Sources of business - Class 11 Business Studies - Chapter 8 - Notes, NCERT Solutions & Extra Questions
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Extra Questions - Sources of business | NCERT | Business Studies | Class 11
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What is business finance? Why do businesses need funds? Explain.
Business finance refers to the funds required for establishing and running business operations. Businesses need funds to purchase fixed assets, manage day-to-day operations, and support growth and expansion. Without adequate finance, businesses cannot function effectively, making finance the lifeblood of any business to fulfill essential functions and strategic goals.
List sources of raising long-term and short-term finance.
Long-term finance can be raised through the issue of shares (equity and preference), debentures, long-term loans from financial institutions, and lease financing. Short-term finance sources include trade credit, commercial paper, factoring, loans from commercial banks (like cash credits and overdrafts), and public deposits for periods not exceeding one year.
What is the difference between internal and external sources of raising funds? Explain.
Internal sources of funds are generated within the business such as through retained earnings. External sources lie outside the organization, like funds from suppliers, lenders, and investors. Internal sources maintain operational freedom, whereas external sources often come with conditions and may require security against assets, impacting a company's financial flexibility.
What preferential rights are enjoyed by preference shareholders. Explain.
Preference shareholders enjoy preferential rights to receive a fixed rate of dividend before any dividend is paid to equity shareholders. Additionally, they have a preferential claim over the company's assets for repayment of capital upon liquidation, after creditors' claims are settled but before equity shareholders. These shares often don't carry voting rights, focusing on financial benefits rather than control.
Name any three special financial institutions and state their objectives.
Three special financial institutions mentioned are:
International Finance Corporation (IFC) - Provides loans and grants to promote the development of economically backward areas around the world.
Asian Development Bank - Aims to foster economic growth and cooperation in the Asia-Pacific region and assists its members in the development process through loans and technical assistance.
EXIM Bank - Facilitates and promotes India's international trade by providing loans, export credits, and other financial services.
What is the difference between GDR and ADR? Explain.
The key difference is geographic scope and target investors. Global Depository Receipts (GDRs) are issued outside the issuer's country and outside the U.S., targeting international investors. Conversely, American Depository Receipts (ADRs) are specifically issued in the USA and are only available to American citizens, being traded on American stock exchanges. Both serve to raise capital internationally with local shares as a base.
Explain trade credit and bank credit as sources of short-term finance for business enterprises.
Trade credit is a form of short-term finance where one trader extends credit to another for the purchase of goods and services. It facilitates buying supplies without immediate payment and varies by industry, often specified on invoices. This type of credit is especially beneficial for small and new firms that may have difficulty accessing other types of financing.
Bank credit, on the other hand, includes different forms like cash credits, overdrafts, and short-term loans provided by commercial banks. This source of finance is flexible, repaid in installments or lump sum, and the interest rate is influenced by the borrower's financial status and market interest rates. Though essential, obtaining bank credit involves scrutiny of the firm’s finances and often requires security.
Discuss the sources from which a large industrial enterprise can raise capital for financing modernisation and expansion.
A large industrial enterprise can finance modernization and expansion from various sources, each with distinct advantages. Equity shares provide permanent capital raised by issuing common stock, giving investors ownership and voting rights, suitable for long-term funding needs without repayment obligations. Debentures offer a way to secure capital with fixed interest rates, favorable for entities with stable revenue streams. Financial institutions and development banks, both governmental and international, provide substantial funding and support, ideal for significant expansions with added advisory services. Lease financing and public deposits offer alternative methods, with the former allowing use of assets without full ownership costs and the latter harnessing public investment under typically higher interest rates than banks. These sources collectively provide a robust framework to support substantial capital requirements for modernization and expansion endeavors.
What advantages does issue of debentures provide over the issue of equity shares?
The issue of debentures offers several advantages over the issue of equity shares. Firstly, debentures are a preferred choice for investors seeking fixed income with lower risk, as they provide fixed interest returns. Secondly, debentures do not involve any ownership rights; hence, they do not dilute the control of equity shareholders over company management. Furthermore, financing through debentures is less costly compared to equity capital since interest on debentures is tax-deductible, making it more economical for the issuing company. Additionally, the stability of income from debentures appeals to investors, especially in businesses with relatively stable sales and earnings. However, it’s important to consider that debentures can impose a fixed financial burden.
State the merits and demerits of public deposits and retained earnings as methods of business finance.
Public Deposits:
Merits:
- Public deposits have a simple procedure without restrictive conditions, making it a straightforward form of funding.
- They offer a lower cost of capital compared to borrowing from banks.
- No dilution of control since depositors do not have voting rights.
Limitations:
- New companies may find it difficult to attract public deposits.
- The source is unreliable as public response can be unpredictable.
- Large sums may be challenging to collect, especially for substantial funding needs.
Retained Earnings:
Merits:
- Retained earnings are a permanent source of funds with no explicit costs such as interest or dividends.
- They provide flexibility and operational freedom.
- Useful for enhancing the company's capacity to absorb losses.
Limitations:
- Can lead to shareholder dissatisfaction due to lower dividends.
- Considered an uncertain source as profits can fluctuate.
- If not optimally utilized, the opportunity cost can be high, leading to inefficient fund use.
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Comprehensive Sources of Business Class 11 Notes
Introduction
Understanding the different sources of business finance is crucial for Class 11 students as it lays the foundation for comprehending more complex financial concepts in the future. Business finance refers to the money that businesses require for various purposes such as starting a business, running day-to-day operations, expanding the business, and more.
Meaning, Nature, and Significance of Business Finance
What is Business Finance?
Business finance refers to the funds and credit employed in the business. It involves managing money in such a way that it is available when needed and allocated to those parts of the business where it will yield the best returns.
Importance of Business Finance
Business finance is essential because it affects every aspect of a business. Adequate finance ensures the smooth running of the business, helps in expansion and growth, and allows the business to overcome unexpected challenges or losses.
Classification of Sources of Finance
Period Basis
Based on the period, sources of finance can be categorised into:
- Long-term sources: Used for a period exceeding 5 years, such as shares, debentures, and long-term loans.
- Medium-term sources: Required for a period of more than one year but less than five years, such as borrowings from banks and financial institutions.
- Short-term sources: Needed for a period not exceeding one year, such as trade credit and short-term loans.
Ownership Basis
On the basis of ownership, finance sources can be divided into:
- Owner's Funds: Provided by the business owners, including equity shares and retained earnings.
- Borrowed Funds: Raised through loans or debentures and must be repaid with interest.
Source of Generation Basis
Based on the source of generation, finance can be:
- Internal Sources: Generated from within the business, like retained earnings.
- External Sources: Sourced from outside the business, such as bank loans, public deposits, and trade credit.
Evaluating Sources of Finance
Retained Earnings
Retained earnings are profits not distributed as dividends but reinvested in the business. They serve as a permanent source of funds and offer operational flexibility.
Trade Credit
Trade credit allows businesses to buy goods and services without immediate payment, making it a commonly used short-term financing method.
Factoring
Factoring involves selling receivables to a third party (factor) at a discount. This method ensures a steady cash flow and reduces the burden of debt collection.
Lease Financing
Lease financing allows a business to use an asset without owning it by making periodic payments. It’s ideal for acquiring expensive assets like machinery and equipment.
Public Deposits
Public deposits are funds a company raises directly from the public for medium-term needs. They offer higher interest rates than banks but are unsecured.
Commercial Paper
Commercial Paper is an unsecured, short-term promissory note issued by companies. It is a versatile tool for managing short-term financial needs.
Equity Shares
Equity shares represent ownership in a company. Shareholders earn dividends from profits and have voting rights but bear higher risks.
Preference Shares
Preference shares provide a fixed dividend before distributing to equity shareholders and have priority in asset repayment during liquidation.
Debentures
Debentures are long-term debt instruments with a fixed interest rate, offering investors a safer option than equity shares but creating a repayment obligation for the business.
Factors Affecting the Choice of Source of Finance
Cost
The total cost, including procurement and utilisation, should be considered. Lower cost options are usually preferred.
Financial Strength and Stability of Operations
Businesses in a strong financial position can consider various sources, while those with unstable earnings should opt for safer, less risky options.
Form of Organisation and Legal Status
The business structure (e.g., partnership, joint-stock company) influences the choice of finance. For instance, only joint-stock companies can issue equity shares.
Purpose and Time Period
The reason and duration for which funds are needed determine the type of source. Short-term needs may be met with trade credit, while long-term needs might require equity or debentures.
Risk Profile
The risk involved should be assessed. Equity shares carry higher risk than loans but do not require repayment during losses.
Control
Certain sources, like issuing equity shares, may dilute the owners' control over the business.
graph TD
A[Factors Affecting Choice of Finance] --> B[Cost]
A --> C[Financial Strength]
A --> D[Organisation Form]
A --> E[Purpose & Time]
A --> F[Risk Profile]
A --> G[Control]
A --> H[Credit Worthiness]
A --> I[Flexibility & Ease]
A --> J[Tax Benefits]
International Sources of Finance
Commercial Banks
Global commercial banks extend foreign currency loans, providing a vital source of international business finance.
International Agencies and Development Banks
Institutions like the International Finance Corporation (IFC) and Asian Development Bank offer long-term loans to promote economic development.
International Capital Markets
Instruments such as Global Depository Receipts (GDRs), American Depository Receipts (ADRs), and Foreign Currency Convertible Bonds (FCCBs) enable companies to raise capital globally.
Summary and Key Takeaways
Understanding the diverse sources of business finance is fundamental for Class 11 students. By exploring options like retained earnings, trade credit, factoring, lease financing, equity and preference shares, debentures, and international sources, students can grasp the complexities of business financial management and appreciate the critical role finance plays in the business world.
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