The choice of the source of finance depends upon a number of factors which includes:
There are two types of cost, the cost of procurement of funds and the cost of utilizing the funds. Both these costs should be taken into account while deciding about the source of funds that will be used by an organization.
The financial strength of a business is also a key determinant. In the choice of source of funds, the business should be in a sound financial position so as to be able to repay the principal amount and interest on the borrowed amount.
Owned funds do not invite any risk while using borrowed funds entails a lot of risk. The Probable default in paying interest and capital may lead to the liquidation of business enterprises besides damaging the reputation of the business concern in the business world.
A new business enterprise finds it hard to mobilise business finance than an established firm. Therefore it may have to rely on owned sources in the initial stage. Once the business enterprise has established itself in the business world, they can tap borrowed source of funds and offer its assets as security there for.
The choice of source of fund depends on the form of organization. Sole proprietor and Partnership firms cannot issue shares and debentures. They have to depend on short term sources like bank finance, leasing, hire purchase, factoring, etc. On the other hand Companies and Government organizations mobilize funds both from long term sources like shares, debentures, public deposits etc. and from short term sources.
The period for which business finance is required determines the suitable source. For instance, where funds are required for shorter period, bank finance like overdraft, cash credit, leasing, hire purchase, factoring and so on, are suitable sources. Funds required for longer period can be tapped from issue of shares, debentures, bonds, term loan and the like.
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.
A business should plan according to the time period for which the funds are required. A Short-term need, for example, can be met through borrowing funds at a low rate of interest through i.e. trade credit. For long term finance, sources such as the issue of shares and debentures are more appropriate.