Financial decisions: raising finance
In the previous section, we discussed the scope and control of financial management in business, as well as the objectives and operational functions of financial management. Now, let’s delve deeper into one of the key operational functions – raising finance.
Raising finance is a critical aspect of financial management as it involves obtaining the necessary funds to support the business operations and achieve its objectives. There are various sources of finance available to businesses, and the choice of the appropriate source depends on factors such as the nature of the business, its size, and its financial requirements.
Sources of finance
Businesses can raise finance from both internal and external sources. Internal sources include retained profits, which are the profits generated by the business that are reinvested back into the company. Retained profits are an attractive source of finance as they do not involve any interest or repayment obligations.
External sources of finance, on the other hand, involve obtaining funds from outside the business. Some common external sources of finance include:
- Debt financing: This involves borrowing funds from external parties such as banks, financial institutions, or private lenders. Debt financing can be in the form of bank loans, overdraft facilities, or issuing corporate bonds. It is important to carefully consider the terms and conditions of the debt, including interest rates, repayment period, and any collateral requirements.
- Equity financing: Equity financing involves raising funds by selling a portion of the ownership of the business to external investors. This can be done through issuing shares or seeking investment from venture capitalists or angel investors. Equity financing provides the advantage of not having to repay the funds, but it involves diluting the ownership and control of the business.
- Government grants and subsidies: In some cases, businesses may be eligible for government grants or subsidies to support their operations or specific projects. These grants and subsidies can provide a significant boost to the business’s financial resources and help in achieving its objectives.
- Trade credit: Trade credit refers to the credit extended by suppliers to businesses for the purchase of goods or services. This can be an important source of short-term finance, allowing businesses to manage their cash flow effectively.
Factors to consider
When making financial decisions regarding raising finance, it is important for businesses to consider various factors:
- Cost of finance: Different sources of finance come with different costs, such as interest rates, fees, or equity dilution. Businesses need to carefully evaluate the cost implications of each source and choose the one that offers the most favourable terms.
- Risk profile: Each source of finance carries its own level of risk. Debt financing, for example, involves the risk of default and potential loss of collateral. Equity financing, on the other hand, involves the risk of dilution of ownership and control. Businesses need to assess their risk tolerance and choose the appropriate source accordingly.
- Flexibility: Some sources of finance may offer more flexibility in terms of repayment schedules or the ability to access additional funds in the future. Businesses need to consider their future financial needs and choose a source that aligns with their long-term goals.
Conclusion
Raising finance is a crucial aspect of financial management that requires careful consideration of various factors. Businesses need to assess their financial requirements, evaluate the available sources of finance, and choose the most suitable option based on factors such as cost, risk, and flexibility. By making informed financial decisions, businesses can ensure they have the necessary funds to support their operations and achieve their objectives.
In the next section, we will explore another operational function of financial management – profit distribution decisions.