Business Finance Chapter 8
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Questions and Answers

What is factoring in the context of financial services?

Factoring is a financial service where a factor provides services such as bill discounting and debt collection by purchasing receivables at a discount.

List two methods of factoring mentioned in the content.

The two methods of factoring are recourse factoring and non-recourse factoring.

How does recourse factoring differ from non-recourse factoring?

In recourse factoring, the client is not protected against bad debt losses, while in non-recourse factoring, the factor assumes that risk.

What is one reason why factoring might be considered a costly source of funds?

<p>Factoring is generally considered costly because it charges fees for the services rendered, which can be higher compared to other financing sources.</p> Signup and view all the answers

What types of organizations provide factoring services in India?

<p>Factoring services in India are provided by banks like SBI and non-banking finance companies.</p> Signup and view all the answers

What are trade credits in the context of factoring?

<p>Trade credits refer to the limited amount of funds that can be generated through sales made on credit.</p> Signup and view all the answers

Why might businesses prefer obtaining funds through factoring over bank credit?

<p>Businesses may prefer factoring because it is often cheaper than obtaining finance through traditional bank credit methods.</p> Signup and view all the answers

What role does the Reserve Bank of India (RBI) play in the context of factoring?

<p>The RBI played a crucial role in introducing factoring services in India by initiating steps for its development in the early nineties.</p> Signup and view all the answers

What factors influence the amount of credit extended by a seller?

<p>Reputation of the purchasing firm, financial position of the seller, volume of purchases, past payment record, and market competition.</p> Signup and view all the answers

How does trade credit enhance a business's capacity to absorb unexpected losses?

<p>It provides a reliable source of funds that can be accessed quickly, allowing for better financial flexibility.</p> Signup and view all the answers

What is one potential negative impact of excessive ploughing back of earnings on shareholders?

<p>It may lead to lower dividends for shareholders, causing dissatisfaction.</p> Signup and view all the answers

What prevents trade credit from being considered a reliable source of funds?

<p>The uncertainty arising from fluctuating business profits makes it an unreliable funding source.</p> Signup and view all the answers

Explain why trade credit can vary between industries.

<p>Terms of trade credit can differ based on industry standards and the competitive landscape.</p> Signup and view all the answers

What is the importance of creditworthiness in relation to trade credit?

<p>Creditworthiness determines the likelihood that a seller will extend credit, influencing deal terms.</p> Signup and view all the answers

What is the relationship between retained earnings and funding limitations?

<p>Excessive reliance on retained earnings may lead to sub-optimal use of funds due to overlooked opportunity costs.</p> Signup and view all the answers

In what way is trade credit a continuous source of funds?

<p>It is often readily available to businesses as they establish relationships with suppliers.</p> Signup and view all the answers

What is the significance of finance in a business?

<p>Finance is considered the lifeblood of any business as it is essential for carrying out various activities and meeting financial requirements.</p> Signup and view all the answers

Why is it important for entrepreneurs to understand different sources of business finance?

<p>Entrepreneurs need to know various sources of finance to ensure they can adequately cover all financial requirements beyond their initial capital.</p> Signup and view all the answers

What are the factors that determine the choice of a suitable source of business finance?

<p>Factors include the specific financial needs, cost of funds, repayment terms, and the potential risks involved with each source.</p> Signup and view all the answers

How does the initial capital contributed by an entrepreneur influence business finance?

<p>Initial capital is often insufficient to meet all financial needs, requiring entrepreneurs to seek additional sources of funding for their business operations.</p> Signup and view all the answers

What are some advantages of using external sources for business finance?

<p>External sources provide access to larger amounts of funds and can help sharing financial risk while allowing the business to grow more rapidly.</p> Signup and view all the answers

Identify one limitation of relying on borrowed funds for business finance.

<p>One limitation is the obligation to repay the borrowed amount along with interest, which can strain cash flow.</p> Signup and view all the answers

What is a clear assessment of financial needs in the context of business finance?

<p>A clear assessment involves determining how much capital is required, when it is needed, and for what specific purposes.</p> Signup and view all the answers

Why is it essential to understand the relative merits and demerits of different sources of finance?

<p>Understanding the merits and demerits helps business owners make informed decisions when selecting the most appropriate funding source.</p> Signup and view all the answers

What trends have been seen in leasing among public sector undertakings?

<p>Public sector undertakings have experienced a significant growth in lease financing.</p> Signup and view all the answers

How do mid-market companies utilize lease financing?

<p>Mid-market companies use lease financing as an alternative to traditional bank or institutional financing.</p> Signup and view all the answers

What impact has corporate financing experiences had on consumers regarding lease financing?

<p>Negative experiences with corporate financing have shifted consumer focus towards retail funding options like car leasing.</p> Signup and view all the answers

Which sector has recently begun engaging in lease financing in India?

<p>The government sector has recently entered the leasing market.</p> Signup and view all the answers

What are public deposits and why are they beneficial for organizations?

<p>Public deposits are funds raised directly from the public, typically offering higher interest rates than bank deposits.</p> Signup and view all the answers

What is a major limitation for new companies regarding public deposits?

<p>New companies generally find it challenging to raise funds through public deposits.</p> Signup and view all the answers

Why are interest rates on public deposits typically higher than those on bank deposits?

<p>Interest rates on public deposits are usually higher to attract more investors directly into the organization.</p> Signup and view all the answers

What is the significance of lease financing for consumers in the current market?

<p>Lease financing is significant for consumers as it provides an accessible means to acquire durables, like cars, without large upfront payments.</p> Signup and view all the answers

What distinguishes second debentures from first debentures?

<p>Second debentures are repaid after first debentures.</p> Signup and view all the answers

What kind of security is typically required by banks for loan transactions?

<p>Borrowers are required to provide security or create a charge on the firm's assets.</p> Signup and view all the answers

What are some difficulties associated with obtaining loans from banks?

<p>Difficult terms and conditions, such as restrictions on the sale of mortgaged goods, can be imposed.</p> Signup and view all the answers

Name one merit of obtaining funds from commercial banks.

<p>Banks provide timely assistance to businesses in need of funds.</p> Signup and view all the answers

How does the confidentiality of information benefit borrowers seeking loans?

<p>It allows borrowers to maintain secrecy about their business operations.</p> Signup and view all the answers

What formalities are bypassed when obtaining loans from banks?

<p>The issuance of prospectuses and underwriting are not required.</p> Signup and view all the answers

What is one characteristic of loans from banks compared to traditional financial agencies?

<p>Loans from banks are typically more flexible.</p> Signup and view all the answers

What role do financial institutions play in aiding businesses?

<p>They provide both owned capital and loan capital for long and medium term requirements.</p> Signup and view all the answers

What is one benefit of short-term borrowings for business firms?

<p>Short-term borrowings offer the benefit of reduced costs due to the reduction of idle capital.</p> Signup and view all the answers

What legal limitation does a partnership firm face in raising funds?

<p>A partnership firm cannot raise money by issuing equity shares, as only joint stock companies are permitted to do so.</p> Signup and view all the answers

Why is it advisable for a business to use a combination of financing sources?

<p>Using a combination of sources is advisable because it allows businesses to address the limitations associated with each type of funding.</p> Signup and view all the answers

What factors affect the choice of source for raising funds in a business?

<p>Factors include the cost of procurement, the period of funds needed, the purpose of use, and the financial structure of the firm.</p> Signup and view all the answers

In what situation is it more appropriate to use shares and debentures for finance?

<p>Shares and debentures are more appropriate for long-term finance needs such as business expansion plans.</p> Signup and view all the answers

How should the cost of utilizing funds be considered when deciding on a funding source?

<p>The cost of utilizing funds should be compared alongside the cost of procurement to ensure effective financial decision-making.</p> Signup and view all the answers

What is an example of a short-term source of financing?

<p>An example of a short-term source of financing is trade credit or commercial paper.</p> Signup and view all the answers

Why is matching the purpose of funds with their source important?

<p>Matching the purpose with the source ensures that the financing aligns with the company's operational and strategic goals.</p> Signup and view all the answers

Flashcards

Business Finance

The funding required to operate and grow a business.

Sources of Business Finance

Different ways a business can obtain the funds necessary for its operations.

Financial Needs Assessment

Evaluating the funding required by a business.

Startup Capital

Initial funding contributed by the business owner.

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Sufficient Funding

Adequate funds to cover all operational costs

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Business Operation

A company's activities.

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Entrepreneur

A person who starts their own business.

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Choice of funding source

The decision on which funding to utilize.

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Factoring

A financial service where a 'factor' provides services like discounting bills and collecting debts.

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Discounting of bills

Part of factoring, where a factor buys a business's outstanding invoices at a discount.

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Recourse Factoring

A type of factoring where the client is not protected against bad debts.

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Non-Recourse Factoring

A type of factoring where the client is protected against bad debts.

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Factor

A financial entity providing factoring services.

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Trade Credit

Limited funds for businesses through credit provided by suppliers.

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Cost of Factoring

Factoring involves fees for the services rendered, making it potentially expensive compared to other sources of financing.

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Merit of Factoring

Factoring can be a cheaper source of funding than bank credit.

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Lease Finance

A financial arrangement where a company leases an asset (like a car or equipment) instead of buying it outright.

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Lessee

The company or individual who uses the leased asset.

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Public Sector Undertakings

State-owned government agencies or companies.

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Mid-Market Companies

Companies with good creditworthiness but not major public profiles.

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Consumer Durables

Products purchased by consumers that are expected to last for a long time, such as cars, appliances, and furniture.

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Public Deposits

Funds raised by companies directly from the public, often at higher interest rates than bank deposits.

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Voting Rights

The right of an individual or company to influence decisions made by a corporation.

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Control of the Company

The power to make key decisions and guide the direction of a company.

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Trade Credit Merits

Advantages of using trade credit as a financing tool.

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Trade Credit Convenience

Trade credit is a simple and easy way to get funding for transactions.

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Trade Credit Availability

Trade credit is often immediately accessible if creditworthiness is known.

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Credit Terms Variety

Different businesses and customers can have different credit agreements.

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Retained Earnings Limitations

Problems related to using retained earnings as a business funding source.

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Ploughing Back (Excessive)

Putting too much profit (from earnings) back into the business, which may cause shareholder dissatisfaction.

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Opportunity Cost (Retained Earnings)

The potential return that could have been earned by investing elsewhere.

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Factors of Trade Credit

Attributes of the buyer and seller that can influence the terms of trade credit provided.

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What are debentures?

Debentures are long-term debt instruments issued by companies to raise funds from the public. They represent a loan that the company is obligated to repay with interest.

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What are second debentures?

Second debentures are debt instruments that are paid back only after the first debentures (senior debentures) have been fully repaid.

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Why are commercial banks a good source of financing for businesses?

Commercial banks provide timely financial assistance, maintain confidentiality, require simpler processes compared to issuing bonds, and offer flexible loan terms.

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What are some potential drawbacks of using commercial bank loans?

Obtaining a loan can be difficult, terms and conditions can be strict, and restrictions on the use of borrowed funds can impact business operations.

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What are financial institutions?

Financial institutions, established by the government, provide financial services to businesses and individuals. These include both long-term and medium-term financing options.

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What's the purpose of financial institutions?

Financial institutions supplement traditional financial services provided by commercial banks by offering alternative funding options. They focus on long-term and medium-term needs of businesses.

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What are examples of financial institutions?

Examples of financial institutions include development banks, investment banks, and venture capital funds, among others.

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How do financial institutions help businesses?

Financial institutions act as a bridge between those who have surplus capital and those who need it. They help businesses access necessary funding for growth and expansion.

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Why do businesses need different sources of funding?

Businesses need different funding sources based on their financial needs. Short-term borrowing is ideal for temporary needs because it's cheaper due to less idle capital. However, long-term borrowing is necessary for sustained needs like expansion.

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What's the difference between short-term and long-term borrowing?

Short-term borrowing is for a limited time, often used for temporary needs. Long-term borrowing is for an extended period, usually for significant investments or expansion.

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Why is the legal structure of a business important for funding?

A business's legal structure dictates what funding sources are available. Partnerships cannot issue shares, for example, but joint-stock companies can.

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What factors influence the choice of funding sources?

Businesses need to consider the cost of obtaining the funds, the cost of using the funds, the purpose of the funding, and the time frame for needing the funds.

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Why should businesses use a combination of funding sources?

Using a variety of funding sources helps to balance risk and optimize cost. Relying solely on one source can lead to financial instability.

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What is the cost of procurement?

The cost of procurement is the expense incurred in acquiring funds. This includes interest rates, fees, and other charges associated with borrowing or raising capital.

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What is the cost of utilizing funds?

The cost of utilizing funds refers to the expenses incurred while using the obtained funds. This includes operational costs, maintenance, and any other expenditures related to putting the funds to work.

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How does the purpose of funding affect the choice of source?

The specific reason for needing funds influences the best source. For example, long-term business expansion requires long-term funding like shares or bonds, while short-term needs like trade credit are better suited for short-term borrowing.

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Study Notes

Chapter 8: Sources of Business Finance

  • Learning Objectives:
    • Define business finance, its nature, and importance.
    • Categorize different sources of business finance.
    • Evaluate the advantages and disadvantages of different financial sources.
    • Identify international financing sources.
    • Analyze factors influencing the choice of a suitable financial source.

8.1 Introduction

  • Business finance is crucial for any business's operations, including production and distribution of goods/services.
  • Starting and running a business often requires more funds than initially available.
  • Business owners must understand various sources of finance and their characteristics.

8.2 Meaning, Nature and Significance of Business Finance

  • Business finance is the funds required for production and distribution.
  • It's the lifeblood of any business.
  • Adequate funds are essential for smooth operations.

8.3 Classification of Sources of Funds

  • Based on ownership: Owner's funds (equity shares/retained earnings) vs. Borrowed funds (loans, debentures).
  • Based on period: Short-term (trade credit, commercial paper), medium-term, long-term (equity, debt).

8.4 Sources of Finance

  • 8.4.1 Retained Earnings:

    • Profits not distributed as dividends.
    • Internal source of funds.
    • Advantages: permanent, no explicit cost.
    • Disadvantages: fluctuating profits, opportunity cost.

  • 8.4.2 Trade Credit:

    • Credit extended by one trader to another.
    • Facilitates sales without immediate payment.
    • Advantages: convenient, readily available, doesn't affect the firm's assets.
    • Disadvantages: may lead to overtrading, limited funds.

  • 8.4.3 Factoring:

    • Financial service where a factor collects the company's receivables.
    • Advantages: faster receivables, protection from bad debts.
    • Disadvantages: costly, loss of control.

  • 8.4.4 Lease Financing:

    • Leasing an asset instead of buying it.
    • Advantage: lower up-front cost, flexibility, tax benefits.
    • Disadvantage: limitations on use, higher total cost in the long run.

  • 8.4.5 Public Deposits:

    • Funds raised directly from the public, usually for a fixed period.
    • Advantage: relatively easy to obtain compared to loans, cost-effective.
    • Disadvantages: reliance on public response, potentially unreliable.

  • 8.4.6 Commercial Paper:

    • Short-term, unsecured debt instrument.
    • Advantage: higher liquidity, lower cost compared to other short-term instruments.
    • Disadvantage: high risk for less creditworthy companies.

  • 8.4.7 Issue of Shares:

    • Equity shares (ownership) vs. Preference shares (preference over dividends).
    • Advantages: equity is permanent capital, preference shares are stable returns.
    • Disadvantages: diluting control, fluctuating returns.

  • 8.4.8 Debentures:

    • Long-term secured debt instruments.
    • Advantage: fixed interest rates, tax deductions.
    • Disadvantage: secured debt.

  • 8.4.9 Commercial Banks:

    • Loans for various purposes.
    • Advantages: flexibility, ease of access.
    • Disadvantages: short time frames, stringent terms, risk assessments/security requirements.

  • 8.4.10 Financial Institutions:

    • Long-term loans, development-oriented support.
    • Advantages: specialized expertise, flexibility, longer terms.
    • Disadvantages: stringent criteria, increased formality, time-consuming.

8.5 International Financing

  • International financing sources from banks, agencies, and capital markets.
    • Global depository receipts (GDRs), American depository receipts (ADRs), International capital markets.

8.6 Factors Affecting the Choice of the Source of Funds

  • Cost: Procurement and utilization costs.
  • Risk Profile: Volatility and risk tolerance of the source.
  • Control: Impact on management control.
  • Availability: Time frame of funds required.
  • Flexibility: Adaptability of the chosen source.
  • Credit Worthiness: Impact of the chosen on credit rating.
  • Tax Benefits: Tax implications of various sources.

Projects/Assignments

  • Research on companies using debentures and suggest ways to popularize debentures.
  • Compile information on Indian financial institutions.
  • Recommend suitable financial solutions for the restaurant owner.
  • Create a comparative chart of all finance sources.

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Sources Of Business Finance PDF

Description

This quiz covers Chapter 8 of business finance, focusing on the various sources of finance and their significance in business operations. You will learn about different categorization methods and evaluate the advantages and disadvantages of each financial source. Test your knowledge on the international financing options available and the factors that influence financial decisions.

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