NCERT Solutions for Class 11 Business Studies Chapter 8 - Sources of Business Finance
Short Answer Questions:
1. What is business finance? Why do businesses need funds? Explain.
Ans. Business finance refers to capital funds and credit funds invested in the business.
Businesses need funds due to many reasons:
- A business needs buildings, machinery, furniture etc., to set up operations, and funds are necessary for purchasing all the fixed assets which is called fixed capital requirement.
- Running day-to-day operations such as purchasing raw materials requires regular money, also called working capital requirements.
2. List sources of raising long-term and short-term finance.
Ans. Source of Long-term finance are:
(b) Preference Shares
(c) Loans from banks
(d) Equity Shares
(e) Retained Earnings
Source of Short-term finance are:
(a) Trade credit
(b) Commercial papers
(c) Short-term loans from banks
3. What is the difference between the internal and external sources of raising funds? Explain.
|Basis of Comparison||Internal Source||External Source|
|Source||Funds are generated from within the business||Funds are generated from outside sources|
|Need Fulfillment||The internal source of funds can fulfill only limited needs of the business||Large amount of money can be raised through external sources|
|Security||Business is not required to provide security||Security required in the form of mortgaging assets|
4. What preferential rights are enjoyed by preference shareholders? Explain.
Ans. Rights enjoyed by preference shareholders are as follows:
- At the time of declaration of dividend, preference shareholders receive a fixed rate of dividend prior to the equity shareholders from profits.
- In case of dissolution, the preference share capital will be refunded before the equity share capital.
- In case of winding up, the preference shareholders receive capital after settling all the claims of the creditors.
5. Name any three special financial institutions and state their objectives.
- IFCI refers to as Industrial Finance Corporation of India. It was incorporated in 1948 under the Industrial Finance Corporation Act 1948. Its main aim is to encourage industrialists to explore rising sectors and assist in balanced regional development. Also, contributes to the development of education.
- LIC refers to the Life Insurance Corporation of India. It was established in 1956 under the LIC Act, 1956, making all existing insurance companies nationalised. The main aim is to promote savings as a premium and invest it in the form of loans to manufacturing units.
- UTI refers to as Unit Trust of India. It w
as incorporated in 1964 under the Unit Trust of India Act, 1963. The main aim is setting up the UTIs, mobilizing savings, and making funds available for investment in lucrative ventures.
6. What is the difference between GDR and ADR? Explain.
Ans. GDR: It stands for Global Depository Receipts. It is a type of bank certificate that acts as shares in foreign companies. It is a mechanism by which a company can raise equity from the international market. These can be traded on all stock exchanges over the world. They are denoted in US dollars. So, it can be easily converted into shares at any time.
ADR: It stands for American Depository Receipts: US-based companies issue these kinds of receipts. These are only traded in the US Securities market and are only sold to US citizens only.
Long Answer Questions:
1. Explain trade credit and bank credit as sources of short-term finance for business enterprises.
Ans. Trade credit refers to the credit extended by a supplier to a business enterprise, allowing the business to purchase goods or services on credit and defer payment for a certain period of time, typically ranging from 30 to 90 days. The terms of trade credit are usually negotiated between the supplier and the buyer, and may involve discount for early payment of penalties for late payment. Trade credit is an important source of short-term finance for many business, particularly small and medium-sized enterprises (SMEs), as it allows them to manage cash flow and maintain inventory levels without having to use their own funds or seek external financing.
Bank credit, on the other hand, refers to the credit extended by a financial institution, such as a bank or a credit union, to a business enterprise in the form of a loan or a line of credit. Bank credit may be secured or unsecured, and may be offered at a fixed or variable interest rate, depending on the creditworthiness of the borrower and the terms of the loan. Bank credit is a common source of short-term finance for businesses, particularly those that require large amounts of capital for investment or expansion, as it allows them to access funds quickly and at a relatively low cost.
2. Discuss the sources from which a large industrial enterprise can raise capital for financing modernisation and expansion.
Ans. Following sources of capital are suitable for raising capital for expansion:
- Equity Shares: These shares are part of the owner's funds. The persons having such shares are called shareholders and enjoy voting rights and participate in decision-making. Therefore, they also bear a higher risk for getting high returns.
- Preference Shares: These type of shareholders have a preferential right over equity shareholders at the time of winding up and at dividend declaration.
- Loans: A firm can get funds in the form of loans from commercial banks and financial institutions for a certain period of time and at a fixed rate of interest.
- Retained earnings: Company retains a part of the profit instead of giving as a dividend for future use.
- Debentures: Company can raise funds through the issue of debentures. These are called as borrowed funds, as one has to pay a fixed interest even at the time of loss. It is a source of long-term capital.
3. What advantages does the issue of debentures provide over the issue of equity shares?
- It is preferred by those investors who want fixed income at lesser risk.
- Debentures are fixed charge funds and do not participate in profits of the company.
- As debentures do not carry voting rights, financing through debentures does not dilute control of equity shareholders on management.
- The issue of debentures is suitable in the situation when the sales and earning are relatively stable.
- Financing through debt is less costly as compared to cost of reference of equity capital as the interest payment on debentures is tax deductible.
4. State the merits and demerits of public deposits and retained earnings as methods of business finance.
Ans. Public deposits are raised by firms directly from the public and which aids them in financing medium-term sources. These deposits offer a higher return as compared to bank deposits.
- Raising funds from the public is very easy as it does not involve any formalities.
- This method is less expensive as compared to getting loans from commercial banks.
- Ownership of the company is not diluted, as the public does not get the right to control.
- New companies find it difficult to obtain funds through public deposits due to trust issues.
- The amount of funds raised from the public is limited as it is based on willingness and availability of funds.
- Raising funds from public deposits is not a good option if a firm needs huge capital.
Retained Earnings: Businesses keep a part of the profit for future use instead of distributing the dividends to the equity shareholders. This is called as retained earnings.
- As retained earnings rise, the price of equity shares also rises.
- Funds are raised from internal sources and thus do not involve cost.
- These are surplus profits which reduce the chances of an unforeseen loss.
- Sometimes, funds are misused as business do not cash in on the opportunity at the appropriate time.
- Company profits keeps on fluctuating, so retained earnings are not certain.
- Investing huge profits into business can make equity shareholders disappointed.
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