There are several ways to finance a business but the most important thing is to select the right source. When making financial decisions, there are factors that determine the right choice of finance for businesses.
Taking those important decisions is no easy task, the way of the entrepreneur is decorated with uncertainty especially when it involves bringing something that is yet to be seen to the markets around you.
Even when one is able to choose the right business finance, how do you convince your loan providers especially when you want to start out big?
Need I remind you, for small term loans, no one cares what you are using the loan for. if you were asked, it is only for the records.
Short term loan is mostly taken care of by banks and finance house and also the easiest source of finance to get for small business.
The best part of personal loan offered by banks and finance companies is that it comes with no collateral.
If you are going for a big investment, then you will need medium or long term finance to help you run the daily activities of the firm.
Factors that determine the choice of finance
1. The life span of the project
Are you planning for long term or short term? The life span of the project would determine the source of finance that can be utilized for the project whose source of finance may be any of short, medium or long term finance.
A short term loan is used to finance short term project, while project that will last for many years should be financed with either medium or long term finance.
Using the wrong source of finance to finance a project will lead to idle cash, individuals or companies must examine project in term of life span in order to determine the best choice of finance.
2. Size of the business
The size of the business will also determine what source of finance for business.
For instance, a joint stock company can be financed through ordinary shares, preference shares or debentures while small and medium enterprises will need to look for short or medium term finance.
Small business can access short term finance like trade credit or short term loans.
In practice, small scale business needs short term finance while top companies need medium or long term source of finance to run the affairs of the company, such as capital projects and assets acquisition.
3. The current state of the business
A new business may find it easier to use medium or long term finance for financing.
For new business, the best available options are short term loans, bank overdraft, and trade credit.
As the business grows, one can elevate it with other sources of finance. It will also be easy to convince loan providers because of the assets and reputation the business has achieved during the period.
4. Cost of source of finance
Another important factor that determines the selection of source of finance is the charged attached to the source of finance.
Every bank or finance house wants to make money; instead of keeping cash idle, they would rather lend it out and earn interest on it. Getting loans are becoming easy to get these days but the drawback is the high interest rate attached to the principal.
It is advisable to evaluate the cost of the source of finance available and select the source of finance that has the cheapest cost. The lower the cost of finance of a business, the higher the profit that will be made.
If you are operating a small business, you can always go for personal loans and make a comparison between the money lenders to determine the best rate. There are several loan apps available on the play store and each of them with their unique offers.
This plays a huge role in determining the best business finance. When the economy of a country find the right balance, there will not be any doubt between the lender and borrower. Both will be able to strike deal knowing there is no cause for alarm.
It will also make it easier for directors to use undistributed dividends for reinvestment since the shareholders trust the economy.
This also gives the company heads up on how much is needed to finance a project now that profit can be estimated due to the booming state of the country. Predicting the actual income in a volatile environment is no easy task.
6. Company’s financial policy
For big companies, a decision has to be agreed on by the board of directors and made known to the residual owners of the company before selecting the best source of finance for the running of the business.
Small business owners are not left behind as well – for small business, the common practice is to secure short term loans but not without providing fully satisfactory answers to certain questions…
Will the decision to borrow money won’t reduce the profit? Is it okay to borrow money to start a business or use trade credit to run it?
Whatever decision arrived at, make sure it is the best practise for the small business.
Lastly, some top companies’ financial policy favour financing of project with shareholders’ funds than using debts or debenture while some firms favour the use of debts to finance the project. All final decisions will depend on policy already established by the parties involved.
7. Expected cash inflow
When organizations or individuals calculate expected cash inflow, it can be used to determine the pattern of finance for the project.
Businesses with lesser risk and high profit can be financed by medium term of finance while investment with irregular inflows will need all the cash it can get for the running cost of the firm, such businesses can be financed with long term finance.
8. Level of risk
Level of risk also determines the source of finance that would be used to finance a project. It is common practice for top companies to finance projects that have a higher risk with share capital in order to reduce the risk since they come with no interest.
If projects with high risk are financed by using debts or debentures, it may ruin the company because of the binding agreement to pay principal and interest.