Unit – VIII: Sources of Business finance
Very Short answer Question
(One mark each):
Q.1. In Which year IDBI was
established? 2009
Ans:
1964
Q.2. Name the first public
financial institution set up in India.
Ans:
IFCI (Industrial Finance Corporation of India)
Q.3. Write the full form of
IDBI and SIDBI.
Ans:
IDBI: Industrial Development Bank of India.
SIDBI:
Small Industries Development Bank of India
Q.4. What do the
debentures represent?
Ans: Borrowed
Capital of the company.
Q.5. What is the
source of raising the Public Deposits?
Ans: The
Public.
Q.6. What is equity shareholders called?
Ans: Owners of the company.
Q.7. What is the
maturity period of Commercial Papers?
Ans: The
maturity period of commercial paper ranges from 90-364 days.
Q.8. From where
internal source of capital is generated?
Ans: - It
is generated within the business.
Q.9. Funds
required for purchasing current assets comes under which head?
Ans: Working
capital Requirement
Q.10. Define the
term convertible debentures.
Ans: Convertible
debentures are when the debenture holders get the right to convert equity
shares into debentures at the time of issue of debenture.
Q.11. What is a commercial paper?
Ans: Commercial paper is an unsecured promissory note issued by
the company with maturity period varying from 90 days to 364 days .It is issued
by one firm to other firm’s insurance companies, banks. It is issued by
creditworthy and reputed companies.
Q.12. Define fixed
capital.
Ans: According
to Wheeler "Fixed Capital is invested in fixed or long run assets”. The
amount of fixed capital needed mainly to acquire fixed assets by the business.
Q.13. What is meant
by working Capital?
Ans: Working
Capital is required for day to day operations of the business. Working capital
is computed when the current liabilities are deducted by Current Assets.
Q.14. What is factoring?
Ans: Factoring: It has emerged as a popular
source of short term finance. It is a financial service where by the factor
responsible for all credit control and debt collection from the buyers and
provides protection against any bad debt losses to the firm.
Q.15. Dividend is Paid only
to the Shareholders on the FACE VALUE of the shares.
Q.16.
Explain ‘Inter-Corporate deposit’ as a source of finance. 2016
Ans: An Inter-Corporate Deposit (ICD) is an
unsecured borrowing by corporates and FIs from other corporate entities registered
under the Companies Act’ 2013. The corporate having
surplus funds would lend to another corporate in need of funds.
Short answer type Questions
(Two/Three/five marks each):
Q.1. Define Business Finance. Why do
business needs funds? Mention its merits.
Ans: According to Howard and Upton, “Business Finance involves a
set of administrative functions in an organisation which relate with the
arrangement of cash and credit so that the organisation may have the means to
carry out its objectives as satisfactorily as possible”.
Need of Business finance: Business needs funds
to purchase assets and to run day to day operations of the business for the
smooth functioning. The needs of the business can be classified as:
a) Fixed capital needs to acquire fixed
assets.
b) Working Capital Needs for day to day
management of the company.
Merits of Business
Finance
a. Finance helps the firm to meet its
liabilities on time.
b. Smooth flow of business activities.
c. Use of Business opportunities.
Q.2. What are the sources of Business
Finance? Explain them briefly.
Ans: There are two sources of finance:
a)
Owner’s Fund.
b)
Borrowed Fund.
Owner’s Fund: Owner’s fund consists of funds contributed by owners and
accumulated profits.
Features of owner’s fund:
A) Source of permanent capital.
B) No security.
C) Provision of risk capital.
Merits of Owner’s Fund:
A) Permanent capital.
B) No security is required to raise capital.
C) Improve credit-worthiness of the company.
Demerits of owner’s fund:
A) Diffusion of control
B) Under-utilisation of capital
Borrowed Fund: It refers to the borrowings of
the firm. It is mainly in the form of debentures, loans from financial
institutions.
Features of Borrowed fund:
A) Finance for fixed time
B) Security required
C) Regular payment of interest.
Merits of Borrowed Fund:
A) No interference in decision making.
B) Interest as an expense.
C) Fixed rate of interest.
Demerits of Borrowed fund:
A) Adequate security required
B) Fixed liability
C) Regular interest payment
irrespective of profits.
Q.3. What is the difference between
Owners Capital and Borrowed Capital?
Ans: - The difference between Owners Capital and Borrowed
Capital is given here:
|
BASIS |
BORROWED CAPITAL |
OWNERSHIP CAPITAL |
|
TIME |
It is for a specific time only. |
It is permanent source of capital. |
|
SECURITY |
It requires assets of the company. |
It does not require any security. |
|
RISK |
Borrowed capital is not risky. |
Ownership capital is subject to risk. |
|
CONTROL |
No control over management. |
It has right to control over management. |
|
RETURN |
Interest is the return. |
Profit is the return. |
Q.4. What is the source of Long term &
short term finance?
Ans: Sources of Long term Finance:
a) Equity Shares and Preference shares, b) Debentures, c) Retained
Shares, d) Loan from Banks and Financial institutions
Sources of Raising Short term Finance: a)
Trade credit, b) Factoring, c) Loan from Banks, d) Commercial paper.
Q.5.Define Shares and Share capital.
What are two types of Share?
Ans: When the capital of a firm is divided into certain number of
units these units are called shares. The share of a company is a movable
property, transferable in the manner provided by the articles of the company.
The capital of a company is divided into
shares which are collectively called ‘Share Capital’. The share capital is
regarded as owned capital. It is permanent source of finance.
Shares may be of two types:
a)
Preference Shares
b)
Equity Shares
Q.6. Define Equity Shares. Mention its
features, merits and demerits.
Ans: According to Indian Companies Act 2013 " an equity share
is share which is not preference share". An equity share does not carry any
preferential right.
Features of Equity shares:
a)
Primary risk-bearers
b)
Control over management
c)
Higher profits available for equity share
holders.
Merits of equity shares:
a)
Permanent source of capital
b)
No charge over assets
c)
Huge funds can be raised
Demerits of equity shares:
a)
Risk of fluctuating return.
b)
Depends on market conditions.
c)
Low Dividend on equity shares
Q.7. Define Preference Shares. Mention
its features, merits and demerits.
Ans: Preference shares are those which carry a preference over
dividend and return on capital. The dividend rate on preference shares is
fixed. The preference shareholders get the dividend on fixed rate and out of
net profits of a company prior to distribution of dividend on equity shares.
Following are the basic features of preference
share:
a)
Fixed rate of dividend
b)
Preferential payment of dividend
c)
Preferential right in redemption of capital in
case of winding up of a company.
d)
Absence of voting rights
Merits of Preference shares:
a)
Helps to collect huge funds.
b)
No fixed liability.
c)
No charge over assets.
Demerits of Preference shares:
a)
Risk of Fluctuating return.
b)
Dividend not treated as an expense.
c)
No voting rights.
Q.8. What are various types
of Preference shares? 2015,
2017
Ans: Preference shares are those which carry a preference over
dividend and return on capital. The dividend rate on preference shares is
fixed. The preference shareholders get the dividend on fixed rate and out of
net profits of a company prior to distribution of dividend on equity shares.
Types of Preference shares
a) Cumulative and
Non-Cumulative Preference shares.
Cumulative Preference Shares: When unpaid dividends on preference shares are treated as arrears and are carried forward to subsequent years, then such preference shares are known as cumulative preference shares.
Non-cumulative Preference Shares: Non-cumulative preference shares are those type of preference shares, which have right to get fixed rate of dividend out of the profits of current year only. They do not carry the right to receive arrears of dividend.
b) Participating and non-participating preference shares.
Participating Preference shares: After dividend has been paid to the equity shareholders, holders of participating preference shares have the right to participate in the remaining profits.
Non Participating Preference shares: Preference
shares which do not have the right to participate in the profits remaining
after equity shareholders have been paid dividend.
c) Convertible and non Convertible preference shares.
Convertible Preference Shares: These preference shares can be
easily converted into other preferences shares or equity shares or debentures.
Non-convertible Preference shares: These preference shares cannot
be converted into other preferences shares or equity shares or debentures.
d) Redeemable and Irredeemable preference shares.
Redeemable Preference Shares: These Preference
Shares are paid off or redeemed after the prescribed period.
Irredeemable Preference Shares: These
Preference shares are permanent shares of a company. They are paid back only in
the event of winding up of a company.
Q.9. Define Debentures. Mention its features, merits and demerits. 2016
Ans: Debenture: It constitutes the borrowed funds of the company
which is raised against the floating charges on its assets. It is an
acknowledgement of debt. Debenture capital may be called DEBT CAPITAL. 2018
Features of Debentures:
a)
Debenture holders are the creditors of the company.
b)
Debenture is redeemed after a fixed period of time.
c)
Debentures may be either secured or unsecured.
d)
Debenture holders do not enjoy any voting right.
Merits
a)
Regular return to investors
b)
Safety of investment since debentures are secured
c)
Long term source of finance for the company
d)
Debentures interest reduces tax liability
Demerits
a)
Floating Charge on assets of the company
b)
No voting rights to debenture holders
c)
Permanent burden of interest
d)
Rate of interest is low as compared to return on shares.
Q.10. What are various types
of debentures? 2018
Ans: Types of Debentures: Debentures
are classified as follows:
1. On the
Basis of Repayment
a. Redeemable Debentures: These debentures are
paid off or redeemed after the prescribed period.
b. Irredeemable or Perpetual Debentures: These
debentures are permanent debentures of a company. They are paid back only in
the event of winding up of a company.
2. On the
Basis of Transferability
a. Registered Debentures: These are debentures
for which the company maintains record of debenture holders.
b. Bearer Debentures: These debentures are
transferable by mere delivery. There is no need or registration of transfer
with the company.
3. On the
Basis of Security
a. Simple or Naked Debentures: These are debentures
not secured by any asset of the company.
b. Mortgage Debentures: Mortgage debentures
are issued on the security of certain assets of the company.
4. On the
basis of Conversion
a. Convertible Debentures: These debentures
are issued with an option to debenture holders to convert them into shares
after a fixed period.
b. Non Convertible Debentures: These are
debentures issued without conversion option.
5. On the
Basis of Pre-Mature Redemption Rights:
a. Debenture with “Call” option: A callable
debenture is one in which the issuing company has the option of redeeming the
security before the specified redemption date at a pre-determined price.
b. Debenture with “Put” option: This is a
debenture in which the holder has the option of getting it redeemed before
maturity.
Q.11. What is the
difference between Share & Debenture? 2016,
2019
Ans: The
difference between Share & Debenture is given here:
|
BASIS |
SHARE |
DEBENTURE |
|
NATURE |
Shareholder is an owner of the company. |
Debenture holder is a creditor of a company. |
|
RETURN |
A shareholder receives dividend. |
A debenture holder receives interest. |
|
SECURITY |
A share is not secured by any charge of assets. |
A debenture is secured by a floating charge of assets. |
|
REPAYMENT |
Share Capital cannot be repaid. |
Debentures can be repaid by the company. |
|
CONTROL AND RIGHT TO VOTE |
A shareholder has control over the company. |
A debenture holder does not have right to control or vote. |
|
Forfeiture |
Shares can be forfeited for non-payment of allotment or call
money. |
Debentures cannot be forfeited for non-payment of allotment or
call money. |
Q.12. Distinguish between
preference and equity shares.
Ans: Difference between Preference Share and Equity Share are
given below:
|
Basis of
Difference |
Preference
Share |
Equity
Share |
|
1.Right of Dividend |
Preference shares are paid dividend before the Equity shares. |
Equity shares are paid after the dividend paid to preference
shareholders. |
|
2. Rate of Dividend |
Rate of dividend is fixed. |
Rate of dividend is not fixed. |
|
3. Convertibility |
Preference Shares may be converted into Equity shares. |
Equity shares are not convertible. |
|
4. Voting Right |
Preference shareholders do not carry the voting right. They can
vote only in special circumstances. |
Equity shareholders have voting rights. |
|
5. Redemption of Share Capital |
Preference shares may be redeemed. |
A company may buy-back its equity shares. |
Q.13. Explain the
trade credit & bank Credit as a source of short term finance?
Ans: Trade
credit is the credit extended by one trader to another for the purchase of
goods and services. There are various merits of trade credit as a source of
short term finance which are mentioned below:
a)
It is readily available according to the
customs
b)
It is flexible source of finance
c)
It is an economical source of finance.
Its limitation is that only limited amount of
funds can only be generated
Bank credit is provided by the banks in many ways like
cash credits, overdrafts, term loans discounting, of bills. There are various
merits of bank credit as a source of short term finance which are mentioned
below:
a)
Bank finance can be raised as and when
required
b)
Banks keep the information of bank finance
secret
c)
A company can rely upon the amounts up to
credit limit sanctioned for it.
The limitation is that it is subject to many
terms and conditions.
Q.14. Explain public deposits
as a source of finance. 2015,
2017
Ans: Public deposit refers to the unsecured deposits invited by
companies from the public. It can invite for a period of six months to 3 years.
Public deposit cannot exceed 25% of its share capital & resources.
Merits of Public Deposits:
a)
Simple: The system is very simple in raising the
loans.
b)
Economical: It is cheap method of raising working
capital.
c)
Elasticity in capital structure: Public
deposits keep the capital structure elastic.
d)
No security Requirement Deposits are usually unsecured.
Demerits of Public Deposits:
a)
Unsuitable for new concerns: It is very difficult for the new
companies to rely on Public deposits.
b)
Unreliable- It is very uncertain and unreliable.
c)
Unhealthy for Capital Market.
Q.15. Explain retained
earnings as a source of finance. 2015,
2018
Ans: Retained Earnings: Like an individual, companies too, set
aside a part of their profit to meet future requirements. The portion of
profits not distributed among the shareholders but retained and used in
business is called retained earnings. It is also referred to as ploughing back
of profit. This is one of the important sources of internal financing used for
fixed as well as working capital. Retained earnings increase the value of
shareholders in case of a growing firm. 2018
Advantages of Retained Earnings:
i. Cheaper Source of
Financing:
ii. Financial
Stability:
iii. Stable
Dividend:
Disadvantages
of Retained Earnings:
i.
Improper Utilization of Funds:
ii.
Over-capitalization:
iii.
Lower Rate of Dividend:
Q.16. Discuss the
financial instruments used in international financing?
Ans: The financial
instruments used in international Financing are given here:
a)
ADR i.e. American Depository Receipts can be
issued only to the American citizens and can be listed and traded on a stock
exchange of America.
b)
GDR i.e. Global Depository receipts can be
issued abroad and can be listed and traded on stock exchange of any country
other than America. 2018
c)
FCCB i.e. Foreign Currency Convertible Bonds are equity
linked debt securities that are to be converted into equity receipts after a
specific period. They are similar to convertible debentures.
Q. 17. Write a brief note on various
types of loans from commercial banks and financial institutions.
Ans: Loans From Commercial Banks: Business can raise finance from
commercial banks in the following ways
a)
Term Loan: For medium term
b)
Cash Credit: Interest is charged on the amount
actually withdrawn.
c)
Overdraft:
Current Account holders are allowed to overdraw his A/c.
d)
Discount of bill:
e)
Banks provide short term finance in exchange
for bill.
Loans from financial Institutions:
Institutional finance means finance arranged from financial institutions other
than commercial banks like IFCI, ICICI, IDBI, SFI etc.
Q.18. What points should be kept in
mind before choosing the source of finance? 2018
Ans: The following points should be kept in mind before selecting
the source of finance:
|
TIME PERIOD |
Long term finance is raised through shares and debentures. Short
term finance is raised through trade credit, commercial paper, etc. |
|
RISK |
There is least risk on Equity shares as the capital need not be
repaid. But in case of loan, interest has to be paid |
|
CONTROL |
Issue of equity shares may lead to dilution of control but debt
involves no dilution of control. |
|
EARNINGS |
Stability of earnings are important because loan should be
raised only when earning are sufficient. |
|
TAX IMPACT |
Interest on debenture is tax deductible. Dividend is not tax
deductible. |