opt for sources whose payment obligations are non-binding in nature.

iii. Dilution of control involved- Certain sources of funds involve dilution of ownership of the business. For instance, issue of equity shares leads to the dilution of control of the owners. However, this dilution does not take place in case of borrowed funds. Thus, the company should also consider the extent to which the owners are ready to share their control over the business.

iv. Credit worthiness of the issuer- High dependence on certain types of borrowings tends to adversely affect the credit worthiness of a company or an issuer. For instance, if a company highly depends on the secured debentures, then this may hamper the interests of the unsecured creditors in the company. As a result, they may not extend further credit to the company.

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the cost, financial strength and stability, form of business org, period and purpose, risk, control flexibility and tax benefits.

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