NCERT Solutions for Class 11 Business Chapter 8 - Sources Of Business Finance

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

Ans: Finance is the life blood of a business and the money required to run the business is known as business finance.

Business needs finance for three reasons mainly:

• To purchase plant and machinery, land, buildings and other fixed assets (Fixed capital requirements).

• Smooth functioning of day to day operations of the business (Working capital requirements)

• Expansion, growth and diversification.
  
  

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

Ans: Long-term financial resources are:

• Equity Shares

• Retained earnings

• Preference shares

• Debentures

• Loans from financial institutions

• Loans from Banks

Short-term financing sources are:

• Trade credit

• Factoring

• Banks

• Commercial papers
  
  

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

Ans: The difference between internal and external sources of raising funds are as follows:

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

Ans: Preference shareholders have the following preferred rights:  

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

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

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

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

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

Ans: The three institutions are:

• Unit Trust of India or UTI: It was established under Unit Trust of India Act, 1963 in 1964. The purpose of the establishment of the UTI was supposed to combine savings and monetization of investment in profitable businesses.

• The Industrial Finance Corporation of India or IFCI: It was established in 1948, under Industrial Finance Corporation Act, 1948. Its purpose was to assist in balanced regional development, encouraging entrepreneurs to enter emerging sectors, and to contribute to management education development.

• State Financial Corporation (SFC): SFC’s fulfils the long term, and medium term finance needs of industries which are beyond the scope of IFCI. It covers public limited, private limited, partnership firms as well, thus its scope is broader than IFCI.
  
  

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

Ans: the difference between GDR and ADR is:

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

Ans: Trade Credit

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

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

Merits

• A continuous and a convenient source of funds.

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

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

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

Limitations

• There can be chances of over-trading.

• Fulfils only limited financial needs.

• Costly in comparison to few other sources.

Bank Credit

A loan provided by a bank to a business firm is known as bank credit. The bank's interest rate on the loan is usually determined by the current interest rate in the economy. To secure the loan, the borrower must mortgage assets with the bank.

Advantages 

• Secrecy of business is maintained.

• An easier source of finance as formalities of issuing of prospectus and underwriting is not required.

• Bank credit gives the borrower flexibility because the amount of the loan can be increased or decreased depending on the borrower's business demands.

Disadvantages

• Generally, the funds are available for a short period of time and renewal becomes a difficult process and is uncertain.

• The company may have to keep assets as security as the banks ask for security assets before issuing such loans.

• Sometimes, the terms and conditions imposed by the banks are quite difficult.

• Banks' terms are frequently highly restrictive; for example, a bank that has provided a loan may limit the borrower's ability to sell commodities mortgaged to it.
  
  

8. Discuss the sources from which a large industrial enterprise can raise capital for financing modernization and expansion.

Ans: The following are some long-term funding options:

• Equity shares: These shares represent a company's ownership capital. These shareholders are known as equity shareholders, and they have a say in the management and benefit from higher returns when profits are higher. They are also known as the company's owners, or residual owners because payments to them are provided only after external debts or claims have been paid.

• Retained earnings: Before paying out dividends to shareholders, companies often keep a portion of their income. These undistributed profits are referred to as retained earnings since the money is kept for future use.

• Preference shares: As the name suggests, these shareholders are the ones who hold a preferential position in respect to getting a fixed rate of dividend before any dividend for the equity shareholders, and receiving the capital at the time of liquidation just after the payment to the creditors of the company.

• Debentures: Debentures are long-term debt capital raising financial instruments employed by companies. They signify that a corporation has borrowed a particular amount of money, which it will eventually repay to the holders of debentures. They have a predetermined rate of return and a stipulated time for debt payback. Debenture holders are called the creditors of the company. 

• Bank and other financial institution loans: Businesses can borrow funds from banks and financial institutions for a certain period of time in exchange for a defined periodic payment known as interest. The repayment period for such a loan is predetermined and announced at the time of loan approval.
  
  

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

Ans: Debentures are long-term debt capital raising financial instruments employed by companies. They signify that a corporation has borrowed a particular amount of money, which it will eventually repay to the holders of debentures. They have a predetermined rate of return and a stipulated time for debt payback. The Debenture holders are also termed as the creditors of the company. 

Advantages of debentures over equity shares

• No dilution of ownership: The issuance of equity shares signifies a dilution of a company's ownership. Because equity shareholders own specific shares of the corporation and have voting rights, this is the case. Debenture holders, on the other hand, have no ownership rights in the corporation. That is, they do not have any voting rights or ownership in the company. Rather, they are only entitled to a set amount of money as compensation. As a result, debentures do not affect the firm's ownership structure. As a result, issuing debentures is preferable to issuing stock shares for a company.

• Tax deductible expense: A company must incur significant fees to issue shares. Furthermore, it must provide non tax-deductible dividends to its stockholders. On the other hand, a firm can deduct interest paid to its debenture holders from its taxable income. As a result, issuing debentures is cost-effective for a company.

• Fixed Interest: Debentures have a set interest rate. This means that regardless of profit, the company is only required to pay a predetermined interest rate to its debenture holders. A corporation that issues shares, on the other hand, is required to pay dividends to its shareholders, which vary according to profit—that is, the larger the profit, the higher the dividends.
  
  

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

Ans: Public deposits: 

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

Merits of Public Deposits:

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

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

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

Demerits of Public Deposits:

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

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

Retained Earnings: 

Before issuing dividends to shareholders, companies normally keep a portion of their income. Retained earnings are profits that are not distributed and are kept in the business for future usage.

Merits of Retained Earnings:

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

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

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

Demerits of Retained Earnings:

• Unreliable: Because corporate revenues fluctuate from time to time, retained earnings are an unreliable source of funding.

• Dissatisfied shareholders: If a company reinvests a large portion of its profits back into the business, it leaves very little money for dividends to shareholders, which causes dissatisfaction.

• Mismanagement: Companies frequently overlook the opportunity cost of earnings kept in the business. As a result, these funds are frequently mismanaged or underutilized.
  
  

11. Discuss the financial instruments used in international financing.

Ans: Three types of financial instruments are commonly used in international financing:

• GDRs (Global Depositary Receipts): These are receipts issued by depository banks against a firm's shares, such as those issued by an Indian company abroad to raise foreign money. Global Depository Receipts are generally denominated in US dollars. These are convertible to shares at any time. They can be listed and traded on any stock exchange outside of the United States.

• ADRs (American Depository Receipts): These are receipts issued by firms domiciled in the United States. They are typically traded in the same way as any other security on the market. However, such trading is limited to the securities markets in the United States. Furthermore, ADRs are only available to nationals of the United States.

• Foreign Currency Convertible Bonds (FCCBs): These bonds are debt securities that, after a set length of time, can be converted into equity shares or depository receipts. In most cases, the terms and prices of such conversions are set in advance. Such securities have a predetermined return that is lower than non-convertible securities.
  
  

12. What is commercial paper? What are its advantages and limitations?

Ans: A commercial paper is an unsecured promissory note which has been used in India since 1990. It is used as a promissory note by corporate buyers  who are highly rated. It helps them meet their short term funding requirements and can be issued for anytime between 7 days to 1 year. Non Resident Indians (NRIs), primary dealers, Foreign Institutional Investors (FIIs), All-India financial institutions  can raise commercial papers.

It is distributed to other businesses, insurance companies, pension funds, and banks by a single company. The sum raised by CP is usually rather substantial. Because this debt is completely unsecured, the CP can only be given by companies with a solid credit rating. 

The Reserve Bank of India regulates the issuance of CP. 

Advantages 

• As the commercial paper is supplied unsecured, it does not carry any restrictive limitations. 

• In comparison to other sources, it delivers greater funds.

• The cost of commercial bank loans is often higher than the cost of CP for the issuing enterprise. 

• As the maturity of commercial papers may be customized to meet the needs of the issuing firm, they provide a consistent stream of funds. 

• Businesses can put their spare cash into commercial paper and earn a nice return. 

Limitations:

• Commercial papers can only be used to raise funds by companies that are financially stable and have a high credit rating. Because this approach is unsecured, it is not suitable for new or moderately rated businesses. 

• Commercial paper has a finite amount of money that can be raised.

• Commercial paper is an impersonal form of financing, and extending the maturity of a CP is not conceivable if a company is unable to redeem its paper owing to financial difficulties.
  
  

13. Collect information about the companies that have issued debentures in recent years. Give suggestions to make debentures more popular.

Ans: Company debentures are lending instruments for a medium to a lengthy period of time in corporate finance. Both major corporations and the government provide these services. Debentures are primarily based on the issuing authority's reputation and operate at a set interest rate. When government agencies want to borrow money from the public at a fixed rate of interest, they issue debentures.

Muthoot Finances, Reliance Capital, Shriram Transport Finances, and Tata Global Beverages are among the firms that have recently issued debentures.

To increase the popularity of debentures, two techniques may be used: 

• Making them high yielding 

• Making them completely convertible to equity shares at maturity.

An appealing interest payment rate can be used for the first technique.

14. Institutional financing has gained importance in recent years. In a scrapbook paste detailed information about various financial institutions that provide financial assistance to Indian companies.

Ans: Following are some of the Financial Institutions that provide financial assistance to Indian companies:

• Finance Corporation of India (IFCI)
  Under the Industrial Finance Corporation of India Act, 1948, the Industrial Finance Corporation of India (IFC) was established in 1948. The corporation's main purpose has been to supply Indian industrial businesses with medium and long-term financing. According to the preamble of the IFC Act, 1948, the corporation's goal is to “make medium and long-term financing more easily available to industrial enterprises in India, particularly in circumstances where regular banking accommodation is inadequate or capital issuance procedures are impracticable.”

• Industrial Credit and Investment Corporation of India (ICICI)
  To support private sector medium and small enterprises, the Industrial Credit and Investment Corporation of India (ICICI) was founded in 1955 as a public limited company under the Indian Companies Act.

Initially, it was held by corporations, institutions, and people, but now it is owned by public sector organizations like banks, LIC, and GIC, among others. It offers term loans in Indian and international currencies, underwrites share and debenture offerings, subscribes directly to these issues, and guarantees payment of credit extended by others.

• State Financial Corporations (SFCs)
  The Government of India created the State Financial Corporation Act in 1951 intending to provide financial support to small and medium-sized businesses that were not covered by the IFCI. This Act gives a state government the authority to create a financial corporation that will operate within the state. There are now 18 such businesses operating in the nation.

These companies are intended to work in tandem with India's Industrial Finance Corporation. IFCI, on the other hand, exclusively helps major industrial enterprises that are controlled by public limited corporations or co-operatives.

• Industrial Development Bank of India (IDBI)

The Industrial Development Bank of India was created as a wholly owned subsidiary of the Reserve Bank of India under the Industrial Development Bank of India Act, 1964. Since February 16, 1976, the ownership of IDBI has been transferred to the Central Government.

The primary goal of creating IDBI was to create an apex organization that would coordinate the activity of other financial institutions and serves as a reservoir from which they could draw. IDBI also provides direct financial support to industrial entities to bridge the supply and demand for medium and long-term financing.

15. On the basis of the sources discussed in the chapter, suggest suitable options to solve the financial problem of the restaurant owner.

Ans: Suitable options to solve the financial problem of the restaurant owner are:

• Bank Credit
  A loan provided by a bank to a business firm is known as bank credit. The bank's interest rate on the loan is usually determined by the current interest rate in the economy. To secure the loan, the borrower must mortgage assets with the bank.

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

• Crowdfunding
  Crowdfunding is a method of finance where a  large number of people finance a new business initiative.  This strategy harnesses the collective efforts of a large group of people (friends, family, customers, and individual investors ) mostly via social media and crowdfunding platforms and utilises their networks for increased reach and exposure.

• Angel Investor
  These are the investors who provide funding for new or small business startups. These investors can be wealthy individuals, retired individuals, former entrepreneurs etc, who provide finance to a start up company against an ownership stake, or convertible debt.

• Equipment Financing
  Restaurants are in need of a number or equipment, such ovens, grills, stove, refrigerators etc. Hence, they can go for equipment financing, in which the provision of loan is made to a business for the purchase of machinery and equipment.

• Merchant cash advance
  A merchant cash advance (MCA) allows restaurants to borrow money in exchange for future payments made through their merchant payment system.

• Business line of credit
  A line of credit is one of the quickest and most handy tools available to restaurant owners, and it can be tailored as per specific needs of a person. A business line of credit (LOC) is a revolving loan that gives an individual access to a set amount of money that one can use whenever needed to satisfy short-term company finance needs.
  
  

16. Prepare a comparative chart of all the sources of finance.

Ans: The financial requirements may be for the long term, medium term, or short term.

The comparative chart is shown below:

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NCERT Solutions for Class 11 Business Studies Chapter 8 Sources of Business Finance

Objectives of Learning The Chapter 8 Business Studies Class 11

After studying the chapter, a student should be able to solve the sources of business finance Class 11 NCERT Solutions easily. However, to be precise, the students should be able to –

• State the meaning of business finance along with its nature and importance.

• Classify the several sources of business finance along with evaluating their merits and limitations.

• Students should also be able to identify the international sources of finance.

• Discuss the factors that affect in choosing an appropriate source of finance.

Vedantu helps students fulfil all the objectives of learning by providing them Business Studies Class 11 Chapter 8 solutions of exercise questions, in a downloadable free PDF format.

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Experienced teachers at Vedantu have prepared the Class 11 Business Studies Chapter 8 NCERT Solutions PDF that will come in handy for practising before exams. Vedantu offers the NCERT solutions of all subjects and their chapters to help students of all classes. The Business Studies Class 11 Chapter 8 solutions PDF provided by Vedantu can be easily downloaded from our official website or app.

Related Questions

Q. State the Advantages of the Issues of Debentures Provided Over the Issue of Equity Shares. 

Answer: The advantages of debentures over the issue of equity shares are-

• The shareholders get a part in the ownership of the company once equity shares are issued, and they also get voting rights in the organization. Unlike issuing equity shares, the issuing of debentures does not give the debenture holders any right to the organization; instead, the holders get a fixed amount of payment. 

• Unlike bearing costs for issuing shares where dividends payments are not tax-deductible, for paying the interest to debenture, the companies receive the tax deductions, which is more beneficial. 

• Since debentures have a fixed rate of returns; therefore, even if no profit is earned, the companies will still have to pay the dividend on the rate that was fixed. However, the companies issuing equity shares will have to pay varying amounts with the number of profits earned. 

Hence, in comparison, we can see it is best to issue debentures.

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Q. What Are the Merits and Demerits of Public Deposits? 

Answer: The deposits that are raised by an organization directly from the public and used to help them with short-term and medium-term requirements are called public deposits. These deposits are better than bank deposits because they have higher returns. For investing, one has to fill out and submit a prescribed form along with the amount that is to be deposited, and in return, a deposit receipt will be issued as acknowledgement.

There are Several Merits of Public Deposits Like –

• Borrowing loans from banks is costlier than raising funds from the public. 

• Public deposits require significantly fewer regulations. 

• The ownership of the organization doesn’t get diluted because the depositors do not have voting rights in the organization.
  
  

There are Also Demerits of Public Deposits Like-

• The amount of money raised is limited and uncertain because it depends on the willingness of depositors. 

• Public deposits are not good options for companies or firms with a higher capital requirement.

• It is more difficult for new companies to raise funds through this method because of less trust among people.

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