Choosing the Best Type of Finance

Exam code: 7115

Written by: Ashika|Reviewed by: Caroline Carroll|Updated 2 July 2026

There are many factors that managers must consider before deciding upon the type and source of finance required
- They may need to use more than one source of finance at the same time

Factor	Explanation
What is the purpose of obtaining finance?	Fixed assets are most likely to need a long-term source of finance, such as a bank loan Day-to-day costs such as rent and wages could be covered by a short-term overdraft
How long is the finance required for and when can it be paid back?	Overdrafts are a short term option to help a firm who needs a smaller amount of finance urgently Mortgages can be paid back over many years
How much finance is needed?	Large amounts of capital can be raised through the issue of shares to family and friends, or through a flotation on a stock exchange Smaller sums may be accessed through business credit cards or overdrafts
What is the legal structure of the business?	Businesses which are already Public Limited Companies can issue shares or debentures Sole traders often rely on owners' capital
How much risk is involved?	Businesses with existing loans may have high gearing and pay high rates of interest as they are seen as risky Leasing involves little risk as assets can be returned if finance costs are not paid
How much control and ownership does the company want to keep?	If limited companies issue too many shares, the current owners may lose some control of the business Borrowing retains control, though interest is payable

This risk of not being able to raise the finance can be reduced in several ways
Bank loans will most likely be approved when
- A business presents a convincing business plan including a cash-flow statement, and income statement for the last time period
- Existing sources of external finance are minimal and being managed effectively
- A business has collateral to reduce risk to the bank
Investment from shareholders will most likely happen when
- The share price is improving
- Dividends are generous
- The company has good profit potential and is planning to grow
- Alternative investments are less attractive

Finance managers frequently have to make recommendations to their CEOs about the most suitable form of financing to use
- The most suitable form is determined by conducting an analysis using the questions in the table above

A bank loan could be easy to obtain due to business success over the last 15 years. Repayments are spread over several years and interest must be paid
The business could issue new shares to existing shareholders, which may increase their investment due to business success as family and friends may want to be part of its exciting growth plans
The decision will depend upon how much control and ownership the business owner may lose by issuing more shares
Most finance managers would recommend obtaining a bank loan, as this is often preferable to losing ownership and a share of future profits

An overdraft is a short-term source of finance and Toby will have to pay interest on the amount that he uses
Trade credit would ease financial pressure as stock is replenished and he may receive a discount when he sets up the agreement
Most finance managers would recommend to Toby that he first seek trade credit. If he is unable to secure that, then he should consider using his overdraft facility

Factors to consider when choosing a source of finance