NCERT Solutions for Class 11 Business Studies Chapter 8 Sources of Business Finance

NCERT
SOLUTIONS
CLASS - 11th

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Book : Business Studies Ncert Solutions | Chapter - 8 Business Studies

Class : 11th

Subject : Business Studies

Chapter : 8

Chapter Name : Sources of business finance

Q1 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) Owners of the company

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Q2 The term ‘redeemable’ is used for

(a) Preference shares

(b) Commercial paper

(c) Equity shares

(d) Public deposits

Answer. (a) Preference shares

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Q3 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) Working capital requirement

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Q4 ADRs are issued in

(a) Canada

(b) China

(c) India

(d) USA

Answer. (d) USA

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Q5 Public deposits are the deposits that are raised directly from

(a) The public

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(b) The directors

(c) The auditors

(d) The owners

Answer. (a) The public

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Q6 Under the lease agreement, the lessee gets the right to

(a) Share profits earned

(b) Participate in the by the lessor management of the organisation

(c) Use the asset for a specific period

(d) Sell the assets specified period

Answer. (c) Use the asset for a specific period

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Q7 Debentures represent

(a) Fixed capital of the company

(b) Permanent capital of the company

(c) Fluctuating capital of

(d) Loan capital of the company

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Answer. (d) Loan capital of the company

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Q8 Under the factoring arrangement, the factor

(a) Produces and distributes

(b) Makes the payment on the goods or services behalf of the client

(c) Collects the client’s debt

(d) Transfer the goods from or account receivables one place to another

Answer. (c) Collects the client’s debt

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Q9 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) 90 to 364 days

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Q10 Internal sources of capital are those that are

(a) generated through outsiders

(b) generated through loans such as suppliers from commercial banks

(c) generated through issue

(d) generated within of shares the business

Answer. (d) generated within of shares the business

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Q1 What is business finance? Why do businesses need funds? Explain.

Answer. Business is concerned with the production and distribution of goods and services for
the satisfaction of needs of society. For carrying out various activities, business requires money.
Finance, therefore, is called the life blood of any business. The requirements of funds by
business to carry out its various activities is called business finance. The need for funds arises
from the stage when an entrepreneur makes a decision to start a business. Some funds are
needed immediately say for the purchase of plant and machinery, furniture, and other fixed
assets. Similarly, some funds are required for day-to-day operations, say to purchase raw
materials, pay salaries to employees, etc. Also when the business expands, it needs funds.

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Q2 List sources of raising long-term and short-term finance.

Answer. The long-term sources fulfil the financial requirements of an enterprise for a period
exceeding 5 years and include sources such as shares and debentures, long-term borrowings

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and loans from financial institutions. Such financing is generally required for the acquisition of
fixed assets such as equipment, plants , etc.

Short-term funds are those which are required for a period not exceeding one year. Trade
credit, loans from commercial banks and commercial papers are some of the examples of the
sources that provide funds for short duration.

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Q3 What is the difference between internal and external sources of raising funds? Explain.

Answer. Internal sources of funds are those that are generated from within the business. A
business, for example, can generate funds internally by accelerating collection of receivables,
disposing of surplus inventories and ploughing back its profit. The internal sources of funds can
fulfill only limited needs of the business.

External sources of funds include those sources that lie outside an organisation, such as
suppliers, lenders, and investors. When large amount of money is required to be raised, it is
generally done through the use of external sources. External funds may be costly as compared
to those raised through internal sources. In some cases, business is required to mortgage its
assets as security while obtaining funds from external sources.

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Q4 What preferential rights are enjoyed by preference shareholders. Explain.

Answer. The capital raised by issue of preference shares is called preference share capital. The
preference shareholders enjoy a preferential position over equity shareholders in two ways: (i)
receiving a fixed rate of dividend, out of the net profits of the company, before any dividend is
declared for equity shareholders; and (ii) receiving their capital after the claims of the company’s
creditors have been settled, at the time of liquidation. In other words, as compared to the equity
shareholders, the preference shareholders have a preferential claim over dividend and
repayment of capital.

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Q5 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.
(ii) State financial corporation : (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.
(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.

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Q6 What is the difference between GDR and ADR? Explain.

Answer. Global Depository Receipts (GDR’s): The local currency shares of a 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 Global Depository
Receipts (GDR). 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 (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 season stocks. It 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.

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Q1 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. Trade credit facilitates the purchase of supplies without immediate payment. Such
credit appears in the records of the buyer of goods as ‘sundry creditors’ or ‘accounts payable’.
Trade credit is commonly used by business organisations as a source of short-term financing. It
is granted 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 one industry to
another and from one person to another. A firm may also offer different credit terms to different
customers.

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.

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Q2 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) State industrial development corporation : (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.
(ii) Union 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.
(iii) 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.

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Q3 What advantages does issue of debentures provide over the issue of equity shares?

Answer. Debentures are an important instrument for raising long term debt capital. A company
can raise funds through issue of debentures, 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, therefore, termed
as creditors of the company. Debenture holders are paid a fixed stated amount of interest at
specified intervals say six months or one year. Public issue of debentures requires that the

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issue be rated by a credit rating agency like CRISIL (Credit Rating and Information Services of
India Ltd.) on aspects like track record of the company, its profitability, debt servicing capacity,
credit worthiness and the perceived risk of lending. A company can issue different types of
debentures (see Box C and D). Issue of Zero Interest Debentures (ZID) which do not carry any
explicit rate of interest has also become popular in recent years. The difference between the
face value of the debenture and its purchase price is the return to the investor.

Merits

The merits of raising funds through debentures are given as follows:

(i) It is 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) As debentures do not carry voting rights, financing through debentures does not dilute
control of equity shareholders on management;

(v) Financing through debentures is less costly as compared to cost of preference or equity
capital as the interest payment on debentures is tax deductible.

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Q4 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.

Merits

The merits of public deposits are:

(i) The procedure of obtaining deposits is simple and does not contain restrictive conditions as
are generally there in a loan agreement;

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(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. The assets
can be used as security for raising loans from other sources;

(iv) As the depositors do not have voting rights, the control of the company is not diluted.

Demerits

The major limitation of public deposits are as follows:

(i) New companies generally find it difficult to raise funds through public deposits.

(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

A company generally does not distribute all its earnings amongst the shareholders as dividends.
A portion of the net earnings may be retained in the business for use in the future. This is known
as retained earnings. It is a source of internal financing or self-financing or ‘ploughing back of
profits, The profit available for ploughing back in an organisation depends on many factors like
net profits, dividend policy and age of the organisation.

Merits

The merits of retained earning as a source of finance are as follows:

(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, dividend or floatation cost;

(iii) As the funds are generated internally, there is a greater degree of operational freedom and
flexibility.

Demerits

Retained earning as a source of funds has the following limitations:

(i) Excessive ploughing back may cause dissatisfaction amongst the shareholders as they
would get lower dividends;

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(ii) It is an uncertain source of funds as the profits of business are fluctuating;

(iii) The opportunity cost associated with these funds is not recognised by many firms. This may
lead to sub-optimal use of the funds.

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Q5 Discuss the financial instruments used in international financing.

Answer. These are the financial institution :

(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.

(ii) State financial corporation : (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.

(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.

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Q6 What is a commercial paper? What are its advantages and limitations.

Answer. Commercial Paper emerged as a source of short term finance in our country in the
early nineties. Commercial paper is an unsecured promissory note issued by a firm to raise

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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. As the debt is totally unsecured, the firms having good credit rating can
issue the CP. Its regulation comes under the purview of the Reserve Bank of India.

The merits and limitations of a Commercial Paper are as follows:

Merits

(i) A commercial paper is sold on an unsecured basis and does not contain any restrictive
conditions;

(ii) As it is a freely transferable instrument, it has high liquidity;

(iii) It provides more funds compared to other sources. Generally, the cost of CP to the issuing
firm is lower than the cost of commercial bank loans;

(iv) A commercial paper provides a continuous source of funds. This is because their maturity
can be tailored to suit the requirements of the issuing firm. Further, maturing commercial paper
can be repaid by selling new commercial paper;

(v) Companies can park their excess funds in commercial paper thereby earning some good
return on the same.

Demerits

(i) Only financially sound and highly rated firms can raise money through commercial papers.
New and moderately rated firms are not in a position to raise funds by this method.

(ii) The size of money that can be raised through commercial paper is limited to the excess
liquidity available with the suppliers of funds at a particular time;

(iii) Commercial paper is an impersonal method of financing. As such 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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