Raising funds - which source is best?

The choice of source of funds that a business makes will depend on a number of factors. These include:

·         Cost - this has to be one of the most important. To use an overdraft for the medium to long-term may be an expensive way of raising money and so businesses need to look carefully at the cost of each of their loan options. This will mainly be the rate of interest charged, but there may be other costs as well (charges for debt factoring, leasing charges and so on). For example, share issues can carry high administration costs.

·         Uses of Funds: When a company undertakes heavy capital expenditure, it is usually funded by a long-term source of finance. For example; building of a new plant may be financed by a share issue or a mortgage. Revenue expenditure tends to be financed by short-term sources. For example, Purchase a large amount of raw materials may be funded by trade credit or a bank overdraft.

·         Financial outlook - the financial strength of a business may also be a key determinant. If the business already has a very high gearing ratio, then they may want to look carefully to see if they can access internal sources of funds before borrowing even more. They may also find that banks and other lenders are going to be less willing to lend if they are not in a strong financial position.

·         Legal status - a sole trader will be unable to issue shares and may also face much higher rates of interest on loans as they may be considered a greater risk. The business status may therefore influence the routes that are available to them for raising money.

·         Time period - the company needs to plan ahead carefully to see how long they will need the funds for. The shorter the time period, the more they may be able to reduce the cost of the borrowing. If it is very long-term finance required then they may want to look at debentures or share issues. In the short-term, a simple overdraft may be the most flexible solution.