Factors Affecting Financing Decision
Financing decision is concerned with the decisions about how much funds are to be raised from which long-term source, i.e. by means of shareholders’ funds or borrowed funds. Factors influencing financial decisions are discussed in two different ways. These are: Internal Factor and External Factor. Internal Factors are: Nature of business, Size of business, Structure of business, Structure of assets etc. External Factors are: Economical conditions, Tax policy, Government control, Capital structure and financial market etc.
Some of the important factors are as follows:
(a) Cost: the costs of raising funds through different sources are different. A prudent financial manager would normally opt for a source which is the cheapest.
(b) Risk: The risk associated with different sources is different.
(c) Floatation Costs: Higher the floatation cost, less attractive the source.
(d) Cash Flow Position of the Business: A stronger cash flow position may make debt financing more viable than funding through equity.
(e) Level of Fixed Operating Costs: If a business has high level of fixed operating costs (e.g., building rent, Insurance premium, Salaries etc.). It must opt for lower fixed financing costs. Hence, lower debt financing is better. Similarly, if fixed operating cost is less, more of debt financing may be preferred.
(f) Control Considerations: Issues of more equity may lead to dilution of management’s control over the business. Debt financing has no such implication. Companies afraid of a takeover bid may consequently prefer debt to equity.
(g) Tax Rate: Since interest is a deductible expense, cost of debt is affected by tax rate. If the tax rate is higher, debt, financing becomes more attractive.