Factors that Affect the Choice of Finance – Business Studies A Level

When a firm needs finance, it becomes crucial to pick how much finance they need and for how long. It can ruin or make a business. A firm will have a wide range of sources to choose finance from such as a bank loan or overdraft, share capital, venture capital, profit, or trade credit. However, some sources of cash are suited best for short term while others are best for long term and some are suited for little injections of cash while others are suited to huge injections of cash.
Before a business decides what source of finance it should choose, they need to ask the question:
How Much Finance Can the Business Obtain? Click here for more sources of finance
The type and amount of finance that is available will depend on several factors. These are as follows:

• The type of business – a sole trader will be limited to the capital the owner can put into the business plus any money he or she is able to borrow. A limited company will be able to raise share capital. In order to become a plc it will need to share capital of £50,000+ and a track record of success.This will make borrowing easier. 
• The stage of development of the business – a new business will find it much harder to raise finance than an established firm. As the business develops it is easier to persuade outsiders to invest in the business. It is also easier to obtain loans as the firm has assets to offer as security.
• The state of the economy – when the economy is booming, business confidence will be high. It will be easy to raise finance both from borrowing and from investors. It will be more difficult for businesses to find investors when interest rates are high. They will invest their money in more secure accounts such as building societies. Higher interest rates will also put up the cost of borrowing. This will make it more expensive for the business to borrow.

These factors will help make the firm decide how much it needs or can borrow. So, at this stage the business knows how much it needs and in the space period it needs it for. Here are the most logical solutions to sources of finance for short/long term and high/low finance:

High Amount of Finance Needed – Short Term
For this, the business should use a bank overdraft. A bank overdraft allows the business to ‘fall into the red’. It is a short term source of finance and has a high interest rate which may not suit this as the additional cost will be high due to the high amount of finance needed. Another option is to reinvest profits! It requires no interest charge therefore no additional costs.

High Amount of Finance Needed – Long Term
This would have the use of a bank as the source of finance. With a loan, the firm can either be repaid in instalments over time or at the end of the loan period. A bank loan has a much lower interest rate than an overdraft which is why it suits long term finance more. Banks provide loans up to 5 years +! Another option is a venture capitalist such as a ‘dragon den’, in which they will provide cash straight up will want a substantial part of the ownership of the company in return.

Low Amount of Finance Needed – Short Term
This isn’t a serious worry to firms and only needs a quick injection of cash to sort out the cash flow. The business could sell assets or sale and lease them back to provide this injection of cash or squeeze out cash from day-to-day finances. Either way, cash will be provided for the short term problem.

Low Amount of Finance Needed – Long Term
You don’t really have a solution to this as if a business constantly needs low amounts of finance, they can’t be that successful. The only solution is to see why the business needs the finance and solve the problem. Other than that, a long-term bank overdraft or short-term loan is the only other option, both I would not reccomend for the high additional costs included from interest charges.