Why is a mix of different financing sources often recommended for businesses?

A mix of different financing sources is often recommended for businesses to spread risk, increase flexibility, and optimise cost of capital.

Diversifying financing sources is a strategic move that can help businesses manage financial risk. By not relying on a single source of funding, businesses can protect themselves from potential issues such as sudden changes in interest rates, stringent loan conditions, or unexpected withdrawal of funds. For instance, if a business relies solely on bank loans for financing and the bank suddenly increases the interest rate, the business could face financial strain. However, if the business also has equity financing or retained earnings, it can weather such changes more easily.

Moreover, having a mix of different financing sources increases a business's financial flexibility. Different sources of finance come with different terms and conditions. Some may offer large amounts of money but require collateral, while others may offer smaller amounts but with more flexible repayment terms. By having a mix of different sources, a business can choose the most suitable option for each situation. For example, it might use a bank loan to finance a long-term project, while using trade credit for short-term operational needs.

Lastly, a mix of different financing sources can help a business optimise its cost of capital. The cost of capital is the cost a business incurs to finance its operations, and it varies depending on the source of finance. For example, equity financing might be more expensive than debt financing because shareholders expect a higher return on their investment. By carefully balancing different sources of finance, a business can minimise its cost of capital and maximise its profitability.

In conclusion, a mix of different financing sources can provide businesses with a range of benefits, from risk management to financial flexibility and cost optimisation. Therefore, it is often recommended as a sound financial strategy.