NIOS Class 12 Business Studies Chapter 15 Financing of Business

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NIOS Class 12 Business Studies Chapter 15 Financing of Business

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Also, you can read the NIOS book online in these sections Solutions by Expert Teachers as per National Institute of Open Schooling (NIOS) Book guidelines. These solutions are part of NIOS All Subject Solutions. Here we have given NIOS Class 12 Business Studies Chapter 15 Financing of Business, NIOS Senior Secondary Course Data Business Studies for All Chapter, You can practice these here.

Financing of Business

Chapter: 15

Module – 6 : BUSINESS FINANCE

INTEXT QUESTIONS 15.1

Q. 1. List the various needs of the business for which funds are required.

Ans: (a) To purchase fixed assets.

(b) To meet day-to-day expenses.

(c) To fund business growth.

(d) To bridge time gap between production and sales.

(e) To meet contingencies. 

(f) To avail of business opportunities.

Q. 2. Give examples of specific expenditures for which funds will be required for the following terms/time periods:

(a) Short-term. 

Ans: (i) Purchase of raw material.

(ii) Payment of electricity bill.

(b) Medium-term.

Ans: (i) Modernisation and renovation.

(ii) Special promotional programmes.

(c) Long-term.

Ans: (i) Purchase of land and building.

(ii) Purchase of furniture. 

INTEXT QUESTIONS 15.2

Q. 1. Give specific examples of the following kinds of assets that may be given as security for obtaining bank credit:

(a) Document of title to goods.

(b) Moveable goods.

(c) Jewellery or precious metals. 

Ans: (a) Bill of Lading, Railway Receipts, Warehouse Warrant etc.

(b) Stock of raw material like leather, chemicals etc. or finished goods like industrial machinery, leather shoes etc.

(c) Gold Bangles, Diamond Necklace, Silver ware.

Q. 2. Which type of bank credit is being referred to here?

(a) Accountholder is allowed to withdraw an amount in excess of the balance in his current account in the bank.

Ans: Bank Overdraft.

(b) The bank advances money against a document, after deducting some discount. 

Ans: Discounting of Bill.

(c) Interest is charged on the amount actually withdrawn, and not on the entire amount sanctioned.

Ans: Cash Credit.

(d) The amount is credited to a separate account by the bank and interest is paid by the borrower on the whole of this amount, irrespective of the amount actually drawn.

Ans: Loans and Advances.

Q.3. Multiple choice Questions.

(i) Name the deposit arranged by one company with another company for a short term:

(a) Fixed deposit.

(b) Inter corporate deposits.

(e) Owned deposit.

(d) Borrowed deposits.

Ans: (b) Inter corporate deposits

INTEXT QUESTIONS 15.3

Q. 1. Complete the following chart that compares equity shares and preference shares:

Ans: 

Q. 2. Some of the features of the different methods of raising long-term capital are given below. Identify the features that relate to equity shares, preference shares and debentures.

(i) In case of winding up of the company, the capital is refunded after payment of debentures but before payment to equity shareholders. 

Ans: Preference shares.

(ii) Their holders are creditors of the company for a fixed period.

Ans: Debentures.

(iii) Their holders are the owners of the company and enjoy voting rights.

Ans: Equity Shares.

(iv) They bear high degree of risk-in case of losses they do not get dividend and in case of winding up of the company, they are the last to get refund of their invested money.

Ans: Equity Shares.

(v) Their holders have no say in the management of the company and they do not have the right to attend the company’s meetings.

Ans: Debentures.

Q. 3. Mention the difference between shares and Debentures, on the basis of the criteria listed below:

Ans: 

Q. 4. Multiple Choice Questions:

(i) Name the types of manufacturing industry in which Rs 50 lakhs have been invested: 

(a) Micro Enterprise. 

(b) Small Enterprise.

(c) Tiny Units.

(d) None of the above.

Ans: (b) Small Enterprise.

(ii) Identify the service industry which have investment of Rs 20 lakh.

(a) Micro Enterprise. 

(b) Small Enterprise. 

(c) Tiny Units.

(d) None of the above.

Ans: (b) Small Enterprise.

(iii) A service enterprise with an investment of Rs 3 crore is called a:

(a) Micro Enterprise.

(b) Small Enterprise.

(c) Medium Enterprise.

(d) None of the above.

Ans. (c) Medium Enterprise.

INTEXT QUESTIONS 15.4

Q. 1. Give the full form of the following abbreviations:

(a) IFCI

Ans: Industrial Finance Corporation of India.

(b) SFC

Ans: State Financial Corporation Financing.

(c) SIDC

Ans: State Industrial Development Corporation.

(d) GDR

Ans: Global Depository Receipt.

(e) FDI

Ans: Foreign Direct Investment.

(f) ADR

Ans: American Depository Receipt.

Q. 2. Which method of long-term financing, Public Deposit or Retention of Profits, are being referred to, in each of the following statements:

(a) Management is less careful about funds utilization by this method.

Ans: Retained Earnings.

(b) To raise funds through this method, an advertisement is generally given through the newspapers.

Ans: Public Deposit.

(c) They offers flexibility and the funds can be refunded when not required.

Ans: Public Deposit.

(d) They offer benefit to shareholders as company may draw upon them to pay dividend to them.

Ans: Retained Earnings.

(e) No obligation on the company to pay interest on it or repay the money.

Ans: Retained Earnings.

Q. 3. (a) How are funds raised through lease financing? Explain briefly, in your own words.

Ans: Leasing is an arrangement that enables a business enterprise to use and exercise complete control over the assets without owning it. The owner gets rent in return and at any time as per the terms of the contract he can cancel the agreement. This system helps the business to use the plants and machinery and other fixed assets for a long period of time without investing a large amount of money in purchasing them. At the end of the lease period the asset goes back to the owner. The owner of the assets also has the option of selling it to the user at a reduced price. Sometimes the user company may request the leasing company to purchase its existing assets and allow them to use the same assets on lease basis. This enables the company to save the long-term funds that can be utilised for other purposes. This is known as ‘sale and lease back’ system.

(b) List any two limitations of long-term borrowings from Commercial Banks.

Ans: Following are the limitations of long term borrowing from commercial banks:

1. Banks require personal guarantee or pledge of assets while granting loans. So the business cannot raise further loans on these assets. Thus, it reduces the borrowing capacity of the borrowers.

2. In case the short-term loans are extended again and again, there is always uncertainty about their continuity.

3. Too many formalities are to be fulfilled for getting term loans from banks. These formalities make the borrowings from banks time consuming and inconvenient.

TERMINAL EXERCISE

Very Short Answer Type Questions:

Q. 1. What is meant by ‘Discounting of Bill’? 

Ans: When a bill of exchange is presented before the bank for encashment, bank credits the amount to customer’s account after deducting some discount. The amount of discount is charged on the basis of the interest for the period of bill. On maturity of the bill, the payment is received by the bank from the drawee.

Q. 2. What is Trading on Equity?

Ans: Trading on Equity refers to the use of high debt for ensuring higher returns for the equity share holders. This is workable when the profitability is high and the rate of return on investment of funds is higher than the rate of interest to be paid on the borrowed money. Let us take an example. Suppose Rs 5 crores is required to be invested on a project that may give 20% return per annum. If the management decides to raise Rs 2.50 crores by issuing equity shares of Rs 10 each and Rs 2.5 crores by issuing 10% debentures, then the share holders will get a return of 30% on their funds.

Q. 3. What is meant by lease financing?

Ans: Lease Financing: Lease is a contract whereby one can use the assets of the other with due permission of the owner on payment of rent without purchasing them. The owner of the asset is called lessor’ and the user is called lessee. The period of use is called the lease period after which the lessee may opt for purchase of the asset.

Q. 4. State the meaning of ‘sale and lease back’ system.

Ans: Sometimes the user company may request the leasing company to purchase its existing assets and allow them to use the same assets on lease basis. This enables the company to save the long-term funds that can be utilised for other purposes. This is known as ‘sale and lease back’ system.

Q. 5. State the meaning of ‘Preference shares’.

Ans: Preference shares: They carry preferential rights in respect of dividend and return of capital. The rate of dividend on preference shares is fixed. 

Q. 6. Define a Small Scale Enterprise as per ‘MSMED Act, 2006. 

Ans: Small Business: Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 has classified enterprises as follows:

1. Manufacturing Enterprises

(a) Micro Enterprise: A unit with an investment up to Rs 25 lakh.

(b) Small Enterprise: A unit with an investment above Rs 25 lakh and upto Rs 5 crore.

(c) Medium Enterprise: A unit with an investment above Rs 5 crore and upto Rs 10 crore. 

2. Service Enterprises

(a) Micro Enterprise: A unit with an investment up to Rs 10 lakh. 

(b) Small Enterprise: A unit with an investment above Rs 10 lakh and up to Rs 2 crore.

(c) Medium enterprise: A unit with an investment above Rs 2 crore and up to Rs 5 crore. 

Q.7. Mention any two roles of small business in India.

Ans: Roles of Small business in India: 

(i) It is helpful by providing employment to a large number of people.

(ii) It provide opportunity for entrepreneurship.

Short Answer Type Questions:

Q. 8. Distinguish between GDR and ADR.

Ans: Global Depository Receipt (GDR): Under GDR, shares of the company are first converted into depository receipts by an international banks. These depository receipts are denominated in US dollars. Then these depository receipts are offered for sale globally through foreign stock exchanges. The holder of GDRs are entitled for dividend just like shareholders. But they do not enjoy the the voting rights. Many Indian companies like ICICI, Wipro etc. have raised foreign capital through issue of GDRs.

American Depository Receipts (ADR): The depository receipts which are issued by a USA Bank for trading only in American Stock markets are known as American Depository Receipts (ADR). The ADRs are issued only to the American citizens.

Q. 9. ‘Finance is considered as the life-line of the business, especially in the modern day’. Give reasons for the same.

Ans: Finance is considered as life-line of the business in modern days due to following reasons:

(a) Need for Large Scale Operation: Now-a- days business activities are generally undertaken on a large scale. The products of any country are now freely and easily available in other countries. The entire world has become a big market. So to survive in the business world the businessman has to expand the horizon of 

his activities and function on large scale. This expansion of business always demands more funds.

(b) Use of Modern Technology: Use of latest technology in the process of production as well as distribution has become imperative for every business now-a-days. To meet the competition, production process now demands use of modern machinery, equipments and tools. Hence, there is a greater need for finance to meet the challenge of the world’s markets successfully.

(c) Promotion of sales: In this era of competition lot of money is to be spent on activities for promoting sales. This involves advertisement, personal selling. use of sales promotional schemes, providing after sales service and free home delivery,etc. which need huge amount of funds. 

Q. 10. What do you mean by ICDs?

Ans: Deposits made by one company with another company for a short term are termed as Inter Corporate Deposits. It is a type of unsecured debt. It is arranged by a broker. This is a form of short term finance. This source of finance is free from legal formalities. ICDs are kept secret and are not disclosed to the public. The interest payable depends on the amount and period of deposit. There is no organised market for exchanging these deposits.

Q. 11. Enumerate different types of ICDs. 

Ans: Following are the different types of inter corporate deposits: 

(a) Call Deposits: Call deposits can be withdrawn by the lender by giving a one day notice. The rate of interest on such deposits is 10% p.a.

(b) Three Months Deposits: These ICDs are for a period of three months. The rate of interest on these deposits is 12% p.a.

(c) Six Months Deposits: These ICDs are for a period of 6 months. The rate of interest on these deposits is 15% p.a.

Q. 12. Define a Small Scale Enterprise as per ‘MSMED Act, 2006’.

Ans: Small Business: Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 has classified enterprises as follows:

1. Manufacturing Enterprises

(a) Micro Enterprise: A unit with an investment up to Rs 25 lakh.

(b) Small Enterprise: A unit with an investment above Rs 25 lakh and upto Rs 5 crore.

(c) Medium Enterprise: A unit with an investment above Rs 5 crore and upto Rs 10 crore.

2. Service Enterprises 

(a) Micro Enterprise: A unit with an investment up to Rs 10 lakh. 

(b) Small Enterprise: A unit with an investment above Rs 10 lakh and up to Rs 2 crore.

(c) Medium enterprise: A unit with an investment above Rs 2 crore and up to Rs 5 crore. 

Q. 13. Mention any five roles of small business in India.

Ans: Role of Small Business in India: Small Scale Industries are small in size but constitute 95% of the industrial units in India. They contribute 45% of the total exports from India. 

They are helpful in the following ways:

1. Employment: As Small Scale Industries are laboure-intensive, they provide employment to a large number of people.

2. Supply Variety of Products: SSIs supply variety of products like mass consumption goods, readymade garments, stationery items, detergents, leather,plastic and rubber products, processed foods and vegetables, wood and steel furniture, safety matches etc. Some sophisticated items like electric and electronic goods such as TV, Calculator, agricultural tools etc. and handloom and handicraft products are made by SSIs.

3. Balance Regional Development: SSIs use single technologies and depend on locally available resources (material, labour etc.). This enables it to start its unit anywhere in the country.

4. Opportunity for Entrepreneurship: SSIs provide opportunity for entrepreneurship. These units can be started with little capital so talented and skilled people can have their own business units.

5. Low Cost of Production: SSIs use locally available resources which are less expensive. Therefore, establishment and running cost of small industries are less.

6. Capture New Business Opportunities: Due to the small size of the organisations, quick decisions can be taken by SSI units. This enables them to capture new business opportunities.

7. Customised Production: SSI units manufacture products according to the needs of customers. They manufacture products according to the specifications provided by consumers.

Q. 14. Explain any two ways in which a business enterprise can obtain Bank Credit.

Ans: Bank Credit: Commercial banks usually provide 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 as and when needed. 

Bank credit may be granted in any of the following ways:

(a) Loans and Advances: When a certain amount of money is advanced by a bank repayable after a specified period, it is known as bank loan. Such advance is credited to a separate loan account and the borrower has to pay interest on the whole amount of loan irrespective of the amount of loan actually drawn. Usually loans are granted against security of assets.

(b) Cash Credit: It is an arrangement whereby banks allow the borrower to withdraw money upto a specified limit. This limit is known as cash credit limit. This facility is granted against the security of goods in stock or promissory notes or other marketable securities like government bonds. Under this arrangement, the borrower can draw, repay and again draw the amount within the sanctioned limit. Interest is charged only on the amount actually withdrawn and not on the amount of entire limit.

Q. 15. Give two merits and two limitations of equity shares, from the point of view of the management.

Ans: Merits of equity shares from Management point of view:

(i) A company can raise capital by issuing equity shares without creating any charge on its fixed assets.

(ii) The capital raised by issuing equity shares is not required to be paid back during the lifetime of the company. It will be paid back only when the company is winding up.

(iii) There is no binding on the company to pay dividend on equity shares. The company may declare dividend only if there are enough profits.

(iv) If a company raises more capital by issuing equity shares, it leads to greater confidence among the creditors.

Limitations of equity shares from management point of view:

(i) It requires more formalities and procedural delay to raise funds by issuing equity shares. Also the cost of raising capital through equity share is more as compared to debt.

(ii) As the equity shareholders carry voting rights, groups are formed to garner the votes and grab the control of the company. This may lead to conflict of interests, which is harmful for the smooth functioning of a company.

Q. 16. Explain the four types of preference shares that a company can issue.

Ans: Types of Preference Share: A company has the option to issue different types of preference share. The different types of preference share a company can issue:

(i) Convertible and Non-convertible Preference Share: The preference shares which can be converted into equity shares after a specified period of time are known as convertible preference share. Otherwise, it is known as non-convertible preference share.

(ii) Cumulative and Non-cumulative Preference Share: In cumulative preference shares, the unpaid dividends are accumulated and carried forward for payment in future years. On the other hand, in non-cumulative preference share, the dividend is not accumulated if it is not paid out of the current year’s profit.

(iii) Participating and Non-participating Preference Share: Participating preference shares have a right to share the profit after making payment of divided at a predecided rate to the equity shares. The non-participating preference shares do not enjoy such a right.

(iv) Redeemable and Irredeemable Preference Share: Preference shares having a fixed date of maturity are called as redeemable preference shares. Here, the company undertakes to return the amount to the preference shareholders immediately after the expiry of a fixed period. Where the amount of the preference shares is refunded only at the time of liquidation, are known an irredeemable preference shares.

Long Answer Type Questions:

Q. 17. What are ‘Debentures’? Describe three merits and three limitations of debentures as a source of long-term finance for a company.

Ans: Issue of Debentures: The companies can raise long term funds by issuing debentures that carry assured rate of return for investors in the form of a fixed rate of interest. It is known as debt capitalor borrowed capital of the company. The debenture is a written acknowledgement of money borrowed. It specifies the terms and conditions, such as rate of interest, time of repayment, security offered, etc. These are offered to the public to subscribe in the same manner as is done in the case of shares. The debenture holders are the creditors of the company and are entitled to get interest irrespective of profit earned by the company. They do not have any voting right. So they do not interfere in the day-to-day management of the business. Ordinarily, debentures are fully secured. In case the company fails to pay interest on debentures or repay the principal amount, the debenture holders can recover it from sale of its assets.

Merits of Debentures are:

(a) Debentures are secured loans. On winding up of the company, they are repayable before making any payment to the equity and preference shareholders.

(b) The debentureholders get assured return irrespective of profit.

(c) Issue of debentures enables the company to provide high return to equity shareholders when the earnings of the company are good. This is called Trading on Equity.

(d) Debenture holders have no right either to vote or take part in the management of the company. So by issuing debentures the company raises the additional capital without diluting the control over its management.

(e) Interest paid on debentures is treated as an expense and is charged to the profits of the company. The company thus, saves income tax. 

Limitations of Debentures are:

(a) If the earnings of the company are uncertain and unpredictable, issue of debentures may pose serious problems due to fixed obligation to pay interest and repay the principal. So, when the company expects good and stable income, then only it should issue debentures. 

(b) The company, which issues debentures, creates a charge on its assets in favour of debentureholders. So a company not having enough fixed assets car not borrow money by issuing debentures.

(c) The assets of the company once mortgaged cannot be used for further borrowing. So, issue of debentures reduces the borrowing capacity of the company.

Q. 18. Differentiate between ‘Shares’ and ‘Debentures’ as sources of long-term finance. 

Ans: Difference between Shares and Debenture:

Q. 19. What is meant by Special Financial Institutions (SFIs)? Explain two merits and two demerits of taking loans from SFIs as a source of long-term funds.

Ans: After independence a large number of financial institutions have been established in India with the primary objective to provide medium and long-term financial assistance to industrial enterprises. Institutions like Industrial Finance Corporation of India (IFCIs). Industrial Reconstruction Bank of India, State Financial Corporation (SFCs), State Industrial Development Corporation (SIDCs), have been established to provide financial support to set up new enterprises as well expansion and modernisation of the existing enterprises. These financial institutions grant loans for a maximum period of 25 years. 

The major benefit derived from such loans are:

(i) The rate of interest payable is lower than the market rate. and

(ii) The amount of loan is large and sufficient enough for expansion and modernisation. 

Demerits:

(i) The procedure for granting loans, is time. consuming and exhensive due to many formalties. 

(ii) SFIs put certain restrictions on the firm, Financial institutions have their nominees on the board to directors of the borrowing company with restricts power of the company.