Posted by Anjali Kaur on Jan 04, 2020

The Factors Affecting Financing Decisions

The financing decision is the second most important decision which the finance manager has to take while deciding the source of finance. In this post, we will learn about the factors affecting the financing decisions. The main sources of finance can be divided into 2 categories:

  1. Owner’s fund
  2. Borrowed fund

Let’s learn more about it.

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Owner’s Fund

The owner’s fund is those which are owned by the company. It includes retained earnings and shares capital.

Borrowed Fund

Borrowed fund are those which is not owned by the company. It includes debentures, loans, bonds, etc.

The main concern of the finance manager is to decide how much to be raised from the owner’s fund and how much to be raised from borrowed funds. Let’s look at the factors which help us decide.

Factors affecting financing decisions

While taking financing decisions, the finance manager keeps in mind the following factors:

1. Cash

The cost of raising finance from various sources is different and the finance manager always prefers the source with the minimum cost involved.

2. Risk

More risk is associated with the borrowed funds as compared to the owner’s fund security. The finance manager compares the risk with the cost involved and prefers securities with moderate risk factors.

3. Cash Flow Position

A stronger cash flow position may make debt financing more viable than funding through equity because it reflects the repaying capacity of the manager.

4. Floatation Cost

It refers to the cost involved in the issue of securities such as broker’s commission etc. The firm prefers securities that involve less floatation cost.

5. Fixed Operating Cost

If a company is having a high fixed operating cost which includes building rent, salaries, then they must prefer the owner’s fund because due to the high fixed operational cost, the company may not be able to pay interest on debt securities which can cause serious trouble for the company.

6. Control Consideration

If existing shareholders want to retain complete control of business then they prefer borrowed fund securities to raise further funds. On the other hand, if they do not mind losing control then they may go for the owner’s fund security.

7. State of Capital Market

The health of the capital market may also affect the choice of the source of funds. During the period, when the stock market is rising, more people invest in equity. However, a depressed capital market may make an issue of equity shares difficult for any company.

Photo by Brooke Lark on Unsplash

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