Primary Sources Of Finance Essay

2.9 Factors influencing the choice of financing

The choice between using debt and using equity might differ from one organization to another based on each company’s particular situations. Thus firms can choose different sources of funds. According to Mazhar and Nasr (2010) there are three primary sources of finance for businesses:

• Surplus cash from operating activities ( retained earnings);

• Funding from new equity

• Borrowed funds from the bank or non-bank sources (debt).

There are a number of factors that influence companies’ choice of appropriate finance. Some firms are not able to receive bank loans and some have enough retained earnings to finance their investments without acquiring any bank loans (Kamsvag 2001), and some does not want to engage in any form of debt by principle ( Anderson and Williamsson 2001). Petersen and Rajan (1994) debated that there are more suitable and relevant measures one can use when assessing the capital structure of a firm than those presented by Modigliani and Miller (1958). He argues that business size, age and the firm’s cash flow are the important factor to consider when analysing the capital structure of a firm. Thus

Thus optimal capital structure for a company is one that offers a balance between the ideal debt-to-equity ranges and minimizes the firm's cost of capital. It is very crucial to note that a non-optimal capital structure can lead to higher project financing that would have improved shareholders’ value with an optimal financing by the company. The effect of differing business risk and different capital structure are mirrored in a company’s statement of comprehensive income. According to Akintoye (2007) operating leverage tends to increase the effect of variability in sales and produce a percentage change in operating income i.e. earnings before interest and tax greater than the changes in