Factors to consider when choosing a source of finance

Deciding on where you will get funding for your business can be an arduous task that takes a lot of time. This is because there aren’t so many sources of finance available. Each source has different criteria and implication on your business. It is imperative first to take a look at the benefits as well as the costs to help you decide which source of funding is suitable for you and your business. Below are the factors to consider when choosing a source of finance.

The risk

I put this as the first point because I feel it is the most important factor that you should consider whenever you choose a source of funding. Try and imagine what would happen if you are unable to pay back this money. If you take a loan from a bank, look at the implications that they have should you become incapable of paying the loan or if the business fails. If you are thinking of borrowing from family or friends, take a look at what will happen to your relationship if it gets to a point where you can’t pay back.

The costs

The cost of finance is a huge factor to consider when determining the source of finance. This is because you want to minimize your costs as you maximize on wealth. Will your cost of equity increase if you increase your borrowing? If shareholders see the borrowing as something that is steering you towards bankruptcy, then they may want something more to compensate the risk. Understand also that there are so many costs involved in borrowing such as the fee for the broker or interest rates. Consider all this before you arrive at a decision.

Amount needed

An important factor to consider is the amount required by the business. Some sources are not good for a large amount of money. Bank overdrafts, for example, have set limits to the amount of money that you can withdraw. Some sources also are not suitable if the amount of money you are raising is small.

The purpose

What kind of project is this money going into? This is one of the most important things to consider. A capital expenditure will require a long-term source of finding. A revenue expenditure, on the other hand, will require short-term sources. An example of a capital expenditure is building a factory. Payment people on the supply chain is a revenue expenditure.