8 CBSE Term-II Business Studies XI

Sources of
Business Finance
5. Funds needed for the day-to-day operations is
PART 1 called ………. capital of the company.
(a) fixed (b) loan
Objective Questions (c) permanent (d) working
Ans. (d) working
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Multiple Choice Questions 6. In order to avoid failure in non-payment, fixed
1. Requirement of funds by business to carry out its capital requirements should be met through which
various activities is known as type of source of finance?
(a) business management (a) Long-term sources
(b) business finance (b) Short-term sources
(c) business budgeting (c) Medium-term sources
(d) financial management (d) None of the above
Ans. (b) A business requires funds for each and every activity Ans. (a) Long-term source of finance gives more opportunity
from its commencement till it’s winding up. This to the borrower to repay the debt thereby helping in
requirement of funds is known as business finance. avoiding the failure of non-repayment.

2. Primary goal of business finance is to 7. Mary owns a small farm to grow fruits. She wants to
(a) increase corporate value purchase neighbouring land and convert it to farm
(b) increase brand value for increasing the variety of fruits. She wishes to
(c) reduce debt burden take tractor and some other machine for the same.
(d) avail opportunities
She will also need money to purchase the land.
Which source of finance is required by Mary?
Ans. (a) Increase in brand value, reduction of debt burden and
availing opportunities are the secondary goals of business (a) Short-term (b) Medium-term
finance, while primary goal is to increase corporate value. (c) Long-term (d) Both (a) and (b)
Ans. (c) Mary will be able to pay only when her new farm
3. Fixed capital requirements of a manufacturing starts giving high quantity of fruits which will require
concern are long time, therefore, she requires long-term finance.
(a) same as that of a trading concern
(b) more than that of a trading concern
8. Statement I Medium-term funds remain invested
in a business for more than 1 year but less than 5
(c) less than that of a trading concern
years.
(d) None of the above
Ans. (b) Fixed capital requirements of a manufacturing Statement II Payment of dividend on equity shares
concern are more since they require more machine and is compulsory.
other factory tools as compared to trading concerns. Alternatives
4. The working capital requirements of a business is (a) Statement I is correct and statement II is wrong
high if …… (b) Statement II is correct and Statement I is wrong
(a) sales turnover of business is high (c) Both the statements are correct
(b) it sells goods on credit (d) Both the statements are incorrect
(c) it has any expansion plans Ans. (a) Equity shareholders are the residual owners of the
(d) All of the above company. So, dividend is only paid when amount is left
after making payment to all other liabilities.
Ans. (d) All the mentioned options lead to more requirement of
working capital majorly in the form of high inventory 9. Directors of X Ltd wants to expand the company, for
levels, high outflow of cash and low inflow of cash. this they need land, new factory shed and machines.
 Being the financial advisor of the company which Ans. (d) Retained earnings do not involve any explicit cost as it
source from the following you will recommend does not involve any form of interest, dividend or
them? floatation cost. As the profits of business are fluctuating, it
(a) Debentures is an uncertain source of fund.
(b) Inter-corporate deposits 14. Non-payment of debts on time results in
(c) Loan from commercial banks (a) higher interest costs (b) loss of goodwill
(d) Equity shares (c) fines and penalties (d) All of these
Ans. (d) Acquisition of land and construction of factory shed on Ans. (d) Non-payment of debts on time results in imposition of
it takes time. This means that the factory will not generate fines or penalties by the lender. In normal course of
any revenues for that time period. Therefore, funds business, money is borrowed at compound interest rates
required for the construction of the factory should be which means interest is charged on interest therefore, if
arranged from sources which are of long-term and do not there is any delay in repayment, interest costs would be
require fixed interest payments. Debentures requires higher. Extraordinary delay may also result in court cases
fixed interest payment while inter-corporate deposits and leading to loss of goodwill.
loans from commercial banks are short-term in nature.
Therefore, equity is the best option among the given
15. Unsecured debentures are also known as ……..
options. debentures.
(a) simple (b) naked
10. Equity share capital represents (c) collateralised (d) Both (a) and (b)
(a) fixed capital of the company Ans. (d) Both (a) and (b)
(b) loan capital of the company
(c) permanent capital of the company 16. The depository receipts issued by the company in
(d) fluctuating capital of the company the USA are known as ………. .
Ans. (c) Equity shares are permanent source of capital which (a) GDR (b) ADR
are redeemed only at the winding up of the company. (c) FDR (d) Both (b) and (c)
11. Statement I Participating preference shares Ans. (b) ADR
participate in the management of the company. 17. One of the demerits of loan from financial institutions
Statement II The owner funds are a permanent is that, financial institutions may put …… in the
source of finance. board of directors of the borrowing company which
Alternatives restricts their power.
(a) Statement I is correct and statement II is wrong (a) independent directors
(b) Statement II is correct and Statement I is wrong (b) nominee directors
(c) Both the statements are correct (c) experts
(d) Both the statements are incorrect
(d) auditors
Ans. (b) Participating preference shares can participate for
Ans. (b) nominee directors
additional dividend of the company. They cannot take
part in the management of the company. 18. Companies generally invites public deposits for a
12. Instead of distributing entire profits to the owners in period up to
the form of dividend, some profits are re-invested in (a) 5 years (b) 3 years
business in order to finance the future earnings of (c) 4 years (d) 10 years
the business. This is known as .......... . Ans. (b) 3 years
(a) ploughing back (b) dividend
(c) working capital (d) dividend stripping 19. Statement I In certain situations, collection of
Ans. (a) ploughing back
public deposits is difficult.
Statement II The dividends to be paid to the
13. Statement I Retained earnings involve any explicit preference shareholders are fluctuating.
cost in the form of interest, dividend or floatation cost.
Alternatives
Statement II Retained earnings are an uncertain (a) Statement I is correct and statement II is wrong
source of fund. (b) Statement II is correct and Statement I is wrong
Alternatives (c) Both the statements are correct
(a) Statement I is correct and statement II is wrong (d) Both the statements are incorrect
(b) Statement II is correct and Statement I is wrong Ans. (a) Collection of public deposits may prove difficult, when
(c) Both the statements are correct the size of deposits required is large. The dividends to be
(d) Both the statements are incorrect paid to the preference shareholders are fixed.
 20. ……is the credit extended by one trader to another Ans. (c) In public deposit, the depositors of company are not
for the purchase of goods and services. given any voting rights.
(a) Loan (b) Trade Credit 5. Assertion (A) Borrowed funds are not considered as
(c) Trade Loan (d) Both (a) and (b) permanent source of capital.
Ans. (b) Trade Credit Reason (R) Borrowed funds are raised from
external source and are required to be paid back
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Assertion–Reasoning MCQs after a stipulated period.
Directions (Q. Nos. 1 to 7) There are two Ans. (a) Both Assertion (A) and Reason (R) are true and Reason
statements marked as Assertion (A) and Reason (R). (R) is the correct explanation of Assertion (A)
Read the statements and choose the appropriate 6. Assertion (A) To overcome problems during
option from the options given below difficult times, a business needs finance.
(a) Both Assertion (A) and Reason (R) are true and Reason
(R) is the correct explanation of Assertion (A) Reason (R) During recession and depression, the
(b) Both Assertion (A) and Reason (R) are true, but Reason sales of the business go down and the profitability is
(R) is not the correct explanation of Assertion (A) adversely affected.
(c) Assertion (A) is true, but Reason (R) is false Ans. (a) Both Assertion (A) and Reason (R) are true and Reason
(d) Assertion (A) is false, but Reason (R) is true (R) is the correct explanation of Assertion (A)

1. Assertion (A) The procedure of obtaining funds 7. Assertion (A) Tax benefits are available on dividend
from commercial banks is complex. paid on preference shares.
Reason (R) Banks make detailed investigation of Reason (R) Dividend paid on preference shares is
the company’s affairs, financial structure, etc. an appropriation of profits.
Interest charged by banks depends upon a number Ans. (d) Tax benefits are not available on dividend paid on
of factors, such as nature of advance, period for preference shares because of the reason given.
which the loan is taken, etc. l
Case Based MCQs
Ans. (a) Both Assertion (A) and Reason (R) are true and Reason
(R) is the correct explanation of Assertion (A). 1. Direction Read the following text and answer the
2. Assertion (A) Financing through debentures is less question no. (i) to (vi) on the basis of the same.
costly. A company is searching options to raise ` 20,000
Reason (R) Debentures do not carry voting rights. crore from the financial market for diversification
Therefore, financing through debentures does not and modernisation of existing projects. It hired the
dilute the control of equity shareholders on services of a renowned financial consultancy firm
management. for suggesting options for the same. The financial
Ans. (b) The interest paid on debentures is admissible as an consultancy firm suggested a list of options to the
expense according to the provisions of income tax. This board of directors of the company.
helps a company to reduce its tax liability. Therefore, It was decided that for the immediate requirement
financing through debentures is less costly. of ` 1,500 crore, the company will make a new issue
3. Assertion (A) Payment of dividend on equity shares of shares without diluting the right of existing
is compulsory. shareholders according to the terms and conditions
of the company and ` 4,500 crore, would be raised
Reason (R) Voting rights are conferred upon equity
by taking loans from financial institutions.
shareholders and they participate in the affairs of
the business. It was further decided to raise capital to the term of
Ans. (d) Equity shareholders are the residual owners of the ` 6,000 crore through debentures. All these options
company. So, dividend is only paid when amount is left were accepted by the board of directors. The board
after making the payment for all other liabilities. further decided that trade credit can be used to
finance short-term capital requirements. The
4. Assertion (A) The control of the company is not company also decided that they will use their
diluted when they go for public deposits. undistributed profits in case of shortfall of funds.
Reason (R) The depositors of company are given (i) It was decided that for the immediate requirement
minor voting rights to keep their preference in of ` 1,500 crore, the company will make a new issue
consideration. of shares at a fixed rate of dividend without diluting
the control of existing shareholders, according to
 the terms and conditions of the company. Name the source of raising capital. The company is also
type of financial securities issued by the company. considering using retained earnings for the same.
(a) Equity shares (i) Name the source of owned capital which is available
(b) Debentures free of cost.
(c) Commercial papers (a) Equity shares (b) Preference shares
(d) Preference shares (c) Retained earnings (d) Bonds
Ans. (d) Preference shares Ans. (c) Retained earnings
(ii) Which of the following sources of finance used by (ii) Vinita is of the view to finance the fund requirements
company does not involve any cost? from owned capital sources rather than from
(a) Shares borrowed capital sources as the risk of borrowed
(b) Debentures capital is …. and cost is ….. .
(c) Trade credit (a) high, low (b) low, high
(d) Loans from financial institutions (c) low, low (d) high, high
Ans. (c) Trade credit Ans. (a) high, low
(iii) Debentures are said to be the economical source of (iii) If the cash flow position of the company is strong,
finance because of which of the merits? the company can raise the required capital by
(a) Low floatation cost (b) Tax benefits
issuing ……… to enjoy tax benefits.
(a) shares
(c) No loss of control (d) Fixed interest
(b) bonds
Ans. (b) Tax benefits
(c) debentures
(iv) ` 4,500 crore would be raised by taking loans from (d) commercial papers
financial institutions. Loans from financial institutions
Ans. (c) debentures
are provided for
(iv) The control of shareholders over management will
(a) short-term (b) medium-term
get diluted if the company raises the capital by
(c) long-term (d) Both (b) and (c)
(a) equity shares (b) debentures
Ans. (d) Both (b) and (c)
(c) loans (d) preference shares
(v) The board of directors further decided that trade Ans. (a) equity shares
credit can be used to finance short-term capital (v) Which of the owned source can be used by
requirements. Identify one of the sources of trade company without much of regulations?
credit. (a) Raising share capital
(a) Banks (b) Traders
(b) Retained earnings
(c) Suppliers (d) Customers
(c) Using ADR/GDR
Ans. (b) Traders
(d) Both (b) and (c)
(vi) The usage of undistributed profits indicates the Ans. (b) Retained Earnings
usage of which source of capital?
(vi) Which of the following is a merit of retained
(a) Bonds (b) Equity shares
earnings?
(c) Preference shares (d) None of these
(a) Retained earnings are permanent source of funds for an
Ans. (d) The undistributed profit indicates retained earnings. organisation.
2. Direction Read the following text and answer the (b) It enhances the capacity of business to absorb unexpected
losses.
question no. (i) to (vi) on the basis of the same. (c) This source offers a greater degree of operational freedom
Vinita is the finance manager of Kipla pharma Co. As and flexibility.
the company wants to import a piece of new (d) All of the above
machinery from Japan for its expansion, the capital Ans. (d) All of the above
requirements for the same are estimated to be ` 5 3. Direction Read the following text and answer the
crore. Vinita reported that the company is not in a question no. (i) to (vi) on the basis of the same.
position to bear extra burden of paying interest so the
company should use owned capital sources than Sahil Ltd. a firm manufacturing textile, wished to
borrowed capital. diversify their business. They were considering two
options, either to diversify into manufacturing
The board of directors are confident about the sales toothpaste or switches. They wanted to invest in the
turnover and cash flow position of the company in the purchase of land, to set up a manufacturing unit in
coming years and supports the borrowed capital the backward areas of Gujarat. The finance manager
 of the company was asked by the management to do
financial planning by identifying most suitable
PART 2
source of raising long-term funds for financing the
investment decisions and short-term sources for Subjective Questions
working capital decisions.
The objective was to keep the financial risks as low
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Short Answer (SA) Type Questions
as possible. Therefore, the company decided to 1. Why is finance important for business?
source the raw materials using a source of finance Ans. Finance is the life blood of the business. Funds are
which facilitates the purchase of supplies without required to commence and carry on business. All business
immediate payment. Moreover, apart from the activities such as planning, organising, managing,
outside funds used, the company also decided to controlling, purchasing, selling, directing, marketing, etc
plough back the profits. The company also decided cannot take place without finance. Business needs funds
that after a certain point of time, they will release for purchasing fixed and current assets, for day-to-day
their IPO and get benefit of the bull run of the operations, purchase of raw material, to pay salaries, etc.
market. 2. For the successful running of a business, it is
(i) Identify which of the following is not the long-term necessary to determine the amount of working
source of finance? capital. Do you agree? If yes, then give reasons in
(a) Equity shares (b) Retained Earnings support of your answer.
(c) ADR (d) Public deposits Ans. Yes, I agree with the statement. Working capital is that
Ans. (d) Public deposits portion of capital which is used to conduct day-to-day
operations. It is very important for a business to
(ii) Name the source of finance having least financial determine the required amount of working capital.
risk on the business.
The reasons for estimating required working capital are
(a) Debentures (b) Trade credit
(i) Prosperity and progress of the projects can be
(c) Equity shares (d) Public deposits
maintained by adequate working capital.
Ans (c) Equity shares
(ii) Adequate working capital enables a firm to improve
(iii) “…. facilitates the purchase of supplies without the efficiency and profitability of its operations.
immediate payment.” Identify the source of finance (iii) It is also required to channelise the day-to-day
stated above. operations. That’s why it is also called circulating or
(a) Commercial paper (b) Retained earnings revolving capital.
(c) Subsidy (d) Trade credit 3. Komalika wants to start her own business dealing in
Ans. (d) Trade credit high end crockery items. She decides to arrange for
(iv) Which of the following long-term source of finance initial finance from her savings. However, her
is also known as ploughing back of profits? savings are not enough to fulfil all the initial needs
(a) Preference shares (b) Lease financing of the business. She seeks help of her husband, who
(c) Retained earnings (d) Equity shares works in government sector.
Ans. (c) Retained earnings He advises her that to start her business with
(v) Which of the following factor appears to be the limited finance and then use the revenues earned
primary factor taken into consideration by the by the business to fulfil other financial
management? requirements. Is the view of Komalika’s husband
(a) Cost (b) Degree of risk justified? Why or why not?
(c) Financial strength (d) Tax benefit Ans. No, I don’t think that the view of Komalika’s husband is
justified. Adequate finance is required in the business
Ans. (b) Degree of risk
because of following reasons
(vi) Which of these sources of finance would be raised (i) Necessary to Start Business Every new venture
through IPO as stated in the last line of the text? needs money to buy plant and machinery or to
(a) Preference shares (b) Lease financing conduct certain activities. All financial needs will not
(c) Retained earnings (d) Equity shares be estimated in the absence of this concept.
Ans. (d) Equity shares
 (ii) Necessary for Business Cycle No matter how well Share Capital Total amount raised by issue of shares
the business is doing, a good finance manager has to constitute the share capital of the company.
prepare for rainy or even for stormy season. Business Shareholders The persons who buy shares are referred to
and economic cycles bring dark clouds that one can’t as ‘shareholders’.
predict. That’s why financial plans are created for In the given example, number of shares issued are 10,000,
downturns. share capital is of ` 1,00,000 and the persons who
(iii) Necessary for Growth Success can bring a business purchase these shares are the shareholders.
to a difficult crossroads. Sometimes in order to attain
more or to achieve greater success, a company needs 7. Discuss the features of equity shares as a source of
significant financial investment to acquire new finance.
capital, staff or inventory. This can only be possible Ans. Features of equity shares are
after proper arrangements of business finance. (i) The equity shareholders are the primary risk bearers
4. What are the different expenditures that any firm as they provide fixed capital to the business.
incurs in (ii) The equity share capital is not redeemable during
(i) Short-term (ii) Medium-term the lifetime of the company.
(iii) Long-term (iii) Returns are uncertain as the rate of dividend is not
fixed.
Ans. (i) Short-term
(a) Purchase of raw material. (iv) Equity shareholders can participate in the
company’s decisions and management.
(b) Payment of telephone bill, electricity bill, etc.
(ii) Medium-term 8. Preference shareholders have some preferential rights
(a) Expenditure made on renovation of office. in the capital structure of any company. Comment.
(b) Expenditure made on the promotion of company’s Ans. The following preferential rights are enjoyed by
product. preference shareholders
(iii) Long-term (i) Receiving a fixed rate of dividend, out of the net
profits of the company, before any dividend is
(a) Purchase of building
declared for equity shareholders.
(b) Purchase of machinery
(ii) Preference over equity shareholders in receiving
5. Differentiate between owner’s funds and borrowed their capital after the claims of the company’s
funds on the basis of creditors have been settled but before any amount is
(i) Reward paid to equity shareholders at the time of liquidation.
(ii) Security 9. Preference shares are not suitable for those
(iii) Order of payment investors who are willing to take risk and are
Ans. Difference between owner’s funds and borrowed funds. interested in higher returns. This highlights one of
the demerits of preference shares. State any other
Basis Owner’s Funds Borrowed Funds
four demerits of preference shares.
Reward Owner’s funds earn rewards Borrowed funds earn Ans. Demerits of preference shares are
in the form of share in profit, rewards in the form of
as in the form of dividend. interest. (i) These shares dilute the claim of equity shareholders
over the assets of the company.
Security These funds are raised These funds are
without providing for raised on security of (ii) The company has to pay higher rates of dividends to
security of assets. assets. the preference shareholders as compared to interest
on debentures.
Order of They rank last in the order They have priority in
Payment of payment. the order of payment. (iii) The dividend on these shares is to be paid only when
the company earns profit. Thus, the returns are not
6. Sun Rise company issues 10,000 shares of ` 10 each assured and they are unable to attract the investors.
for a total value of ` 1,00,000. With reference to the (iv) The dividend paid on preference shares is not
given statement, explain the meaning of the term deductible from profits as expense. Thus, there is no
share, share capital and shareholders. tax savings, as in the case of interest on loans.
Ans. Shares The capital of a company is divided into small 10. Shares are used to raise funds by the company.
units and each such unit is referred to as a ‘share’. Each However, there is a distinction in shares. There are
share forms a unit of ownership and is offered for sale to two types of shares – preference and equity.
raise the capital of the company. Shares are classified as Differentiate between equity shares and preference
equity shares and preference shares. shares on any three basis.
Ans. The differences between equity shares and preference 12. Though retained earnings are firm’s own source of
shares are (any three) funding and they are free to use them but using
Basis Equity Shares Preference Shares retained earnings can sometimes prove to be
disadvantageous. Do you agree? Explain.
Participation in Full right to No right to Ans. Yes, I agree that using retained earnings can sometimes
Management participate. participate. prove to be disadvantageous. Following points helps in
Sequence of Dividend is paid last Preference is given in explaining the demerits of retained earnings
Dividend of all. payment of dividend. (i) Excessive ploughing back may cause dissatisfaction
amongst the shareholders, as they would get lower
Sequence of On winding up of the Preference is given in
dividends.
Refund of company, capital is refunding the capital.
Capital refunded after (ii) As the profits of business are fluctuating, it is an
preference shares. uncertain source of fund.
(iii) Firms do not recognise the opportunity cost
Refund of Not possible at all. Capital can be
Capital During refunded in case of associated with this source, leading to sub-optimal
Lifetime redeemable use of funds.
preference shares. 13. What is the difference between GDR and ADR?
Permanency of Dividend is Dividend is certain (NCERT)
Dividend uncertain as it and fixed.
fluctuates with the Ans. Basis GDR ADR
amount of divisible
Location of Global Depository American Depository
profits decision of
Financial Receipts (GDR) can Receipts (ADR) can
board of directors.
Markets be bought and sold be bought and sold
in many only in America.
11. Amar owns a small farm in which he grows flowers. international
He is able to earn a small amount of profit, but being markets.
of an ambitious nature, he wants to take over a Disclosure Issue of GDRs do Issue of ADRs require
neighbouring farm and increase the range of flowers Requirements not require strict strict disclosure
he is selling. disclosure requirements.
requirements.
He is of the view that he will need long-term finance
for this purpose and plans to take a bank loan to pay Liquidity GDRs are less ADRs are more
for the take-over. He has already borrowed money to liquid. liquid.
buy a new tractor. Maintenance Maintenance costs Maintenance costs of
Costs of GDRs are less ADRs are more than
On the basis of above case, answer the following than that of ADRs. that of GDRs.
questions.
(i) What is meant by ‘long-term sources of finance’? 14. A seminar was held in New York on the problems
(ii) Identify and explain a form of internal finance Amar generally classified into owners fund and borrowed
could have used to buy the tractor.
funds. ABC Ltd. can raise required funds by
(iii) What factors would the bank consider before
employing both the above mentioned sources to
granting loan to Amar?
fulfill its needs of finance.
Ans. (i) Long-term sources of finance means those sources
which provide finance to business firms for a period Its topic was “The difference finance sources
exceeding five years. available at the global level in the modern context”.
(ii) A form of internal finance which Amar could have 200 representatives from different countries
used to buy the tractor is ‘retained earnings’. These participated in this seminar. All the representatives
earnings are a part of trading profits which are not expressed their respective opinions.
withdrawn by the proprietor, but are reinvested by
them in the business. One of the sources of finance discussed in the
seminar was such through which the foreign
(iii) The bank would consider the following factors
before granting loan to Amar companies could issue their securities in India.
(a) Amount of loan required. Looking at the great possibilities of obtaining
(b) Period for which the loan is required. capital from the investors in India, all of them
(c) Security offered. showed a great interest in the discussion of the
(d) Profit earning capacity of the business source.
(e) Repayment schedule of any previous loan taken.
 Another source of finance which created interest in 17. State the demerits of public deposits.
everyone was the source through which money Ans. Demerits of public deposits are
could be obtained from the investors in America and (i) New companies generally find it difficult to raise funds
other European countries. Since this source was through public deposits due to lack of goodwill.
concerned with a very big area, the number of (ii) It is an unreliable source of finance as the public may
people who took interest in its was also large. One not always respond when the company needs money.
of the Indian representatives throw light on the (iii) Collection of public deposits may prove difficult,
special characteristics of this source. You are particularly when the size of deposits required is
required to identify the source discussed by large.
highlighting the relevant lines.
Ans. (i) Indian Depository Receipts (IDR)
18. The company getting finance through public
deposits enjoys some benefits. Explain.
Line ‘‘One of the sources of finance ……… securities
Ans. Following points illustrate the benefits of public deposits
in India.’’
to the company
(ii) Global Depository Receipts (GDR)
(i) The procedure of obtaining deposits is simple and
Line “Another source …. …. European countries”. does not contain restrictive conditions.
(iii) American Depository Receipts (ADR) (ii) Cost of public deposits is generally lower than the
Line “In the final session … … only in America.’’ cost of borrowings from banks and others institutions.
15. Mahindra and Mahindra was the first company in (iii) Public deposits do not usually create any charge on
India to issue convertible zero interest debentures the assets of the company.
in January 1990. Recently, the board of Titan (iv) As the depositors do not have voting rights, the
Industries has approved the issue of partly control of the company is not diluted.
convertible debentures on a right’s basis to raise 19. Along with financial assistance, financial institutions
around ` 126.83 crore. The issue will comprise also provide technical assistance and managerial
21 lakh partly convertible debentures of ` 600 each services to business units. This reflects one of the
in the ratio of one partly convertible debenture for merits of obtaining finance through financial
every 20 equity shares held in the company to the institutions. Write any three more such merits.
shareholders. Ans. Merits of obtaining finance from financial institutions are
On the basis of above case, answer the following as follows
questions (i) Financial institutions provide long-term finance,
(i) Explain the meaning of convertible zero interest which is not provided by the commercial banks.
debentures issued by Mahindra and Mahindra. (ii) A financial institution, before extending financial
(ii) Explain the meaning of partly convertible debentures support to a business unit, conducts detailed study
on right’s basis. (NCERT) about its state of affairs. Only a promising and sound
Ans. (i) Convertible zero interest debentures are debentures business is able to get a loan from these institutions.
which carry no interest and are convertible into So, if a firm gets a loan from these institutes, then
equity shares at the end of a specified period. this will also help in raising the goodwill of the
(ii) Partly convertible debentures on right’s basis means borrowing company in the capital market.
that a part of these debentures will be converted into (iii) Repayment can be made in easy instalments therefore;
equity shares at the end of the stipulated period and it does not prove to be a burden on the business.
that these debentures can be subscribed by only 20. State the disadvantages of financial institutions as a
existing equity shareholders of the company.
source of finance.
16. What advantages does issue of debentures provide Ans. Disadvantages of financial institutions as a source of
over the issue of equity shares? finance are as follows
Ans. Following are the advantages of issuing debentures (i) Too many formalities are required by these institutes
instead of equity shares to grant a loan.
(i) Debentures are fixed charge funds and do not (ii) Restrictions are imposed by these institutes on
participate in the profits of the company. companies such as restrictions on the payment of
(ii) Financing through debentures does not dilute dividends or restrictions on the autonomy of
control of shareholders on management as management.
debentures do not carry voting rights. (iii) Generally, the financial institutions have their
(iii) Financing through debentures is less costly as nominees in the Board of Directors of the borrowed
compared to cost of equity capital as the interest company. This restricts their powers and the
payment on debentures is tax deductible. borrowed companies feel helpless in certain cases.
 21. Mr. Anil Singh has been running a restaurant for (iii) Every successive issue of equity shares dilutes the
the last two years. The excellent quality of food has voting power and earnings of existing equity
shareholders.
made the restaurant popular in no time. Motivated
by the success of his business, Mr. Singh is now (iv) Many formalities and procedural delays are involved
contemplating the idea of opening a chain of similar while raising funds through equity.
restaurants at different places. 2. Rohit Ltd. is a manufacturing firm which has been
However, the money available with him from his running in deep losses due to the onset of
personal sources is not sufficient to meet the pandemic. The company wants to innovate the
expansion requirements of his business. products to increase the sales and have therefore
His father told him that he can enter into a decided to purchase a new machinery for the same.
partnership with the owner of another restaurant, The company decided to use its funds which it has
who will bring in more funds, but it would also saved over the years to fund this machinery. Which
require sharing of profits and control of business. source of finance is highlighted here? Define. Also,
give the merits of the same.
He is also thinking of taking a bank loan. As a
Ans. The source of finance highlighted here is ‘retained
financial consultant, state the various sources of earnings’. It means that part of trading profits which are
owned funds and debt funds that Anil Singh can use. not distributed in the form of dividends, but retained by
(NCERT)
directors for future expansion of the company. This is also
Ans. The various sources of owned funds that Anil Singh can referred to as ‘ploughing back of profits’.
use are Merits of retained earnings are
(i) Selling a part of his business to other partners. (i) Retained earnings are a permanent source of funds
(ii) Issuing equity shares and preference shares (if he for an organisation.
decides to form a joint stock company). (ii) Retained earnings do not involve any explicit cost in
The various sources of debt funds are (any two) the form of interest, dividend or floatation cost.
(i) Loan from commercial banks. (iii) This source offers a greater degree of operational
(ii) Loan from specialised financial institutions. freedom and flexibility.
(iii) Issue of debentures (if he decides to form a joint
stock company). (iv) It enhances the capacity of business to absorb
unexpected losses.
l
Long Answer (LA) Type Questions 3. Debenture issued by a company is an
acknowledgment that the company has borrowed a
1. State any three merits and three limitations of certain amount of money, which it promises to
equity shares.
repay at a future date. However, there are both
Ans. Merits of equity shares are (Any three)
merits and demerits of debentures. Explain those
(i) Equity shares are suitable for those investors who merits and demerits.
are willing to assume risk for higher returns.
Ans. Merits of debentures are (any three)
(ii) Payment of dividend to the equity shareholders is
(i) It is preferred by investors who want fixed income at
not compulsory. Therefore, there is no burden on the
lesser risk.
company.
(ii) Debentures are fixed charge funds and do not
(iii) It is considered as a good source of long-term finance.
participate in profits of the company.
A company is not required to pay back the equity
capital during its lifetime. It is repaid only at the time (iii) The issue of debentures is suitable in the situation
of liquidation of company. Also, since it is paid in last, when the sales and earnings are relatively stable.
even on liquidation, therefore it provides a cushion for (iv) Financing through debentures does not dilute
creditors. Thus, it is a permanent source of capital. control of equity shareholders on management.
(iv) Funds can be raised through equity shares without (v) Financing through debentures is less costly as
creating any charge on the assets of the company. compared to cost of preference or equity capital.
These assets can be mortgaged to raise finance from Limitations of debentures are
other sources. (i) As fixed charge instruments, debentures put a
Demerits of equity shares are as follows (Any three) permanent burden on the earnings of a company.
(i) Investors who want steady income may not prefer (ii) In case of redeemable debentures, the company has to
equity shares due to fluctuating returns. make provisions for repayment on the specified date.
(ii) The cost of equity shares is more as compared to (iii) With the issue of debentures, the capacity of a
other sources of funds. company to further borrow funds reduces.
 4. Differentiate between shares and debentures on the than IFCI as it covers not only public limited
basis of companies, but also private limited companies,
partnership firms and proprietary concerns.
(i) Nature of finance (ii) Nature and rate of return
(iii) Life Insurance Corporation of India (LIC) It was
(iii) Status of holders (iv) Degree of control
set up in 1956 under the LIC Act, 1956 after
(v) Security offered (vi) Level of risk nationalising 245 existing insurance companies. It
Ans. The differences between shares and debentures are mobilises savings in the form of insurance premium
Basis Shares Debentures and makes it available to industrial concerns in the
form of direct loans and underwriting and
Nature of Shares are a part of Debentures are a part of subscribing to shares and debentures.
Finance owner’s fund. debt fund.
Nature Dividend is the return Interest is the return on 6. Commercial banks accept deposits from general
and Rate on shares. The rate of debentures. The rate of public and extend loans to those who are in need.
of Return dividend is not fixed interest is fixed and is This also includes companies who are in need of
and is dependent on required to be paid even capital for multiple business purposes. Getting
the profits of the if the company incurs
company and the losses. finance from commercial banks has some merits
decision of the and some limitations, explain.
management. Ans. Merits of loan from commercial banks are
Status of Shareholders are Debenture holders are (i) Banks provide timely assistance to business by
Holders deemed to be the deemed to be the providing funds as and when needed by it.
owners of the company. creditors of the company. (ii) Secrecy of business can be maintained as the
Degree Shareholders can Debenture holders are in information supplied to the bank by the borrowers is
of exercise reasonable no position to control the kept confidential.
Control degree of control on the affairs of the business as
affairs of the business they do not have the right (iii) Formalities such as issue of prospectus and
by exercising their to vote. underwriting are not required for raising loans from
right to vote. a bank.
Security No security is required Security is required to (iv) Loan from a bank is a flexible source of finance as
Offered to be offered at the be offered, either by the loan amount can be increased according to
time of issue of shares. creating a charge on business needs
assets or by mortgaging Limitations of loan from commercial banks are
the assets, at the time of
issue of debentures. (i) Funds are generally available for short periods.
Level of Shareholders assume a Risk is comparatively
(ii) Banks make detailed investigation of the company's
Risk high level of risk. lower for debenture affairs, financial structure etc., and may also ask for
holders. security of assets and personal sureties.
(iii) In some cases, difficult terms and conditions are
5. Write a short note on the following three financial imposed by banks for the grant of loan.
institutions 7. Sujeet is a proprietor of a stationery trading firm. The
(i) Industrial Finance Corporation of India (IFCI) business of the firm is flourishing over last 18 months.
(ii) State Financial Corporations (SFCs) Sujeet decided to expand the product line and
(iii) Life Insurance Corporation of India (LIC) include basic confectionery items as well. He
Ans. (i) Industrial Finance Corporation of India (IFCI) It negotiated deals with multiple suppliers and stroked
was established in July, 1948 as a statutory contracts in such a way that he facilitated the
corporation under the Industrial Finance purchase of supplies without immediate payments.
Corporation Act, 1948.
Which source of finance is highlighted here? Also,
Its objectives include assistance towards balanced
regional development and encouraging new explain the concept of the same and write three
entrepreneurs to enter into the priority sectors of the merits and demerits each.
economy. IFCI has also contributed to the Ans. The source of finance highlighted here is ‘trade credit’.
development of management education in the Trade credit facilitates the purchase of supplies without
country. immediate payment.
(ii) State Financial Corporations (SFCs) They are Such credit appears in the records of the buyer as sundry
established by the state governments under the State creditors or accounts payable. It is commonly used by
Financial Corporations Act, 1951 for providing business organisation as a source of short-term financing.
medium and short-term finance to industries which It is granted to those customers who have reasonable
are outside the scope of the IFCI. Its scope is wider amount of financial standing and goodwill.
 Merits of trade credit are (ii) Financial Strength The financial strength of an
(i) Trade credit is a convenient and continuous source enterprise is also a key determinant in making the
of funds. choice of funds. If the firm is financially strong with
(ii) It may be readily available in case the credit a steady flow of income, then it can raise finance by
worthiness of the customers is known to the seller. issuing debt instruments. Otherwise, owner’s funds
would be the logical choice.
(iii) It helps to promote the sale of an organisation.
(iii) Form of Organisation The form of organisation also
Demerits of trade credit are influences the decision of a finance manager while
(i) This may motivate a firm to overtrade. deciding about the source of finance.
(ii) Only limited amount of funds can be raised through As we are aware that there are various forms of
this source. business organisations such as sole proprietorship,
(iii) It is generally a costly source of fund as compared to partnership, joint stock company, etc. A joint stock
others, as sellers charge more for goods sold on company can raise funds from various sources, but
credit. on the other side a sole proprietor has access to
limited sources to raise funds.
8. X-cellent company is well established domestically.
It manufactures educative toys for children. The (iv) Control It is also an important factor to be
considered while raising finance. If the existing
company has recently analysed the prospects of
owners do not want to dilute their control on the
going global and founds them to be very promising. business, then they should opt for debt funds,
Now, it wants to choose suitable funds to finance otherwise they can raise finance from owner’s funds.
the proposition. (v) Degree of Risk The risk associated with each of the
State some of the factors which should be considered source is different. Thus, a finance manager must
by X-cellent company, before making a choice for evaluate the degree of risk involved in each source to
source of funds. make an appropriate choice.
Ans. Following points should be considered to make a choice (vi) Tax Benefit To avail tax benefits, companies consider
for source of funds every possible source very minutely. They should
(i) Cost Two types of costs are there viz. the cost of remember that interest paid on debt funds would be
procurement and the cost of utilising the funds. admissible as business expense and will generate tax
These two costs should be considered very carefully benefits, but dividend paid will not give any such
before making a choice. benefit to the firm.
CBSE Term-II Business Studies XI 19

Chapter Test
Multiple Choice Questions
1. Which of the following can be the negative implications of non-payment of debts?
(a) Higher interest costs (b) Loss of goodwill
(c) Fines and penalties (d) All of these
[Link] return earned by ………….. is known as interest.
(a) equity shareholders (b) preference shareholders
(c) debenture holders (d) Both (b) and (c)
3. Equity shareholders are also called ……… of company.
(a) borrowers (b) partners
(c) owners (d) Both (b) and (c)
4. Statement I Public deposits are not issued against security of assets of the company.
Statement II FCCBs are issued in foreign currency.
Alternatives
(a) Statement I is correct and statement II is wrong (b) Statement II is correct and Statement I is wrong
(c) Both the statements are correct (d) Both the statements are incorrect
5. Statement I Public deposits are issued in foreign currency.
Statement II Debentures create charge on assets of the company.
Alternatives
(a) Statement I is correct and statement II is wrong (b) Statement II is correct and Statement I is wrong
(c) Both the statements are correct (d) Both the statements are incorrect

Short Answer (SA) Type Questions

1. What do you mean by fixed capital? What type of organisation need more fixed capital?
2. Mridul is an ambitious man. He wants to participate in the affairs of the company. What will he choose amongst the
two— preference share or equity share? Also, give reason for the same.
3. Devika is considering taking loan from a commercial bank for her business. Advise her on the same by highlighting the
cons of borrowing from commercial bank.
4. “Umya manufacturers” is a firm manufacturing cricket balls in India. The company had been fairly successful in last many
years. The owners of the firm decided to raise finance from public and launched its IPO. The company received positive
feedback from the market and used the IPO proceedings to expand its manufacturing to pink cricket balls as well. The
company earned lot of profits in the following year. Instead of distributing entire profits to the owners in the form of
dividend, some profits were re-invested in business in order to finance the future earnings of the business.
(i) Identify the source of finance discussed in the last part of the passage.
(ii) Highlight the demerits of the given method.
5. Name and explain any four reasons as to why businesses require finance.
Long Answer (LA) Type Questions
1. Burman Ltd. is a medicines trading firm. The family owning the business has got some ancestral land vacant in the recent
times. The company decides to make use of this land and expand its product line. Consequently, it started to trade the
medical equipments as well. The company needed to purchase raw materials, payment of electricity bill, rent, etc.
(i) Identify and define the type of business finance needed by the company. Also, what type of source of finance is required
for the same?
(ii) On what factors, these requirements are dependent upon?
2. Differentiate between owner’s fund and borrower’s fund on the basis of
(i) Meaning (ii) Nature (iii) Risk (iv) Control
(v) Nature of obligation (vi) Rate of return

Answers
Multiple Choice Questions
1. (d) 2. (c) 3. (c) 4. (c) 5. (b)