Business Finance Questions and Answers AP Inter 1st Year Commerce Chapter 8

Regular practice with AP Inter 1st Year Commerce Study Material Chapter 8 Business Finance Questions and Answers helps students stay prepared for examinations.

AP Inter 1st Year Commerce 8th Lesson Business Finance Questions and Answers

Fill in the Blanks

Question 1.
The requirement of funds by a business firm to accomplish its various activities is called _________
Answer:
Business Finance

Question 2.
Funds required for day-to-day operations for holding current assets are called _________
Answer:
Working capital

Question 3.
Funds required for more than one year but less than five years are called _________ sources of Finance.
Answer:
Medium Term

Question 4.
Funds required to purchase fixed assets in a business are called _________
Answer:
Fixed capital

Question 5.
Funds required for more than five years are called _________ sources of finance.
Answer:
Long Term

Question 6.
Funds required for a period not exceeding one year are called source of finance.
Answer:
Short term

Question 7.
_________ and _________ are two important sources of owners funds.
Answer:
Equity shares, retained earnings

Question 8.
The capital obtained by the issue of shares is known as _________
Answer:
Share

Question 9.
The person holding the share is known as _________
Answer:
Shareholder

Question 10.
The two types of shares normally issued by a company are _________ and _________ shares.
Answer:
Equity & preference

Question 11.
Retained earnings can also be called as _________
Answer:
Ploughing back of profits

Question 12.
Debenture holders are also terned as _________ of the company.
Answer:
creditors

Question 13.
ZID full form _________
Answer:
Zero Interest Debentures

Question 14.
The acceptance of public deposits is regulated by _________
Answer:
Reserve Bank of India

Question 15.
_________ is an unsecured promissory note issued by a firm to raise funds for a short-period.
Answer:
Commercial Paper

Question 16.
CRISIL full form _________
Answer:
Credit Rating or Information Services of India limited

Question 17.
_________ shareholders are also referred to as residual owners.
Answer:
Equity

Very Short Answer Questions

Question 1.
Business Finance.
Answer:
The requirement of funds by a business firm to accomplish its various activities is called “business Finance.” Finance is considued the lifeblood of any organization. The succcess of an industry depends on the availability of adequate finance. Finance is also labeled as capital of a company.

Question 2.
Fixed capital.
Answer:
To start a business, funds are required to purchase fixed assets like land and buildings, plant and machinery, and furniture and fixtures. This is known as “fixed capital” requirements of a business enterprise. The funds required in fixed assets remain invested in the business for a long period. Different business units need varying amount of fixed capital depending on various factors such as the nature of business etc. A trading concern, for example, may require a small amount of fixed capital as compared to a manufacturing concern.

Question 3.
Working capital.
Answer:
The financial requirements of a business enterprize do no end with the procurement of fixed assets. No matter how small or large a business is, it needs funds for its day-to-day operations. This is known as the “Working capital” of an enterprise, which is used for holding current assets such as stock of material, bills receivables and for meeting expenses like salaries, wages, taxes and rent.

The amount of working capital required varies from one busines enterprise to another depending on various factors.

Question 4.
Long-term Finance.
Answer:
The capital raised for a period more than 5 years is called long-term capital. This type of capital is used to acquire fixed assets such as land and buildings, plant and machinery expansion and growth of the business etc.

Question 5.
Short-term Finance.
Answer:
Funds raised for a period not exceeding one year is called short-term capital or short-term Finance. This type of finance is used to meet day-to-day operating expenses of business such as purchase of raw-materials, wages, salaries etc. The main sources of short-term funds are Trade, credit, Bank credit. Advances from customers, Bank Loans, Retained earnings and Bills of Exchange etc.

Question 6.
Debenture.
Answer:
The Debenture issued by a company is an acknowledgement that the company has borrowed a certain amount of money, which it promises to repay on a future date. ‘Debenture holders’ are, therefore, termed as ‘creditors of the company.1

A company can raise funds through issue of debentures. It bears a fixed rate of interest irrespective of Profits and Loss.

Question 7.
Equity shares.
Answer:
Equiry shares are the most important source of raising long-term capital for a company. Equity shares also known as ordinary shares represent the ownership of a company and thus the capital raised by issue of such shares is known as “ownership capital or owner’s funds”. Equity share capital is a prerequisite of the creation of a company. Equity shareholders do not get a fixed dividend but are paid onthe basis of earnings by the company.

Question 8.
Retained earnings.
Answer:
A company generally does not distribute all its earnings to the shareholders as dividend. A portion of the net earnings may be retained in the business for use in the future. This is known as ‘Retained Earnings’. It is a source of internal financing or ‘Ploughing back of Profits.’

Question 9.
Preference shares.
Answer:
The capital raised by issue of Preference shares is called “Preference Share Capital.” The preference shareholders enjoy a preferential position over equity shareholders in two ways.

1. Receiving a fixed rate of ‘dividend1, out of the net profits of the company, before any dividend is declared for equity shareholders and
2. Receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation.

Question 10.
Lease Financing.
Answer:
A lease is a contractual obligation where by the lessor or owner grants the Lease the right to use the asset in return for a periodic payment known as ‘Lease Rent.’ At the end of the lease period, the asset goes back to the lessor. Lease Financing is an important means for modernisation and diversification to the firm. Such financing is resorted to in acquiring assets like computers and electronic equipment.

Question 11.
Overdraft.
Answer:
Under an overdraft financing facility, bank allows the business firm to withdraw the amount even more than the customer’s balance in the Bank account. The limit of extra withdrawal is also fixed by the bank. This limit is decided on the basis of credit worthiness of borrower. Interest is charged on the overdrawn money.

Question 12.
Cash credit.
Answer:
Bank grants the cash credit up to a specified limit. Business firms can withdraw any amount within that limit. Interest is charged on the actual amount drawn.

Question 13.
Internal Sources of Finance.
Answer:
These are the funds generated from internal sources. Internal source of funds are those which are generated from within the business, like ploughing back of earnings, retained earnings, reserves etc.

Question 14.
External sources of finance.
Answer:
These are the funds generated from external sources of business, like shares, debentures, public deposits, loans, and borrowings from banks, suppliers, lenders and investors etc.

Question 15.
Public Deposits.
Answer:
The deposits that are raised by organisations directly from the public are known as “Public Deposits.” Any person who is interested in depositing money in an organisation can do so by filling up a prescribed form. The organisation in return issues a deposit receipt as an acknowledgement of the debt. Public deposits can take care of medium-term financial require¬ments of a business.

Question 16.
Trade credit.
Answer:
Trade credit is the credit extended by one trader to another for the purchase of goods and services. Trade credit facilitates the purchase of supplies without immediate payment. Such credit appears in the records of the buyer of goods as ‘Sundry creditors’ or ‘Accounts Payable.’ Trade credit is commonly used by business organisation as a source of Short-term financing. It is granted to those customers who have reasonable amount of financial standing and goodwill.

Question 17.
Commercial Paper.
Answer:
Commercial paper emerged as a sources of short term finance in our country in the early nineties. 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 Commercial Pa¬per (CP) is generally very large. As the debt is completely unsecured, only firms having good credit rating can issue C.R. Its regulation falls under the purview of the RBI.

Question 18.
Commercial Banks.
Answer:
Commercial Banks occupy a vital position as they provide funds for different purposes as well as for different time periods. Banks extend loans to firms of all size and in many ways like cash credits, overdrafts, term loans, purchase/discounting bills and issue of letter of credit.

Question 19.
Definitions of Business Finance.
Answer:

• “Finance is the art & science of raising and spending money.” – Hasings
• “Business finance can be broadly defined as the activity concerned with the planning, raising, controlling and administrating the funds used in the business.” – Guthmann & Dougall.

Question 20.
Bank Loan.
Answer:
Bank Loans are provided for a specific short period. The amount of loan depends upon the size and goodwill of the firm. Such advance is credited to a separate loan account and the borrower must pay interest on the entire amount of loan irrespective of the amount of loan granted. Bank loans are usually granted against the security of assets.

Question 21.
Advances.
Answer:
It is a source of short-term finance and it is the cheapest mode of source. It is a kind of sourcing financing by getting advance from customers and agents against orders placed by the customers.

Short Answer Questions

Question 1.
What are the sources of short-term finance?
Answer:
Short-term Sources of Finance : The short-term loans and credits are raised by a firm to meet its working capital requirements. These are generally for a short period not exceeding accounting period i.e. one year.

The main sources of short-term funds are as follows :

I) Bank credit Commercial Banks extend the short-term financial assistance to business firms by means of bank credit. Bank credit may be povided in following forms.

• Loans : Loans are given for short period can be taken into this category.
• Cash credit : Bank grants the cash credit up to a specified limit. Business firms can withdraw any amount within that limit. Interest is charged on the actual amount drawn.
• Overdraft : Overdraft is a facility provided by the Banker, to withdraw some specific amount than the customer has in the business account with the Banker.

II) Trade credit: Trade credit extended by one trader to another for the purchase of goods and services. Trade credit facilitates the purchase of supplies without immediate payment. Such credit appears in the being an unsecured instrument, the firms having good credit rating can issue commercial paper. Its regulation falls under the purview of the RBI.

Question 2.
What are the sources of long-term finance?
Answer:
Long-term sources of Finance : The capital raised for a period more than 5 years can be treated as long-term source of finance. Issue of equity shares, preference shares, retained earnings, debentures etc. are the examples for this.

I) Issue of shares The capital obtained by issue of share is known as ‘share capital.’ The capital of a company is divided into small units called ‘shares.’ The person holding a share is known as a ‘Shareholder’. There are two types of shares normally issued by a company. These are “equity shares” and “Preference shares.” The money raised by issue of equity shares is called ‘equity share capital.’ While the money raised by issue of preference shares is called “Preference share capital.”

II) Equity Shares : Equity shares are the most important source of raising long-term capital for a company. Equity shares, also known as ordinary shares represent the ownership of a company and thus the capital raised by issue of such shares is known as ownership capital or owner’s funds. Equity share capital is records of the buyer of goods as ‘Sundry creditors or accounts payable.’ Trade credit is commonly used by business organizations as a source of short-term financing. It is granted to those customers who have reasonable amount of financial standing and goodwill.

III) Installment credit : This is another method by which the assets are purchased and possession of goods is taken immediately but the payment is made in installment over a Predetermined period. Generally, interest is charged on the unpaid price or it may be adjusted in the price. In any case, it provides finance for some time and is used as a source of short term working capital by many business organisations that have difficult funds positions.

IV) Advances : It is a source of short-term finance and it is a cheapest mode of source. It is a kind of sourcing financing by getting advance from customers and agents against orders placed by the customers.

V) Commercial Paper : Commercial Paper emerged as a source of short-term finance in our country in the early nineties. 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. Commercial Papers is an acknowledgement that the company has borrowed a certain amount of money, which it promises to repay on a future date. “Debenture holders” are, therefore, termed as ‘creditors of the company.’

Question 3.
What are the sources of medium-term finance?
Answer:
Medium-term Finance : It includes

1) Public Deposits : The deposits that are raised by organisations directly from the Public are known as ‘Public Deposits’. Any person who is interested in depositing money in an organisation can do so by filling up a prescribed form. The organisation in return issue a deposit receipt as an acknowledgement of the debt. Public deposits can take care of both medium and short-term financial requirements of a business.

2) Commercial Banks: Commercial Banks occupy a vital position as they provide funds for different purposes as well as for different time periods. Banks extend loans to firms of all sizes and in many ways, like, cash crdits, overdrafts, term loans, purchase/discounting of bills, and issue of letter credit. Though banks have started extending loans for longer periods, generally such loans are used for medium to short periods.

The borrower is required to provide some security or create a charge on the assets of the term before a loan sanctioned by a commercial bank, prerequisite to the creation of a company. Equity shareholders do not get a fixed dividend but are paid on the basis of earnings by the company. They are referred to as ‘residual owners’. They enjoy the reward as well as bear the risk of ownership. These shareholders have a right to participate in the management of a company.

1. Preference Shares : The capital raised by issue of preference shares is called “Pref¬erence share capital.” In other words, as compared to the equity shareholders, the preference shareholders have a preferential claim over dividends and repayment of capital. Preference shareholders generally do not enjoy any voting rights. A company can issue different types of preference shares.
2. Retained Earnings : A company generally does not distribute all its earnings to the shareholders as dividends. A portion of the net earnings may be retained in the busi¬ness for use in the future. This is known as ‘retained earnings.’ It is a source of Internal financing or self-financing or ‘Ploughing back of Profits.’
3. Debentures : ‘Debentures are an important instrument for raising long term debt capital. A company can raise funds through issue of debentures. It bears a fixed rate of interest.

3) Lease Financing : A lease is a contractual agreement whereby one party i.e. the owner of an asset, grants the other party the right to use the asset in return for periodic payments. In other words it is the rental of an asset for a specified period .The owner of the assets is called the ‘lessor’ while the party that uses the assets is known as the ‘Lessee.’ Lease finance provides an important means of modernisation and diversification to the firm such type of financing is more prevalent in the acquisition of such assets as computers and electronic equipment.

Question 4.
Differentiate between the equity shares and preference shares.
Answer:
Equity shares : Equity shares also known as ordinary shares represent the ownership of a company and thus the capital raised by issue of such shares is known as ‘ownership capital’ or ‘owner’s funds’. Equity share capital is a prerequisite to the creation of a company. Equity shareholders do not get a fixed dividend but are paid on the basis of earnings by the company.

Preference shares : The capital raised by issue of preference shares is called “Preference share capital.” The preference shareholders enjoy a preferential position over equity shareholders.

Differences between Equity shares and Preference shares.

Question 5.
Differentiate between a share and debenture.
Answer:
Share : The capital obtained by issue of share is known as ‘share capital.’ The capital of a company is divided into small units called ‘Shares.’ Each share has its nominal value. The person holding a share is known as ‘shareholder.’

Debentures : A company can raise funds through issue of debentures. It bears a fixed rate of interest. The debentures issued by a company is an acknowledgement that the company has borrowed a certain amount of money which it promises to repay on a future date. ‘Debenture holders’ are therefore, termed as ‘creditors of the company.’

Differences between Shares and Debentures.

Question 6.
What are the various types of capital required for business enterprises?
Answer:
The requirement of funds by business firm to accomplish its various activities is called as “Busi¬ness Finance.” The amount of capital required for a business can be divided into

1. Fixed capital and
2. Working capital.

1) Fixed capital : To start a business, funds are required to purchase fixed assets like land and buildings, plant and machinery, and furniture and fixtures. This is known as fixed capital requirements of a business enterprise. The funds required in fixed assets remain invested in the business for a long period. The need for fixed capital investment would be greater for a large business enterprise as compared to that of a small enterprize.

2) Working capital : The financial requirements of a business enterprise do not end with the procurement of fixed assets. No matter how small or large a business is, it needs funds for its day-to-day operations. This is known as the “working capital” of an enterprise, which is used for holding current assets such as stock of material, bills receivables and meeting expenses like salaries, wages, taxes, and rent.

Question 7.
Explain the classification of source of Finance.
Answer:
In case of a company form of business organisation, the different sources of business finance are available in the market. The sources of funds can be divided into three, viz.

1. on the basis of the period.
2. on the basis of ownership and
3. on the basis of sources of generation.

I) Based on Period : Based on Period,the sources of funds required by a company are classifed as.

1. Long-term sources : The long-term sources fulfill the financial requirements of an enterprises for a period exceeding five years.
2. Medium-term Finance : Such financing is generally required for the acquisition of fixed assets, where the funds are required for a period more than one year less than five years, medium-term sources of finance are used.
3. Short-term Finance : Short-term funds are those which are required for short-duration i.e. a period not exceeding one year.

II) Based on Ownership : On the basis of ownership, the sources can be classified into ‘owners’ funds’ and ‘borrowed funds.’ Owners funds are funds that are provided by the owners of an enterprise. Issue of equity shares” and retained earnings are the two important sources from where owner’s funds can be obtained. “Borrowed funds’ on the other hand, refer to the funds raised through loans or borrowings. The sources for raising borrowed funds include loans from commercial banks, loans from financial Institutions, issue of debentures, public deposits & trade credit.

III) Based on generation : Sources of finances can be generated from internal or external sources. Internal sources of funds are those that are generated from within the business. Such a ploughing back of profits, retained earnings, collection of receivables, disposing of surplus inventories and depreciation of funds etc. External sources of funds include those sources that are outside an organisation, such as debentures, public deposits, borrowing from commercial banks and financial institutions, suppliers, lenders and investors.

Long Answer Questions

Question 1.
Define Preference shares. Explain its advantages and limitations.
Answer:
Definition : As per section 85 of the Indian companies Act 1956, Preference shares those shares which carry special rights in respect of dividends and also repayment of capital at the time of winding up. The rate of dividend on these shares are fixed. Preference shareholders are paid dividends when the company makes profits.

In other words, as compared to the equity shareholders, the Preference shareholders have a Preferential claim over dividends and repayment of capital.

Advantages /Merits : The merits of preference shares are given as under :

1. Preference shares provide reasonably steady income in the form of fixed rate of return and safety of investment.
2. Preference shares are useful for investors who want to get a fixed rate of return with comparatively low risk.
3. It is a superior security compared to equity shares.
4. The payment of a fixed rate of dividend on preference shares may enable a company to declare a higher rate of dividends for equity shareholders during good times.
5. Preference shareholders have a preferential right of repayment over equity shareholders in the event of liquidation of a company.
6. Preference capital does not create any sort of charge against the assets of a company.

Disadvantages/demerits/Limitations : The major limitations of preference shares as a source of business ar as follows :

1. Preference shares are notsuitable for those investors who are willing to take risk and are interested in higher returns.
2. Preference capital dilutes the claims of equity shareholders over the assets of the company.
3. The rate of dividend on preference shares is generally higher than the rate of interest on debentures.
4. As the dividend on these shares is to be paid only when the company earns profit, there is no assured return for the investors. Thus, these shares may not be very attractive to the investors.

Question 2.
Discuss the various types of Preference Shares.
Answer:
Types of Preference Shares :

1. Cumulative Preference shares : Under cumulative preference shares the dividend is accumulated if it is unpaid during a year, as cumulative preference shareholders carry the right to accumulate unpaid dividend in the future years.
2. Non-cumulative Preference shares : Under non-cumulative preference shares, the dividend does not accumulate.
3. Participating Preference shares : Participating preference shares are those Preference shares which have a right to participate in the company’s surplus after paying dividend to equity shareholders and preference shareholders.
4. Non-Participating preference shares : The holders of such shares do not enjoy right to participating in the profit of the company.
5. Convertible Preference shares : These shares can be converted into equity shares within a specific period.
6. Non-convertible Preference shares : Non-convertible preference shares cannot be converted into equity shares.
7. Redeemable Preference shares : Redeemable preference shares are those shares, the investments which are to be paid back to their respective holders after the completion of a certain time.
8. Irredeemable Preference shares : Irredeemable preference shares do not carry any fixed period of repayment.

Question 3.
What do you mean by retained earnings? Explain its advantages and limitations.
Answer:
Meaning : A company generally does not distribute all its earnings to the shareholders dividends. A portion of the earnings as may be retained in the business for use in the future. This is known as retained earnings. It is a source of internal financing or self-financing or ‘Ploughing back of Profits.

Merits : The merits of retained earnings as a source of finance are as follows :

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

Limitations :

1. Excessive ploughing back 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 are fluctuating.
3. The opportunity cost associated with these funds is not recognized by many firms. This may load to sub-optimal use.

Question 4.
What is a Debenture? Explain various types of debentures issued by a company.
Answer:
Meanings : ‘Debentures’ are an important instrument for raising long-term debt capital. A company can raise funds through issue of debentures. It bears a fixed rate of interest. The debentures issued by a company is an acknowledgement that the company has borrowed a certain amount of money, which it promises to repay on a future date. ‘Debenture holders’ are, therefore, termed as ’creditors of the company.’

Types of Debentures : Debentures may be of various types. Some important types of debentures are as follows :

1. Mortgage Debentures : They are also known as ‘secured debentures,’ i.e. the payment of interest and principal is secured by some charge on any part or the whole of the com¬pany.
2. Simple Debentures : These debentures have no charge of the assets of the company. They are also known as naked or unsecured debentures. They are not secured by any charge or security on any asset of the company.
3. Redeemable Debentures : These debentures which are issued for a particular fixed period and after expiry of that period the principal amount is returned.
   For example : 5 years, 10 years. 15 years maturity period, after that the amount of deben¬ture is paid back to their holders.
4. Irredeemable Debentures : They are to be paid back at the time of winding up of the company. They are not refundable i.e. perpetual in nature. A company can, however, redeem such debentures wherever it deems fit.
5. Regisered Debentures : The names of the holders are recorded in the books of the company. If such debentures are transferred, the name of the transferee is entered in the regiseter and the name of the original holders is cancelled.
6. Bearer Debentures : The debentures which are not recorded in the register of debenture holders are known as bearer debentures. These debentures are transferable by mere delivery.
7. Convertible Debentures : They carry the option of having a part of the full value of their investments converted into equity shares on a fixed date.
8. Non-Convertible Debentures : They do not enjoy any such right to get themselves converted into equity shares.

Question 5.
Narrate the advantages and limitations of issuing debentures by a Joint stock company.
Answer:
Issuing debentures has both advantages and disadvantages for a Joint stock company.

Merits :

1. Long-term funding : Debentures provide a source of long-term capital, which can-be used for investments and operations that require sustained funding.
2. No Dilution of ownership : Issuing debentures does not dilute the ownership of existing shareholders, as debenture holders are creditors and not owners of the company.
3. Trading on Equity : Debentures allow a company to leverage its equity, potentially increasing returns for shareholders while managing debt.
4. Attracts investors : Debentures can attract investors who prefer fixed income invest-ments, particularly if they are issued at attractive interest rates.
5. Financial Protection for Directors : Debentures holders have a higher claim on com-pany assets than shareholders, potentially providing financial protection of directors.

Demerits :

1. Fixed Interst Payments: Debentures require regular interest payments, which can be a financial burden on the company, especially if it faces financial difficulties or losses.
2. Restrictions on Asset Use : Debentures may include convenants that restrict the use of company assets, which can limit flexibility and potentially hinder business operations.
3. No voting Rights : Debenture holders do not have voting rights in the company, so they have no say in the management or direction of the business.
4. Increased Financial strain : Issuing debentures increases the company’s debt burden, potentially loading to increased financial strain and a higher risk of default if the company’s financial performance deteriorates.
5. Potential for compromised Business Growth : In some cases, the fixed interest pay-ments and restrictions on asset use association with debentures can compromise a company’s ability to pursue growth opportunities.
6. Insolvency Risk : If a company cannot meet its interest payments or repay the principal amount of debentures, it can lead to insolvency.

Question 6.
What are the various factors that determine the selection of source of finance?
Answer:
The financial needs of a business are of different types long-term, short-term, fixed, and fluctuating. Therefore, business firms resort to different types of sources for raising funds. The choice of selecting a better source of finance depends on the following factors.

1. Cost : There are two types of cost viz. The cost of procurement of funds and cost of utilizing the funds. Both these costs should be taken into account while deciding about the source of funds that will be used by an organisation.
2. Financial strength and stability of operations : The financial strength of a business is also a key determinant. The choice of source of funds for business should be in a sound financial positon to be able to repay the principal amount and interest on the borrowed amount.
3. Form of organisation and legal status : The form of business organisation and status influences the choice of a source for raising money. A partnership firm, for example, cannot raise money by issuing of equity shares as these can be issued only by a joint stock company.
4. Purpose and Period : Businesses should plan according to the period for which the funds are required. A short- term need for example can be met through borrowing funds at a low rate of interest, through trade credit, commercial paper etc. For long term finance, sources such as issue of shares and debentures are more appropriate.
5. Risk Profile : Businesses should evaluate each of the source of finance in terms of the risk involved. For example, there is a least risk in equity as the share capital has to be repaid only at the time of winding up and dividends need not be paid if no profits are available. A loan on the other hand, has a repyment schedule for both the principal and the interest. The interest is required to be paid irrespective of whether the firm earning a profit or incurring a loss.
6.  Control : A particular source of funds may affect the control and power of the owners on the management of a firm. Issue of Equity shareholders, enjoy voting rights, financial institutions may take control of the assets or impose conditions as part of the loan agreement.
7. Effect on credit worthiness : The dependence of a business on certain sources may affect its credit worthiness in the market.
   Ex : Issue of secured debentures may affect the interest of unsecured creditors of the company and may adversely affect their willingness to extend further loans as credit to the company.
8. Flexibility and ease : Another aspect affecting the choice of a source of finance is the flexibility and ease of obtaining funds. Restrictive provisions, detailed investigation, and documentation in case of borrowings from banks and financial institutions. For example, may be the reason that business organisations may not prefer, if other options are readily available.
9. Tax Benefits : Various sources may also be weighted in terms of their tax benefits.
   Ex : While the dividend on preference shares is not tax deductible and may, therefore, be preferred by organisations seeking tax advantage.

Question 7.
What is Business Finance ? Explain its need and significance in the business organisation. [March-2026]
Answer:
Meaning : The requirement of funds by a business firm to accomplish its various activities is called “Business Finance.”

Definition : “Finance is that business activity which is concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objectives of a business Enterprise.” – B.O. Wheeler

Business needs finance main by for acquiring various types of assets and to meet various expenses on a day-to-day basis. There are also many other reasons for the requirement of business finance. The significance and need of business finance are explained below.

1. To meet fixed capital requirement of business : To purchase fixed assets like land and buildings, plant and machinery, furniture and fixtures etc. business requires finance.
2. To meet working capital requirements : Working capital is used for holding current assets such as stock of material, payment of wages, transportation expenses etc.
3. For growth and expansion : For growth and expansion activities, a business requires finance. It may be required to increase production, install more machines, set up a R & D center etc.
4.  For diversification : Business Finance is needed to start any new activity in business. Entering into new business and new lines of activities is known as diversification.
   Ex : ITC dealing with tobacco started ITC kakatiya (Hotel), vivel (Shampoos and cosmet¬ics), classmate (notebooks & stationery) etc.
5. For survival : To carry out the various business operations in continuity, business finance is needed. Without the required finance, organisations cannot survive for long.
6. To meet liabilities : To meet the liabilities of a business, be it long-term or short-term, a business requires sufficient finance, e.g. for payment of loan installments, creditors etc.
7. For Payment of expenses : For paying salaries,wages, taxes, advertisements and rent, finance is needed.
   Therefore, to execute the various plans of the business, finance is needed.

Question 8.
What are the advantages and disadvantages of equity sources of funds?
Answer:
Meanings : Equity shares are the most important source of raising long-term capital for a company. Equity shares also known as ordinary shares represent the ownership of a company and thus the capital raised by issue of such shares is known as “ownership capital” or owner’s funds. Equity share capital is prerequisite to the creation of a company. Equity shareholders do not get a fixed dividend but are paid on the basis of earnings by the company.

Merits : The important merits of raising funds through issuing equity shares are given below:

1. Equity shares do not create any obligation to pay fixed rate of dividend.
2. Equity shares can be issued without creating any charge over the assets of the company.
3. It is a permanent source of capital and the company need not repay it except under liquidation.
4. Equity shareholders are the real owners of the company who have the voting rights.
5. In case of profits, equity shareholders are the real gainers by way of increased dividends and appreciation in the value of shares.

Limitations : The major limitations of raising funds through issue of equity shares are as follows :

1. Investors who want steady income may not prefer equity shares as equity shares get fluctuating returns.
2. The cost of equity shares is generally higher compared to the cost of raising funds through other sources.
3. Issue of additional equity shares dilutes the voting power, and earnings of existing equity shareholders.
4. More legal formalities and procedural delays are involved while raising funds through issue of equity shares.

Question 9.
Critically examine the advantages and disadvantages of raising funds by issuing shares of different types.
Answer:
Shares : The capital obtained by issue of shares is known as ‘share capital’. The capital of a company is divided into small units called ‘shares’. Each share has its nominal value. The person holding a share is known as “Shareholder.”

There are two types of shares. They are :

1) Equity shares : Equity shares are the most important source of raising long-term capital for a company. Equity shares, also known as ordinary shares represent the ownership of a company and thus the capital raised by issue of such shares is known as “owenership capital” or “owner’s funds”. Equity share capital is is prerequisite to the creation of a com¬pany. Equity shareholders do not get a fixed dividend but are paid on the basis of earnings by the company.

Merits : The important merits of raising funds through issuing equity shares are given below :

1. Equity shares do not create any obligation to pay a fixed rate of dividend.
2. Equity shares can be issued without creating any charge over the assets of the company.
3. It is a permanent source of capital and the company need not repay it except under liquidation.
4. Equity shareholders are the real owners of the company who have the voting rights.
5. In case of profits, equity shareholders are the real gainers by way of increased dividends and appreciation in the value of shares.

Limitations : The major limitations of raising funds through issue of equity shares are follows :

1. Investors who want steady income may not prefer equity shares as equity shares get fluctuating returns.
2. The cost of equity shares is generally higher compared to the cost of raising funds through other sources.
3. Issue of additional equity shares dilutes the voting power, and earnings of existing equity shareholders.
4. More legal formalities and procedural delays are involved while raising funds through issue of equity share.

2) Preference shares : The capital raised by issue of preference shares is called “Preference share capital.” The preference shareholders enjoy a preferential position over equity share¬holders.

Merits : The merits of preference shares are given as under.

1. Preference shares provide reasonably steady income in the form of fixed rate of return and safety of investment.
2. Preference shares are useful for investors who want to get a fixed rate of return with comparatively low risk.
3. It is superior security compared to equity shares.
4. The payment of a fixed rate of dividend on preference shares may enable a company to declare a higher rate of dividends for equity shareholders during good times.
5. Preference shareholders have preferential right of repayment over equity shareholders in the event of liquidation of a company.
6. Preference capital does not create any sort of charge against the assets of a company.

Limitations : The major limitations, preference shares as a source of business finance are as follows :

1. Preference shares are not suitable for those investors who are willing to take risk and are interested in higher returns.
2. Preference capital dilutes the claims of equity shareholders over the assets of the com¬pany.
3. The rate of dividend on preference shares is generally higher than the rate of interest on debentures.
4. As the dividend on these shares is to be paid only when the company earns profit, there is no assured return for the investors. Thus, these shares may not be very attractive to the investors.

Check Your Knowledge

I. Fill in the blanks for the following questions :

Question 1.
The foremost objective of Financial management is _________
Answer:
Maximisation of share holders

Question 2.
Which of the following can be considered as a use of funds ? _________
Answer:
A decrease in cash

Question 3.
Which of the following are short-term Finance ? _________
Answer:
Bank overdraft

Question 4.
Share warrants are issued by which company ? _________
Answer:
Public Limited company

Question 5.
Equity shares are _________
Answer:
Transferable

Question 6.
A busines loan repayable as per a specified schedule is known as _________
Answer:
Term Loan

Question 7.
Employing more of cheaper debt may enhance the EPS such practice is called _________
Answer:
Trading on Equity

Question 8.
SEBI full form _________
Answer:
Security Exchange Board of India.

Question 9.
SEBI became a statutory body under _________
Answer:
SEBI Act, 1992

Question 10.
Which of the following is Not a source of working capital ? _________
Answer:
Unsecured Term Loan

Question 11.
Funds raised through loans or borrowings are _________
Answer:
Borrowed Funds

Question 12.
Equity shareholders are called _________
Answer:
Owners of the company

Question 13.
Debentures represent _________
Answer:
Loan capital of the company

Question 14.
When one party grants the right use the asset to the other party, in return for a periodic payment it is known as _________
Answer:
Lease Financing

Question 15.
Short-term funds are those which are required for a period not exceeding _________
Answer:
1 year

Question 16.
Internal sources of capital are those that are _________
Answer:
generated within the business

Question 17.
Under the lease agreement, the lessee get the right to _________
Answer:
Use the assets for a specified period

Question 18.
If the credit is extended by one trader to another for the purchase of goods and service it is called _________
Answer:
Trade credit

II. State whether the statement are True or False.

Question 1.
Finance is considered the life bood of any organization. (True/False)
Answer:
True

Question 2.
Finance is the Arts and science of raising and spending money. (True/False)
Answer:
True

Question 3.
Short-Term funds are those which are required for a period of not exceeding 2 years. (True/False)
Answer:
False

Question 4.
If the credit is extended by one trader to another for the purchase of goods and service it is called cash credit. (True/False)
Answer:
False

Question 5.
Funds required for purchasing current assets is an example of working capital requirement. (True/False)
Answer:
True

Question 6.
Public Deposits can take care of both long-term and medium financial requirements of a business. (True/False)
Answer:
False

Question 7.
Debenture holders are only creditors of the company. (True/False)
Answer:
True

Question 8.
Commercial paper is an unsecured promissory note. (True/False)
Answer:
False

Question 9.
Cash credit is commonly used by business organizations as a source of short term financing. (True/False)
Answer:
True

Question 10.
Bank loans are provided for a specific short-period. (True/False)
Answer:
False

Question 11.
Short-term loans and credits are raised by a firm to meet its fixed capital requirements. (True/False)
Answer:
True

Question 12.
Issue of equity shares may mean dilution of the control. (True/False)
Answer:
True

Question 13.
Sources of Finance can be generated from internal or external sources. (True/False)
Answer:
False

Question 14.
Borrowed funds on the first hand. (True/False)
Answer:
True

Question 15.
Lease finance provides an important means of modernisation and diversification to the firm. (True/False)
Answer:
True

Question 16.
Bank credit is not a permanent source of funds. (True/False)
Answer:
False

Question 17.
Debentures are not payable in priority over share capital. (True/False)
Answer:
True

Question 18.
The acceptance of public deposits is regulated by the Reserve Bank of India. (True/False)
Answer:
True

Student Activity

State whether the statements are True or False.

Question 1.
The funds required to purchase fixed assets like land and buildings are known as working capital of an enterprize. (True/False)
Answer:
False

Question 2.
The requirement for fixed and working capital increases with the growth and expansion of business. (True/False)
Answer:
True

Question 3.
The funds required for more than one year but less than five years are called short-term sources of finance. (True/False)
Answer:
True

Question 4.
The dependence of a business on certain sources may affects its credit worthiness in the market. (True/False)
Answer:
True

Question 5.
Equity shares do not represent the ownership of a company. (True/False)
Answer:
False

Question 6.
Preference shares enjoy voting rights. (True/False)
Answer:
True

Question 7.
Irredeemable preference shares carry a fixed period of repayment. (True/False)
Answer:
False

Question 8.
Preference shares are useful for those investors who want to get a fixed rate of return with comparatively higher risk. (True False)
Answer:
False

Question 9.
Issue of additional equity shares dilutes the voting power and earnings of existing equity shareholders (True/False)
Answer:
True

Question 10.
The cost of equity shares is same as compared to the cost of raising funds through other sources. (True/False)
Answer:
True

Question 11.
Issue of additional equity shares dilutes the voting power and earnings of existing equity shareholders. (True/False)
Answer:
True

Question 12.
The cost of quity shares is same as compared to the cost of raising funds through other sources. (True/False)
Answer:
True