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

Chapter at a glance

Exercises – Short Answer Questions

Question SA – Q1

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

Answer

Business finance refers to the money required for carrying out business activities — to establish, run, modernise and expand a business.

Need for funds

1. Fixed capital requirements — to buy fixed assets like land, building, plant and machinery.
2. Working capital requirements — for day-to-day operations: buying raw materials, paying wages, rent and other expenses, maintaining stock and giving credit to customers.
3. Growth and expansion — for modernisation, diversification and new projects.
4. Meeting contingencies — unexpected situations like losses or delays in collection.

Question SA – Q2

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

Answer

Question SA – Q3

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

Answer

Question SA – Q4

What preferential rights are enjoyed by preference shareholders. Explain.

Answer

Preference shareholders enjoy two preferential rights over equity shareholders:

1. Right to dividend — they receive a dividend at a fixed rate before any dividend is paid to equity shareholders.
2. Right to return of capital — on winding up of the company, their capital is repaid before equity capital is repaid.

They generally do not have voting rights except on matters directly affecting their rights (or if dividends remain unpaid for a specified period).

Question SA – Q5

Name any three special financial institutions and state their objectives.

Answer

Question SA – Q6

What is the difference between GDR and ADR? Explain.

Answer

In both cases an Indian company issues shares to a depository bank, which issues receipts denominated in foreign currency; holders receive dividends but have no voting rights.

Exercises – Long Answer Questions

Question LA – Q1

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

Answer

Trade credit: Credit extended by one trader to another when goods are bought on credit, i.e. payment is made later. It appears as sundry creditors or accounts payable.

Merits: convenient and continuous source; no formalities or charge on assets; helps in increasing inventory when demand rises. Limitations: may induce over-trading; only limited amount available; costlier if cash discounts are forgone.

Bank credit: Commercial banks provide short-term finance in forms such as loans, cash credit, overdraft, purchase/discounting of bills and letters of credit. Usually some security is required and interest is charged.

Merits: timely assistance; secrecy is maintained; easy to arrange; flexible — loan amount can be increased or repaid as needed. Limitations: generally short-term only; requires detailed investigation and security; terms and conditions may be strict; interest cost.

Question LA – Q2

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

Answer

Modernisation and expansion need large long-term funds. A large enterprise can raise them from:

1. Equity shares — issue of new shares to the public or rights issue to existing shareholders; no fixed burden, permanent capital.
2. Preference shares — fixed dividend; no voting rights; does not dilute control.
3. Debentures/bonds — borrowed capital at fixed interest; cheaper due to tax deductibility; no dilution of control.
4. Retained earnings (ploughing back of profits) — internal source with no cost of issue.
5. Term loans from commercial banks and financial institutions (e.g. IFCI, SIDBI, LIC).
6. Public deposits for medium-term needs.
7. International sources — ADR, GDR, foreign currency convertible bonds, external commercial borrowings, loans from international agencies (World Bank, ADB).
8. Lease financing of equipment.

A suitable mix is chosen considering cost, risk, control, flexibility and tax benefits.

Question LA – Q3

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

Answer

1. No dilution of control — debenture holders have no voting rights.
2. Lower cost — interest on debentures is a tax-deductible expense, and debenture holders accept lower returns because their investment is secured.
3. Trading on equity — if the return on investment exceeds the interest rate, earnings per equity share increase.
4. Fixed and limited obligation — interest is fixed; debenture holders do not share in profits.
5. Flexibility — debentures can be redeemed when the company has surplus funds, reducing capital; equity is permanent.
6. Suitable when sales and earnings are stable, so that fixed interest can be paid easily.
7. Attracts conservative investors who prefer safety and fixed income.

Question LA – Q4

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

Answer

Public deposits (deposits raised directly from the public, usually for 1–3 years):

Retained earnings (ploughing back of profits):

Topic checklist

• Meaning, significance and classification of business finance
• Owners’ funds: equity shares, preference shares, retained earnings
• Borrowed funds: debentures, loans, public deposits, trade credit, commercial paper, factoring, lease
• International sources: ADR, GDR, FCCB
• Factors affecting the choice of source of funds

Total questions answered: 10 of 10