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A business entity may use one or a combination of several sources of finance. Such a composition may be referred to as a capital structure and may be determined by the following factors;
1. Matching fluctuating finance needs with short term sources e.g. a business may have a busy season before Christmas and since the need is only for this period its better to use short term finance
2. Degree of risk - any business will go for the least risky source of finance e.g. use equity finance instead of debt finance.
3. Future flexibility - a business entity is expected to maintain a balanced mixture of debt and equity securities. Excessive debt reduces a business ability to borrow and hence reduces flexibility.
4. Availability of funds in the market - at times money may be plentiful while in other times it may be scarce and this affects the ability of a business to debt and equity securities.
5. General level of business activity - if the overall level of business activity is rising, most businesses need money to expand their operations.
6. Cost of finance - any finance to be raised by a business entity should be at a cost lower than the expected return from the project where such finance is invested.
Lellah answered the question on November 8, 2021 at 07:34
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