Question

Describe three sources of finance and outline their advantages and disadvantages (150 to 180 words).

Answer 1

The three sources of finance from a business point of view are

a) Finance from selling of assets

b) Finance from ownership or equity

c) Finance from external sources(debt)

a) Finance from selling of assets

Finance from selling of assets is one of the least advised yet commonly followed techniques by a business. When some assets are redundant and reached a scrap, these assets are sold in exchange for cash or stock. Sometimes a business raises finance while restructuring through selling of assets when excess assets are sold to either repay debt or invest for future purposes. The advantage of such a process is less time taking when considering other sources of finance like debt or equity. The disadvantage is the assets could have been used for business operations is now used for financing doesn't augur well for business

b) Finance from Equity

Ownership stake in the business is done through infusion of capital. This is one of the major components of financing for a business. The advantage of such a financing is that it stays within the firm and reinvested as internal accruals once the firm makes profit. The disadvantage is that the owners have risk of losing control in subsequent financing through equity as their equity could be diluted. The cost of issuing and raising equity is also high from a firm's point of view.

c) Finance from Debt

Another major source of financing for a firm is raising capital externally through debt. The advantage is lower cost of debt and the tax advantages that debt provides over equity. The disadvantage is excess financial leverage could cause distress and hence a higher risk for the firm in bad times.