This page contains the NCERT Business Studies class 11 chapter 8 Sources of Business Finance from Part 2 Corporate Organisation, Finance and Trade. You can find the solutions for the chapter 8 of NCERT class 11 Business Studies, for the Short Answer Questions, Long Answer Questions and Projects/Assignments Questions in this page. So is the case if you are looking for NCERT class 11 Business Studies related topic Sources of Business Finance question and answers.
Short Answer Questions
1. What is business finance? Why do businesses need funds? Explain.
Business Finance
Business finance is the money required by a business to conduct its activities. It’s deemed the lifeblood of any business as it supports both the production and distribution of goods and services.
Reasons Why Businesses Need Funds:
1.
Fixed capital requirements: For purchasing assets like land, machinery, and furniture at the start of the business.
2.
Working capital requirements: To support day-to-day operations like buying raw materials and paying salaries.
3.
Expansion: As businesses grow, more funds are needed for activities like technology upgrades or inventory buildup.
In essence, funds are crucial for starting, operating, and growing a business.
2. List sources of raising long-term and short-term finance.
The follownig is the list of sources of raising long-term and short-term finance.
Long-term Finance:
1.
Retained Earnings: Companies often keep a part of their net earnings for future use instead of distributing it all as dividends. This internally retained profit is known as retained earnings.
2.
Issue of Shares: Companies raise money by issuing both equity and preference shares. Equity shareholders are the real owners of a company, while preference shareholders have a preferential claim over dividend and repayment of capital.
3.
Debentures: These are instruments for raising long-term debt capital. Companies promise to repay the borrowed amount at a future date and pay a fixed interest to debenture holders.
4.
Lease Financing: It is similar to renting an asset for a specified period where the lessee pays periodic lease rentals to the lessor.
5.
Public Deposits: Organizations raise funds directly from the public, often offering a higher rate of interest than banks.
6.
Financial Institutions: Government-established institutions that provide both owned capital and loan capital for long and medium-term requirements.
Short-term Finance:
1.
Trade Credit: Extended by one trader to another, it allows businesses to purchase supplies without immediate payment.
2.
Factoring: A financial service where the ‘factor’ offers services like discounting of bills and collecting the client’s debts. They can also provide protection against bad debt losses.
3.
Commercial Paper (CP): An unsecured money market instrument issued as a promissory note. It’s used by high-rated corporate borrowers to diversify their short-term borrowing sources.
4.
Commercial Banks: These banks provide short-term loans in various forms like cash credits, overdrafts, and purchase/discounting of bills.
In essence, these sources offer businesses the flexibility to obtain the required funds based on their needs and terms most favorable to them.
3. What is the difference between internal and external sources of raising funds? Explain.
The following are the differences between Internal and External Sources of Raising Funds
The sources of funds for a business can be categorised based on whether they are generated from within the organisation (internal sources) or from outside the organisation (external sources).
Internal Sources: Internal sources of funds are those generated from within the business. Some of the ways a business can generate funds internally include:
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Accelerating the collection of receivables.
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Disposing of surplus inventories.
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Ploughing back its profits.
It’s important to note that the internal sources of funds can only fulfil limited needs of the business.
External Sources: External sources of funds refer to those sources that lie outside the business organisation. They include:
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Suppliers.
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Lenders.
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Investors.
When a business needs to raise a large amount of money, it generally relies on external sources. However, obtaining funds from external sources might be costlier compared to internal sources. In some cases, the business may be required to mortgage its assets as security to obtain funds from external sources. Common examples of external sources include the issue of debentures, borrowing from commercial banks and financial institutions, and accepting public deposits.
4. What preferential rights are enjoyed by preference shareholders. Explain.
The following preferential rights are enjoyed by the preference shareholders in comparison to equity shareholders:
1. Dividend Rights:
Preference shareholders have the first right to receive dividends. They get a fixed rate of dividend, out of the net profits of the company, before any dividend is declared for equity shareholders.
2. Repayment of Capital during Liquidation:
In case of company’s liquidation, preference shareholders stand ahead of equity shareholders. They get back their invested capital after the company’s creditors have been repaid but before the equity shareholders.
In essence, these preferential rights ensure that preference shareholders get priority both in terms of profit distribution and capital repayment.
5. Name any three special financial institutions and state their objectives.
Financial Institutions
Financial institutions play a significant role in the economic development of a country by providing financial support and advisory services to businesses. Established by the government, they offer both owned capital and loan capital to cater to long and medium-term requirements, supplementing the roles of traditional financial agencies like commercial banks. Their primary aim is to promote the country’s industrial development, and therefore, they are also termed ‘development banks’. These institutions don’t just provide financial aid but also extend market surveys, technical assistance, and managerial services.
Three Special Financial Institutions and Their Objectives
1.
State Bank of India (SBI):
Objective: SBI, the largest public sector bank in India, aims to provide various financial products and services to individuals, businesses, and governments, facilitating economic growth and promoting financial inclusion in the country.
2.
Industrial Credit and Investment Corporation of India (ICICI):
Objective: ICICI’s primary goal is to assist in the development and growth of major sectors in the Indian industry, offering a diverse range of financial products and services to cater to the different needs of the business sector.
3.
Punjab National Bank (PNB):
Objective: PNB, one of the prominent public sector banks, aims to offer a wide array of banking and financial services, promoting commerce, trade, and industry in the country while ensuring financial stability.
The aforementioned financial institutions play pivotal roles in bolstering economic activities, supporting industrial ventures, and ensuring that businesses have access to the necessary funds and guidance to prosper and contribute to the nation’s growth.
6. What is the difference between GDR and ADR? Explain.
The following are the differences between GDR and ADR
Global Depository Receipts (GDRs):
●
GDRs are financial instruments wherein the local currency shares of a company are delivered to the depository bank. In return, the depository bank issues depository receipts against these shares.
●
These are denominated in US dollars and are known as Global Depository Receipts.
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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 a foreign currency. It is listed and traded on a foreign stock exchange.
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A holder of GDR can convert it into the number of shares it represents.
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The holders of GDRs do not have voting rights but only receive dividends and capital appreciation.
American Depository Receipts (ADRs):
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ADRs are a type of depository receipt issued by a company in the USA.
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They are bought and sold in American markets like regular stocks.
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ADR is similar to a GDR but has some key distinctions. It can only be issued to American citizens and can be listed and traded on a stock exchange of the USA.
In essence, while both GDRs and ADRs serve as a medium for foreign companies to raise funds in a different country, the primary difference lies in the geographical area of issuance and trading. GDRs are typically issued and traded outside the USA, while ADRs are specifically issued and traded within the USA.
Long Answer Questions
1. Explain trade credit and bank credit as sources of short-term finance for business enterprises.
Trade Credit as a Source of Short-Term Finance
Trade credit is the credit extended by one trader to another for the purchase of goods and services. It allows a business to purchase supplies without having to make an immediate payment. This type of credit becomes a part of the buyer’s records as ‘sundry creditors’ or ‘accounts payable’.
Merits of Trade Credit:
(i)
It serves as a convenient and continuous source of funds.
(ii)
Readily available if the buyer’s creditworthiness is known to the seller.
(iii)
Helps promote the sales of an organisation.
(iv)
Allows an organisation to increase its inventory to meet expected sales volumes in the future.
(v)
Does not place any charge on the assets of the firm.
Limitations of Trade Credit:
(i)
Excessive availability might induce a firm to overtrade, increasing the risks.
(ii)
Generates only a limited amount of funds.
(iii)
Generally, it’s a more costly source of funds compared to other money-raising methods.
Commercial Banks as a Source of Short-Term Finance
Commercial banks play a pivotal role by providing funds for various purposes and durations. They extend loans to firms in multiple ways such as cash credits, overdrafts, term loans, bill purchasing/discounting, and issuing letters of credit. The rate of interest that banks charge is dependent on factors like the nature of the firm and the prevailing interest rates in the economy. Bank credit, in essence, is not a permanent source of funds. Although they now offer longer-term loans, such loans are typically for medium to short periods. Security or a charge on the firm’s assets is usually required by the bank before sanctioning a loan.
Merits of Commercial Bank Credit:
(i)
They provide timely assistance by supplying funds as needed.
(ii)
Maintains business secrecy as the bank keeps the borrower’s information confidential.
(iii)
Securing a loan is relatively easier, with no need for formalities like issuing a prospectus or underwriting.
(iv)
Bank loans are flexible; the amount can be adjusted based on business needs and can be paid in advance when not required.
Limitations of Commercial Bank Credit:
(i)
Funds are typically available for shorter periods, and renewing or extending such funds can be uncertain and challenging.
(ii)
Banks conduct a thorough investigation of the company’s financial health and often require asset security or personal guarantees, making the borrowing process more cumbersome.
(iii)
In some instances, banks might impose stringent terms and conditions on loans, which can hinder normal business operations.
In conclusion, both trade credit and commercial bank credit serve as viable sources of short-term finance for business enterprises. However, the appropriateness of either depends on the specific needs and circumstances of the business. Trade credit is more suited for businesses looking for flexibility in payment terms with suppliers, while commercial bank credit is better for businesses seeking more structured and substantial funding.
2. Discuss the sources from which a large industrial enterprise can raise capital for financing modernisation and expansion.
The following are the sources from which a large industrial enterprise can raise capital for financing modernisation and expansion
A large industrial enterprise has a plethora of options to raise capital for modernisation and expansion. Here’s a detailed discussion on the sources:
1. Retained Earnings
Retained earnings refer to the portion of net earnings that is retained in the business rather than being distributed as dividends. This is a form of internal financing or ‘ploughing back of profits’. For a large industrial enterprise, this is a significant source as they often have substantial profits, and retaining a part of it can provide a considerable amount for modernisation and expansion.
2. Issue of Shares
Large industrial enterprises can raise capital by issuing shares. There are two main types of shares:
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Equity Shares: Representing the ownership of a company, equity shares are a primary source of long-term capital. Equity shareholders are termed as ‘residual owners’ and have the right to participate in the management of the company.
●
Preference Shares: These shareholders enjoy a preferential position in terms of dividend distribution and repayment of capital. There are various types of preference shares like cumulative, non-cumulative, participating, non-participating, convertible, and non-convertible.
3. Debentures
Debentures are instruments for raising long-term debt capital. Large enterprises can issue various types of debentures, such as secured, unsecured, convertible, non-convertible, registered, bearer, first, and second debentures. Zero Interest Debentures (ZID) have also become popular, where the return to the investor is the difference between the face value of the debenture and its purchase price.
4. Lease Financing
Leasing is an agreement where the owner (lessor) of an asset grants the right to use the asset to another party (lessee) in exchange for periodic payments. Large industrial enterprises can lease expensive machinery and equipment, which is especially beneficial for assets that become obsolete quickly due to technological advancements.
5. Commercial Banks
Commercial banks play a pivotal role in providing funds. They offer various loan facilities like cash credits, overdrafts, term loans, and more. For large industrial enterprises, banks can provide substantial amounts, especially for medium to short-term requirements.
6. Financial Institutions
Government-established financial institutions, also known as ‘development banks’, offer both owned capital and loan capital for long and medium-term requirements. They not only provide financial assistance but also offer technical and managerial services. These institutions are particularly beneficial for large-scale expansion and modernisation projects.
7. Inter Corporate Deposits (ICD)
ICDs are unsecured short-term deposits made by one company with another. They are used for short-term cash management and can be a viable option for large industrial enterprises facing short-term fund insufficiencies.
8. Factoring
Factoring can be an essential source for large enterprises. It involves selling receivables on account of goods or services to a ‘factor’ at a discount. The factor then becomes responsible for credit control and debt collection. This method provides immediate cash flow, which can be reinvested in modernisation and expansion.
9. Commercial Paper (CP)
CP is an unsecured money market instrument. It allows highly rated corporate borrowers to diversify their sources of short-term borrowings. Given the stature and creditworthiness of large industrial enterprises, they can effectively use CPs to meet short-term funding requirements.
In conclusion, large industrial enterprises have a range of options to source funds for modernisation and expansion. The choice of source would depend on the specific needs, cost considerations, and associated risks of the enterprise.
3. What advantages does issue of debentures provide over the issue of equity shares?
The following are the advantages of issuing debentures over equity ehares
1.
Fixed Income for Investors: Debentures provide a fixed income at lesser risk, making them suitable for investors who want consistent returns. In contrast, equity shareholders receive dividends which can vary based on the company’s performance.
2.
No Dilution of Control: Debentures do not carry voting rights, ensuring that the control of equity shareholders over the management remains undiluted. Issuing more equity shares can dilute the voting power of existing shareholders.
3.
Tax Benefits: The interest payment on debentures is tax deductible, leading to potential tax savings for the company. Dividends to equity shareholders, however, are not deductible and are paid from post-tax profits.
4.
Fixed Charge Funds: Debentures are fixed charge funds and do not participate in the company’s profits. This contrasts with equity shareholders who might expect higher dividends when the company performs well.
5.
Cost-Effective: Financing through debentures is often less costly compared to equity. This is because the interest rate on debentures is typically lower than the expected dividend rate by equity shareholders.
6.
No Interference in Management: Debenture holders, lacking voting rights, cannot interfere in the company’s management. Equity shareholders, with their voting rights, can influence major company decisions.
7.
Flexibility in Terms: Debentures offer flexibility with various types available, such as convertible, non-convertible, secured, and unsecured. This provides the company with multiple options based on its needs.
8.
Predictable Financial Obligation: With debentures, the company has a clear and predictable financial obligation in the form of interest payments. In contrast, dividends for equity shareholders can vary and might be higher during profitable years.
So, it’s evident that debentures offer several advantages for companies, especially when they aim to raise funds without diluting control or sharing a larger portion of their profits.
4. State the merits and demerits of public deposits and retained earnings as methods of business finance.
Public Deposits
Merits:
1.
Simplicity and Flexibility: The procedure for obtaining public deposits is simple and does not contain the restrictive conditions often found in loan agreements.
2.
Cost-Effective: The cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions.
3.
No Charge on Assets: Public deposits do not usually create any charge on the assets of the company. This means the assets remain free to be used as security for raising loans from other sources.
4.
No Dilution of Control: Since depositors do not have voting rights, there is no dilution of the company’s control.
Limitations:
1.
Challenges for New Companies: New companies might find it challenging to raise funds through public deposits.
2.
Unreliability: Public deposits can be an unreliable source of finance. There’s no guarantee that the public will deposit money when the company needs it.
3.
Collection Difficulties: Especially when a large amount is required, collecting public deposits may prove to be difficult.
Retained Earnings
Merits:
1.
Permanent Source: Retained earnings offer a permanent source of funds available to an organization.
2.
No Explicit Cost: Using retained earnings does not involve any explicit cost like interest, dividend, or floatation cost.
3.
Operational Freedom: Since these funds are generated internally, businesses have a greater degree of operational freedom and flexibility.
4.
Buffer Against Losses: Retained earnings enhance a business’s capacity to absorb unexpected losses.
5.
Potential for Increased Share Price: The use of retained earnings might lead to an increase in the market price of a company’s equity shares.
Limitations:
1.
Shareholder Dissatisfaction: Excessive ploughing back of profits might cause dissatisfaction among shareholders due to lower dividends.
2.
Uncertainty: Retained earnings can be uncertain since business profits fluctuate.
3.
Opportunity Cost: Many firms do not recognize the opportunity cost associated with retained earnings, which might lead to sub-optimal use of the funds.
Both public deposits and retained earnings have their unique advantages and limitations. The choice between them depends on the specific needs and circumstances of the business.
Projects/Assignment
1. Collect information about the companies that have issued debentures in recent years. Give suggestions to make debentures more popular.
Companies that have issued debentures in recent years:
1.
Reliance Industries Limited (RIL): In recent years, RIL has issued non-convertible debentures (NCDs) to raise funds for its various business ventures and to refinance existing debt.
2.
Tata Motors: Tata Motors has also raised funds through the issuance of NCDs, especially to support its operations and manage its debt.
3.
Housing Development Finance Corporation (HDFC): Being a leading housing finance company in India, HDFC frequently resorts to debenture issuances to raise funds for its lending operations.
4.
Larsen & Toubro (L&T): L&T has issued debentures as part of its diversified financial strategy to fund its infrastructure and other projects.
Suggestions to make debentures more popular:
1.
Tax Incentives: The government can provide tax incentives or rebates for investors who invest in debentures, making them more attractive compared to other investment avenues.
2.
Higher Interest Rates: Companies can offer slightly higher interest rates on debentures compared to bank fixed deposits to attract more investors.
3.
Credit Rating: Companies should get their debentures rated by top credit rating agencies. A higher rating can instill confidence among potential investors.
4.
Liquidity: Introducing or increasing the liquidity of debentures in secondary markets can make them more attractive to investors who might need to liquidate their investments.
5.
Transparency: Regular and transparent communication about the company’s financial health and use of debenture proceeds can build trust among investors.
6.
Diversified Options: Companies can offer various types of debentures, such as convertible and non-convertible, secured and unsecured, to cater to the diverse needs of investors.
7.
Digital Platforms: Leveraging digital platforms for the issuance, management, and redemption of debentures can make the process more seamless and user-friendly for investors.
8.
Educational Campaigns: Companies, in collaboration with financial institutions, can run educational campaigns to inform potential investors about the benefits and safety of investing in debentures.
2. Institutional financing has gained importance in recent years. In a scrapbook paste detailed information about various financial institutions that provide financial assistance to Indian companies.
Here’s an approach to prepare a scrapbook pasing detailed information about various financial institutions that provide financial assistance to Indian companies.
Scrapbook Title: “Institutional Financing in India: Pillars of Business Growth”
Page 1: Introduction
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Image: A collage of logos of major financial institutions in India.
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Text: “Institutional financing plays a pivotal role in the economic development of India. These institutions provide the much-needed financial muscle to businesses, from budding startups to established conglomerates. Let’s embark on a journey to explore these financial giants!”
Page 2: Reserve Bank of India (RBI)
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Image: A picture of the RBI headquarters.
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Text:
○
Established: 1935
○
Role: Central bank of India, regulator of monetary policy.
○
Services: Regulates money supply, issues currency, supervises financial institutions, and provides financial support to scheduled banks.
Page 3: Industrial Finance Corporation of India (IFCI)
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Image: IFCI’s emblem or building.
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Text:
○
Established: 1948
○
Role: Provides financial support to the industrial sector.
○
Services: Offers long-term financial support to industries, underwriting shares, and debentures.
Page 4: Industrial Credit and Investment Corporation of India (ICICI)
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Image: ICICI’s logo.
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Text:
○
Established: 1955
○
Role: Offers diversified financial services.
○
Services: Project financing, underwriting, direct subscription to securities, and assistance to backward areas.
Page 5: Industrial Development Bank of India (IDBI)
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Image: IDBI’s logo.
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Text:
○
Established: 1964
○
Role: Main institution for providing credit and other facilities for developing industries.
○
Services: Coordinates working of institutions engaged in financing, promoting, or developing industries.
Page 6: State Financial Corporations (SFCs)
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Image: Collage of logos of various SFCs.
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Text:
○
Established: 1951
○
Role: Provides financial assistance to small and medium enterprises.
○
Services: Granting loans and advances to industrial concerns, underwriting guarantees, and subscribing to debentures.
Page 7: Life Insurance Corporation of India (LIC)
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Image: LIC’s emblem.
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Text:
○
Established: 1956
○
Role: Provides insurance and investment services.
○
Services: Mobilizes community savings in the form of insurance and makes it available for economic development.
Page 8: Unit Trust of India (UTI)
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Image: UTI’s logo.
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Text:
○
Established: 1964
○
Role: Mobilizes savings of the community and channels them into productive ventures.
○
Services: Manages various mutual funds, provides resources for capital markets and other investments.
Page 9: Conclusion
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Image: A collage of various industries – IT, manufacturing, agriculture, and services.
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Text: “Institutional financing is the backbone of India’s economic growth. By providing necessary funds and financial services, these institutions propel businesses to new heights, ensuring a prosperous future for the nation.”
Page 10: References and Sources
List down the sources from where the information was gathered, including websites, books, and financial reports.
Remember, the scrapbook can be made more interactive with charts, graphs, and even testimonials from businesses that benefited from these institutions. It’s also a good idea to keep it updated with the latest data and trends.
3. On the basis of the sources discussed in the chapter, suggest suitable options to solve the financial problem of the restaurant owner.
The following are the suitable options to solve the financial problem of the restaurant owner.
1.
Trade Credit: The restaurant owner can negotiate with suppliers for extended credit terms. This will allow the owner to purchase ingredients and other supplies without immediate payment, giving them some breathing room to manage their finances.
2.
Public Deposits: The restaurant can invite the public to deposit money with them for a fixed period of time, offering a rate of interest slightly higher than banks. This can be an effective way to raise medium to short-term finance.
3.
Bank Loans: Commercial banks can provide loans for various purposes. The restaurant owner can approach a bank for a term loan or an overdraft facility. This would be especially useful for medium to short-term financial needs.
4.
Lease Financing: Instead of purchasing expensive kitchen equipment or furniture outright, the restaurant owner can consider leasing them. This would reduce the initial capital outlay and spread the cost over a period of time.
5.
Factoring: If the restaurant offers services to corporate clients or large parties on credit, they can use factoring services to get immediate cash. By selling their receivables at a discount to a factor, they can manage their cash flow more effectively.
6.
Financial Institutions: Development banks or financial institutions established by the government can provide both owned capital and loan capital for long and medium-term requirements. They can also offer technical assistance and managerial services which can be beneficial for the restaurant’s growth.
7.
Issue of Shares: If the restaurant is structured as a company, it can consider issuing shares to raise capital. This would bring in ownership capital. However, this might be more suitable for a larger restaurant chain or a well-established brand.
8.
Retained Earnings: If the restaurant has been in business for some time and has accumulated profits, it can reinvest these profits (or a portion of them) back into the business. This is a cost-effective way of financing as it doesn’t involve any interest payment or dilution of ownership.
9.
Commercial Paper: If the restaurant has a good credit rating, it can issue commercial papers to raise short-term funds. This would be more suitable for larger restaurant chains with a good financial standing.
10.
Inter Corporate Deposits (ICD): If the restaurant owner has connections with other businesses, they can consider borrowing from them through inter-corporate deposits. This can be a quick way to raise short-term funds.
Conclusion: The choice of the source of finance would depend on the exact financial needs of the restaurant, its size, its financial health, and its growth prospects. It’s essential for the restaurant owner to carefully evaluate each option, considering the cost of finance, the duration for which funds are needed, and the terms and conditions associated with each source.
4. Prepare a comparative chart of all the sources of finance.
Comparative Chart of Sources of Finance
Source of Finance
Nature/Type
Duration
Cost/Interest
Security Required
Advantages
Limitations
Trade Credit
Short-term
Short
Varies
No
Quick & easy
Limited period
Public Deposits
Debt
Medium
Moderate
No
Flexible
Regulatory constraints
Bank Loans
Debt
Short/Medium
Moderate-High
Yes
Reliable
Interest cost
Lease Financing
Debt/Ownership
Medium/Long
Moderate
No
Spreads cost
Long-term commitment
Factoring
Short-term
Short
Fees/Discount
No
Immediate cash
Costs associated
Financial Institutions
Debt/Equity
Long
Moderate-High
Often required
Large amounts
Strict criteria
Issue of Shares
Ownership
Long
Dividends
No
Permanent capital
Dilutes ownership
Retained Earnings
Ownership
N/A
None
No
No external liability
Limited to profits
Commercial Paper
Debt
Short
Low-Moderate
No
Flexible
Only for high credit firms
Debentures
Debt
Long
Fixed
Often required
Large amounts
Fixed interest cost
Commercial Banks
Debt
Short/Medium
Moderate-High
Yes
Multiple services
Repayment pressure
International Financing
Debt/Equity
Varies
Varies
Varies
Access to large funds
Complex regulations
Note: The above chart provides a general overview of the sources of finance. The exact nature, cost, and other attributes might vary based on specific circumstances, market conditions, and regulatory changes.
