Topic: Sources of Business Finance

------ 11th CBSE

Characteristics
1. Mr. Ajay Menon wants Rajeev to invest in equity shares due to following reasons:
(i) Equity shares are suitable for investors who are willing to assume risk for higher returns.
(ii) Democratic control over management of the company is assured due to voting rights of equity
shareholders.
(iii) The return available to equity shareholders is more if the profits of the company are high.
2. The source of finance used by company to meet its funds requirement is America Depository Receipts(ADRs)
American Depository Receipts are the depository receipts issued by a company in the USA. ADRs are bought
and sold in American markets, like regular stocks. It can be issued only to American citizens and can be listed
and traded on a stock exchange of USA.
3. Indian Depository Receipt (IDRs): Indian Depository Receipts is a financial instrument denominated in Indian
Rupees in the form of a Depository Receipt. It is created by an Indian Depository to enable a foreign company
to raise funds from the Indian securities market. IDRs are issued to Indian residents in the same way as
domestic shares are issued.
4. (a) Retained Earnings is the most suitable source of owner's fund for the company.
(b) The merits of retained earrings as a source of finance are as follows:
(i) Retained earnings is a permanent source of funds available to the company.
(ii) It does not involve any explicit cost in the form of interest, dividend or floatation cost.
(iii) As funds are generated internally, there is greater degree of operational freedom and flexibility.

5. (a) Global Depository Receipts: 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. A holder of GDR can at any time
convert into the number of shares it represents. The holders of GDRs do not carry any voting rights but only
dividends and capital appreciation.
(b) The local currency shares of an European company are delivered to the depository bank. The depository
bank issues depository receipts against these share.
(c) An European company planning to raise funds from Indian financial market will issue Indian Depository
Receipts (IDR).
6. The most appropriate source of funds suitable for the company to finance its expansion programme are:
(i) Retained Earnings: company generally does not distribute all its earnings amongst the shareholders as
dividends. A portion of the net earnings is 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'. Retained
earnings is a permanent source of funds available to an organization. It does not involve any explicit cost in
the form of interest, dividend or floatation cost, As the funds are generated internally, there is a greater
degree of operational freedom and flexibility.
(ii) Debentures: 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
Money, which it promises to repay at a future date. Debenture holders are, therefore, termed as creditors of
the company. As debentures do not carry voting rights, financing through debentures does not dilute control
of equity shareholders on management. Financing through debentures is less costly as compared to cost of
preference or equity capital as the interest payment on debentures is tax deductible.
7. (a) 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.
(b) The merits of raising funds through debentures are 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.

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 (iii) As debentures do not carry voting rights, financing through debentures does not dilute control of equity
shareholders on management.
(iv) Financing through debentures is less costly as compared to cost of preference Or equity capital as the
interest payment on debentures is tax deductible.
8. (a) Loans from Financial Institution: The government has established a number of financial institutions all
over the country to provide finance to business organizations. These institutions are established by the central
as well as state governments. They provide both owned capital and loan capital for long and medium-term
requirements and supplement the traditional financial agencies like commercial banks. As these institutions
aim at promoting the industrial development of a country, these are also called 'development banks'.
(b) The merits of raising funds through financial institutions are as follows:
(i) Financial institutions provide long-term finance, which are not provided by commercial banks.
(ii) Besides providing funds, many of these institutions provide financial, managerial and technical advice and
consultancy to business firms.
(c) The demerits of raising funds from financial institutions are given below:
(i) Financial institution follow rigid criteria for grant of loans. Too many formalities make the procedure
consuming and expensive
(ii) Financial institutions may have their nominees on the Board of Directors of the borrowing company
thereby restricting the powers of the company.
9. (a) 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. Trade credit is commonly used by
business organizations as a source of short-term financing. It is granted to those customers who have
reasonable amount of financial standing and goodwill
(b) The important merits of trade credit are as follows:
(i) Trade credit is a convenient and continuous source of funds.
(ii) Trade credit may be readily available in case the credit worthiness of the customers is known to the seller.
(iii) Trade credit needs to promote the sales of an organization.
(iv) Trade credit does not create any charge on the assets of the firm while providing funds.
10. (a) Public Deposits is the most suitable source of fund for meeting the financial requirements of Emami Paper
Mills.
(b) The merits of public deposits are as follow :
(i) The procedure of obtaining deposits is simple and does not contain restrictive conditions as are generally
there in a loan agreement
(ii) Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions.
(c) The Demerits of public deposits are as follow:
(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.
11. The issue of equity and preference shares do not provide tax benefits to the company because the dividend
paid is not deductible from profits as expense. Thus, there is no tax saving as in the case of interest on
borrowings.
The sources which provide tax benefit to the company are:
(i) Debentures.
(ii) Loans from commercial banks.
(c) (i) The merits of raising through debentures are as follows:
 As debentures do not carry voting rights, financing through debentures does not dilute control of equity
shareholders on management.
 Financing through debentures less costly as compared to cost of preference or equity capital as the
interest payment on debentures is tax deductible.
(ii) The demerits of raising funds from a commercial bank are as follows:
 Banks provide timely assistance to business by providing funds as and when needed by it.
 Secrecy of business can be maintained as the information supplied to the bank by the borrowers is kept
confidential.
12. (a) The sources through which Amber Electrotech can meet its working capital requirements are:
 (i) Trade credit.
(ii) Loans from commercial banks.
(b) The merits of trade credit are as follows:
(i) Trade credit is a convenient and continuous source of funds.
(ii) Trade credit may be readily available in case the credit worthiness of the customers is known to the seller.
(c) The demerits of trade credit are as follows:
(i) Availability of easy and flexible trade credit facilities may induce a firm to indulge in overtrading which may
add to the risks of the firm.
(ii) Only limited amount of funds can be generated through trade credit.
13. (a) Morey required for carrying out business activities is called business finance. Almost all business activities
require some finance. Availability of adequate finance is very crucial for survival and growth of a business.
A business firm needs finance for following two purpose:
(i) 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 such as trademarks, patents, technical expertise etc.
(ii) Finance is needed for day to day operations of business like buying materials, paying bills, salaries,
collecting cash from customers etc. needed at every stage in life of the a business entity.
(b) The two categories of fund suggested by the consultancy firm:
(i) Owner's Funds: Owner's funds means funds that are provided by the owners of an enterprise. The owner's
capital remains invested in the business for a longer duration and is not required to be refunded during the
life period of the business. Equity shares and retained earnings are the two important sources from where
owner's funds can be obtained
(ii) Borrowed funds: Borrowed funds refer to the funds raised through loans or borrowings. The sources for
raising borrowed funds include loans from commercial banks, loans from financial institutions, issue of
debentures, public deposits and trade credit. Such sources provide funds for a specified period, on certain
terms and conditions and have to be repaid after the expiry of that period. A fixed rate of interest is paid by
the borrowers on such funds. Generally, borrowed funds are provided on the security of some fixed assets.
14. The two types of capital requirements of the company are:
(i) Fixed Capital Requirements: In order to start business, funds are required to purchase fixed assets like
land and building, plant and machinery, and furniture and fixtures. This is known as fixed capital requirements
of the company.
Lines: "Company will require about Rs.5000 crores to set up the plant."
(ii) Working Capital Requirements: The financial requirements of a company do not end with the
procurement of fixed assets. No matter how small or large a business is, it needs funds for its day-to-day
operations. This is known a working capital of the company, which is used for holding current assets and for
meeting current expenses.
Lines: "Company will require Rs.50 crores for power, fuel and operation of the new plant."
(b) The factors that affect the requirements of fixed and working capital are:
(i) Nature of Business: A manufacturing concern requires more fixed and working capital as compared to
trading concern.
(ii) Growth and Expansion: The requirement for fixed and working capital increases with the growth and
expansion of the company.
15. Let us compare the merits and demerits of equity shares and debentures for the company before advising the
directors about the most appropriate source of finance.
(a) Equity Shares:
The merits of raising funds through issuing equity shares are given below:
(i) Payment of dividend to the equity shareholders is not compulsory. Therefore, there is no burden on the
company.
(ii) Equity capital is a permanent source of capital as it is to be repaid only at the time of liquidation of a
company.
(iii) Funds can be raised through equity issue without creating any charge on the assets of the company. The
assets of a company are, therefore, free to be mortgaged for the purpose of borrowings.
 The major limitations of raising funds through issue of equity shares are as follows:
(i) The cost of equity shares is generally more as compared to the cost of raising funds through other sources.
(ii) Issue of additional equity shares dilutes the voting power, and earnings of existing equity shareholders.
(b) Debentures:
The merits of raising funds through debentures are as follows:
(i) Debentures are fixed charge funds and do not participate in profits of the company.
(ii) As debentures do not carry voting rights, financing through debentures does not dilute control of equity
shareholders on management.
(iii) Financing through debentures is less costly as compared to cost of preference or equity capital as the
interest payment on debentures is tax deductible.
The demerits of raising funds through debentures are as follows:
(i) As fixed charge instruments, debentures put a permanent burden on the earnings of a company. There is a
greater risk when earnings of the company fluctuate.
(ii) With the issue of debentures, the capacity of a company to further borrow funds reduces.
The decision of the directors to install a new water based paint plant in South India at an estimated cost of
rupees five crore is not a risky project. So the company should issue debentures for raising the funds due to
the relative advantages of this source over equity shares.
16. (a) Trade credit. (b) Public deposits. (c) Loans from commercial banks.
17. (a) Trade credit.
(b) Merits:
(i) Convenient source of finance. (ii) No formalities.
18. (a) Development banks/Financial Institutions.
(b) Merits of Financial Institutions:
(i) Repayment on easy terms.
(ii) Provide financial, managerial and technical advice to business firms.
19. (a) Public Deposits.
(b) Merits of Public Deposits:
(i) Simple Procedure. (ii) No dilution of control.
20. (a) Inter Corporate Deposits (ICD).
(b) Merits:
(i) Short-term source. (ii) Secured deposits.
21. (a) Financial strength of the company and stability of earnings.
(b) Financial burden.
(c) Equity Shares.
22. (a) Debentures
(b) Retained Earnings
(c) Inter Corporate Deposits
(d) Preference Shares
23. Problems of Financial Institutions:
(i) Follow rigid criteria for grant of loans.
(ii) Expensive Source.
(iii) Complex procedure.
(iv) May restrict the powers of the company.

24. Merits of Debentures:

(i) Fixed income at lesser risk.
(ii) No dilution of control.
(iii) Safe an secured investment.
(iv) Interest payment tax deductibles.

25. (a) Retained Earnings.

(b) Merits of Retained Earnings:
 (i) Permanent Source.
(ii) No-explicit cost.
Limitations of Retained Earnings:
(i) Dissatisfaction amongst the shareholders.
(ii) Uncertain source.
26. (a) Debentures.
(b) Merits of Debentures:
(i) No dilution of control.
(ii) Safe and secured investment.
Limitations of Debentures:
(i) Reduces the borrowing capacity.
(ii) Charge on assets.
27. (a) The two types of capital requirements of the company are:
(i) Fed capital requirements.
(ii) Working capital requirements.
(b) The factors that affect the requirements of fixed and working capital are:
(i) Nature of business.
(ii) Scale of operation.
28. The factors that affect the requirements of fixed capital are:
(i) Nature of business.
(ii) Scale of operation.
(iii) Growth and expansion.
29. (i) Trade credit.
(ii) Public deposits.
(iii) Loans from commercial banks.
30. (a) Equity share capital
(b) Trade credit
(c) Preference share capital
(d) Debenture
(e) Equity share capital
(f) Retained earnings