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Class 11 Business Studies Chapter 8 Sources of Business Finance
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Sources of Business Finance
VERY SHORT TYPE QUESTIONS ANSWERS (1 MARK EACH)
A. Multiple Choice Question:
1. Equity shareholders are called
(a) Owners of the company.
(b) Partners of the company.
(e) Executive of the company.
(d) Guardian of the company
Ans: (a) Owners of the company.
2. The term irredeemable is used for
(a) Preference shares.
(b) Commercial paper.
(c) Equity shares.
(d) Public deposit.
Ans: (a) Preference shares.
3. Funds required for purchasing current assets is an example of
(a) Fixed capital requirement.
(b) Ploughing back of profits.
(c) Working capital requirement.
(d) Lease financing.
Ans: (c) Working capital requirement.
4. ADRS are issued in
Ans: (d) USA.
5. Public deposits are the deposits that are raised directly from –
(a) The public.
(b) The directors.
(c) The auditors.
(d) The owners.
Ans: (a) The public.
6. Under the lease agreement the lessee gets the right to –
(a) Share profits earned.
(b) Participate in the management of the organisation.
(c) Use the asset for a specificized period.
(d) Sue the assets.
Ans: (c) Use the asset for a specified period.
7. Debenture represent –
(a) Fixed capital of the company.
(b) Permanent capital of the company.
(c) Fluctuating capital of the company.
(d) Loan capital of the company.
Ans: (a) Loan capital of the company.
8. Under the factoring arrangement, the factory
(a) Produces and distributes.
(b) Makes the payment on behalf of the client.
(c) collects the clients’s debt or account receivable.
(d) Transfer the goods, from one place to another.
Ans: (c) Collects the clients debt or account receivables.
9. The maturity period of a commercial paper usually range from –
(a) 20 to 40 days.
(b) 60 to 90 days.
(c) 120 to 365 days.
(d) 90 to 364 days.
Ans: (a) 90 to 364 days.
10. Internal sources of capital are those that are:
(a) Generated through outsiders such as suppliers.
(b) Generated through loans from commercial banks.
(c) Generated through issue of shares.
(d) Generated within the business.
Ans: (d) Generated within the business.
Short Answer Questions
1. What is business finance? Why do businesses need funds? Explain.
Ans: Business finance refers to money and credit employed in business. It involves procurement and utilisation of funds so that business firms may be able to carry out their operations effectively and efficient.
Business needs funds due to the following reasons:
(i) To purchase fixed assets.
(ii) To meet day to day expenses.
(iii) To achieve business growth.
(iv) To adopt modern technology.
(v) To improve existing facilities.
2. List sources of raising long term and short term finance?
Ans: Following are the sources of long term finance:
(c) Public Deposits.
(d) Retained earnings.
(e) Term loans from banks.
(f) Loan from financial institutions.
Following are the short term finance:
(i) Trade credit.
(ii) Bank credit.
-Loans and Advance.
-Discounting of bills.
(iii) Customer’s advances.
(iv) Instalment credit.
(v) Loans from the co-operative.
3. What is the difference between internal and external sources of raising funds? Explain.
Ans: Following are the difference between internal and External sources of raising funds:
(i) Internal sources of funds are generated from within the business. But, external sources of funds are generated from the outside organisation.
(i) Internal source of fund can fulfil, only limited needs of business. But, the external sources of fund can fulfil an unlimited needs of Business.
(iii) Examples of internal sources of fund are accelerating collection of receivables, disposing of surplus inventories and ploughing bank of profit.
But, the examples of external sources of funds are debentures, lenders, banks loans from financial Institutions, public deposits etc.
(iv) Against internal source of funds business is to bear no any fixed rate of interest.
But, against external source of fund business it to bear a fixed rate of interest
4. What preferential rights are enjoyed by preference shareholders.
Ans: Following are the preferential rights enjoyed by preference shareholders:
(i) Receiving dividends at a fixed rate.
(ii) Getting back the capital in case the company is wound-up.
(iii) Investment in these shares are safe.
(iv) A preference shareholders also gets dividend regularly.
5. Name any three special financial institutions and state their objectives.
Ans: Below the name of three special financial institutions are mentioned along with the objectives.
Industrial Finance corporation of India (IFCI):
(a) To provide long and medium term credit to industrial concerns engaged in manufacturing, mining, shipping and electricity generation and distribution.
(b) The period of credit can be as long a 25 years and should not exceed that period.
(c) To grant credit to a single concert up to a maximum amount of rupees one crore.
State Financial corporations (SFC):
(a) To provide financial assistance to small and medium industrial concerns.
(b) Provide long and medium term long repayable ordinarily within a period not exceeding 20 years.
(c) Grant financial assistance to any single industrial concern under corporate or co-operative sector.
Industrial Development Bank of India:
(a) coordination, regulation and supervision of the working of other finance Institutions such as IFCI, ICICI, UTI, LIC, commercial Banks and SFCs.
(b) Supplementing the source of other financial institutions and thereby widening the scope of their assistance.
(c) Planning, promotion and development of key industries, and diversifications of Industrial growth.
6. What is the difference between GDR and ADR? Explain.
Ans: Following are the differences between GDR and ADR:
(i) GDR is Global Depository Receipts and ADR is American Depository Receipts.
(ii) The local currency shares of the company are delivered to the depository bank. The depository Bank issues depository receipts against these shares, such depository receipts denominated in US dollars are known as GDR.
But the depository receipts. issued by company in the U.S are known as American Depository Receipts.
(iii) GDR is an instrument issued abroad by an Indian company to raise funds in some foreign currency and is listed and traded on a foreign stocks exchange.
But, ADR is similar to a GDR except that it can be issued only to American citizens and can be listed and traded on a stock exchange of USA.
Long Answer Questions
1. Explain trade credit and bank credit as sources of short – term finance for business enterprise.
Ans: Trade credit: Trade credit refers credit granted to manufacturers and traders by the suppliers of raw material, finished good,etc. Usually business enterprise buy supplier on a 30 to 90 days credit. This means that the goods are delivered but payments are not made until the expiry of period of credit. This type of credit does not make the funds available in cash but it facilitates purchases within making immediate payment. This is quite a popular source of finance.
Bank credit: Commercial banks grant short-term finance to business firms which is known as bank credit. When bank credit is granted the borrower gets a right to draw the amount of credit at one time or in instalments as and when needed. Bank credit may be granted by way of loans, cash credit, overdraft and discounted bills.
2. Discuss the sources from which a large Industrial enterprise can raise capital for financing modernisation and expansion.
Ans: Generally Medium term finance may be required to modernise machinery and to improve other facilities. So, this medium term finance can be raised from banks and financial institutions and public deposits are the main sources of medium term finance.
Banks loans: Commercial banks give term loans, i.e. for more than one year as modern term loan for modernisation and expansion.
Financial Institutions: IFCI assist in setting up new projects, as well as in modernisation of existing Industrial concerns in medium and large scale sector. It is a main function of IFCI is to grant loans and advances for the establishment, expansion, diversification and modernisation of industries in corporate and cooperative sectors. ICICI also is to provide medium loans in Indian and foreign currency for importing capital equipment and technical services.
3. What advantage does issue of debentures provide over the issue of equity shares?
Ans: Following are the advantages of Issuing debentures over the Issue of equity shares.
(i) Raising funds without allowing control over the company: Debenture, holders have no right either to vote or take part in the management of the company.
(ii) Reliable source of long term finance: Since debenture are ordinarily issued for a fixed period, the company can make in best use of the money. It helps long term planning.
(iii) Tax Benefits: Interest paid on debentures is treated as an expense and is charged to the profits of the company, the company thus saves income tax.
(iv) Investor’s Safety: Debenture are mostly secured. On winding up of the company they are repayable before any payment is made to the shareholders. Interest on debentures is payable irrespective of profit or loss.
4. State the merits and demerits of public deposits and retained earnings as methods of business finance.
Ans: Following are the merits of public deposits:
(i) Simple and Easy: The method of borrowing money through public deposit is very simple. It does not require many legal formalities. It has to be advertised in the newspapers and a receipt is to be issued.
(ii) No charge on assets: Public deposits are not secured. They do not have any charge on the fixed assets of the company.
(iii) Economical: Expenses incurred on borrowing through public deposits is much less than expenses of other sources like shares and debentures.
(iv) Flexibility: Public deposits bring flexibility in the structure of the capital of the company. These can be raised when needed and refunded when not required.
Following are the demerits of public Deposits:
(i) Uncertainty: A concern should be of high repute and have a high credit rating to attract public to deposit their savings. There may be sudden withdrawals of deposits which may create financial problem.
(ii) Insecurity: Public deposits do not have any charge on the assets of the concern. It may not always be safe to deposit savings with companies particularly those which are not very sound.
(iii) Lack of attraction for professional investors: As the rate of return is low and there is no capital appreciation the professional investors do not appreciate this mode of investment.
(iv) Uneconomical: The rate of interest paid on public deposits may be low but then there are other expenses like commission and brokerage which make it uneconomical.
(v) Hindrance to growth of capital market: If more and more money is deposited with the companies in this form there will be less investment in securities. Hence the capital market will not grow. This will deprive both the companies and the investors of the benefits of good securities.
(vi) Over-capitalisation: As it is an easy convenient and cheaper source of raising money, companies may raise more money that is required. In that case, it may not be able to make the best use of the funds of may indulge in speculative activities.
Following are the merits of retained earning:
(i) Cheap source of capital: No expenses are increased when capital is available form this source. There is no obligation on the part of the company either to pay interest or pay back the money. It can safely be used for expansion and modernisation of business.
(ii)Financial Ability: A company which has enough reserves can face ups and downs in business. Such companies can continue with their business even in depression, These building up its good will.
(iii) Benefits to the shareholders: Shareholders may get dividend out of reserves even if the company does not earn enough profit. Due to reserves even if the company does not earn enough profit. Due to reserves, there is capital appreciation i.e the value of shares go up in the share market.
Following are the demerits of retained earning:
(i) Huge profit: This method of financing is possible only when there are huge profits and that too for may years.
(ii) Dissatisfaction among shareholders when funds accumulate in reserve, bonus shares are issued to the shareholder to capitalise such funds. Hence the company has to pay more dividends. By retained earnings the real capital does not increase while the liability increases. In case bonus shares are not issued, it may create situation of under capitalisation because the rate of dividend will be much high as compared to other companies.
(iii) Fear of Monopoly: Through ploughing back of profits, companies increase there financial strength. Companies may throw out their competitors from the market and monopolies their position.
(iv) Mis-management of funds: Capital accumulate through retained earnings encourages management to spend carelessly.
5. Discuss the financial instruments used in international financing.
Ans: Following are the financial Instruments used in international financing:
(i) Global Depository Receipts: The local currency share of a company are delivered to the depository bank. Against these shows the depository receipts are issued by the depository bank. Global
Depository Receipts are such depository receipts denominated in US dollars. GDR is a negotiable instrument and can be traded freely like any other security. In case of India; a GDR is an instrument issued abroad by an Indian Company to raise funds in source foreign currency and is listed and traded on a foreign stock exchange. A holder of GDR can at any time convert it into the member of shares it represents. The holders of GDR do not carry any voting rights out but only dividends and capital appreciation. There are many Indian companies such as Infosys. Reliance, Wipro and ICICI have raised lot of money through issue of GRDs.
(ii) American Depository Receipts (ADR’s): ADR’s are those depository receipts which are issued by Company in the USA. ADR’s are bought and sold in American markets like regular stocks. ADRs are same with GDR. Only difference is that ADRs can be issued only to American citizens and can be listed and traded on a stock exchanges of USA.
(iii) Foreign Currency Convertible Boards (FCCBs): FCCB are such equities which are linked debt securities that are to be converted into equity or depository receipt after a specific period. There is a option for a holder of FCCB of either converting them into equity shares at a predetermined price or exchange late or retaining the bonds. The FCCB are issued in a foreign currency and carry a fixed interest rate which is lower than the rate of other non- convertible debt instrument. It is to be mentioned that FCCB are listed and traded in foreign stock Exchange, FCCBs are almost same with convertible debentures issued in India.
6. What is a commercial paper? What are its advantages limitations and limitations.
Ans: During early nineties in India, commercial papers were used as an important source of short term finance. It is an unsecured promissory note issued by a firm to raise funds for a short period varying form 90 days to 364 days. Commercial paper is issued by one firm to other business firms, insurance companies, pensions funds and banks.
The amount of commercial paper is very large. As a debt commercial paper is completely unsecured. Hence, it can be raised only by the firm, which have adequate credit rating. The commercial paper is regulated by the reserve bank of India.
Advantage of commercial paper:
(i) There is no restrictive condition in case of commercial paper as because it has no secured.
(ii) It is freely transferable instrument and it is highly liquid.
(iii) As compared to other source of fund, commercial paper can provide more founds.
(iv) It can provide a continuous source of funds. Because, their maturity can be tailored to suit the requirements of issuing firm.
(v) The company can earn a satisfactory return on commercial paper by parking their excess fund in commercial paper.
Disadvantages of commercial paper-
(i) The commercials paper can be used to raised only by the financially sound and highly rated firm. It is not possible to use commercial paper by new and moderately rated firms.
(ii) By commercial paper only a limited amount of money can be raised.
(iii) Commercial paper is an impersonal method of financing. It is not possible to redeem the paper owing to financial problem, then the extension of the maturity of commercial paper is not possible.
ADDITIONAL QUESTIONS & ANSWER
A. Say true or False:
1. Purchase of fixed assets is a day to day expense.
2. Business finance means money and credit employed in business firms.
3. Business finance deals only with investment of money
4. Business finance is concerned with estimation of funds, raising of funds from different sources and their investment indifferent types of activities.
5. Without adequate finance, business may run into difficulties.
B. Fill in the blanks.
1. Generally there are ________ types of business finance.
2. Long term finance is required to be invested for a period of above ________ years.
3. Public deposit is a source of ________ .
Ans: Medium term finance.
4. Short term financial requirements are also known as ________ capital requirement.
5. Long term finance is required for the purchase of ________ assets.
6. Short term finance is essential for ________ day to day expenditure.
7. Overdraft limit is granted on the basis of ________ of customer.
Ans: Credit worthiness.
8. Banks ask for ________ security while granting cash credit.
9. While making payment on discounted fill, banks deduct ________ which is equal to the amount of interest for the period of bill.
10. When suppliers extend credit to the buyers it is called –
Ans: Trade credit.
Short type Question Answer
1. Mention four characteristics of business finance
Ans: (i) Business finance includes all types of funds used in business.
(ii) Business finance is needed in all types of Organisations large or small, manufacturing or trading.
(iii) The amount of business finance differs from our business firm to another depending upon its nature and size. It also varies from time to time.
(iv) Business finance involves estimation of funds. It is concerned with raising funds from different sources as well as investment of funds for different purpose.
2. Mention the three types of finance.
Ans: (i) Long term finance.
(ii) Medium term finance.
(iii) Short term finance.
3. Write the five purposes of short term finance.
Ans: (i) It facilitates the smooth running of business operations by meeting day to day requirements.
(ii) It enables firms to hold stock of raw materials and finished product.
(iii) With the availability of short terms finance goods can be sold on credit.
(iv) Short terms finance becomes more essential when it is necessary to increase the volume of production at a short notice.
(v) Short terms funds are also required to allow flow of cash during the operating cycle.
4. Mention three difference between preference shares and equity shares.
Ans: Following are the difference between preference shares and equity shares:
(i) Choice: Preference shares and not compulsory to issues. But, it is compulsory to issue the equity shares.
(ii) Payment of dividend: Dividend paid on preference shares in preference to the equity shares. But, dividend is paid on there shares only after paying dividend on preference shares.
(iii) Return of capital: In case of winding up of a company the capital as refunded in preference over the equity shares.
But capital on the equity shares in refund in case of winding up of the company after refund of preference share capital.
5. Mention five difference between shares and debentures.
Ans: Following are the difference between shares and debentures:
(i) Status: Share holders are the owners of the company. But the debentures holders are the creditors of the company.
(ii) Nature of return on investment: Shareholders get dividends. But, interest is paid on debenture at a fixed rates.
(iii) Rights: Shareholders are the real owners of the company. But, debenture holders do not have the right to attend meetings of the company.
(iv) Security: No security is required to issue shares. Generally debentures are secured.
(v) Orders of repayment: Shareholders take the maximum risk because their capital will be paid back only after repaying the loan of debenture holders.
But, debenture holders have the priority of repayment over shareholders.
6. Discuss the merits and demerits of long term borrowings from commercial banks
(i) It is a flexible source of finance as loans can be repaid when the need is met.
(ii) Finance is available for a definite period hence it is not a permanent burden.
(iii) Banks keep the finance operations of their clients secret.
(iv) Less time and cost is involved as compared to issue of shares debentures etc.
(v) Banks do not interfere in the internal affairs of the borrowing concern, hence the management, retains the control of the company.
(i) Banks require personal guarantee or pledge of assets and business cannot raise further loans on these assets.
(ii) In case the short term loans are attended again and again, there is always uncertainty about its continuity.
(iii) Too many formalities are to be fulfilled for getting them loans from banks. There formalities make the borrowing from banks time consuming and inconvenient.
7. Discuss the importance of specialised financial institutions
Ans: Following are the importance of SEls:
(i) They constitute an important source of long term finance to industry. Over a period of time, there has been a steady growth in the number of industrial units assisted and in the amount of loan sanctioned and distributed by SFI’s.
(ii) SFI’s have played an important role in the development of
(a) Small scale industry. and
(b) Project in backward areas.
(iii) They have helped new and small entrepreneurs in setting up industry.
(iv) Through their operations involving under writing of and direct subscription to the issue of shares and debentures, they have been important player in the capital market. These operations have a favourable impact on the ability of industrial concerns to raise funds from capital market.
(v) These Institutions have improved the allocation of fund to industry and these have aided in better use of the available resources for the economic development of the country.
8. Note the role of IDBI for the development of the industry?
Ans: The role played by the IDBI are:
(i) To coordinate the activities of other institution Providing term finance to industry.
(ii) To Provide refinance to financial institutions granting medium and long term loans to industry.
(iii) To provide refinance for expert credits granted by banks and financial institutions.
(iv) To provide technical and administrative assistance for promotion, management and growth of industry.
(v) To undertake market surveys and techno economic studies for the development of industry.
9. What is equity Share? Write the differences between equity share and preference share.
Ans: Equity shares represent the ownership of a company and thus the capital raised by issue of such shares is known as ownership Capital of owner’s fund. Equity share capital is a Prerequisite to the creation of a
company. equity share holders do not get a fixed dividend but are paid on the basis of earnings by the company.
10. Define Retained Earnings?
Ans: Retained earnings denote the profit not distributed among the shareholders. The practice of retained earnings as a method of ‘self financing or internal financing is commonly used by the established companies. It is also known as “ploughing back of profits.
11. Write of “NABARD” full from?
Ans: National Bank for Agriculture and Rural Development (NABARD).
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