Choosing the best type of Finance | Business Studies for GCSE/IGCSE - Year 11 PDF Download

Factors to Consider when Choosing a Source of Finance

• There are numerous factors that managers need to evaluate before determining the type and source of finance required. 
• They may even need to utilize multiple sources of finance simultaneously.

 Diagram: Factors Affecting the Suitable Choice of Finance 

An Explanation of the Factors Affecting the Choice of Finance 

Reducing the risk of being unable to raise finance

• This risk of not being able to raise finance can be mitigated through various strategies.
• Bank loans are more likely to be approved under certain conditions:
  • A business should present a compelling business plan, complete with a cash-flow statement and income statement from the previous period.
  • External sources of finance should be minimal and effectively managed.
  • The business should possess collateral to lower the risk for the bank.
• Shareholder investment is more probable when:
  • The share price shows improvement.
  • Generous dividends are being offered.
  • The company demonstrates good profit potential and has plans for growth.
  • Alternative investments are less appealing.

Recommending an Appropriate Source of Finance

• Finance managers often need to advise their CEOs on the best financing options to utilize. This decision is typically made after conducting a thorough analysis based on the questions outlined in the table above.
• Determining the most suitable form of financing involves analyzing the questions provided in the table.

Example 1

• Successful private limited company specializing in wooden furniture seeks additional funding to expand into new markets, after 15 years of established operations and a strong reputation.

Key Considerations:

• As a limited company, the option of selling shares to family and friends exists, albeit with limitations on the amount raised.
• With a track record of 15 years, the company poses lower risk compared to a new startup, making it a viable candidate for a bank loan.
• Reinvestment of profits alone may not suffice to fuel expansion plans.

Recommendation:

• A bank loan presents a viable option, leveraging the company's successful track record. Repayments can be spread out over several years, although interest payments are required.
• Issuing new shares to existing shareholders is another avenue, potentially attracting increased investment from those familiar with the company's success and eager to participate in its growth.
• However, the decision hinges on the owner's willingness to cede control and ownership by issuing additional shares.
• Overall, finance managers are likely to advocate for securing a bank loan, given its potential to preserve ownership and a share of future profits.

Example 2

A fashion trainer retail store experiences a surge in sales following promotion by an influencer on TikTok and Instagram, necessitating swift replenishment of stock. Sole trader Toby contemplates utilizing his existing overdraft or trade credit.

Key Considerations:

• Replenishing stock urgently favors leveraging the existing overdraft facility, providing instant access to finance.
• Opting for trade credit allows Toby to defer immediate payment for stock, mitigating potential cash flow challenges as sales can be made before payment to the supplier is due.

Recommendation:

• An overdraft, being a short-term finance solution, entails interest payments on the utilized amount.
• Trade credit offers relief on financial strain as stock is replenished, possibly accompanied by discounts upon agreement setup.
• Most finance managers would advise Toby to prioritize seeking trade credit initially. Should this option prove unattainable, utilizing the overdraft facility becomes a viable alternative.