Factors that Contribute to a Firm's Financing Choice

The financial decisions of any type of an organisation can be divided into two categories. The first of these is concerned with spending – what spending decisions should be made in order to suffice a particular organisation’s future goals, which might be expressed in terms of profits, success in competition, new product development, growth and so forth. However, in order to realise these visions, each company necessarily needs to make decisions falling into the second category which is concerned with raising money for its spending. Spending financing represents an important issue in each company’s existence as the decisions within this category can have a wide variety of influences on the present and future of each organisation. A company’s financing decisions may be further subdivided into two categories: finance from internal capital (capital raised from the company’s earnings), and finance from external capital which is obtained from external investors in a wide variety of ways. Since it is often not feasible for companies to finance their activities purely from internal sources as these do not allow the transfer of finance over time, they often choose external public for its higher flexibility in terms of obtaining financial resources at different times and for various purposes. This essay will mainly concentrate on determining the factors which influence a company’s decisions of raising funds for financing its further activities – obtaining external sources of capital.

External capital can be obtained in to major ways of issuing securities: the first of these is debt financing built on the basis of obtaining loans, leases, or issuing commercial paper, corporate bonds et cetera. This type of financing is tax-deductible. The second is equity financing through common stock, preferred stock or warrants. Equity financing is non-tax deductible and junior to debt financing – money can only be transferred to investors after debt payments have been made. Large equity holders have the possibility to influence the company as they have the rights to become members of the board of directors which oversees the decision making process of the company and often appoints senior managers. Thus, as opposed to debt holders, equity holders can be seen as the formal owners of the company. Of course, the instruments of both debt and equity financing are not limited to the above mentioned ones – new instruments falling into either category are constantly developed through the mutual agreement of investors and companies. Further, companies may decide on the type of trade with securities they issue – this trade can be private or public.