Business Studies XI

Sources of Business Finance

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

Funds required to carry the load of the organisation and its daily operations is called Business finance. Businesses need funds due to following reasons:

1. An organisation needs machinery, building, furniture etc. to setup operations and for purchasing all these items funds are necessary, it is called fixed capital requirement, the amount of varies with type of business.

2. To run day to day operations like purchasing raw materials require regular funds, also called as working capital requirement.

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

Long term finance sources are:

1. Equity Shares

2. Debentures

3. Retained earnings

4. Preference shares

5. Loans from banks and other financial institutions

Short term finance sources are:

1. Commercial papers

2. Trade credit

3. Short term loans from banks

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

Basis of Comparison Internal Source External Source
Source Funds generated from within the business Funds generated from outside source such as suppliers, investors.
Need Fulfilment Able to fulfil limited needs Can gather many links for raising capital
Security No security required Security required in form of mortgaging assets

4. What preferential rights are enjoyed by preference shareholders? Explain.

Following rights are enjoyed:

1. At the time of dividend declaration be the first to receive a fixed rate of dividend from profits.

2. In case of liquidation, the preference to receive capital after creditor claims are settled.

3. In case of company dissolution, preference share capital will be refunded before equity share capital.

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

Global Depository Receipts or GDR: Receipts that are shared by depository banks against company shares. GDR are denoted in US dollars and can be easily converted into shares at any time. They can be listed and traded on all stock exchanges over the world.

American Depository Receipts or ADR: These receipts are issued by companies which are US based, and like other securities get traded in the market. The only factor is that the trading is restricted to US Securities market and these receipts are only sold to US citizens.

Long questions

1. Explain trade credit and bank credit as sources of short-term finance for business enterprises.

Trade credit: The credit offered by one supplier to a purchaser of goods is called as trade credit. This helps in promoting sale of goods and services, as the purchaser is not required to make payment at that time in the form of cash. Such credit is granted only to creditworthy customers. There are factors that influence the volume and period of the credit and they are:

1. Financial position of seller

2. Past payment record

3. Volume of purchases

Benefits of trade credit:

1. It helps a company in accumulating inventories for increasing sales in future.

2. Trade creditors do not have any rights over company assets. Therefore assets can be mortgaged for raising money from other sources.

Bank credit: Commercial banks provide source of funds and these funds are used for different purposes and time periods in the form of overdrafts, cash credits, discounting bills. These loan needs to be paid in lump sum or by paying in instalments.

Benefits of bank credit

1. There is secrecy in providing information about their customers.

2. Provides flexibility in terms of loan repayment.

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

Debentures provide the following advantages over equity shares:

1. Issuing equity shares makes the shareholders own the company, and they become entitled to voting rights while debenture holders do not have any rights in the organisation. They get a fixed amount in form of payment. Debentures thus do not contribute towards dilution of ownership of company and can be issued without any risk.

2. For issuing shares, the company has to bear huge costs, also dividends payment is not tax deductible. For interest paid to debenture company receives tax deductions, so issuing debenture is beneficial.

3. Debentures are having a fixed rate of return. So if no profit is also earned, then also the company needs to pay the dividend, which is at a fixed rate, on the other hand, a company issuing equity shares and making profit needs to share more with the shareholders, which varies with the profit earned. Thus, it is better to issue debentures.

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