Question

Justify the following statement: The firm has multiple choices of sources of financing.

Hint:

Think of financing like a buffet. A company can pick and choose different items (shares, debentures, loans) based on its appetite (capital needs), taste (risk preference), and budget (cost of capital).

Answer 1

The statement is correct. A business firm requires capital for its establishment, operations, and expansion, and it can choose from a wide variety of sources to raise the necessary funds. The choice depends on factors like the purpose, time period, and cost. These multiple sources can be classified as follows:

Based on Ownership:

Owned Capital: This is the capital provided by the owners of the company and forms the core financial base. It includes issuing shares (Equity and Preference) and reinvesting profits (Retained Earnings). This capital stays with the company permanently.
Borrowed Capital: This refers to funds raised from creditors. It is a form of debt that must be repaid after a specified period, with regular interest payments. Sources include debentures, term loans from banks, public deposits, and bonds.

Based on Tenure:

Long-term Sources: When funds are needed for more than five years, typically for purchasing fixed assets, a firm can issue shares and debentures or take long-term loans.
Medium-term Sources: For a period of one to five years, a firm can opt for medium-term bank loans or public deposits.
Short-term Sources: For working capital needs (less than one year), a firm can use sources like trade credit, bank overdrafts, and commercial papers.

Based on Source of Generation:

Internal Sources: Funds generated from within the business operations, with retained earnings being the primary example.
External Sources: Funds raised from individuals or institutions outside the business, such as issuing securities, taking bank loans, or accepting public deposits.

Thus, a financial manager can evaluate these various options and create an optimal mix of different sources to fund the firm's requirements, proving that a firm has multiple choices of financing.