1st PUC Business Studies Question Bank Chapter 8 Sources of Business Finance

Karnataka 1st PUC Business Studies Question Bank Chapter 8 Sources of Business Finance

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1st PUC Business Studies Sources of Business Finance Textual Questions and Answers

1st PUC Business Studies Sources of Business Finance Multiple Choice Questions

Question 1.
Equity shareholders are called
(a) Owners of the company
(b) Partners of the company
(c) Executives of the company
(d) Guardian of the company
Answer:
(a) Owners of the company

Question 2.
The term‘redeemable’ is used for
(a) Preference shares
(b) Commercial paper
(c) Equity shares
(d) Public deposits
Answer:
(b) Commercial paper

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Question 3.
Funds required for purchasing current assets is an example of
(a) Fixed capital requirement
(b) Ploughing back of profits
(c) Working capital requirement
(d) Lease financing.
Answer:
(c) Working capital requirement

Question 4.
ADRs are issued in.
(a) Canada
(b) China
(c) India
(d) USA
Answer:
(d) USA

Question 5.
Public deposits are the deposits that are raised directly from
(a) The public
(b) the directors
(c) The auditors
(d) The owners
Answer:
(a) The public

Question 6.
Under the lease agreement, the lessee gets the right to
(a) Share profits earned by the lessor
(b) Participate in the management of the organisation
(c) Use the asset for a specified period
(d) Self the assets
Answer:
(c) Use the asset for a specified period

Question 7.
Debentures represent
(a) Fixed capital of the company
(b) Permanent capital of the company
(c) Fluctuating capital of the company
(d) Loan capital of the company
Answer:
(d) Loan capital of the company

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Question 8.
Under the factoring arrangement, the factor
(a) Produces and distributes the goods or services
(b) Makes the payment on behalf of the client
(c) Collects the clients debt or account receivable
(d) Transfer the goods from one place to another
Answer:
(c) Collects the clients debt or account receivable

Question 9.
The maturity period of a commercial paper usually ranges from
(a) 20 to 40 days
(b) 60 to 90 days
(c) 120 to 365 days
(d) 90 to 364 days
Answer:
(d) 90 to 364 days

Question 10.
Internal sources of capital are those that are
(a) generated through outsiders such as suppliers
(b) generated through loans from commercial banks
(c) generated through issue of shares
(d) generated within the business
Answer:
(d) generated within the business

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1st PUC Business Studies Sources of Business Finance Short Answer Questions

Question 1.
What is business finance? Why do businesses need funds? Explain.
Answer:
Business is an economic activity directed towards producing, acquiring wealth through buying and selling of goods. It is a very wide term. Finance is the life blood of the business. Funds are required to commence and carry on business. All business activities such as planning, organizing, managing, controlling, purchasing, selling, directing, marketing etc cannot take place without finance.

Thus, we can say requirements of funds by business to carry out its various activities is called business finance. When an entrepreneur takes a decision to start business the need of fund arises in order to meet the expenses of establishment of business, finance is required for purchasing fixed and current assets, for day-to-day operations, -purchase of raw material, to pay salaries etc. Smooth functioning, expansion and growth of business is possible when it has sufficient funds.

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Question 2.
List sources of raising long term and short term finance.
Answer:
Sources of Long Term Finance

  1. Equity Shares
  2. Retained earnings
  3. Preference shares
  4. Debentures
  5. Loans from banks and other financial institutions

Sources of Medium Term Finance

  1. Lease financing
  2. Public deposits
  3. Loans from banks and other financial institutions

Sources of Short Term Finance

  1. Trade credit
  2. Factoring
  3. Commercial papers
  4. Short term loans from banks

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

SI. No. Internal Sources of Finance External Sources of Finance
(i) Internal sources of funds are those that are generated within the business. External sources of funds include those sources that lie outside the organization, such as suppliers, lenders, and investors.
(ii) Examples of internal sources of finance are accelerating collection of receivables, disposing of surplus inventories and ploughing back of profit. Examples of external sources of finance are Issue of debentures, borrowing from commercial banks and financial institutions and accepting public deposits.
(iii) The internal sources of funds can fulfill only limited needs of the business. Cost of internal funds is low. Large amount of money can be raised through external sources. External funds are more costly.
(iv) Business is not required to provide security while obtaining funds from internal sources. Business is required to mortgage its assets as security while obtaining funds from external sources.

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Question 4.
What preferential rights are enjoyed by preference shareholders? Explain.
Answer:
The following preferential rights are enjoyed by preference shareholders

  1. Receiving a fixed rate of dividend, out of the net profits of the company, before any dividend is declared for equity shareholders.
  2. Preference over equity shareholders in receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation.
  3. In case of dissolution of the company preference share capital is refunded prior to the refund of equity share capital.

Question 5.
Name any three special financial institutions and state their objectives.
Answer:
(i) Industrial Finance Corporation of India (IFCI)
It was established in July, 1948 as a statutory corporation under the Industrial Finance Corporation Act, 1948. Its. objectives include assistance towards balanced regional development and encouraging new entrepreneurs to enter into the priority sectors of the economy. IFCI has also contributed to the development of management education in the country.

(ii) State Financial Corporation’s (SFCs)
State Financial Corporations are established by the State Governments under the State Financial Corporations Act, 1951 for providing medium and short term finance to industries which are outside the scope of the IFCI. Its scope is wider than IFCI i as it covers not only public limited companies but also private limited companies, partnership firms and proprietary concerns.

(iii) Life Insurance Corporation of India (LIC)
LIC was set up in 1956 underthe LIC Act, 1956 after nationalizing 245 existing insurance companies. It mobilizes savings in the form of insurance premium and . makes it available to industrial concerns in the form of direct loans and underwriting of shares and subscription to shares and debentures.

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Question 6.
What is the difference between GDR and ADR? Explain.
Answer:
Global Depository Receipts (GDR)
The depository receipts denominated in US dollars issued by depository bank to which the local currency shares of a company are delivered. GDR is a negotiable instrument and can be traded freely like any other security. In the Indian/eontext, a GDR is an instrument issued abroad by an Indian company to raise ftmds in some foreign currency and is listed and traded on a foreign stock exchange.

American Depository Receipts (ADR)
The depository receipts issued by a company in the USA are known as American Depository Receipts. ADRs are bought and sold in American markets like regular stocks. ADRs similar to a GDR except that it can be issued only to American citizens and can be listed and traded on a stock exchange of USA.

1st PUC Business Studies Sources of Business Finance Long Answer Questions

Question 1.
Explain trade credit and bank credit as sources of short term finance for business enterprises.
Answer:
Trade Credit : Trade credit is the credit extended by one trader to another for the purchase of goods and services. It facilitates the purchase of supplies without immediate payment and is commonly used by business organizations as a source of short-term financing. Trade credit appears in the records of the buyer of goods as ‘sundry creditors’ or ‘accounts payable’. It is granted prudently to those customers who have reasonable amount of financial standing and goodwill. The volume and period of credit extended depends on factors such as reputation of the purchasing firm, financial position of the seller, volume of purchases, past record of payment and degree of competition in the market.

Terms of trade credit may vary from industry to industry and from person to person. As we know, trade is the purchase and sale of goods on profit motive. So, trade credit strictly refers to the routine business activity. Bank Credit Commercial banks provide funds for different purposes and for different time periods to firms of all sizes by way of cash credits, overdrafts, term loans, purchase/discounting of bills, and issue of letter of credit.

The rate of interest charged by banks depends on various factors such as the characteristics of the firm and the level of interest rates in the economy. The loan is repaid either in lump sum or in installments. Bank’credit is not a permanent source of funds and is generally used for medium to short periods. The borrower is required to provide some security or create a charge on the assets of the firm before a loan is sanctioned by a commercial bank.

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Question 2.
Discuss the sources from which a large industrial enterprise can raise capital for financing modernization and expansion.
Answer:
Financial institutions established by the central as well as State Governments all over the country to provide finance to business organizations are considered the most suitable source of financing when large funds for longer duration are required for expansion, reorganization and modernization of an enterprise. These institutions provide both owned capital and loan capital for long and medium term requirements and supplement the traditional financial agencies like commercial banks. In addition to providing financial assistance, these institutions also conduct market surveys and provide technical assistance and managerial services to people who run the enterprises. The various Special Financial Institutions in India are as under.

(i) Industrial Finance Corporation of India (IFCI)
It was established in July, 1948 as a statutory corporation under the Industrial Finance Corporation Act, 1948. Its objectives include assistance towards balanced regional development and encouraging new entrepreneurs to enter into the priority sectors of the economy. IFCI has also contributed to the development of management education in the country.

(ii) State Financial Corporation’s (SFCs)
State Financial Corporations are established by the State Governments under the State Financial Corporations Act, 1951 for providing medium and short term finance to industries which are outside the scope of the IFCI. Its scope is wider than IFCI as it covers not only public limited companies but also private limited companies, partnership firms and proprietary concerns.

(iii) Life Insurance Corporation of India (LIC)
LIC was set up in 1956 under the LIC Act, 1956 after nationalizing 245 existing insurance companies. It mobilizes savings in the form of insurance premium and makes it available to industrial concerns in the form of direct loans and underwriting of and subscription to shares and debentures.

(iv) Industrial Credit and Investment Corporation of India (ICICI)
It was established in 1955 as a public limited company under the Companies Act. ICICI assists the creation, expansion and modernization of industrial enterprises exclusively in the private sector. The corporation has also encouraged the participation of foreign capital in the country.

(v) Industrial Development Bank of India (IDBI)
It was established in 1964 under the Industrial Development Bank of India Act, 1964 . with an objective to coordinate the activities of other financial institutions including commercial banks. The bank performs throe types of functions, namely, assistance to other financial institutions, direct assistance to industrial concerns, and promotion and coordination of financial-technical services.

(vi) State Industrial Development Corporations (SIDC)
Many State Governments have set up State Industrial Development Corporations for the purpose of promoting industrial development in their respective states. The objectives of the SIDCs differ from one state to another.

(vii) Unit Trust of India (UTI)
It was established by the Government of India in 1964 under the Unit Trust of India Act, 1963. The basic objective of UTI is to mobilize the savings into productive ventures. It sanctions direct assistance to industrial concerns, invests in their shares and debentures, and participates with other financial institutions.

(viii) Industrial Investment Bank of India Limited
Industrial Investment Bank of India assists sick units in the reorganization of their share capital, improvement in management system, and provision of finance at liberal terms.

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Question 3.
What advantages does issue of debentures provide over the issue of equity shares?
Answer:
Debentures are long term debt instruments which bear a fixed rate of interest. The debenture issued by a company is an acknowledgment that the company has borrowed a certain amount of money, which it promises to repay at a future date. Debenture holders are paid a fixed amount of interest at specified intervals say six months or one year. Issue of Zero Interest Debentures (ZID) which do not carry any explicit rate of ’ interest. Has also become popular in recent years. In the case of ZIDs, the difference between the face value of the debenture and its purchase price is the return to the investor.

Merits of Debentures over Equity Shares

  1. Debentures are preferred by investors who want fixed income at lesser risk.
  2. Debentures are fixed charge funds and do not participate in profits of the company.
  3. The issue of debentures is suitable in the situation when the sales and earnings are relatively stable.
  4. Financing through debentures does not dilute control of shareholders on management as debentures do not carry voting rights.
  5. Financing through debentures is less costly as compared to cost of equity capital as the interest payment on debentures is tax deductible.

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Question 4.
State the merits and demerits of public deposits and retained earnings as methods of business finance.
Answer:
Public Deposits The deposits that are raised by organizations directly from the public are known as public deposits. Rates of interest offered on public deposits are usually higher than that offered on bank deposits. The amount raised from public deposits is generally used by the company for meeting the requirement of working capital. It can take care of both medium and short term financial requirements.

Merits of Public Deposits

  1. The procedure of obtaining deposits is simple and does not contain restrictive conditions as in case of a loan agreement.
  2. Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions.
  3. Public deposits do not usually create any charge on the assets of the company and hence the assets can be used as security for raising loans from other sources.
  4. The control of the company is not diluted as the depositors do not have voting . rights.

Limitations of Public Deposits.

  1. New companies generally find it difficult to raise fund;; through public deposits due to lack of goodwill.
  2. It is an unreliable source of finance as the public may not respond when the company needs money.
  3. Collection of public deposits may prove difficult, particularly when the size of deposits required is large.

Retained Earnings
The portion of the net earnings which is not distributed amongst the shareholders as dividends and is retained in the business for use in the future is known as retained earnings. It is a source of internal financing and is also termed as accumulated earning.

Merits of Retained Earnings

  1. etained earnings is a permanent source of funds available to an organization.
  2. It does not involve any explicit cost in the form of interest, or floatation cost.
  3. There is a greater degree of operational freedom and flexibility as the funds are generated internally.
  4. It enhances the capacity of the business to absorb unexpected losses.
  5. It may lead to increase in the market price of the equity shares of a company.

Limitations of Retained Earnings

  1. High retention ratio may cause dissatisfaction amongst the shareholders as they would get lower dividends.
  2. It is an uncertain source of funds as the profits of business keep fluctuating.
  3. If the opportunity cost associated with these funds is high it may lead to sub¬’ optimal use of the funds.

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Question 5.
Discuss the financial instruments used in international financing.
Answer:
Various financial instruments used in international financing include:
(i) Commercial Banks
Commercial banks extend foreign currency loans for business purposes. They are an important source of financing non-trade international operations. The types of loans and services provided by banks vary from country to country. Banks do not interfere in the management of companies and such loans can be repaid in parts and interest can be saved.

(ii) International Agencies and Development Banks
A number of international agencies and development banks provide long and medium term loans and grants to promote the development of economically backward areas in the world. These bodies were set up by the Governments of developed countries of the world at national, regional and international levels for funding various projects. The more notable among them include International Finance Corporation (IFC), EXIM Bank and Asian Development Bank.

(iii) International Capital Markets
Prominent financial instruments used for international financing through capital markets are:

(a) Global Depository Receipts (GDRs)
These are the depository receipts denominated in US dollars issued by depository bank to which the local currency shares of a company are delivered. GDR is a negotiable instrument and can be traded freely like any other security. In the Indian context, a GDR is an instrument issued abroad by an Indian company to raise funds in some foreign currency and is listed and traded on a foreign stock exchange.

(b) American Depository Receipts (ADRs)
The depository receipts issued by a company in the USA are known as American Depository Receipts. ADRs are bought and sold in American markets like regular stocks. ADR is similar to a GDR except that it can be issued only to American citizens and can be listed and traded on a stock exchange of USA.

(c) Foreign Currency Convertible Bonds (FCCB’s)
Foreign currency convertible bonds are equity linked debt securities that are to be converted into equity or depository receipts after a specific period at a pre-determined exchange rate. The FCCB’s are issued in a foreign currency and carry a fixed interest rate which is lowrer than the rate of any other similar non-convertible debt instrument. FCCB’s are listed and traded in foreign stock exchanges.

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Question 6.
What is a commercial paper? What are its advantages and limitations?
Answer:
Commercial paper is an unsecured promissory note issued by a firm to raise funds for a short period, varying from 90 days to 364 days. It is issued by one firm to other business firms, insurance companies, pension funds and banks. The amount raised by CP is generally veiy large. The CP can be issued only by firms having good credit rating as this debt is totally unsecured. Issue of CP is regulated by the Reserve Bank of India.

Merits of Commercial Paper

  1. A commercial paper does not contain any restrictive conditions as it is sold on an unsecured basis.
  2. It has high liquidity as it is a freely transferable instrument.
  3. It provides more funds compared to other source.
  4. The cost of CP to the issuing firm is generally lower than the cost of commercial bank loAnswer:
  5. A commercial paper provides a continuous source of fund because their maturity can be tailored to suit the requirements of the issuing firm.
  6. Companies can invest their excess funds in commercial paper and can earn good return on them.

Limitations of Commercial Paper

  1. Only firms which are financially sound and have high credit ratings can raise money through commercial papers. New and moderately rated firms are not in a position to raise funds by this method as these are unsecured.
  2. The amount of money that can be raised through commercial paper is limited.
  3. Commercial paper is an impersonal method of financing and if a firm is not in a position to redeem its paper due to financial difficulties, extending the maturity of a CP is not possible.

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1st PUC Business Studies Sources of Business Finance Additional Questions And Answers

1st PUC Business Studies Sources of Business Finance Multiple Choice Questions

Question 1.
The most common cause (s) of financial problems are:
a. undercapitalization.
b. inadequate expense control.
c. credit terms.
d. all of the above.
Answer:
d. all of the above.

Question 2.
The steps in financial planning are:
a. forecasting financial needs and developing budgets to meet those needs.
b. identifying sources of financing.
c. establishing financial controls to ensure the company is following the financial plans.
d. A&C.
Answer:
d. A&C.

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Question 3.
Which forecast gives management some sense of the profit potential possible of different strategic plans?
a. short-term forecast.
b. cash flow forecast.
c. long-term forecast.
d. none of the above.
Answer:
c. long-term forecast.

Question 4.
A statement that projects management’s expectations for revenues and, based on those financial expectations, allocates the use of specific resources throughout the firm is called:
a. a cash flow.
b. a budget.
c. a resource plan.
d. a resource allocation.
Answer:
b. a budget.

Question 5.
A budget is the plan of the various costs and expenses needed to operate the business, based on the short-term forecast.
a. capital budget
b. operating budget
c. cash budget
d. resource budget.
Answer:
b. operating budget

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Question 6.
Debt capital refers to:
a. money raised through the sale of shares.
b. funds raised by borrowing that must be repaid.
c. factoring accounts receivable.
d. inventory loans.
Answer:
b. funds raised by borrowing that must be repaid.

Question 7.
The most widely used source of short-term funding is:
a. factoring.
b. trade credit.
c. family and friends.
d. commercial banks.
Answer:
b. trade credit.

Question 8.
A loan backed by collateral is called a:
a. line of credit.
b. dividend.
c. secured loan.
d. trade credit.
Answer:
c. secured loan.

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Question 9.
Which of the following is a short-term source of funds
a. issue corporate bonds.
b. factor accounts receivable.
c. issue common stock
d. A & B
Answer:
b. factor accounts receivable.

Question 10.
A short-term corporate equivalent of an IOU that is sold in the market place by a firm is called:
a. sinking bond. b. mortgage.
b. mortgage.
c. commercial paper.
d. convertible bond.
Answer:
c. commercial paper.

Question 11.
A bond backed by the company’s real assets is called a:
a. preferred bond.
b. unsecured bond.
c. convertible bond.
d. first mortgage bond.
Answer:
d. first mortgage bond.

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Question 12.
A firm’s profit that is distributed to shareholders is called:
a. interest.
b. dividends.
c. discounts.
d. stock certificate.
Answer:
b. dividends.

Question 13.
The type of corporate ownership stock that gives owners preference over common shareholders in the payment of dividends and in a claim on assets if the company is liquidated is called:
a. preferred stock.
b. common stock.
c. bondholders.
d. creditors.
Answer:
a. preferred stock.

Question 14.
Which of the following is not an advantage of issuing bonds?
a. management retains control.
b. interest paid is tax deductible.
c. bonds are only a temporary source of finance.
d. none of the above.
Answer:
d. none of the above.

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Question 15.
An example of a blue chip stock is:
a. TD bank
b. BCE.
c. Microsoft.
d. All of the above
Answer:
d. All of the above

1st PUC Business Studies Sources of Business Finance Short Answer Questions

Question 1.
Give the full form of ADRs.
Answer:
ADRs = American depository Receipts.

Question 2.
Give the full form of GDRs.
Answer:
GDRs = Global Depository Receipts.

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Question 3.
What is ploughing back of profit?
Answer:
The process of retaining a portion of distributable profits and utilising them in the business is called ploughing-back of profit, self-financing or internal financing or Retained earnings.

Question 4.
Mention the types of business finance.
Answer:
The business finance is classified into three types.

  1. Short – Term Finance
  2. Medium – Term Finance
  3. Long – Term Finance.

Question 5.
What is short-term finance?
Answer:
Short-term finance, usually, refers to finance required by a firm for a period of one year or less. It is the finance required for the purchase of raw materials, payment of wages and salaries and for meeting the other day – to -day manufacturing,-administrative, marketing and other expenses of a firm. It is called short-term finance, as it is required for a short period of one year or less.

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Question 6.
What is Medium-term finance?
Answer:
‘Medium-term finance refers to finance required for a period of one year to five years. It is the finance required for permanent or regular working capital, replacement of worn-out machines, heavy repairs to buildings, heavy advertising changes on a special advertising campaign, small expansion and modernization and also for meeting long-term needs for which long-term finance cannot be quickly arranged.

Question 7.
What is long -term finance?
Answer:
Long-term finance refers to finance required for a period exceeding five years, usually, for a period of five to twenty years. It is required for financing the fixed capital, say for procurement of fixed assets required for the establishment of new undertaking and for major expansion and modernisation of an existing undertaking.

Question 8.
Define a debenture.
Answer: In the words of Palmer, “Debenture signifies an instrument under seal evidencing a debt, the essence of it being the admission of indebtedness”.

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Question 9.
What do you mean by public deposit?
Answer:
Public deposits refer to deposits that are raised by a business firm directly from the public.

Question 10.
What is trade credit?
Answer:
Trade credit refers to credit obtained from the suppliers of goods in the normal course of trade. In other words, it means the goods purchased from suppliers on credit.

Question 11.
What is business finance?
Answer:
It is clear that business finance or financing is the activity concerned with the estimation, raising and administering of funds used in meeting the needs and objectives of a business firm. In other words, it is the process of raising, providing and managing of funds used in the business. In short, it means financing of business activities.

Question 12.
Why do business firms need funds?
Answer:
Finance is the life-blood of business. The plans of a business concern would remain mere dreams unless adequate finance is available to convert the business plans into reality. In fact, finance is needed by a concern not only for expansion and growth but also for the very survival of the business. Finance is needed by a business concern at every stage.

Question 13.
Distinguish between GDR and ADR.
Answer:
There are some differences between ADRs and GDRs. They are:

ADRs GDRs.
1. ADRs enhance shareholders value. 1. The enhancement of shareholders’ value by GDRs is not much.
2. ADRs are more liquid. 2. GDRs are less liquid.
3. ADRs are listed in the American stock exchanges. 3. GDRs are listed in European stock exchanges.

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Question 14.
State any four sources of long-term finance.
Answer:
The various sources of finance can be classified into two categories on the basis of ownership of finance or funds.
They are:
I. Owned Funds or Owners Fund

  1. Equity shares
  2. Preference shares
  3. Re-investment of profits/Retained earning.

II. Borrowed Funds

  1. Debentures and Bonds.
  2. Loans from financial institutions
  3. Loans from Commercial Bank
  4. Public Deposits.
  5. Trade Credit
  6. Bank Credit

Question 15.
State three sources of owned funds for a business.
Answer:
Owned Funds or Owners Fund
a. Equity shares
b. Preference shares
c. Re-investment of profits

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Question 16.
Mention three special features of business finance.
Answer:
The three special features of business finance are:

  1. Business finance or financing is an essential business activity, in the sense that business activities are not possible without finance.
  2. Business finance may be short-term finance, medium-term finance or long-term finances, depending upon the nature of the activities to be financed.
  3. All business concerns, whether small or large, need finance, of course, small business enterprises require less funds, and large business undertakings need more funds.

Question 17.
State the special features of medium-term finance.
Answer:
The special features of medium-term finance are:

  1. Medium-term finance is relatively cheaper as compared to long-term finance, but costlier than short -term finance.
  2. Medium-term finance also is of much importance to small business undertakings.
  3. Medium-term finance is required for a period of one year to five years.

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Question 18.
Explain the special features of pubic deposits.
Answer:
The special features of pubic deposits are:-

  1. Public deposits are rained for long-term and for medium term.
  2. It may be note that, as per the guidelines issued by the Reserve Bank of India.
  3. Public deposits cannot be accepted for a period exceeding 60 moths.
  4. A company can accept public deposits only upto a maximum of 25% of its paid-up capital and free reserves.

Question 19.
Give the meaning of Global depository Receipts.
Answer:
A global depository receipt is an instrument in the form of a depository receipt or certificate, denominated in U.S dollar, created by an overseas Depository Bank outside India, and issued to non-resident Investors against the issue of ordinary shares or foreign currency convertible bonds of the issuing company.

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Question 20.
Explain bank credit.
Answer:
Bank credit refers to credit, financial accommodation or advance taken from commercial banks. Bank credit is, generally, given for a period not exceeding one year. Bank credit is common to all types of business. The amount of bank credit depends upon the nature and size of the business, and the credit-standing of the concern. Bank credit may be unsecured or against guarantee or against hypothecation, pledge or mortgage of assets. An interest of 15% to 18% is, usually, charged on bank credit.

1st PUC Business Studies Sources of Business Finance Long Answer Questions

Question 1.
Explain trade credit and bank credit as source of short-term finance for business enterprise.
Answer:
Trade credit refers to credit obtained from the suppliers of goods in the normal course of trade. In other words, it means the goods purchased from suppliers on credit. The duration of trade credit is, usually, 15 days to 90 days. It is granted without any security except the credit standing of the concern. The amount of trade credit that can be enjoyed by concern depends upon its credit-standing and the volume of business it carries on the supplier of goods.
There are three types of trade credit. They are:

  1. Open accounts or accounts payable or Bills payable
  2. Notes payable
  3. Trade acceptances.

Bank credit refers to credit, financial accommodation or advance taken from commercial banks. Bank credit is, generally, given for a period not exceeding one year. Bank credit is common to all types of business. The amount of bank credit depends upon the nature and size of the business, and the credit-standing of the concern. Bank credit may be unsecured or against guarantee or against hypothecation, pledge or mortgage of assets. An interest of 15% to 18% is, usually, charged on bank credit.

Bank credit takes various forms. They are:

  1. Short-term loan
  2. Overdraft
  3. Cash Credit.
  4. Discounting of bills of exchange
  5. Commercial letter of credit.

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Question 2.
State the merits and demerits of public deposits and retained earnings as methods of business finance.
Answer:
Merits of public Deposits:

  1. These deposits take care of short-term and medium-term financial requirements.
  2. These deposits do not involve the creation of any charge on any asset of the borrower.

Demerits of public Deposits:

  1. Collection of deposits form a large number of depositors is somewhat difficult.
  2. New companies generally find it difficult to borrow funds through public deposits.

Merits of retained earnings:

  1. Retained profits reduce the dependence of company on external borrowings.
  2. The Society stand to benefit from the stability accorded to industrial sector by retained earnings.

Demerits of retained earnings:

  1. Ploughing-back of profits is possible only when there is stability in earnings.
  2. Retained earings may lead to over-capitalisation, which is not good for a concern.

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Question 3.
Explain the special features off long-term finance.
Answer:
The main special features off long-term finance are:

  1. Long-term finance is usually raised through the issue of shares and debentures, through term loans from financial institutions and ploughing-back of profits.
  2. Long-term finance is costlier than short-term finance and medium-term finance.
  3. Long-term loans are, generally, raised against securities.
  4. Long-term finance is the finance required for a long -period exceeding five year.
  5. It is required for financing the fixed capital of an undertaking.
  6.  It is required not only for the establishment of new undertaking, but also for the expansion and development of an existing undertaking.

Question 4.
Explain the special features of short-term finance.
Answer:
The main special features of short-term finance are:

  1. Short-term finance is quickly available, particularly from supplier and commercial banks.
  2. Short-term finance from bank is, usually, in the form of loans, overdrafts, cash. credits and discounting of bills of exchange.
  3. Short-term finance is less costly as compared to long-term finance.
  4. Short-term finance is of greater use to small undertakings.
  5. Short-term finance is the finance required for a short period of one year or less.
  6. It is required for financing working capital requirements of a concern, particularly for financing the seasonal, temporary or variable working capital requirements of a concern.

KSEEB Solutions

Question 5.
Discuss the advantages and disadvantages of ploughing back of profits.
Answer:
Advantages of ploughing back of profits are:

  1. Retained profits reduce the dependence of company on external borrowings.
  2. The Society stand to benefit from the stability accorded to industrial sector by retained earnings.
  3. Retained earnings provide security to shareholders against business uncertainties.

Disadvantages of ploughing back of profits are:

  1. Ploughing-back of profits is possible only when there is stability in earnings.
  2. Retained profits may depress the prices of shares of the company temporarily.
  3. Retained earnings may lead to over-capitalisation, which is not good for a concern.

KSEEB Solutions

Question 6.
Explaiu the meaning and merits of GDRs.
Answer:
A global depository receipt is an instrument in the form of a depository receipt or certificate, denominated in U.S dollar, created by an overseas Depository Bank outside India, and issued to non-resident Investors against the issue of ordinary shares or foreign currency convertible bonds of the issuing company.

Merits of GDRs:

  1. There are less administrative formalities as regards dividend payment on GDRs.
  2. There are less formalities connected with the issue of GDRs.
  3. The cost of raising funds through GDRs from international markets is less as compared to domestic issues.
  4. GDRs help in tapping international capital for domestic companies.
  5. GDRs offer comparatively better share values as compared to domestic issues.
  6. GDRs enhance the image of the company that has issued them.
  7. GDRs broaden shareholders base!

Question 7.
Explain the meaning and merits of ADRs.
Answer:
American depository receipts are negotiable receipts issued to investors by an authorized depositor)’, normally, a U.S. bank or depository in lieu of the Shares of the foreign company, which are actually held by the depository.

Advantages of ADRs:

  1. ADRs can be listed and traded in U.S. based stock exchanges. This would help the Indian companies to be known in the highly liquid U.S. stock exchanges.
  2. ADRs help the U.S based investors to have the twin benefits of having shareholding in a high grown Indian company and the convenience of trading in highly liquid U.S stock market.

KSEEB Solutions

Question 8.
Write the merits of preference shares.
Answer:
The merits of preference shares are:

  1. Preference share is an important source of long-term capital for the company, as the preference share capital is required to be returned only after a long period of 10 years.
  2. They do not involve the creation of any charge on the assets of the company.
  3. They do not give the preference shareholders any control over the affairs of the company.
  4. Preference shareholders get a fixed rate of dividend on their shares.
  5. Preference shares are an attractive investment to cautious investors who desire a fixed rate of dividend.
  6. Preference share capital is, generally, regarded as part of equity or net worth of the company. This increases the credit-worthiness of the company.

Question 9.
State five differences between shares and debentures.
Answer:
Debentures differ from shares in many respects. The main differences between the two are:

Shares Debentures
1. Shares are part of the capital of the company. 1. But debentures are part of the loan capital or loan of the company.
2. Shareholders, being owners, have voting rights. 2. Debenture holders, being only loan creditors, do not have voting rights.
3. Shareholders are entitled to dividend. 3. Debenture holders are entitled to interest.
4. Shares are not secured by a charge on the assets of the company. 4. Debentures are, generally, secured by a charge on the assets of the company.
5. Shares can be forfeited. 5. Debentures are not forfeited.

KSEEB Solutions

Question 10.
Explain the merits and demerits of raising funds through shares.
Answer:
The merits of raising funds through shares:

  1. Equity share are a very good and permanent source of long-term finance for a company, as the equity share capital is to be returned only on liquidation of the company.
  2. Preference shares are an important source of long-term capital for company, as the preference share capital is required to be returned only after a long period of 10 years.
  3. Retained profits are a permanent source of finance.

The demerits of raising funds through shares:

  1. The dividend payable on equity shares is not deductible form profits as an expense for the purpose of income-tax.
  2. Issue of preference shares involves several legal formalities.
  3. Retained earnings may lead to over-capitalisation, which is not good for a concern.

KSEEB Solutions

Question 11.
Explain the merits and demerits of raising funds through debentures.
Answer:
The merits of raising funds through debentures:

  1. Debentures are an important source of long-term fiance for a company.
  2. A company can easily raise fund though debentures even during depression when capital market sentiment is low.
  3. Debentures are more liquid than shares, as they shares, as they can be sold by the holders easily and quickly, when money is required by them.

The demerits of raising funds through debentures:

  1. Debentures can be issued only by public limited companies.
  2. The cost of raising finance through debentures is high because of heavy stamp duty.
  3. The market prices of debentures change with the changes in the rates of interest-

Question 12.
Explain the various sources of long-term and short-term finance.
Answer:
Sources of long term finance: There are many sources of long-term finance. They are equity shares, preference shares, ploughing-back of profits or re-investment or profits, debentures, long-term loans from, financial institutions and banks, long-term public deposits, installment credit, lease financing i.e., acquisition of plant and machinery equipments etc. on lease, mutual funds, venture capital etc.

Sources of Short term finance: There are a number of sources of short-tem finance. The important sources of short-term finance are trade credit, bank credit or bank loan, customer advances, short-term public deposit, installment credit borrowing from indigenous bankers and money lenders, etc.

The various sources of finance can be classified into two categories on the basis of ownership of finance or funds. They are:

Owned Funds or Owners Fund

1. Equity shares: Equity shares are those which are not preference share.

2. Preference shares: Preference shares are shares which have preferential rights in respect of payment of dividend during the existence of the company, and also in respect of repayment or refund of share capital in the event of winding up of the company.

3. Re-investment of profits: The process of retaining a portion of distributable profits and utilizing them in the business is called ploughing-back of profit, self¬financing or internal financing.

II. Borro wed Funds

  1. Debentures and Bonds: In the words of Palmer, “Debenture signifies an instrument under seal evidencing a debt, the essence of it being the admission of indebtedness”
  2. Loans from financial institutions: In India, there are many specilaised financial institutions providing finance to business enterprises. Some of those specilaised financial institutions are the industrial Finance Corporation of India.
  3. Loans from commercial Bank: Finance from commercial banks is a dependable source. Banks provide timely assistance, as funds are provided as and when needed by the borrowing firms.
  4. Public Deposits: Public deposits refer to deposits that are raised by a business firm directly from the public.
  5. Trade Credit: Trade credit refers to credit obtained from the suppliers of goods in the normal course of trade. In other words, it means the goods purchased from suppliers on credit.
  6. Bank Credit: Bank-credit refers to credit, financial accommodation or advance taken from commercial banks.

KSEEB Solutions

Question 13.
Explain the factors affecting the choice of source of funds.
Answer:
Factors affecting the short-term finance:

  1. Nature of the business: The nature of the business affects the short-term financial requirements of a concern to a great extent.
  2. Growth and expansion of business: The growth and expansion of business also effects the short-term capital requirements.
  3. Scale of operations: The scale of operations affects the short-term capital requirements of a concert. A concern carrying on activities on a small scale needs less short-term capital.
  4. Length of the operating Cycle: The length of the operating cycle, influencer the amount of short-term finance.
  5. Fluctuation in supplies: Fluctuations is supplies affect the short-term or working capital requirements of a firm. Operating efficiency:
  6. Credit policy: The credit policy of a firm affects its short-tern of working capital requirements.
  7. Credit facilities enjoyed from creditors: The credit facilities enjoyed by a firm from its creditors will’also affect the short working capital requirements of a firm.
  8. Production policies: The production policies followed by a firm will also affect the working capital requirements.
  9. Rapidity of turnover: There is a high degree of connection between the rapidity of turnover and the amount of working capital requirements.
  10. Seasonal fluctuations in demand: Seasonal fluctuations in demand for products will affect the amount of short-term capital requirements of concern.
  11. Taxes: Taxes imposed by the Government affect the working capital of a firm. Higher taxes are a strain on the working capital of the firm.
  12. Dividend policy: The dividend policy of a company affects its working capita! requirements.
  13. Profit level: Profit level also affects the short-term or working capital requirements of concern. .
  14. Government regulations: Government regulations and restrictions affect the short-term working capital requirements of a firm. ‘
  15. Price level changes: Price level changes also affect the short-term or working capital requirements of a firm.

KSEEB Solutions

Question 14.
Explain the various sources of owned funds.
Answer:
Owned Funds.or Owners Fund:
I. Equity shares: Equity shares are those which are not preference share.

Merits of equity share to the company, Equity shareholder:

  1. Equity shares are very good and permanent source of long-term finance for a company.
  2. The holders of equity shares are the real owners of the company, and so, they have voting rights in the management of the company.

Demerits of equity share to the company, Equity shareholder:

  1. It costs more to finance with equity shares than with the preference shares or debentures.
  2. The equity shareholders cannot be sure of earning regular and fixed divined.

II. Preference shares: Preference shares are shares which have preferential rights in respect of payment of dividend during the existence of the company, and also in respect of repayment or refund of share capital in the event of winding up of the company.

Merits of Preference shares to the company, Preference shareholder:

  1. Preference share are an important source of long-term capital for the company, as the preference share capital is required to be returned only after a long-period of 10 years.
  2. Preference shareholders get a fixed rate of dividend on their shares.

Demerits of Preference shares to the company, Preference shareholder:

  1. Issue of preference shares involves several legal formalities, and as a result, preference shares become costly.
  2. The preference shareholders cannot be quite sure of getting dividend on their shares eveiy year.

III. Re-investment of profits: The process of retaining a portion of distributable profits and utilizing them in the business es called ploughing-back of profit, self-financing or internal financing.

Advantages of ploughing back to the company, shareholders:

  1. Retained profits reduce the dependence of company on external borrowings.
  2. Retained earnings provide security to shareholders against business uncertainties.

Disadvantages of ploughing to the company, shareholders:

  1. Ploughing-back of profits is possible only when there is stability in earnings.
  2. Retained profits may depress the prices of shares of the company temporarily.

KSEEB Solutions

Question 15.
Explain the various sources of borrowed funds.
Answer:
Borrowed Funds:

1. Debentures and Bonds: In the words of Palmer, “Debenture signifies an instrument under seal evidencing a debt, the essence of it being the admission of indebtedness”.

2. Loans from financial institutions: In India, there are many specilaised financial institutions providing finance to business enterprises. Some of those specilaised financial institutions are the industrial Finance Corporation of India.

3. Loans from commercial Bank: Finance from commercial banks is a dependable source. Banks provide timely assistance, as funds are provided as and when needed by the borrowing firms.

4. Public Deposits: Public deposits refer to deposits that are raised by a business firm directly from the public.

Merits of public Deposits:

  • These deposits take care of short-term and medium-term financial requirements.
  • These deposits do not involve the creation of any charge on any asset of the borrower.

Demerits of public Deposits:

  • Collection of deposits from a large number of depositors is somewhat difficult.
  • New companies generally find it difficult to borrow funds through public deposits.

5. Trade Credit: Trade credit refers to credit obtained from the suppliers of goods in the normal course of trade. In other words, it means the goods purchased from suppliers on credit. The duration of trade credit is, usually, 15 days to 90 days. It is granted without and security except the credit standing of the concern. The amount of trade credit that can be enjoyed by concern depends upon its credit-standing and the volume of business it carries on the supplier of goods.

There are three types of trade credit. They are:

  1. Open accounts or accounts payable
  2. Notes payable
  3. Trade acceptances.

6. Bank Credit: Bank credit refers to credit, financial accommodation or advance taken from commercial banks. Bank credit is, generally, given for a period not exceeding one year. Bank credit is common to all types of business. The amount of bank credit depends upon the nature and size of the business, and the credit-standing of the concern. Bank credit may be unsecured or against guarantee or against hypothecation, pledge or mortgage of assets. An interest of 15% to 18% is, usually, charged on bank credit.
Bunk credit takes various forms. They are:

  1. Short-term loan
  2. Overdraft
  3. Cash credit
  4. Discounting of bills of exchange
  5. Commercial letter of credit.

KSEEB Solutions