Question 1

Isn't the cheapest source of finance always the best one to choose?

Accepted Answer

Not necessarily. While cost (interest rate) is a major factor, it's not the only one. A cheaper loan might require collateral the business doesn't have, or have very strict repayment terms that reduce flexibility. Equity finance might seem expensive due to dilution, but it carries less risk as there are no compulsory repayments. The 'best' choice balances cost, risk, control, and flexibility in the context of the business's specific situation.

Question 2

Can't any business just issue shares to raise money?

Accepted Answer

No, this is a common misconception. Only incorporated businesses (private limited companies, Ltd, and public limited companies, PLC) can issue shares. Sole traders and partnerships cannot. Furthermore, for a private limited company, shares can only be sold to private investors with the agreement of all existing shareholders, which can be a slow and difficult process. Only PLCs can sell shares to the general public on a stock exchange.

Question 3

Is retained profit a 'free' source of finance?

Accepted Answer

No, it is not 'free'. While it doesn't have a direct interest cost like a loan, it has a significant opportunity cost. The retained profit legally belongs to the shareholders, and by reinvesting it, the business is denying them a dividend payment. If shareholders believe they could earn a better return by investing that money elsewhere, they may become dissatisfied and sell their shares, potentially lowering the company's share price.

Selecting the source of finance

What you need to know

Selecting the source of finance