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Question

Discuss the factors affecting the choice of sources of funds.

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Solution

Following are the factors affecting the choice of source of funds :

1. Cost: It refers to the cost incurred in obtaining the fund and the cost of using the funds. So, while deciding about the source of funds both the costs should be taken into consideration.

2. Flexibility and ease: Borrowings from banks and financial institutions involve many restrictions, detailed investigation and documentation. Therefore, business firms may not prefer them in case other sources are easily available.

3. Effect on creditworthiness: The creditworthiness of business is affected by the use of certain sources. For example, the issue of secured debentures by a company may lead to the withdrawal of loans by unsecured creditors. It might become difficult for the company to raise further unsecured loans.

4. The form of organisation and legal status: The form of the legal status of business firms also affect the choice of the source of finance. For example, a sole proprietor or a partnership firm cannot obtain funds by issue of equity shares as these can be issued only by joint stock companies.

5. Purpose and time period: The time period for which the funds are required also affects the selection of the source of funds. For example, if the funds are required for a short period, sources such as trade credit, commercial papers, etc. can be used. For the long term, sources such as the issue of shares, debentures, etc. are preferred. Therefore, the purpose of the business should also be considered while choosing the source of finance.

6. Tax benefits: Certain sources of funds like debentures and loans provide tax benefits. The interest payable on them is tax deductible. Hence, the organisations seeking tax advantage prefer to raise funds through debentures or loans.


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