NCERT Solution for Class 11 Business Studies Chapter 8 – Sources of Business Finance

NCERT Solution for Class 11 Business Studies Chapter 8 – Sources of Business Finance

NCERT Solutions are an invaluable resource for students preparing for the CBSE Class 11 Business Studies exams. These solutions, curated by subject matter experts, provide comprehensive knowledge and are highly effective for exam preparation. NCERT Solutions for Class 11 Business Studies Chapter 8 – Sources of Business Finance offer a concise introduction to the fundamental concepts in Business Studies.

Short Answer Questions

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

Ans.

Business Finance

Definition: Business finance refers to the management of funds and financial resources required for business activities. It involves the planning, allocation, and control of financial resources to achieve the company’s objectives and ensure its smooth functioning.

Importance of Business Finance:

1. Capital Investment: Businesses need funds to invest in assets such as land, buildings, machinery, and technology. These investments are essential for the production of goods and services.
2. Working Capital: Funds are required for day-to-day operations, including purchasing raw materials, paying wages, and covering other operational expenses.
3. Expansion and Growth: Businesses require funds to expand their operations, enter new markets, and develop new products. Financial resources support research and development (R&D) activities and marketing efforts.
4. Managing Risks: Adequate funds are necessary to manage risks and uncertainties, such as economic downturns, market fluctuations, and unexpected expenses.
5. Debt Repayment: Businesses need funds to repay loans and other financial obligations. Timely repayment helps maintain a good credit rating and access to future financing.
6. Ensuring Liquidity: Maintaining sufficient liquidity is crucial for meeting short-term obligations and ensuring the company’s financial stability.

Conclusion:
In summary, business finance is the management of financial resources required for various business activities. Businesses need funds for capital investment, working capital, expansion, risk management, debt repayment, and ensuring liquidity. Proper financial management is essential for achieving business objectives and sustaining long-term growth.

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

Ans.

Sources of Raising Long-term and Short-term Finance

Long-term Finance:

1. Equity Shares: Raising funds by issuing shares to investors, giving them ownership in the company.
2. Debentures: Issuing debt securities that pay a fixed interest over a long period.
3. Term Loans: Borrowing from banks or financial institutions for a fixed term, usually more than five years.
4. Retained Earnings: Using the company’s accumulated profits for reinvestment in the business.
5. Venture Capital: Investment from venture capitalists in exchange for equity in high-growth potential businesses.

Short-term Finance:

1. Trade Credit: Obtaining goods and services from suppliers on credit, to be paid within a short period.
2. Bank Overdraft: Allowing the company to withdraw more money than is available in its bank account, within an agreed limit.
3. Commercial Paper: Issuing unsecured short-term promissory notes to raise funds from the market.
4. Factoring: Selling accounts receivable to a factoring company at a discount for immediate cash.
5. Short-term Loans: Borrowing from banks or financial institutions for a period typically less than one year.

Conclusion:
In summary, sources of long-term finance include equity shares, debentures, term loans, retained earnings, and venture capital, while sources of short-term finance include trade credit, bank overdrafts, commercial paper, factoring, and short-term loans. These financial sources help businesses meet their capital requirements for various operational and growth needs.

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

Ans.

Difference Between Internal and External Sources of Raising Funds

Internal Sources of Funds:
Internal sources of funds refer to the capital generated from within the organization. These sources include:

1. Retained Earnings: Profits that are reinvested in the business instead of being distributed as dividends.
2. Sale of Assets: Generating cash by selling unused or underutilized assets.
3. Depreciation Funds: Funds set aside for the replacement of depreciated assets.
4. Working Capital Management: Efficient management of working capital to free up cash for investment.

External Sources of Funds:
External sources of funds refer to the capital obtained from outside the organization. These sources include:

1. Equity Shares: Raising funds by issuing shares to the public or private investors.
2. Debentures: Issuing debt securities that pay a fixed interest over a specified period.
3. Loans: Borrowing from banks, financial institutions, or other lenders.
4. Venture Capital: Investment from venture capitalists in exchange for equity.
5. Trade Credit: Obtaining goods and services on credit from suppliers.

Conclusion:
In summary, internal sources of funds are generated from within the organization, such as retained earnings and the sale of assets, while external sources of funds are obtained from outside the organization, such as issuing equity shares, debentures, and loans. Both internal and external sources are essential for meeting the financial needs of a business and ensuring its growth and sustainability.

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

Ans.

Preferential Rights Enjoyed by Preference Shareholders

1. Dividend Preference:
Preference shareholders have the right to receive dividends before equity shareholders. These dividends are usually at a fixed rate and must be paid out of the company’s profits before any dividends are declared for equity shareholders.

2. Preference in Repayment:
In the event of the company’s winding up or liquidation, preference shareholders have the right to receive repayment of their capital before any payments are made to equity shareholders. This ensures that preference shareholders recover their investment ahead of others.

3. Cumulative Dividends:
If the company is unable to pay dividends in any financial year, cumulative preference shareholders have the right to receive these unpaid dividends in subsequent years before any dividends are paid to equity shareholders. This cumulative feature ensures that preference shareholders do not lose out on their entitled dividends.

4. Participating Rights:
Some preference shareholders have participating rights, which allow them to receive additional dividends if the company performs exceptionally well and declares a higher dividend for equity shareholders. Participating preference shareholders benefit from the company’s higher profits.

5. Convertibility:
Convertible preference shareholders have the option to convert their preference shares into equity shares after a specified period. This gives them the flexibility to benefit from potential capital appreciation in the company’s equity shares.

Conclusion:
In summary, preference shareholders enjoy several preferential rights, including dividend preference, preference in repayment, cumulative dividends, participating rights, and convertibility. These rights provide them with financial security and advantages over equity shareholders, making preference shares an attractive investment option.

Q. 5. Name any three special financial institutions and state their objectives.

Ans.

Special Financial Institutions and Their Objectives

1. Industrial Development Bank of India (IDBI):

• Objective: To provide financial assistance for the development and expansion of industrial enterprises in India. IDBI supports projects through term loans, direct loans, and investment in the capital market.

2. National Bank for Agriculture and Rural Development (NABARD):

• Objective: To promote sustainable and equitable agriculture and rural development through financial support and capacity building. NABARD provides credit for agricultural activities, rural infrastructure, and development projects.

3. Small Industries Development Bank of India (SIDBI):

• Objective: To facilitate the growth and development of small-scale industries in India by providing financial support, including term loans, working capital, and venture capital. SIDBI also offers advisory and consultancy services.

Conclusion:
In summary, special financial institutions like IDBI, NABARD, and SIDBI play a crucial role in providing financial assistance and support for industrial, agricultural, and small-scale enterprises in India. Their objectives focus on promoting economic development, sustainability, and equitable growth across various sectors.

Q. 6. What is the difference between GDR and ADR? Explain.

Ans.

Difference Between GDR and ADR

1. Definition:

• Global Depository Receipt (GDR): A GDR is a negotiable financial instrument issued by a company in the international market to raise capital. It represents shares of a foreign company and is traded on international stock exchanges.
• American Depository Receipt (ADR): An ADR is a negotiable financial instrument issued by a foreign company in the US market to raise capital. It represents shares of the foreign company and is traded on US stock exchanges.

2. Market:

• GDR: GDRs are traded on international stock exchanges, such as the London Stock Exchange and the Luxembourg Stock Exchange.
• ADR: ADRs are traded on US stock exchanges, such as the New York Stock Exchange (NYSE) and NASDAQ.

3. Currency:

• GDR: GDRs are denominated in various currencies, depending on the market in which they are issued.
• ADR: ADRs are denominated in US dollars (USD).

4. Issuance:

• GDR: Issued in multiple international markets, targeting a broader investor base.
• ADR: Issued specifically in the US market, targeting American investors.

5. Regulatory Body:

• GDR: Regulated by the financial authorities of the country where the GDR is issued and traded.
• ADR: Regulated by the US Securities and Exchange Commission (SEC).

Conclusion:
In summary, the key differences between GDR and ADR lie in their definition, market, currency, issuance, and regulatory body. GDRs are traded on international stock exchanges and can be denominated in various currencies, whereas ADRs are traded on US stock exchanges and are denominated in US dollars. GDRs target a global investor base, while ADRs specifically target American investors. Both instruments enable foreign companies to raise capital and expand their investor base.

Long Answer Questions

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

Ans.

Trade Credit and Bank Credit as Sources of Short-term Finance for Business Enterprises

Introduction:
Short-term finance is crucial for business enterprises to manage their day-to-day operations and meet immediate financial needs. Two common sources of short-term finance are trade credit and bank credit. These sources provide businesses with the necessary liquidity to maintain smooth operations and fulfill their short-term obligations.

1. Trade Credit:
Trade credit is a form of short-term financing extended by suppliers to their customers. It allows businesses to purchase goods and services on credit and pay for them at a later date. Trade credit is a widely used financing option, especially for small and medium-sized enterprises (SMEs).

Key Features of Trade Credit:

• Credit Period: Suppliers typically offer a credit period ranging from 30 to 90 days, during which the buyer can defer payment without incurring any interest.
• No Formal Agreement: Trade credit is often based on mutual trust and does not require a formal loan agreement or collateral.
• Discounts for Early Payment: Some suppliers offer cash discounts to buyers who settle their invoices early, incentivizing prompt payment.

Advantages of Trade Credit:

• Improved Cash Flow: Trade credit allows businesses to maintain cash flow by deferring payments, freeing up funds for other operational needs.
• Easy Access: Trade credit is relatively easy to obtain, as it does not involve lengthy approval processes or stringent credit checks.
• Strengthened Supplier Relationships: Utilizing trade credit can enhance relationships with suppliers, leading to better terms and continued support.

Disadvantages of Trade Credit:

• Limited Credit Period: The credit period is short, and businesses must ensure timely payment to avoid damaging their creditworthiness.
• Dependency on Suppliers: Over-reliance on trade credit can make businesses dependent on specific suppliers, potentially affecting their bargaining power.

2. Bank Credit:
Bank credit refers to short-term loans and credit facilities provided by banks to businesses. These credit facilities are designed to meet the immediate financing needs of enterprises and are typically repaid within a year.

Types of Bank Credit:

• Short-term Loans: Banks offer short-term loans to businesses for a fixed period, usually less than a year. These loans can be used for various purposes, such as purchasing inventory or meeting working capital requirements.
• Overdraft Facility: An overdraft facility allows businesses to withdraw more money than is available in their bank account, up to an agreed limit. This facility provides flexibility and ensures that businesses can meet short-term cash needs.
• Cash Credit: Cash credit is a credit facility that allows businesses to borrow against the security of inventory, receivables, or other assets. It provides working capital to manage daily operations.
• Trade Finance: Banks offer trade finance services, such as letters of credit and bill discounting, to facilitate domestic and international trade transactions.

Advantages of Bank Credit:

• Flexibility: Bank credit facilities, such as overdrafts and cash credit, offer flexibility in managing short-term cash flow requirements.
• Access to Larger Funds: Banks can provide significant amounts of credit, making them a reliable source for meeting substantial short-term financial needs.
• Structured Repayment: Bank loans come with structured repayment schedules, helping businesses plan their finances effectively.

Disadvantages of Bank Credit:

• Interest Costs: Bank credit often comes with interest costs, which can be higher than other sources of short-term finance.
• Collateral Requirements: Some bank credit facilities may require collateral, making it challenging for businesses without sufficient assets.
• Approval Process: Obtaining bank credit may involve a thorough approval process, including credit checks and documentation, which can be time-consuming.

Conclusion:
In conclusion, trade credit and bank credit are essential sources of short-term finance for business enterprises. Trade credit, extended by suppliers, provides businesses with the flexibility to defer payments and maintain cash flow. It is easy to access and enhances supplier relationships. On the other hand, bank credit offers various credit facilities, such as short-term loans, overdrafts, cash credit, and trade finance, providing businesses with flexibility and access to larger funds. However, bank credit comes with interest costs and may require collateral. Both sources of finance play a crucial role in helping businesses manage their immediate financial needs and ensure smooth operations.

Q. 2. Discuss the sources from which a large industrial enterprise can raise capital for financing modernisation and expansion.

Ans.

Sources of Capital for Financing Modernisation and Expansion in Large Industrial Enterprises

Introduction:
Large industrial enterprises require substantial capital to finance modernization and expansion projects. These projects are essential for staying competitive, improving efficiency, and increasing production capacity. There are various sources from which these enterprises can raise capital, each with its own advantages and considerations. Understanding these sources is crucial for making informed financial decisions.

1. Equity Shares:
Equity shares, also known as common stock, are a primary source of long-term capital for large industrial enterprises. By issuing equity shares to the public or private investors, companies can raise significant funds without incurring debt. Shareholders become part-owners of the company and have voting rights, but they also bear the risks associated with business performance.

Advantages:

• No repayment obligation.
• Enhances the company’s equity base.
• Increases credibility and investor confidence.

Disadvantages:

• Dilution of ownership control.
• Dividends are not tax-deductible.

2. Debentures:
Debentures are debt instruments used by companies to raise long-term funds. They are essentially loans taken from investors, with a promise to repay the principal amount along with fixed interest. Debentures can be secured or unsecured and are typically issued for a specific period.

Advantages:

• Fixed interest payments provide predictability.
• No dilution of ownership.
• Interest is tax-deductible.

Disadvantages:

• Obligation to make regular interest payments.
• Increase in financial leverage and risk.

3. Term Loans:
Term loans are borrowed from banks and financial institutions for a fixed term, usually more than five years. These loans are used to finance specific projects, such as modernization and expansion.

Advantages:

• Structured repayment schedule.
• Lower interest rates compared to other sources.
• Flexibility in loan terms.

Disadvantages:

• Collateral may be required.
• Strict repayment terms.

4. Retained Earnings:
Retained earnings refer to the portion of the company’s profits that are reinvested in the business rather than distributed as dividends. This internal source of finance is cost-effective and does not involve any additional liabilities.

Advantages:

• No interest or repayment obligations.
• Enhances shareholder value.
• Utilizes existing resources.

Disadvantages:

• Limited by the company’s profitability.
• May not be sufficient for large-scale projects.

5. Venture Capital:
Venture capital is an investment made by venture capitalists in high-potential companies in exchange for equity. This source of funding is particularly useful for innovative and high-growth projects that may not attract traditional financing.

Advantages:

• Access to large capital amounts.
• Expertise and guidance from venture capitalists.
• Increased credibility.

Disadvantages:

• Significant dilution of ownership.
• High expectations for returns.

6. External Commercial Borrowings (ECBs):
ECBs are loans taken by Indian companies from non-resident lenders in foreign currency. These borrowings are used for various purposes, including capital expansion and modernization.

Advantages:

• Access to international financial markets.
• Potentially lower interest rates.
• Diversified funding sources.

Disadvantages:

• Foreign exchange risk.
• Regulatory compliance.

7. Public Deposits:
Public deposits are short to medium-term deposits collected from the public at an agreed interest rate. This source of finance is typically used by well-established companies with a strong reputation.

Advantages:

• Lower interest rates compared to bank loans.
• Flexibility in terms of use.
• Easy to mobilize.

Disadvantages:

• Limited by regulatory restrictions.
• Investor confidence is crucial.

8. Trade Credit:
Trade credit is a short-term financing option where suppliers allow the company to purchase goods and services on credit, to be paid at a later date. This helps in managing working capital requirements.

Advantages:

• Immediate access to goods and services.
• No interest cost if paid within the credit period.
• Enhances supplier relationships.

Disadvantages:

• Short repayment period.
• Potential impact on creditworthiness if not managed properly.

Conclusion:
In conclusion, large industrial enterprises have access to various sources of capital for financing modernization and expansion projects. These sources include equity shares, debentures, term loans, retained earnings, venture capital, external commercial borrowings, public deposits, and trade credit. Each source has its own advantages and disadvantages, and the choice of financing depends on the company’s specific needs, financial health, and strategic objectives. By carefully evaluating these options, enterprises can ensure that they secure the necessary funds to drive growth and enhance their competitive position in the market.

Q. 3. What advantages does issue of debentures provide over the issue of equity shares?

Ans.

Advantages of Issuing Debentures Over Equity Shares

Introduction:
When a company seeks to raise capital, it has various options, including issuing debentures and equity shares. Both methods have their own advantages and considerations. However, issuing debentures often provides specific benefits over issuing equity shares. Understanding these advantages can help businesses make informed financial decisions.

1. Fixed Interest Payments:
Debentures offer fixed interest payments to debenture holders, which provide predictability in financial planning. This fixed cost of borrowing allows companies to budget their interest expenses accurately and manage cash flows more efficiently.

Advantages:

• Predictable financial obligations.
• Easier financial planning and budgeting.

2. No Dilution of Ownership:
Issuing debentures does not affect the ownership structure of the company. Debenture holders are creditors, not owners, and therefore do not have voting rights or influence over company decisions. This allows existing shareholders to retain control over the company.

Advantages:

• Retains ownership control.
• No dilution of voting power.

3. Tax Benefits:
Interest payments on debentures are tax-deductible expenses for the company. This reduces the overall taxable income and the tax liability of the company, providing significant tax savings.

Advantages:

• Reduces taxable income.
• Provides tax savings.

4. Lower Cost of Capital:
The cost of raising capital through debentures is often lower than issuing equity shares. Since debenture interest rates are generally lower than the required rate of return on equity, companies can raise funds more cost-effectively.

Advantages:

• Lower financing costs.
• Enhanced profitability.

5. Flexibility in Terms:
Debentures can be structured with flexible terms, such as varying interest rates, repayment schedules, and conversion options. This flexibility allows companies to tailor the debenture terms to their specific financial needs and market conditions.

Advantages:

• Customizable financing options.
• Adaptability to market conditions.

6. No Obligation to Share Profits:
Unlike equity shareholders who are entitled to dividends, debenture holders receive fixed interest payments irrespective of the company’s profitability. This allows the company to retain a larger portion of its profits for reinvestment and growth.

Advantages:

• Retains profits for reinvestment.
• No profit-sharing obligation.

7. Enhances Creditworthiness:
Issuing debentures can improve the company’s creditworthiness by demonstrating its ability to raise debt capital and meet fixed financial obligations. This can positively impact the company’s credit rating and facilitate access to additional financing in the future.

Advantages:

• Improved credit rating.
• Easier access to future financing.

Conclusion:
In conclusion, issuing debentures provides several advantages over issuing equity shares, including fixed interest payments, no dilution of ownership, tax benefits, lower cost of capital, flexibility in terms, no obligation to share profits, and enhanced creditworthiness. These benefits make debentures an attractive financing option for companies seeking to raise capital for expansion, modernization, or other financial needs. By carefully considering these advantages, businesses can make strategic decisions to optimize their capital structure and achieve long-term financial stability and growth.

Q. 4. State the merits and demerits of public deposits and retained earnings as methods of business finance.

Ans.

Public Deposits and Retained Earnings as Methods of Business Finance

Introduction:
Public deposits and retained earnings are two commonly used methods of business finance. Each method has its own merits and demerits, making them suitable for different financial needs and business situations. Understanding the advantages and disadvantages of these methods can help businesses make informed decisions about their financing options.

Public Deposits:

Merits:

1. Easy to Raise: Public deposits are relatively easy to raise as they do not require lengthy approval processes or collateral. Companies can mobilize funds directly from the public by offering attractive interest rates.
2. Lower Cost: The interest rates on public deposits are generally lower than those on bank loans and debentures. This makes public deposits a cost-effective source of finance.
3. Flexibility: Companies have the flexibility to determine the amount and tenure of public deposits based on their financial needs. The repayment terms can be tailored to suit the company’s cash flow.
4. No Dilution of Ownership: Public deposits do not involve issuing shares, so there is no dilution of ownership or control over the company. Existing shareholders retain their voting rights and decision-making power.

Demerits:

1. Limited Amount: The amount of funds that can be raised through public deposits is often limited compared to other sources of finance. This may not be sufficient for large-scale projects.
2. Investor Confidence: The success of raising public deposits depends on the confidence and trust of the investors. Companies with a weak financial position or poor track record may find it challenging to attract public deposits.
3. Regulatory Compliance: Companies must comply with regulatory requirements and guidelines when issuing public deposits. This includes providing detailed disclosures and adhering to prescribed interest rates and maturity periods.
4. Repayment Obligation: Public deposits create a fixed repayment obligation for the company. Failure to repay the deposits on time can damage the company’s reputation and creditworthiness.

Retained Earnings:

Merits:

1. Cost-Effective: Retained earnings are a cost-effective source of finance as they do not involve any interest payments or issuance costs. The company can reinvest its profits without incurring additional liabilities.
2. No Repayment Obligation: Using retained earnings does not create any repayment obligation. The company can utilize these funds for various purposes, such as expansion, modernization, and research and development.
3. Enhances Financial Stability: Retained earnings contribute to the company’s equity base, enhancing its financial stability and creditworthiness. A strong equity base can attract additional funding from external sources.
4. Shareholder Confidence: Reinvesting profits into the business demonstrates the company’s commitment to growth and long-term sustainability. This can boost shareholder confidence and increase the company’s market value.

Demerits:

1. Limited Availability: The availability of retained earnings depends on the company’s profitability. Companies with low or inconsistent profits may not have sufficient retained earnings to meet their financial needs.
2. Opportunity Cost: Using retained earnings for financing means forgoing the opportunity to distribute profits as dividends to shareholders. This may lead to dissatisfaction among shareholders, especially those seeking regular income from their investments.
3. Internal Constraints: Over-reliance on retained earnings can limit the company’s ability to diversify its funding sources. This may result in missed opportunities for growth and expansion.
4. Impact on Shareholder Wealth: Retaining profits instead of distributing them as dividends can impact shareholder wealth, particularly if the company’s stock price does not appreciate significantly.

Conclusion:
In conclusion, public deposits and retained earnings are valuable methods of business finance, each with its own merits and demerits. Public deposits offer ease of raising funds, lower costs, flexibility, and no dilution of ownership, but they are limited in amount and require investor confidence and regulatory compliance. Retained earnings are cost-effective, have no repayment obligation, enhance financial stability, and boost shareholder confidence, but they are limited by profitability, involve opportunity costs, and may impact shareholder wealth. By carefully evaluating these advantages and disadvantages, businesses can make informed decisions about their financing options and ensure their long-term growth and sustainability.