Tick (\u2713) the correct answer out of the given alternatives :<\/span><\/p>\nQuestion 1.
\nEquity shareholders are called :
\n(a) Owners of the company
\n(b) Partners of the company
\n(c) Executives of the Company
\n(d) Guardian of the company
\nAnswer:
\n(a) Owners of the company<\/p>\n
Question 2.
\nThe terin \u2018redeemable\u2019 is used for :
\n(a) Preference Shares
\n(b) Commercial Paper
\n(c) Equity Shares
\n(d) Public Deposits
\nAnswer:
\n(a) Preference Shares<\/p>\n
<\/p>\n
Question 3.
\nFunds required for purchasing current assets is an example of:
\n(a) Fixed capital requirement
\n(b) Ploughing back of profits
\n(c) Working capital requirement
\n(d) Lease financing
\nAnswer:
\n(c) Working capital requirement<\/p>\n
Question 4.
\nADR\u2019s are issued in:
\n(a) Canada
\n(b) China
\n(c) India
\n(d) USA
\nAnswer:
\n(d) USA<\/p>\n
Question 5.
\nPublic deposits are the deposits that are raised directly from:
\n(a) The Public
\n(b) The Directors
\n(c) The Auditors
\n(d) The Owners
\nAnswer:
\n(a) The Public<\/p>\n
Question 6.
\nUnder the lease agreement, the lessee gets to right to:
\n(a) Share profits earned by the lessor
\n(b) Participate in the management of the organization
\n(c) Use the assist for a specified period
\n(d) Sell the assets
\nAnswer:
\n(c) Use the assist for a specified period<\/p>\n
<\/p>\n
Question 7.
\nDebentures represent:
\n(a) Fixed capital of the company
\n(b) Permanent capital of company
\n(c) Fluctuating capital of the company
\n(d) Loan capital of the company.
\nAnswer:
\n(d) Loan capital of the company.<\/p>\n
Question 8.
\nUnder the factoring arrangement, the factor:
\n(a) Produces and distributes the goods or services
\n(b) Makes the payment on behalf of the client
\n(c) Collects the client\u2019s debt or account receivables
\n(d) Transfer the goods from one place to another.
\nAnswer:
\n(b) Makes the payment on behalf of the client<\/p>\n
Question 9.
\nThe maturity period of a commercial paper usually ranges from:
\n(a) 20 to 40 days
\n(b) 60 to 90 days
\n(c) 120 to 365 days
\n(d) 90 to 364 days
\nAnswer:
\n(d) 90 to 364 days<\/p>\n
Question 10.
\nInternal sources of capital are those that are:
\n(a) generated through outsiders such as suppliers.
\n(b) generated through loans from commercial banks.
\n(c) generated through issue of shares.
\n(d) generated within the business.
\nAnswer:
\n(d) generated within the business.<\/p>\n
Short Answer Questions<\/span><\/p>\nQuestion 1.
\nWhat is business finance? Why do businesses need funds? Explain.
\nAnswer:
\nBusiness is an economic activity directed towards producing, acquiring wealth through buying and selling of goods. It is a very wide term. Finance is the lifeblood of the business. Funds are required to commence and carry on business. All business activities such as planning, organizing, managing, controlling, purchasing, selling, directing, marketing, etc cannot take place without finance.<\/p>\n
Thus, we can say the requirements of funds by a business to carry out its various activities is called business finance. When an entrepreneur takes a decision to start a business the need for funds arises in order to meet the expenses of the establishment of the business, finance is required for purchasing fixed and current assets, for day-to-day operations, purchase of raw material, to pay salaries, etc. Smooth functioning, expansion, and growth of the business are possible when it has sufficient funds.<\/p>\n
<\/p>\n
Question 2.
\nList sources of raising long-term, and short-term finance.
\nAnswer:
\nTypes of Business Finance – On the basis-of nature and purpose served finance used in business is of the following types:
\n(i) Long-term finance
\n(ii) Medium-term finance.
\n(iii) Short-term finance.<\/p>\n
<\/p>\n
Types of Business Finance
\n(i) Long-term Finance – Long-term finance is used for meeting the permanent needs of business. It is required for investment in fixed assets like, building, plant and machinery and for financing expansion programmes. Long-term funds are raised for a long period, say, more than five years. They are generally invested in fixed assets.<\/p>\n
<\/p>\n
The sources of long-term financing are :<\/p>\n
\n- shareholders<\/li>\n
- debenture-holders<\/li>\n
- financial institutions and<\/li>\n
- retained earnings.<\/li>\n<\/ul>\n
The amount of long-term finance required depends bn the type of business and the fixed assets required. For instance, a big steel, Cement or chemicals factory involves heavy investment on building, machinery and equipments.<\/p>\n
A small factory producing garments or a small workship repairing electrical goods will require a small investment in fixed assets. Traders generally require lesser amounts for long-term investment as compared with the requirements of manufactures.<\/p>\n
(ii) Medium-term finance – It is required for upgrading of technology, introduction of a new product, investment in working capital and for repayment of debts. It is raised for a period ranging from more than one year to less than five years. It is needed for modernization and expansion.<\/p>\n
The sources of medium-term financing include :<\/p>\n
\n- debentures<\/li>\n
- financial institutions<\/li>\n
- public deposits and<\/li>\n
- commercial banks.<\/li>\n<\/ul>\n
The need for medium-term funds arises because of changing technology, introduction of a new product or necessity to invest on advertisement and sales promotion. The extra income generated out of his investment is used to pay back the medium-term capital. Medium-term finance is raised from debenture holders, financial institutions and banks.<\/p>\n
(iii) Short-term Finance – it is required for meeting the short term needs of working capital. Its period is one year or less than one year and it can be raised from the following sources:<\/p>\n
\n- public deposits<\/li>\n
- trade credits<\/li>\n
- commercial banks<\/li>\n
- customer advance.<\/li>\n<\/ul>\n
Short-term funds are required for purchase of raw materials, payment of wages and salaries and meeting other day-to-day expenses. They are raised through short-term loans or trade credits. As soon as goods are sold and funds are recovered, the amounts may be used for current operations or for paying back the loans.Generally, production processes are completed within a year and goods are ready for sale. Hence, short term funds can be used over and over again from year to year.<\/p>\n
<\/p>\n
Question 3.
\nWhat is the difference between internal and external sources of raising funds? Explain.
\nAnswer:
\nSources of Company Finance – A business firm can raise funds from two main sources:
\n(a) owned funds (internal sources)
\n(b) borrowed funds (external sources)<\/p>\n
Owned funds refer to the funds provided by the owners. Insole proprietorship, the proprietor himself provides the owned fund from his personal property. In a partnership firm, the funds contributed by partners as capital are called owned funds. In a joint-stock company, funds raised through the issue of shares and reinvestment of earnings are the owned funds.<\/p>\n
Borrowed funds are raised by way of issue of debentures. Raising loans from financial institutions, public deposits and commercial banks. Thus, the various sources of finance may be divided as follows :
\n<\/p>\n
Sources of Finance
\nDifference between owner\u2019s fund and borrowed fund (internal and external source of raising loans):<\/p>\n
(i) Owner\u2019s funds are contributed by the owners and the reinvestment of profits in the business. It is a source of permanent capital of the business while borrowed funds are a source of temporary capital to the business.<\/p>\n
(ii) Internal source of capital attaches risk to the business while borrowed funds have to be paid back regularly depending upon the time period of the loan, as long term, medium-term or short term.<\/p>\n
(iii) owners have control over the management of the business regarding the follow on to the policies laid down, while the lenders do not have any right of control over management of the business.<\/p>\n
(iv) Owners are entitled for dividends in case of sufficient profits while interest on borrowed capital is to be paid at regular intervals.<\/p>\n
<\/p>\n
Question 4.
\nWhat preferential rights are enjoyed by preference shareholders? Explain.
\nAnswer:
\nThe following preferential rights are enjoyed by preference shareholders<\/p>\n
\n- Receiving a fixed rate of dividend, out of the net profits of the company, before the dividend is declared for equity shareholders.<\/li>\n
- Preference over equity shareholders in receiving their capital after the claims of the company\u2019s creditors have been settled, at the time of liquidation.<\/li>\n
- In case of dissolution of the company, preference share capital is refunded prior to the refund of equity share capital.<\/li>\n<\/ol>\n
Question 5.
\nName any three special financial institutions and state their objectives.
\nAnswer:
\nThe government has established a number of financial institutions all over the country to provide finance to business organizations. These institutions are established by the Central or State, Governments. They provide both owned capital and borrowed capital : for long and medium-term requirements and supplement the traditional financial agencies like commercial banks.<\/p>\n
In addition to providing financial assistance, these institutions also conduct market surveys and provide technical assistance and managerial services to people who run the enterprises. This source of financing is considered suitable when large funds for longer duration are required for expansion, reorganization and modernization of an enterprise.<\/p>\n
Major Special Financial Institutions and their Objectives :
\n(1) Industrial Finance Corporation of India (IFCI) – It was established in July 1948 as a statutory corporation under the Industrial Finance Corporation Act 1948. Its objectives include assistance towards balanced regional development and encouraging new entrepreneurs to enter into the priority sectors of the economy. It has also contributed to the development of management education in the country.<\/p>\n
(2) State Financial Corporations (SFC) – The State Financial Corporations Act 1951 empowered the State Government to establish State Financial Corporations in their respective regions for providing medium and short-term finance to industries which are outside the scope of the IFCI.<\/p>\n
(3) Industrial Credit and Investment Corporation of India (ICICI) – This was established in 1955 as a public limited company under the Companies Act. ICICI assists the creation, expansion and modemalization of industrial enterprises exclusively in the private sector. The corporation has also encouraged the participation of foreign capital in the country.<\/p>\n
<\/p>\n
(4) Industrial Development Bank of India (IDBI) – This was established in 1964 under the Industrial Development Bank of India Act 1964 with an objective to coordinate the activities of other financial institutions including commercial banks. It performs the different types of functions such as assistance to other financial institutions, direct assistance to industrial concerns and promotion of financial technical services.<\/p>\n
Question 6.
\nWhat is the difference between GDR and ADR? Explain.
\nAnswer:
\nGlobal Depository Receipts (GDR):
\nThe depository receipts denominated in US dollars issued by depository bank to which the ” local currency shares of a company are delivered. GDR is a negotiable instrument and can be traded freely like any other security. In the Indian context, a GDR is an instrument issued abroad by an Indian company to raise funds in some foreign currency and is listed and traded on a foreign stock exchange.<\/p>\n
American Depository Receipts (ADR):
\nThe depository receipts issued b a company in the USA are known as American Depository Receipts ADRs are bought and sold in American markets like regular stocks. ADR is similar to a GDR except that it can be issued only to American citizens and can be listed and traded on a stock exchange of the USA.<\/p>\n
<\/p>\n
Long Answer Questions<\/span><\/p>\nQuestion 1.
\nExplain trade credit and bank credit as sources of short\u00acterm finance for business enterprises.
\nAnswer:
\nShort-term funds are required for trading purposes like purchase of raw materials, payment of wages and salaries and meeting other day-to-day expenses. They are raised through short-term loans or trade credits. As soon as goods are sold and funds are recovered, the amounts may be used for current operations or for paying back the loans.<\/p>\n
Often all, production cycle is completed within a year and goods are sold during that period, the short-term funds can be used over and over again from year to year.<\/p>\n
Bank credit for short-term needs of working capital reign on the business. Its period is 12 months or less than 12 months and it can be raised by the sources of public deposits, trade credits, commercial banks and customer advances. It is used for meeting the short-term needs of the business.<\/p>\n
It is known as working capital requirements. Working capital is the capital required for meeting the day-to-day needs of the business i.e. purchase of materials and payment of wages, salaries, rent, taxes, freight charges etc. The firm can carry on its business smoothly and without any interruptions with the help of short\u00acterm loans and finances.<\/p>\n
Short-term financing is most common for financing of current assets such as accounts receivables and inventories. Seasonal businesses that must build inventories in anticipation of selling requirements often need – short-term financing for the interim period between seasons. Wholesalers and manufactures with a major portion of their assets tied up in inventories or receivable also require large amount of funds for a short period.<\/p>\n
<\/p>\n
Question 2.
\nDiscuss the sources from which a large industrial enterprise can raise capital for financing modernisation and expansion.
\nAnswer:
\nFinancial institutions established by the central as well as State Governments all over the country to provide finance to business organizations are considered the most suitable source of financing when large funds for longer duration are required for expansion, reorganization, and modernization of an enterprise.<\/p>\n
This institution provides both owned capital and loan capital for long and medium-term requirements and supplements the traditional financial agencies like commercial banks. In addition to providing financial assistance, these institutions also conduct market surveys and provide technical assistance and managerial services to people who run the enterprises.<\/p>\n
The various Special Financial Institutions in India are as under:
\n1. Industrial Finance Corporation of India (IFCI):
\nIt was established in July 1948 as a statutory corporation under the Industrial Finance Corporation Act, 1948. Its objectives Include assistance towards balanced regional development and encouraging new entrepreneurs to enter into the priority sectors of the economy. IFCI has also contributed to the development of management education in the country.<\/p>\n
2. State Financial Corporations (SFC):
\nThe State Financial Corporations Act, 1951 empowered the State Governments to establish State Financial Corporations in their respective regions for providing medium and short-term finance to industries which are outside the scope of the IFCI. Its scope is wider than IFCI since the former covers not only public limited companies but also private limited companies, partnership firms, and proprietary concerns.<\/p>\n
3. Industrial Credit and Investment Corporation of India (ICICI):
\nThis was established in 1955 as a public limited company under the Companies Act. ICICI assists the creation, expansion, and modernization of industrial enterprises exclusively in the private sector. The corporation has also encouraged the participation of foreign capital in the country.<\/p>\n
4. Industrial Development Bank of India (IDBI):
\nIt was established in 1964 under the Industrial Development Bank of India Act, 1964 with an objective to coordinate the activities of other financial institutions including commercial banks. The bank performs three types of functions, namely, assistance to other financial institutions, direct assistance to industrial concerns, and promotion and coordination of financial-technical services.<\/p>\n
5. State Industrial Development Corporations (SIDC):
\nMany state governments have set up State Industrial Development Corporations for the purpose of promoting industrial development in their respective states. The objectives of the SIDCs differ from one state to another.<\/p>\n
6. Unit Trust of India (UTI):
\nIt was established by the Government of India in 1964 under the Unit Trust of India Act, 1963. The basic objective of UTI is to mobilize the community\u2019s savings and channelize them into productive ventures. For this purpose, it sanctions direct assistance to industrial concerns, invests in their shares and debentures, and participates with other financial institutions.<\/p>\n
7. Industrial Investment Bank of India Ltd:
\nIt was initially set up as a primary agency for the rehabilitation of sick units and was known as the Industrial Reconstruction Corporation of India. It was reconstituted and renamed as the Industrial Reconstruction Bank of India in 1985 and again in 1997, its name was changed to Industrial Investment Bank of India. The Bank assists sick units in the reorganization of their share capital, improvement in the management system, and provision of finance at liberal terms.<\/p>\n
8. Life Insurance Corporation of India (LIC):
\nLIC was set up in 1956 under the LIC Act, 1956 after nationalizing 245 existing insurance companies. It mobilises the community\u2019s savings in the form of insurance premia and makes it available to industrial concerns, both public as well as private, in the form of direct loans and underwriting of and subscription to shares and debentures.<\/p>\n
Question 3.
\nWhat advantages does issue of debentures provide over the issue of equity shares?
\nAnswer:
\nDebentures are an important instrument for raising long-term debt capital. The debenture issued by the company is an acknowledgment that the company has borrowed a certain amount of money.<\/p>\n
Merits of Debentures: Debentures are an important source of raising long-term finance. The main advantages of debentures are as follows:<\/p>\n
(1) Appeal to Cautious Investors – Large amount of finance can be raised by issue of debentures from cautious and orthodox investors who prefer safety of investment and a fixed return at lesser risk. In tight money conditions, debentures are the best source of finance. Debentures are liked by the investors who give weightage to safety of principal and a continuous income on their money.<\/p>\n
(2) Regular Return – Debentureholders are paid interest at a fixed rate and at periodical intervals, irrespective of profits. Therefore, debenture holders are free from risk of fluctuations in the company’s earnings. A continuous return in the shape of interest on debentures attract the investor for regular return on their principal amount.<\/p>\n
(3) Safety of Investment – Debentures are usually secured by a charge on the company\u2019s assets. Therefore, their repayment is assured.<\/p>\n
(4) Economical Source – A company can raise funds through debentures at a relatively low cost. This is because investors consider debentures a safe investment. Debentures can be sold more easily than shares. Underwriting commission, brokerage and other expenses of issue are lesser.<\/p>\n
(5) Freedom of Management – Debentures do not carry voting rights. Therefore, a company can raise funds without diluting or weakening the control of the existing members. The management retains its independence as there is no interference from debenture holders.<\/p>\n
(6) Trading on Equity – Interest on debentures is paid at a fixed rate. After payment of interest, the remaining profits are available to shareholders. When the earnings of the company increase, the rate of dividend on equity shares can be increased. This is known as trading on equity! Debenture offer an opportunity to the company to trade on equity and thereby increase the return of equity shareholders.<\/p>\n
<\/p>\n
(7) Flexibility – A company can repay the funds raised through debentures when it does not require the funds any more. The facility of redemption avoids the danger of over capitalisation and keeps the financial structure flexible. Funds are available for a fairly long period and can be repaid out of earnings. Debentures provide financial flexibility as they can be redeemed when the company has surplus funds.<\/p>\n
(8) Tax Relief – Interest paid on debentures is allowed a deduction while calculating taxable income. It results in saving in income tax liability. Thus, the company enjoys tax benefit by issuing debentures.<\/p>\n
Popularity of Debentures – Despite their limitations, issue of debentures as a method of raising long-term finance has gained popularity these days. The response of the investors has been encouraging because of the following factors:
\n(i) Debentures with more attractive terms, particularly having a convertible clause have been issued. The conversion of debentures into equity shares encourages the investors to invest in debentures.<\/p>\n
(ii) Statutory restrictions on the institutional investors like Life Insurance Corporation and Unit Trust of India have been relaxed. They can have more debentures in their investment portfolio.<\/p>\n
(iii) Debentures are issued by the flourishing companies also to have the benefit of trading on equity. This has changed the attitude of banks and other institutions towards the companies having issued the debentures. Formerly, the companies having issued debentures were considered to be less credit-worthy concerns.<\/p>\n
(iv) Companies prefer to issue debentures because of low cost of financing through debentures. Less formalities have to be observed while issuing debentures. Moreover, the interest paid on debentures is allowed as a deductible expenditure against the profit of the company.<\/p>\n
(v) Companies can raise funds through debentures considering it as safe investment. Debentures can be sold more easily than shares. The facility of redemption of debentures avoids the danger of overcapitalization and keeps the financial position of the company strong and stable.<\/p>\n
Question 4.
\nState the merits and demerits of public deposits and retained earnings as methods of business finance.
\nAnswer:<\/p>\n
Public Deposits:
\nThe deposits that are raised by organizations directly from the public are known as public deposits. Rates of interest offered on public deoosits are usually higher than those offered on bank deposits. Any person who is interested in depositing money in an organization can do so by filling up a prescribed form.<\/p>\n
The organization in return issues a deposit receipt as an acknowledgment of the debt. Public deposits can take care of both medium and short-term financial requirements of a business. The deposits are beneficial to both the depositor as well as to the organisation.<\/p>\n
While the depositors get higher interest rate than that offered by banks, the cost of deposits to the company is less than the cost of borrowings from banks. Companies generally invite public deposits for a period upto three years. The acceptance of public deposits is regu\u00aclated by the Reserve Bank of India.<\/p>\n
Merits: The merits of public deposits are,<\/p>\n
\n- The procedure of obtaining deposits is simple and does not contain restrictive conditions as are generally there in a loan agreement.<\/li>\n
- Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions.<\/li>\n
- Public deposits do not usually create any charge on the assets of the company. The assets can be used as security for raising loans from other sources.<\/li>\n
- As the depositors do not have voting rights, the control of the company is not diluted.<\/li>\n<\/ol>\n
Limitations: The major limitation of public deposits are as follows.<\/p>\n
\n- New companies generally find it difficult to raise funds through public deposits;<\/li>\n
- It is an unreliable source of finance as the public may not respond when the company needs money;<\/li>\n
- Collection of public deposits may prove difficult, particularly when the size of deposits required is large.<\/li>\n<\/ol>\n
Retained earnings:
\nA company generally does not distribute all its earnings amongst the shareholders as dividends. A portion of the net earnings maybe retained in the business for use in the future. This is known as retained earnings. It is a source of internal financing or selffinancing or \u2018ploughing back of profits\u2019. The profit available for ploughing back in an organisation depends on many factors like net profits, dividend policy and age of the organisation.<\/p>\n
Merits: The merits of retained earning as a source of finance are as follows.<\/p>\n