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Geetika Tuteja <[email protected]> Thu, 17 Oct, 2024 at 10:42 am

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Sources of Business Finance class 11 Notes

Business Studies

CONCEPT OF BUSINESS FINANCE:

The term finance means money or fund. The

requirements of funds by business to carry
out its various activities is called business
finance. Finance is needed at every stage in
the life of a business. A business cannot
function unless adequate funds are made
available to it.

NEED OF BUSINESS FINANCE:

1. Fixed Capital Requirement: In order to

start a business, funds are needed to
purchase fixed assets like land and building,
plant and machinery.The funds required in
fixed assest remain invested in the business
for a long period of time.

2. Working Capital Requirement: A business

needs funds for its day to day operation. This
is known as working Capital requirements.
Working capital is required for purchase of
raw materials, to pay salaries, wages, rent
and taxes.

3. Diversification: A company needs more

funds to diversify its operation to become a
multi-product company e.g. ITC.

4. Technology upgradation: Finance is

needed to adopt modern technology for
example uses of computers in business.
5. Growth and expansion: Higher growth of a
business enterprise requires higher
investment in fixed assets. So finance is
needed for growth and expansion.

CLASSIFICATION OF SOURCE OF FUNDS

SOURCES OF OWNER'S FUND

METHODS OF RAISING FINANCE:

Issue of Share: The capital obtained by issue

of shares is known as share capital. The
capital of a company is divided into small
units called share. If acompany issue 10,000
shares of Rs. 10/- each then the share capital
of company is 1,00,000. The person holding
the share is known as shareholder. There are
two types of share (I) Equity share (II)
preference share.

(a) Equity Share: Equity shares represent the

ownership of a company. They have right to
vote and right to participate in the
management.

ADVANTAGES/MERITS:
1. Permanent Capital: Equity share capital is
important source of finance for a long term.
2. No charge on assets: For raising funds by
issue of equity shares a company does not
need to mortgage its assets.
3. Higher returns: Equity share holder get
higher returns in the years of high profits.
4. Control: They have right to vote and right
to participate in the management.
5. No burden on company: Payment of equity
dividend is not compulsory.

LIMITATIONS/DEMERITS:
1. Risk: Equity shareholder bear higher risk
because payment of equity dividend is not
compulsory.
2. Higher Cost: Cost of equity shares is
greater than the cost of preference share.
3. Delays: Issue of Equity shares is time
consuming.
4. Issue depends on Share Market
Conditions: Equity Shareholders are the
primary risk bearer therefore the demand of
equity shares is more in the boom time.

(b) Preference Share – Preference shares are

considered safer in investment. (as compare
to equity shares) They receive dividend at a
fixed rate. Preference shareholder are like
creditors. They have no voting right.

Types of preference shares:

1. Cumulative preference shares.
2. Non cumulative preference shares.
3. Participating preference shares.
4. Non participating preference shares.
5. Convertible preference shares.
6. Non Convertible preference shares.

MERITS OF PREFERENCE SHARES:

1. Investment is safe: Preference
shareholders investment is safe. They have
preferential right to claim dividend and
capital.
2. No Charge on assets: The company does
not need to mortgage its assets for issue of
preference shares.
3. Control: It does not affect the control of
equity share holders because they have no
voting right.
4. Fixed dividend: They get fixed dividend. So,
they are useful for those investor who want
fixed rate of return.

LIMITATIONS /DEMERITS:
1. Costly sources of funds: Rate of
preference dividend is greater than rate of
interest on debenture, for a company it is
costly source of funds than Debentures.
2. No tax saving: Preference dividend is not
deductible from profit for income tax.
Therefore, there is no tax saving.
3. Not suitable for risk takers – Preference
shares are not suitable for those who are
willing to take risk for higher return.
4. As dividend on these shares is to be paid
only when the company earns profit, so
investors may not be very attractive to these.
Retained Earnings: A portion of company’s
net profit after tax and dividend, Which is not
distributed but are retained for reinvestment
purpose, is called retained earnings. This is
also called sources of self-financing.

For example: X Ltd. has total capital of Rs.

50,00,000 which consists of 10% Debt of
Rs.20,00,000, 8% preference share capital Rs.
10,00,000, and equity share capital Rs.
20,00,000. Tax rate is 40%, company’s return
on total capital is 20%.

Particulars Rs.

Net profit before interest and tax

(PBIT) (20% of Rs. 50,00,000) 10,00,000

Less: Interest on debentures(10% of 2,00,000

20,00,000)

Net profit before tax(PBT) 8,00,000

Less: Tax provision @ 40% 3,20,000

Net profit after Tax(PAT) 4,80,000

Less: pre dividend(9% of 10,00,000) 80,000

Net profit after tax and predividend 4,00,000

Less: Equity Dividend 2,00,000

Retained Earnings 2,00,000

MERITS

1. No costs: No costs in the form of interest,

dividend, advertisement and prospects, to be
incurred by the company to get it.
2. No charges on assets: The company does
not have to mortgage its assets.
3. Growth and expansion: Growth and
expansion of business is possible by
reinvesting the retained profits.

DEMERITS
1. Uncertain Source: It is uncertain source of
fund because it is available only when profits
are high.
2. Dissatisfaction among shareholder:
Retained profits cause dissatisfaction among
the shareholder because they get low
dividend.

Difference between Equity Shares and

Preference Shares

Preference
Base Equity Shares
Shares

After preference Priority over

1. Dividend
shares equity share

Voting Dividend is paid

2. No voting right.
Right full voting rights.

Risk bearing
3. Risk Less risk
securities

Rate of Fluctuates with Fixed Rate of

4.
Return profit Dividend

Control on the No control on the

5. Control
management. management.

SOURCES OF BORROWED FUND'S

Debentures: Debentures are the important
debt sources of finance for raising long term
finance. Debenture holders get fixed rate of
interest on Debentures. Interest is paid after
every six months or one year. They are like
creditors of acompany.

Type of Debentures:
1. Secured Debentures
2. Unsecured Debentures
3. Convertible Debentures.
4. Non Convertible Debentures
5. Redeemable Debentures.
6. Registered Debentures.

MERITS OF DEBENTURES:
1. Investment is Safe: Debentures are
preferred by those investor who do not want
to take risk and interested in fixed income.
2. Control: Debenture holder do not have
voting right. No control over the managment.
3. Less Costly: Debentures are less costly as
compared to cost of preference shares.
4. Tax Saving: Interest on Debentures is a tax
deductable expense. Therefore, there is a tax
saving.
LIMITATION OF DEBENTURES:
1. Fixed Obligation: There is a greater risk
when there is no earning because interest on
debentures has to be paid if the company
suffers losses.
2. Charge on assets: The company has to
mortgage its assets to issue secured
Debentures.
3. Reduction in Credibility: With the new
issue of debentures, the company’s capability
to further borrow funds reduces.

Difference between Shares and Debentures

Base Shares Debentures

Shares are the Debentures are a

1. Nature
capital loan

2. Return Dividend Interest

Voting Full voting

3. No voting right
Right right

Owner is
4. Holder called Creditor
shareholder.

There are two

More than two
5. Types types of
types
shares

Secured and
generally carry a
Not secured
6. Security charge on the
by any charge
assets of the
company

PUBLIC DEPOSITS: The deposits that are

raised by company direct from the public are
known as public deposits. The rate of interest
offered on public deposits are higher than the
rate of interest on bank deposits. This is
regulated by the R.B.I. and cannot exceed
25% of share capital and reserves.

MERITS:

1. No charge on assets: The company does

not have to mortgage its assets.
2. Tax Saving: Interest paid on public
deposits is tax deductable, hence there is tax
saving.
3. Simple procedure: The procedure for
obtaining public deposits is simpler than
share and Debenture.
4. Control: They do not have voting right
therefore the control of the company is not
diluted.

LIMITATIONS:

1. For Short Term Finance: The maturity

period is short. The company cannot depend
on them for long term.
2. Limited fund: The quantum of public
deposit is limited because of legal
restrictions 25% of share capital and free
reserves.
3. Not Suitable for New Company: New
company generally find difficulty to raise
funds through public deposits.

LOAN FROM COMMERCIAL BANKS

: Commercial Banks give loan and advances
to business in the form of cash credit,
overdraft loans and discounting of Bill. Rate
of interest on loan is fixed.

MERITS

1. Timely financial assistance: Commercial

Bank provide timely financial assistance to
business.
2. Secrecy: Secrecy is maintained about loan
taken from a Commercial Banks.
3. Easier source of funds: This is the easier
source of funds as there in no need to issue
prospectus for raising funds.

LIMITATIONS/DEMERITS

1. Short or Medium term finance: Funds are

not available for a long time.
2. Charge on assets: Required source
security of assets before a loan is
sanctioned.

LOAN FROM FINANCIAL INSTITUTION:

The state and central government have

established many financial institutions to
provide finance to companies. They are
called development Bank. These are IFCI,
ICICI, IDBI, LIC and UTI. etc.
MERITS:

1. Long term Finance: Financial Institution

provide long term finance which is not
provided by Commercial Bank.
2. Managerial Advice: They provide financial,
managerial and technical advice to business
firm.
3. Easy installments: Loan can be made in
easy installments. It does not prove to be
much of a burden on business.
4. Easy availibility: The funds are made
available even during periods of depression.

LIMITATIONS/ DEMERITS:
1. More time Consuming: The procedure for
granting loan is time consuming due to rigid
criteria and many formalities.
2. Restrictions: Financial Institution place
restrictions on the company’s board of
Directors.

Inter-Corporate Deposits (ICD)

Inter-Corporate Deposits are unsecured short
term deposits made by one company with
another company. These deposits are
essentially brokered deposited, which led the
involvement of brokers. The rate of interest
on their deposits is higher than that of banks
and other markets. The biggest advantage of
ICDS is that the transaction is free from legal
hassles.

Type of lCDS
1. Three Months Deposits – These deposits
are most popular type of ICDS.These
deposits are generally considered by
borrowers to solve problems of short term
capital adequacy. The annual rate of interest
for these deposits is around 12%.
2. Six months Deposits – It is usually made
first class borrowers. The annual rate of
interest for these deposits is around 15%
3. Call deposits – This deposit can be
withdrawn by the lender on a day’s notice.
The annual rate of interest on call deposits is
around 10%

Features of ICDS
1. These transactions takes place between
two companies.
2. There are short term deposits.
3. These are unsecured deposits.
4. These transactions are generally
completed through brokers.
5. These deposits have no organized market.
6. These deposits have no legal formalities.
7. These are risky deposits from the point of
view of lenders.

Trade credit
Trade credit refers to the credit provided by
one firm to another for the purchase of goods
and services. It is a source of short-term
finance and facilities purchase of goods and
services without immediate payment.

Advantages (Merits) :

1. It promotes the sales of an organisation.

2. It is a continuous and convenient source of

funds.

3. It does not create any charge on the asset

of the business.

4. This source is very easily available when

the creditworthiness of the customers is
known to the sellers.

Limitations :

1. Through this source, only a limited amount

of funds can be raised.

2. This source is generally costly as

compared to other sources.

3. A loss of cash discount is also noticed.

4. A firm may indulge in overtrading due to

easy availability and flexibility if this source.
This adds risks to the firms