NCERT Solutions for Class 11th Business Studies Chapter 8 – Sources of Business Finance
Multiple Choice Questions
1. Equity shareholders are called
(a) owners of the company
(b) partners of the company
(c) executives of the company
(d) guardian of the company
Answer (a) Equity shares represent the ownership of a company and thus the capital raised by issue of such shares is known as ownership capital and shareholders are called owners of the company.
2. The term ‘redeemable’ is used for
(a) preference shares
(b) commercial paper
(c) equity shares
(d) public deposits
Answer (b) Commercial paper is an unsecured promissory note issued by a firm to raise funds tor a short period. varying from 90 days to 364 days after which it has to be redeemed.
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
Answer (c) Funds which are used for holding current assets such as stock of material, bills receivables and for meeting current expenses like salaries, wages. taxes, and rent is known as working capital of an enterprise.
4. ADRs are issued in
(a) Canada
(b) China
(c) India
(d) USA
Answer (d) The depository receipts issued by a company n the USA are known as American Depository Receipts (ADRs)
5. Public deposits are the deposits that are raised directly from
(a) the public
(b) the directors
(c) the auditors
(d) the owners
Answer (a) The deposits that are raised by organisations directly from the public are known as public deposits.
6. Under the lease agreement, the lessee gets the right to
(a) share profits earned by the lessor
(b) participate in the management of the organisation
(c) use the asset for a specified period
(d) sell the assets
Answer (c) A lease is a contractual agreement whereby the owner of an asset grants the lessee the fight to use the asset for a specified period In return for a periodic payment
7. Debentures 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
Answer (d) The debenture issued by a company is an acknowledgment that the company has borrowed a certain amount of money, which it promises to repay at a future date. Therefore, debentures represent loan capital of the company.
8. Under the factoring arrangement, the factor
(a) produces and distributes the goods or services
(b) makes the payment on behalf of the client
(c) collects the client’s debt or account receivables
(d) transfer the goods from one place to another
Answer (c) Factoring s a Imanciat service whereby the factor is responsible for all credit control and debt collection from the buyer and provides protection against any bad-debt losses to the firm
9. The maturity period of a commercial paper usually ranges from
(a) 20 to 40 days
(b) 60 to 90 days
(c) 120 to 365 days
(d) 90 to 364 days
Answer (d) Commercial paper is an unsecured promissory note issued by a firm to raise funds for a short period, varying from 90 days to 364 days after which it has to be redeemed.
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
Answer (d) Internal sources of capital are those sources that are generated within the business mainly through ploughing back or reinvestment of profits.
Short Answer Type Questions
Question 1. What is business finance? Why do businesses need funds? Explain.
Answer Business is an economic activity directed towards producing, acquiring wealth through buying and selling of goods. It is a very wide term. Finance is the life blood of the business. Funds are required to commence and carry on business. All business activities such as planning, organizing, managing, controlling, purchasing, selling, directing, marketing etc cannot take place without finance, Thus, we can say requirements of funds by business to carry out its various activities is called business finance.
When an entrepreneur takes a decision to start business the need of fund arises in order to meet the expenses of establishment of business, finance is required for purchasing fixed and current assets, for day-to-day operations, purchase of raw material, to pay salaries etc. Smooth functioning, expansion and growth of business is possible when it has sufficient funds.
Question 2. List sources of raising long term and short term finance.
Answer Sources of long Term Finance
(i) Equity Shares
(ii) Retained earnings
(iii) Preference shares
(iv) Debentures
(v) Loans from banks and other financial institutions
Sources of Medium Term Finance
(i) Lease financing
(ii) Public deposits
(iii) Loans from banks and other financial institutions
Sources of Short Term Finance
(i) Trade credit
(ii) Factoring
(iii) Commercial papers
(iv) Short term loans from banks
Question 3. What is the difference between internal and external sources of raising funds? Explain.
Answer
| S.No.. |
Internal Sources of Finance |
External Sources of Finance |
| (i) |
Internal sources of funds are those that are generated WIthin the business. |
External sources of funds Include those sources that lie outside an organisation, such as suppliers, lenders, and Investors. |
| (ii) |
Examples are accelerating collection of receivables, disposing of surplus inventories and ploughing back of profit. |
Examples are Issue of debentures, borrOWing from commercial banks and financial institutions and accepting public deposits. |
| (iii) |
The internal sources of funds can fulfil only limited needs of the business.Cost of internal funds IS low. |
Large amount of money can be raised through external sources.External funds are more costly. |
| (iv) |
BUSiness is not required to provide security while obtaining funds from Internal sources. |
Business is required to mortgage Its assets as security while obtaining funds from external sources. |
Question 4. What preferential rights are enjoyed by preference shareholders? Explain.
Answer The following preferential rights are enjoyed by preference shareholders
(i) Receiving a fixed rate of dividend, out of the net profits of the company, before any dividend is declared for equity shareholders.
(ii) Preference over equity shareholders in receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation.
(iii) In case of dissolution of the company preference share capital is refunded prior to the refund of equity share capital.
Question 5. Name any three special financial institutions and state their objectives.
Answer
(i) Industrial Finance Corporation of India (IFCI) It was established in July, 1948 as a statutory corporation under the Industrial Finance Corporation Act, 1948. Its objectives include assistance towards balanced regional development and encouraging new entrepreneurs to enter into the priority sectors of the economy. IFCI has also contributed to the development of management education in the country.
(ii) State Financial Corporations (SFCs) State Financial Corporations are established by the State Governments under the State Financial Corporations Act, 1951 for providing medium and short term finance to industries which are outside the scope of the IFC!. Its scope is wider than IFCI as it covers not only public limited companies but also private limited companies, partnership firms and proprietary concerns.
(iii) Life Insurance Corporation of India (LIC) LIC was set up in 1956 under the LIC Act, 1956 after nationalising 245 existing insurance companies. It mobilises savings in the form of insurance premium and makes it available to industrial concerns in the form of direct loans and underwriting of and subscription to shares and debentures.
Question 6. What is the difference between GDR and ADR?Explain.
Answer Global Depository Receipts (GDR) are the depository receipts denominated in US dollars issued by depository bank to which the local currency shares of a company are delivered. GDR is a negotiable instrument and can be traded freely like any other security. In the Indian context, a 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 stock exchange.
American Depository Receipts (ADR) The depository receipts issued by a company in the USA are known as American Depository Receipts. ADRs are bought and sold in American markets like regular stocks. 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 Type Questions
Question 1. Explain trade credit and bank credit as sources of short term finance for business enterprises.
Answer Trade Credit Trade credit is the credit extended by one trader to another for the purchase of goods and services It facilitates the purchase of supplies without immediate payment and is commonly used by business organisations as a source of short-term financing. Trade credit appears In the records of the buyer of goods as ‘sundry creditors’ or’ accounts payable’ It is granted prudently to those customers who have reasonable amount of financial standing and goodwill.
The volume and period of credit extended depends on factors such as reputation of the purchasing firm, financial position of the seller, volume of purchases, past record of payment and degree of competition In the market. Terms of trade credit may vary from industry to industry and from person to person As we know, trade is the purchase and sale of goods on profit motive. So, trade credit strictly refers to the routine business activity.
Bank Credit Commercial banks provide funds for different purposes and for different time periods to firms of all sizes by way of cash credits, overdrafts, term loans, purchase/discounting of bills, and issue of letter of credit. The rate of Interest charged by banks depends on various factors such as the characteristics of the firm and the level of Interest rates In the economy
The loan is repaid either in lump sum or in instalments. Bank credit is not a permanent source 01 funds and is generally used for medium to short periods. The borrower is required to provide some security or create a charge on the assets of the firm before a loan is sanctioned by a commercial bank.
Question 2. Discuss the sources from which a large industrial enterprise can raise capital for financing modernisation and expansion.
Answer Financial institutions established by the central as well as State Governments all over the country to provide finance to business organisations are considered (he most suitable source of finance when large funds lor longer duration are required for expansion, reorganisation and modernisation of an enterprise. These institutions provide both owned capital and loan capital for long and medium term requirements and supplement the traditional financial agencies like commercial banks.
In addition to providing financial assistance. these institutions also conduct market surveys and provide technical assistance and managerial services to people who run the enterprises. The various Special Financial Institutions in India are as under.
(i) Industrial Finance Corporation of India (IFCI) It was established in July, 1948 as a statutory corporation under the Industrial Finance Corporation Act, 1948. Its objectives include assistance towards balanced regional development and encouraging new entrepreneurs to enter into the priority sectors of the economy. IFCI has also contributed to the development 01 management education in the
country.
(ii) State Financial Corporations (SFCs) State Financial Corporations are established by the State Governments under the State Financial Corporations Act, 1951 for providing medium and short term finance to industries which are outside the scope of the IFC!. Its scope is wider than IFCI as it covers not only public limited companies but also private limited companies, partnership firms and proprietary concerns.
(iii) Life Insurance Corporation of India (LIC) LIC was set up in 1956 under the LIC Act, 1956 after nationalising 245 existing insurance companies. It mobilises savings in the form of insurance premium and makes it available to industrial concerns in the form of direct loans and underwriting of and subscription to shares and debentures.
(iv) Industrial Credit and Investment Corporation of India (ICICI) This was established in 1955 as a public limited company under the Companies Act. ICICI assists the creation, expansion and modernisation of industrial enterprises exclusively in the private sector. The corporation has also encouraged the participation of foreign capital in the country.
(v) Industrial Development Bank of India (1081) It was established in 1964 under the Industrial Development Bank of India Act, 1964 with an objective to coordinate the activities of other financial institutions including commercial banks. The bank performs three types of functions, namely, assistance to other financial institutions, direct assistance to industrial concerns, and promotion and coordination of financial-technical services.
(vi) State Industrial Development Corporations (SIDC) Many State Governments have set up State Industrial Development Corporations for the purpose of promoting industrial development in their respective states. The objectives of the SIDCs differ from one state to another.
(vii) Unit Trust of India (UTI) It was established by the Government of India in 1964 under the Unit Trust of India Act, 1963. The basic objective of UTI is to mobilise the savings into productive ventures. It sanctions direct assistance to industrial concerns, invests in their shares and debentures, and participates with other financial institutions.
(viii) Industrial Investment Bank of India limited Industrial Investment Bank of India assists sick units in the reorganisation of their share capital. Improvement In management system, and provision of finance at liberal terms.
Question 3. What advantages does issue of debentures provide over the issue of equity shares?
Answer Debentures are long term debt instruments which bear a fixed rate of interest. The debenture issued by a company is an acknowledgment that the company has borrowed a certain amount of money, which it promises to repay at a future date Debenture holders are paid a fixed stated amount of interest at specified Intervals say six months or one year
Issue of Zero Interest Debentures (ZID) which do not carry any explicit rate of interest It has also become popular In recent years. In the case of ZIDs. the difference between the face value of the debenture and its purchase price is the return to the investor.
Merits of Debentures over Equity Shares
(i) Debentures are preferred by investors who want fixed Income at lesser risk.
(ii) Debentures are fixed charge funds and do not participate In profits of the company
(iii) The issue of debentures is suitable in the situation when the sales and earnings are relatively stable
(iv) Financing through debentures does not dilute control of shareholders on management as debentures do not carry voting rights.
(v) Financing through debentures is less costly as compared to cost of equity capital as the Interest payment on debentures is tax deductible.
Question 4. State the merits and demerits of public deposits and retained earnings as methods of business finance.
Answer Public Deposits The deposits that are raised by organisations directly from the public are known as public deposits. Rates of interest offered on public deposits are usually higher than that offered on bank deposits The amount raised from public deposits is generally used by the company for meeting the requirement of working capital. It can take care of both medium and short term financial requirements.
Merits of Public Deposits
(i) The procedure of obtaining deposits is Simple and does not contain restrictive conditions as in case of a loan agreement.
(ii) Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions.
(iii) Public deposits do not usually create any charge on the assets of the company and hence the assets can be used as security for raising loans from other sources
(iv) The control of the company is not diluted as the depositors do not have voting rights.
Limitations of Public Deposits
(i) New companies generally find it difficult to raise funds through public deposits due to lack of goodwill.
(ii) It is an unreliable source of finance as the public may not respond when the company needs money.
(iii) Collection of public deposits may prove difficult, particularly when the size of deposits required is large.
Retained Earnings
The portion of the net earnings which is not distributed amongst the shareholders as dividends and is retained in the business for use in the future is known as retained earnings. It is a source of internal financing and is also termed as accumulated earning.
Merits of Retained Earnings
(i) Retained earnings is a permanent source of funds available to an organisation.
(ii) It does not Involve any explicit cost in the form of interest, or floatation cost.
(iii) There is a greater degree of operational freedom and flexibility as the funds are generated internally.
(iv) It enhances the capacity of the business to absorb unexpected losses.
(v) It may lead to Increase in the market price of the equity shares of a company
Limitations of Retained Earnings
(i) High retention ratio may cause dissatisfaction amongst the shareholders as they would get lower dividends.
(ii) It is an uncertain source of funds as the profits of business keep fluctuating .
(iii) If the opportunity cost associated with these funds is high it may lead to sub-optimal use of the funds.
Question 5. Discuss the financial instruments used in international financing.
Answer Various financial instruments used in international facing include
(i) Commercial Banks Commercial banks extend foreign currency loans for business purposes. They are an important source of financing non-trade international operations. The types of loans and services provided by banks vary from country to country. Banks do not interfere in the management of companies and such loans can be repaid In parts and interest can be saved.
(ii) International Agencies and Development Banks A number of international agencies and development banks provide long and medium term loans and grants to promote the development of economically backward areas in the world. These bodies were set up by the Governments of developed countries of the world at national, regional and international levels for funding various projects. The more notable among them include International Finance Corporation (IFC), EXIM Bank and Asian Development Bank.
(iii) International Capital Markets Prominent financial instruments used for international financing through capital markets are
(a) Global Depository Receipts (GDRs) These are the depository receipts denominated in US dollars issued by depository bank to which the local currency shares of a company are delivered. GDR is a negotiable instrument and can be traded freely like any other security. In the Indian context, a 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 stock exchange,
(b) American Depository Receipts (ADRs) The depository receipts issued by a company in the USA are known as American Depository Receipts. ADRs are bought and sold in American markets like regular stocks. 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.
(c) Foreign Currency Convertible Bonds (FCCB’s) Foreign currency convertible bonds are equity linked debt securities that are to be converted into equity or depository receipts after a specific period at a pre-determined exchange rate. The FCCB’s are issued in a foreign currency and carry a fixed interest rate which is lower than the rate of any other similar non convertible debt instrument. FCCB’s are listed and traded in foreign stock exchanges.
Question 6. What is a commercial paper? What are its advantages and limitations?
Answer Commercial paper is an unsecured promissory note Issued by a firm to raise funds for a short period, varying from 90 days to 364 days. It is issued by one firm to other business firms, insurance companies, pension funds and banks. The amount raised by CP is generally very large. The CP can be issued only by firms having good credit rating as this debt is totally unsecured. Issue of CP is regulated by the Reserve Bank of India.
Merits of Commercial Paper
(i) A commercial paper does not contain any restrictive conditions as it is sold on an unsecured basis.
(ii) It has high liquidity as it is a freely transferable instrument.
(iii) It provides more funds compared to other sources.
(iv) The cost of CP to the issuing firm is generally lower than the cost of commercial bank loans.
(v) A commercial paper provides a continuous source of funds because their maturity can be tailored to suit the requirements of the issuing firm.
(vi) Companies can invest their excess funds in commercial paper and can earn good return on them.
Limitations of Commercial Paper
(i) Only firms which are financially sound and have high credit ratings can raise money through commercial papers. New and moderately rated firms are not in a position to raise funds by this method as these are unsecured.
(ii) The amount of money that can be raised through commercial paper is limited.
(iii) Commercial paper is an impersonal method of financing and if a firm is not in a position to redeem its paper due to financial difficulties, extending the maturity of a CP is not possible .
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