NCERT Solutions for Class 11 Business Studies Chapter 8 Sources of Business Finance. Study Material in Hindi and English Medium are available in PDF file format to free download. Long answer questions and short answer questions are separately given to use online. Please provide suggestion and feedback to improve more this website and its contents.
11th Business Studies Chapter 8 Sources of Business Finance
|Class: 11||Business Studies|
|Chapter: 8||Sources of Business Finance|
|Contents:||Study Material and NCERT Solutions|
Class 11 Business Studies Chapter 8 Solutions
11th B St Chapter 8 Short Answer Questions
What is business finance? Why do businesses need funds? Explain.
Every business needs finance to carry out day to day operations and the running business activities. Almost all business activities require some finance. Finance is needed to establish a business, to run it to modernize it to expand or diversify it. It is required for buying a variety of assets, which may be tangible like machinery, furniture, factories, buildings, offices or intangible assets. The funds required to finance the expansion of a business are also considered a part of business finance.
The following are the reasons why a business needs funds.
(a) Fixed capital requirements: The initial setup of a business requires fixed assets such as building, machinery, furniture and fixtures. The requirement is one time investment for a long term period. The level of requirement of funds depends upon the size and nature of a business.
(b) Working capital requirements: A business needs to carry out various activities in its routine which require inflow and outflow of funds such as purchase of raw materials and payment of wages to workers. The requirement of funds for such operations is known as the working capital requirement.
List sources of raising long-term and short-term finance.
The following are some of the sources of long-term funds:
(a) Equity shares
(b) Retained earnings
(e) Loan Notes
(f) Preference shares
The following are some of the sources of short-term funds.
(a) Trade credit
(b) Banks overdrafts
(c) Commercial paper
(d) Factoring with or without recourse
What is the difference between the internal and external sources of raising funds? Explain.
|Internal Sources||External Sources|
|1. Funds which are generated within a business enterprise internally are known as internal sources.||1. Funds which are generated outside the business enterprise internally are known as internal sources.|
|2. The amounts that can be raised from internal sources are limited and can be used only for specific purposes.||2. Large amounts can be raised from external sources and therefore these funds can be used to finance large operations.|
|3. Internal sources of finance include surplus inventories, collecting bill receivables or reinvestment of profits.||3. External sources of finance include suppliers, creditors, investors, banks and financial institutions.|
|4. Cost of internal sources of finance is much lower than external sources of finance. In fact, the cost is more in the nature of an opportunity cost foregone rather than an actual cost outflow.||4. Cost of external sources of finance has to be paid to outside entities and is thus much higher.|
Preference shares, more commonly referred to as preferred stock, are shares of a company’s stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company enters bankruptcy, preferred stockholders are entitled to be paid from company assets before common stockholders. Preference shares are issued by a company to raise capital, and the repayment to preference share holders is made in accordance with the terms specified in Section 80 of the Companies Act, 1956. Preference share holders are entitled to the following preferential rights.
- (a) Preference shares are entitled to receive fixed dividends amount or at a fixed rate.
- (b) In case of liquidation preference shares have a right to receive repayment of capital invested by them before their equity shareholders
11th B St Chapter 8 Important Questions
Name any three special financial institutions and state their objectives.
Financial institutions refer to central or state government establishments that exist to finance business operations. These institutions provide long-term finance to firms to help them in their expansion, modernisation and reorganisation programmes.
The following are the three main financial institutions.
(a) Unit Trust of India (UTI): The UTI was established in 1964 under the Unit Trust of India Act, 1963, with the objective of mobilising the community’s savings and utilising the funds to finance profitable ventures.
(b) Industrial Credit and Investment Corporation of India (ICICI): The ICICI was established as a public limited company in 1955. The main objective of the ICICI was to facilitate the creation, modernisation and expansion of enterprises in the private sector.
(c) Industrial Finance Corporation of India (IFCI): The IFCI was established in 1948 under the Industrial Finance Corporation Act, 1948, with the objective of facilitating regional development and encouraging new entrepreneurs to enter the priority sectors of the economy.
What is the difference between GDR and ADR? Explain.
American Depository Receipt (ADR) is a depository receipt which is issued by a US depository bank against a certain number of shares of non-US company stock. Whereas Global Depository Receipt (GDR) is a depository receipt which is issued by the international depository bank, representing foreign company’s stock. Global Depository Receipts are usually denoted in US dollars and can easily be converted into shares at any time. GDR can be offered in several foreign countries globally. Depositary receipts only offered in a single foreign market will typically be titled by that market’s name. It can be listed and traded on the stock exchange of any country other than the US. On the other ADRs can be found on many exchanges in the U.S. including the New York Stock Exchange and Nasdaq as well as over the counter. Foreign companies and their depositary bank intermediaries must comply with all U.S. laws for issuing ADRs. This makes ADRs subject to U.S. securities laws as well as the rules of exchanges.
11th B St Chapter 8 Long Answer Questions
Explain trade credit and bank credit as sources of short-term finance for business enterprises.
Trade credit: It is the loan extended by one trader to another when the goods and services are bought on credit. Trade credit facilitates the purchase of supplies without immediate payment. It is commonly used by business organisations as a source of short-term financing. It promotes the purchase of goods and services as the purchaser need not make immediate cash payments if trade credit is extended. Trade credits are granted only to customers or traders who are considered to be creditworthy by the supplier.
Merits of trade credit as a source of short-term finance
(a) Trade credit helps a company to stock up inventories for keeping up with the increase in sales.
(b) The liquidity and working capital problem is sorted with the availability of trade credit.
(c) Trade creditors have no legal rights over the assets of a company, hence a company can mortgage its assets to raise money from other sources of finance.
Demerits of trade credit as a source of short-term finance
(a) Business usually indulges in overtrading due to availability of trade credit, which later increases the future liabilities of the buyer.
(b) Trade credit is a limited source of finance and restricts the financial capacity of the supplier or the creditor.
(c) The interest rate of term credit can be high and a number of restriction appy on it for example, security deposit.
Bank credit: Bank Credit is the aggregated amount financial institutions are willing and able to offer a loan or advance to an individual or organization. Bank credit can be classified into many sections on the various basis terms and interest. The interest charged by the bank on the loan is usually fixed or floating. The borrower needs to mortgage assets with the bank to secure the loan.
Merits of bank credit as a source of short-term finance
(a) Banks are the most secure organisations and maintain confidentiality over information related to their customers.
(b) Bank credit is usually flexibility as the borrower can increase or decrease the amount of loan according to the business needs.
Demerits of bank credit as a source of short-term finance
(a) It is difficult to raise additional amount of loan or another credit.
(b) The rules and regulations imposed by banks are very restrictive in nature and it may be difficult to get loan approval easily.
Discuss the sources from which a large industrial enterprise can raise capital for financing modernisation and expansion.
The following are some of the sources of long-term funds.
(a) Equity shares: These shares represent the ownership capital of a company. The holders of such shares are known as equity share holders and enjoy a say in the management and gain higher returns when the profits are higher. They are also called the owners of the company, or residual owners, since payments to them are made only after paying the external debts or claims.
(b) Retained earnings: Retained earnings (RE) is the amount of net income left over for the business after it has paid out dividends to its shareholders. Often this profit is paid out to shareholders, but it can also be re-invested back into the company for growth purposes. The money not paid to shareholders counts as retained earnings.
(c) Preference shares: Preference shares, more commonly referred to as preferred stock, are shares of a company’s stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company enters bankruptcy, preferred stockholders are entitled to be paid from company assets before common stockholders.
(d) Debentures: Debentures are a means of long-term debt capital. Debentures usually carry a fixed rate of return until maturity and a redemption value at the date of maturity. They imply that a company has borrowed a certain sum of money which it will repay later to the debenture holders.
(e) Unit Trust of India (UTI): The UTI was established in 1964 under the Unit Trust of India Act, 1963, with the objective of mobilising the community’s savings and utilising the funds to finance profitable ventures.
(f) Industrial Credit and Investment Corporation of India (ICICI): The ICICI was established as a public limited company in 1955. The main objective of the ICICI was to facilitate the creation, modernisation and expansion of enterprises in the private sector.
(g) Industrial Finance Corporation of India (IFCI): The IFCI was established in 1948 under the Industrial Finance Corporation Act, 1948, with the objective of facilitating regional development and encouraging new entrepreneurs to enter the priority sectors of the economy.
(h) LIC: Life Insurance Corporation of India is an Indian state-owned insurance group and investment corporation owned by the Government of India. It was set up 1956 with the objective of providing direct loan and underwriting subscriptions of shares and debentures.
Debentures are financial instruments used by companies to raise long-term debt capital. They imply that the company has borrowed a certain sum of money which it will repay later to the debenture holders. They are considered as fixed income securities as they carry a fixed rate of return and are repayable on a certain pre-specified date in the future.
The following are the advantages of issuing debentures over issuing equity shares.
- The issue of equity shares denotes the dilution of ownership of a firm. This is because the equity shareholders own specified shares of the company and have voting rights. In contrast, debenture holders do not have any rights in the company. That is, they do not enjoy voting rights or any kind of ownership in the firm. Rather, they are only entitled to a fixed amount as payment. Thus, debentures do not result in any kind of dilution of ownership of the firm. Thus, issuing debentures is more advantageous for a firm than issuing equity shares.
- In order to issue shares, a company has to incur huge costs. Besides, it has to pay dividends to its shareholders, which are not tax deductible. On the other hand, a company receives tax deductions on the interest paid to its debenture holders. Hence, issuing debentures is advantageous for a firm in terms of low costs.
- Debentures carry a fixed rate of return. This implies that irrespective of the profit earned, the company has to pay only a fixed interest to its debenture holders. On the other hand, a company that issues shares has to pay dividends to the shareholders, which varies with the profit—i.e., the higher the profit, the higher will be the dividends. Thus, companies prefer to issue debentures if they expect to earn higher profits in a year.
State the merits and demerits of public deposits and retained earnings as methods of business finance.
Public deposits: Public deposits refer to the unsecured deposits invited by companies from the public mainly to finance working capital needs. A company wishing to invite public deposits makes an advertisement in the newspapers. Organisations raise public deposits directly from the public to finance their short-term as well as medium-term financial requirements. The rate of return on such deposits is generally higher than the return paid on bank deposits.
Merits of Public Deposits
(a) The process of raising funds by accepting public deposits is relatively easy.
(b) There is no huge transaction cost of raising funds by accepting public deposits.
(c) The ownership does not get diluted as depositors do not have any voting or management rights.
Demerits of Public Deposits
(a) The fund raising capacity from public deposits is limited in nature.
(b) New companies find it difficult to raise capital through public deposits.
(c) Firms with expansion plans or huge capital requirements may find it difficult to borrowing funds through public deposits.
Retained Earnings: It is the amount of net income left over for the business after it has paid out dividends to its shareholders. Often this profit is paid out to shareholders, but it can also be re-invested back into the company for growth purposes. The money not paid to shareholders counts as retained earnings.
Merits of Retained Earnings
(a) The cost of internally generated funds is very low. The only cost involved is the opportunity cost of amount retained and not invested in a positive NPV project.
(b) High amounts of retained earnings give a positive signal to shareholder that the company is ready to invest in bug projects and can lead to an increase in the price of equity shares.
(c) Firms become more stable and liquidity improves as the risk of unexpected cash outflow is reduced.
Demerits of Retained Earnings
(a) Retained earnings are not a regular source of finance as the business profits are not fixed in nature.
(b) Sometimes the shareholders expect dividend reward and too much retained earning might cause dissatisfaction among them.
(c) Firms often fail to recognise the opportunity cost of the earnings retained in the business. As a result, these funds are often misused or sub-optimally used.
Discuss the financial instruments used in international financing.
International financing mainly uses three types of financial instruments.
- Global Depository Receipts (GDRs): Global Depository Receipt (GDR) is a depository receipt which is issued by the international depository bank, representing foreign company’s stock. Global Depository Receipts are usually denoted in US dollars and can easily be converted into shares at any time. GDR can be offered in several foreign countries globally. It can be listed and traded on the stock exchange of any country other than the US.
- American Depository Receipts (ADRs): American Depository Receipt (ADR) is a depository receipt which is issued by a US depository bank against a certain number of shares of non-US company stock. They are usually traded like any other securities in the market. However, such trading is restricted to the US securities markets only. In addition, ADRs are sold only to US citizens. Foreign companies and their depositary bank intermediaries must comply with all U.S. laws for issuing ADRs. This makes ADRs subject to U.S. securities laws as well as the rules of exchanges.
- Foreign Currency Convertible Bonds (FCCBs): A foreign currency convertible bond (FCCB) is a type of convertible bond issued in a currency different than the issuer’s domestic currency. In other words, the money being raised by the issuing company is in the form of foreign currency. A convertible bond is a mix between a debt and equity instrument. The return on such securities is pre-fixed and lower than the return on non-convertible securities.
What is a commercial paper? What are its advantages and limitations?
Commercial paper is a short-term debt instrument issued by creditworthy companies to raise funds generally for a time period up to one year. They are typically issued by large banks or corporations to cover short-term receivables and meet short-term financial obligations, such as funding for a new project. The maturity of commercial papers ranges from 90 to 364 days. They are generally issued to business firms, banks, insurance companies and pension funds, and their issue is regulated by the Reserve Bank of India.
Advantages of Commercial Paper
- It is quick and effective method of raising capital as issue cost of commercial paper is generally low.
- It a highly liquid asset and can be converted on demand.
- It is easily transferable to anyone at any time.
- There is no complex regulation attached to it and is sold on unsecured basis.
- Companies can invest their surplus funds in commercial paper and earn good returns on their investment.
- They are a continuous source of finance to firms.
- There is no restriction on amount of funds generated by commercial paper.
Limitation of Commercial Paper
- (a) Commercial paper is unsecured and only creditworthy firms can raise funds easily. New firms cannot easily raise money by issuing commercial paper.
- (b) The amount of money that can be raised through commercial paper is limited as it depends on the availability of funds with buyers at the time of its issue.
- (c) Commercial paper has fixed maturity which ranges from 90 to 364 days. The time period is restrictive and cannot be extended.