Important Questions for CBSE Class 11 Business Studies Chapter 8 - Sources of Business Finance

Very Short Answer Questions (1 Mark)

1. What do you mean by ploughing back of profits?

Ans: When a company earns profit, a certain amount or percentage of those profits is retained within the business for future use and this is known as retained earnings. When the business is financed through this source it is known as ploughing back of profit or internal financing.

2. Differ between ADR & GDR.

Ans: The difference between GDR and ADR is:

3. State the difference between lessor and lessee with the help of an example.

Ans: The 'lessor' is the person who owns the assets, while the 'lessee' is the person who uses them. Hence, the real owner of the asset is the lessor, while lessee is the temporary owner for the asset.

For example, Amul Dairy Ltd bought machinery from Jindal and Co. on a hire buy arrangement and paid Rs 200000 in lease fees. The lessee is Amul Diary Ltd, while the lessor is Jindal and Co.

4. What type of share capital is also called ‘’Risk Capital”

Ans: Risk capital is another name for equity share capital.

5. Name the return given to debenture holders for using their funds?

Ans: Debenture holders receive a fixed rate of interest for the use of their funds.

6. Name the one unique feature of ‘’Retained Earnings’’ which is not available in any other source of finance?

Ans: It is a self-sustaining source of income with no upfront costs. Retained earnings refers to a percentage of net earnings that is kept in the business for future usage.

7. What is the similarity between ADR and Public Deposits?

Ans: Depositors do not have voting rights in either ADR or Public Deposit, and the company's control is not eroded in both the cases.

8. Which term is concerned with the acquisition and conservation of capital funds in meeting the financial needs of a business enterprise.

Ans: The acquisition and conservation of capital money to meet financial needs is the focus of retained earnings.

9. Name the organization which has been set up by the central as well as State governments to provide medium term and long term loans to the business sector.

Ans: Developmental banks lend to businesses on a medium and long-term basis.

10. Write any one similarity between Equity share capital and preference share capital.

Ans: They are included in the owner's capital.

11. Write the names of 2 Indian companies that offer Factoring services.

Ans: SBI Factors and Commercial Services Ltd., Canbank Factors Ltd., are two Indian companies that provide factoring services.

Short Answer Questions                                        (3 or 4 Marks)

12. What preferential rights are enjoyed by preference shareholders?

Ans: Preference shareholders have the following preferred rights:  

• Preference in Dividend: They receive dividends at a fixed rate, and dividends on these shares are paid before dividends on equity shares.

• Preference in Repayment: When a corporation closes, preference shares are paid out first, followed by equity shares.

• Excess Profits: Preference shares have the right to partake in any excess profits that remain after equity shares have been paid.

• Preference in case of dissolution: They have the preference over equity shareholders in the share capital refund in the event of company dissolution.

13. What factors influence the working capital need in a business? write any three

Ans:  The factors influencing the working capital need in a business are:

• Nature of Business: Manufacturing business requires more working capital as compared to trading business or service provider.

• Business Cycle: During boom period firms require a large amount of working capital to manage the increased sales and production.

• Seasonal Factors: Seasonal businesses require more working capital during their season time.

• Scale of Operations: Businesses operating on a large scale require larger amounts of working capital as compared to small business firms.

• Credit Allowed: A business extending a longer credit period to its buyers will need more working capital as compared to a business doing cash business or offering a lesser credit period.

• Production Cycle: Businesses with longer production cycles require more working capital as compared to businesses with short-term production cycles.

• Credit Availed: A business organisation receiving longer credit period from their supplier will require lesser working capital as compared to business purchases goods for cash or receive short credit period.

14. Define Share and write any two advantages of it.

Ans: A company needs huge investments to start a business, this amount is known as capital. Since, it is impossible for one individual to bring in such a huge amount of capital, the entire capital is divided into small units known as shares, where each person holding shares is referred to as a shareholder.

Advantages

• It serves as permanent capital as it has to be repaid at the time of liquidation.

• Democratic control over the management of the company is given to shareholders through voting rights.

• Equity capital establishes a company's creditworthiness and gives prospective loan providers trust.

15. Write any two differences between share and debentures.

Ans: The difference between shares and debentures are:

16. Write any three limitations of equity share capital.

Ans: The three limitations of equity share capital are:

• The returns are fluctuating in nature so investors who need steady income may not prefer equity shares.

• Cost of raising funds from equity shares is quite high as compared to other sources.

• It is more of a complicated process and may take longer time to raise funds.

• The issuance of additional equity shares dilutes current equity shareholders' voting power and earnings.

17. Write any three advantages of Retained Earnings

Ans: The Merits of Retained Earnings are:

• No initial fees: These funds are not subject to any explicit fees, such as floatation costs or interest, because they are raised internally.

• Positive share price: A large quantity of retained earnings can cause the price of equity shares to rise.

• Loss Absorption: Because these are surplus profits retained in the business, they serve to mitigate the impact of unanticipated losses.

Long answer Questions                                                (5 or 6 Marks)

18. Explain trade credit and Factoring as a source of finance for a business enterprise.

Ans: Trade Credit

It refers to the extension and provision of credit by one one trader to another for the purchase of goods and services, or other supplies without on the spot payment.. 

This is generally used by organizations as short term financing. The terms of trade credit may vary from person to person based on past records and from industry to industry based on industry norms.

Merits

• A continuous and a convenient source of funds.

• It is readily available if credit worthiness is known to the seller.

• It helps in increasing the inventory levels in case of increase in sales volume.

• While providing funds, It does not create a charge on assets of the firm .

Limitations

• There can be chances of over-trading.

• Fulfils only limited financial needs.

• Costly in comparison to few other sources.

Factoring

This is a financial service in which a third party, namely factor, renders various services like discounting of bills and collection of clients' debts.  In this  a company gives the responsibility of the collection of debts from the debtors to the factor.  Also, through factoring large amounts of information can be fetched about trading history of the organization, the credit worthiness of debtors etc.

There are two methods of factoring: 

• Recourse Factoring: Factor does not assume the credit risk.

• Non-recourse factoring: Factor assumes and takes responsibility for the entire credit risk in case the debtor defaults.

Merits

• A cheaper source of finance as compared to other means such as bank credit.

• The organization is relieved from the task of collection of bad debt.

• Protection against bad debts to the firm in case of non-recourse factoring

• At times, the factor also provides finance to the company, that is he makes advance payment of the debts taken by him to the firm.

• It is flexible and does not create charge on assets of the firm.

Demerits

• It can be an expensive source, if there are a number of invoices of smaller amounts.

• Customers may not feel comfortable dealing with a third party(factor).

• The advance loan supplied by the factoring firm is normally accessible at a higher interest rate.

19. Discuss the various international sources from where the funds can be generated.

Ans: Organizations can raise funds in a variety of ways on a global scale. 

1. Commercial Banks

Commercial banks throughout the world issue foreign currency loans for business purposes. Banks offer different forms of loans and services depending on the country. These banks act as an important source of financing to non-trade international operations. They extend their support all over the world for foreign currency loans. For example: Standard Chartered.

2. International Agencies and Development Banks

They provide medium to long term loans for the development of economically backward areas of the world. These are set up by the governments of various developed countries. Example: EXIM Bank and Asian Development Bank (ADB).

3. International Capital Markets

Various MNCs and corporate houses depend on borrowings in the form of rupees and other foreign currency. A company's local currency shares are sent to the depository bank. Depository receipts are issued by the depository bank in exchange for these shares. The financial instruments used for the same are:

1. Global Depository Receipts: A GDR is a negotiable instrument or an instrument that can be traded freely in various foreign capital markets. These are issued by the Indian companies to raise funds from abroad and can also be traded on foreign stock exchanges.

2. American Depository Receipts: This instrument is issued by the American companies and can be traded in American markets. It can be issued to only citizens of America and can only be traded in US stock exchanges.

3. Indian Depository Receipts: IDRs are issued to Indian residents only and can be traded on Indian Stock Exchange. It is denominated in Indian Rupees. It is issued by an Indian Depository to enable foreign companies to raise funds from Indian Capital Markets. Standard Chartered PLC was the first company to issue IDRs.

4. Foreign Currency Convertible Bonds (FCCBs): As the name suggests, FCCBs are those bonds or securities which have an option to be converted into equity or depository receipt after a certain span of time. It is generally done at a predetermined rate or exchange rate. It has a fixed rate of interest and is issued in a foreign currency. It resembles the convertible debentures in India.

20. From which source a firm can raise long-term funds as loans when not provided by a commercial bank? Discuss its merits.

Ans: Financial Institutions

There are numerous financial institutions established by the government of India across the country.  These institutions finance the businesses and are set up by both state and central governments. There are development banks especially established to promote industrial development in the country.

Merits

• Provide long term funds which are not provided by the commercial banks 

• Provide various services such as managerial advice, financial and technical advice to the companies.

• Increases the goodwill of the borrowing company in the capital markets. 

• Funds can be made available even at the time of contingency and can be paid in easy installment without being a burden to the company.

21. What do you mean by owner’s fund? When it is not suitable?

Ans: Funds provided by the owners of the organization are known as Owners' funds. It includes profits that are reinvested into the business. The important sources of owners' funds are 

• Retained earnings 

• Issue of equity shares.

The non-suitability of using owner’s funds is based on the following factors:

• Dilution of Control: The choice of what source from which financing has to be procured also depends upon the extent to which firm is ready for the dilution of control. Such as if existing equity shareholders aren’t willing to dilute the control they enjoy, in such a case the company may issue finance from sources other than equity share capital.

• Tax Advantages: Some sources of finance are tax deductible, and hence firms can enjoy tax advantage using those sources. For example interest on debentures is a tax deductible expense, hence firms wanting to enjoy tax benefits may go for these sources. In such a situation, using the owners' fund is not suitable.

• Cost: There are two types of costs: the cost of obtaining funds and the cost of putting these funds to use. Both of these costs should be considered when deciding on a funding source. If the cost of the owner's fund exceeds the prospective returns, it should not be issued.

• Cash Flow Position: Before raising finance business must consider the projected flow to ensure that it has sufficient cash to pay fixed cash obligations.A company with high liquidity and a good cash flow position can issue debt capital, as the company will have less chances of facing financial risk than the company with a low cash position.

• Purpose and time frame: The business should plan for the time frame in which the finances are needed. A short-term requirement, for example, can be addressed by borrowing cash at a low-interest rate via trade credit, commercial paper, or other means. Long-term financing is best accomplished through the issuance of shares and debentures.

• Stock Market Conditions: If the stock market is flourishing, and there is a condition of boom then the companies may prefer more equity over debt in the capital structure. However, in the case of a bear market, to avoid any more risks, the companies will prefer more debt over equity in the capital structure.

• Ease of issuance of finance: The flexibility and ease with which the firm is able to procure finance also affects the choice of source of finance. Excessive documents, legal restrictions, heavy investigation and other reasons may discourage the company from using a particular source of finance. Hence, if the issue of such a source is difficult, the firm should not go for it.

22. Write the main advantages and disadvantages of Public Deposits.

Ans: Public deposits: 

Organizations raise public deposits from the general public to fund their short- term and medium-term financial needs. The interest rate on these deposits is usually higher than the interest rate on bank deposits. If a person wishes to invest in a business (by making a deposit), he or she must complete and submit a required form together with the deposit. The organization issues a deposit receipt as a mark of debt acknowledgment in exchange for the money borrowed.

Merits of Public Deposits:

• Minimal Restrictions: Accepting public deposits as a means of raising funds is a straightforward process with minimal restrictions.

• Low cost: The cost of raising funds through public deposits is generally lower than the cost of borrowing money from a commercial bank.

• No dilution of control: There are no voting or management rights for depositors. As a result, accepting public deposits does not affect the business's ownership structure.

Demerits of Public Deposits:

• Restricted financing: The quantity of money that may be raised from public deposits is restricted because it is dependent on the availability of capital and people's desire to invest in the company in question.

• Not suitable for new firms: Because people have little faith in new businesses, it is difficult for them to raise capital through public deposits.

23. Comment on the following sources of International finance 

(i) I.D.R. 

Ans: An Indian Depository Receipt (IDR) is a financial instrument in the form of a Depository Receipt that is denominated in Indian Rupees. An Indian Depository creates it for a foreign firm to raise capital from the Indian securities market. IDRs are issued to Indian residents in the same way that domestic shares are issued, according to SEBI norms. Residents can bid in the same style and technique as they can for Indian shares when the issuer company makes a public offering in India.

(ii) F.C.C.B

Ans: FCCB (Foreign Currency Convertible Bonds) are debt securities with an equity component that can be converted into equity or depository receipts after a set length of time. FCCB holders can choose to convert their bonds into equity shares at a predetermined price or exchange rate or keep the bonds. They have a fixed interest rate that is lower than any other non-convertible debt instrument with a similar interest rate. FCCBs are listed on overseas stock exchanges and traded there.

24. ‘’Ojas Auto Ltd. ‘’ is a very well-known auto company in the industry having more equity share capital than long term debt in its capital structure. It is willing to expand and establish a new unit in the backward region and wants to train the tribal women in skill Development to empower them. It has a huge amount of cash reserve of Rs. 1000 crores.

(a) What is the status of the capital structure of the above company?

Ans: The company's financial structure is robust, with more equity share capital than long-term debt in its capital structure and a large cash reserve.

(b) According to you, which source of finance should be used by the company in establishing new units? Give any two reasons in support of your answer.

Ans: As the company has huge cash reserves with itself, it should use retained earnings, or the self-financing technique for the establishment of new unit

When a company earns profit, a certain amount or percentage of those profits is retained within the business for future use and this is known as retained earnings. When the business is financed through this source it is known as ploughing back of profit or internal financing. Retained earnings is a percentage of net earnings that is kept in the business for future usage.

Reasons

• No initial fees: These funds are not subject to any explicit fees, such as floatation costs or interest, because they are raised internally.

• Positive share price: A large quantity of retained earnings can cause the price of equity shares to rise.

• Loss Absorption: Because these are surplus profits retained in the business, they serve to mitigate the impact of unanticipated losses.

(c) What values does the company exhibit in the above case?

Ans: The following values are displayed by the company:

• Balanced Regional Development: The company is willing to expand and open new units in underdeveloped areas, and it contributes to regional development.

• Women Empowerment: The company intends to empower indigenous women by training them in skill development.

25. ‘’Avika Ltd.’’ company, an IT giant company registered in India wants to top the huge amount of resources for its growth and expansion from U.S.A. for long term needs. It also needs money for a period of fewer than 3 years to meet its medium cum short term needs. The company is following the practice of educating and giving employment to underprivileged youth. 50% of its office electricity is generated through solar power. 

(a) Which two sources of finance should be used by the company to meet its requirement. Write any two characteristics of each source.

Ans: ADR and Public Deposits can be used to satisfy the company's needs.

• Public Deposits: Public deposits are deposits that are raised directly from the public by organizations. While depositors receive a greater interest rate than banks, the cost of deposits to the company is lower than the cost of bank borrowings. RBI is in charge of regulating it. Companies typically solicit public contributions over a three-year term.

• ADR (American Depository Receipt): This instrument is issued by the American companies and can be traded in American markets. It can be issued to only citizens of America and can only be traded in US stock exchanges. This instrument is like a regular stock which is purchased and sold in American markets. 

(b) What values does the company exhibit in the above case?

(Hints- ADR and Public Deposits, Employment Generation, Concern for the environment)

Ans: The following values are demonstrated by the company:

• Environmental stewardship: The company uses solar power to generate 50% of its office electricity. As a result, resources are conserved.

• Employment Generation: The company is committed to teaching and employing underprivileged youngsters, hence creating job possibilities for them.