Financing decisions aid in the efficient use of available resources to achieve the company’s goals. Financing decisions are crucial in deciding when, and where the funds can be raised, and how a business acquires funds.
Funds can be raised from the company’s own money like share capital, and accumulated earnings. Funds can be raised by borrowing from the corporation in the form of long-term loans, bonds, debentures, and public deposits.
7 Factors Affecting Financing Decisions
Before making into financing decision, one should keep in mind the following factors that affect it:
1. State of Capital Market:
One of the most critical factors that affect financing decisions is the state of the Capital market. The condition of the capital market and stock market further aids in making the source of funds.
If the stock market is rising, then it is effortless to raise funds for the share since many companies are interested in investing in equity shares. In case of a declining market, companies may face problems in issuing equity shares.
2. Cash Flow Position:
Cash flow in simple terms means, the daily wages or earnings of any institute. Companies with good cash flow can easily afford borrowed fund securities, whereas when there is a shortage in cash flow then, they must depend on the owner’s fund securities.
Smooth and steady cash flow with consistency can help in bringing many investors to invest funds in the companies. Both increase and decrease cash flow will influence investors to invest in a company.
Check out our article by comparing Cash Flow and Fund Flow.
3. Risk:
One of the most important segments of funding decisions is risk assessment. The risk is associated with various factors. The risk related to borrowed funds is higher than the equity funds.
More risk is associated with the outside funds rather than the owner’s fund securities. The finance manager analyses the risk against the cost and approves securities with a low-risk factor. The risk associated with borrowed funds is higher than that associated with equity funds.
4. Control Considerations:
Here, the existing investors who hold control over the business, raise finance through borrowing money. Equity can be employed for raising funds when they are ready to dilute control of the business. Equity issues may end up in a dilution of the administration’s influence over the company.
5. Level of Fixed Operating Costs:
If a company’s fixed operating costs are preferred with a higher level of operating cost, it is a good sign for building rent, insurance premiums, salaries, etc. Thus, debt financing with a lower rate of interest is preferable. If the fixed operational costs are moderate or low, then greater the borrowed financing may be selected.
6. Floatation Cost:
Floatation cost means the charges associated with the issue of securities like broker commissions, underwriters’ fees, prospectus fees, broken range stamp duty, etc. In the case of equity, the floatation cost is less. Whereas, in the case of debt the floatation cost is high. The firm favors securities with the least floatation cost.
7. Cost:
In the Financing decision, the cost has its impacts from various sources. Finance managers always go for the source with minimum cost. The cost of raising finance from various sources is not peculiarly the same, they are different.
Financing decisions are developed based on appropriate funds and cost-cutting. Though the cost from different sources differs a lot, the most cost-efficient source should be preferred.
Bottomline:
Thus, these are the important factors that affect financing decisions. One can be more concerned about how, when, and where the funds will be obtained to satisfy the investment requirements.
The condition of the market plays a vital role in financing decisions. If more loan money is used, then the shareholder’s risk is low. So, the deal between returned risks is critical in financing decisions.