Business Finance Essentials
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Questions and Answers

What is necessary for a business to begin functioning?

  • A detailed business plan
  • A solid customer base
  • Only the entrepreneur's initial capital
  • Adequate funds made available (correct)

Why might an entrepreneur need to seek additional financial sources beyond their initial capital?

  • To pay off existing debts
  • To fund marketing campaigns
  • To invest in new product development
  • To cover all financial requirements of the business (correct)

What is a crucial aspect of managing business finance?

  • Minimizing employee salaries
  • Reducing operating costs
  • Identifying various sources of finance (correct)
  • Focusing solely on fixed assets

When does the need for funding initially arise in a business context?

<p>When an entrepreneur decides to start a business (A)</p> Signup and view all the answers

What is a common requirement for day-to-day business operations?

<p>Payment for raw materials and salaries (C)</p> Signup and view all the answers

Which factor affects the amount of working capital required by a business?

<p>Business operations on credit (C)</p> Signup and view all the answers

Why is a clear assessment of financial needs important for a business?

<p>To make informed funding decisions (C)</p> Signup and view all the answers

What can trigger the need for funds during business expansion?

<p>Funding for new technology (C)</p> Signup and view all the answers

What is the primary characteristic of commercial paper?

<p>It is an unsecured promissory note. (D)</p> Signup and view all the answers

Which firms have the ability to raise funds through commercial paper?

<p>Only financially sound and highly rated firms. (A)</p> Signup and view all the answers

What is the typical duration for which commercial paper is issued?

<p>Between 90 days to 364 days. (D)</p> Signup and view all the answers

Which of the following is a limitation of commercial paper?

<p>The size of money raised is dependent on available liquidity. (A)</p> Signup and view all the answers

What is the term used for investors who hold equity shares?

<p>Shareholders (B)</p> Signup and view all the answers

What does it mean for shareholders to be 'residual owners'?

<p>They bear the risk of ownership after all claims are settled. (C)</p> Signup and view all the answers

What signifies the nominal value of a share?

<p>The fixed value assigned to each share upon issuance. (A)</p> Signup and view all the answers

Which of the following is NOT a merit of raising funds through issuing equity shares?

<p>Elimination of debt obligations. (B)</p> Signup and view all the answers

What is the primary reason investors prefer debentures?

<p>They provide fixed income with lower risk. (C)</p> Signup and view all the answers

How does issuing debentures affect a company's borrowing capacity?

<p>It reduces the company's capacity to borrow further. (D)</p> Signup and view all the answers

What is a key characteristic of debentures regarding voting rights?

<p>Debenture holders do not have voting rights. (A)</p> Signup and view all the answers

What can affect the interest rate charged by banks on loans?

<p>The characteristics of the firm and economic interest rates. (A)</p> Signup and view all the answers

What is one of the benefits of financing through debentures compared to equity capital?

<p>Interest payments on debentures are tax deductible. (D)</p> Signup and view all the answers

Which type of loan do banks typically extend for shorter periods?

<p>Medium to short-term loans. (A)</p> Signup and view all the answers

How can a bank loan be repaid?

<p>In either lump sum or installments. (C)</p> Signup and view all the answers

Why is bank credit not considered a permanent source of funds?

<p>It is intended for short periods. (A)</p> Signup and view all the answers

What type of capital is required for purchasing fixed assets?

<p>Fixed capital (D)</p> Signup and view all the answers

Which category of funding provides financial support for more than five years?

<p>Long-term sources (C)</p> Signup and view all the answers

What is referred to as the capital that comes from owners of the enterprise?

<p>Owner's funds (B)</p> Signup and view all the answers

Which term describes the financial resources sourced from within the business?

<p>Internal sources (A)</p> Signup and view all the answers

What is the duration for which medium-term sources fulfill financial requirements?

<p>More than 1 year but not exceeding 5 years (A)</p> Signup and view all the answers

Which of the following is NOT a classification basis for sources of funds?

<p>Geographic origin (A)</p> Signup and view all the answers

What kind of capital is typically required for day-to-day operations?

<p>Working capital (B)</p> Signup and view all the answers

Which source of funds is primarily generated through loans from individuals or institutions?

<p>Borrowed capital (D)</p> Signup and view all the answers

What advantage do banks provide businesses when raising funds?

<p>They provide timely assistance as needed. (D)</p> Signup and view all the answers

What is one major limitation associated with obtaining funds from commercial banks?

<p>Funds are generally available for short periods with uncertain renewal. (C)</p> Signup and view all the answers

What distinguishes secured debentures from unsecured debentures?

<p>Secured debentures create a charge on the company's assets. (B)</p> Signup and view all the answers

How are registered debentures different from bearer debentures?

<p>Registered debentures are recorded in the company's register. (B)</p> Signup and view all the answers

Convertible debentures can be characterized by which feature?

<p>They can be converted into equity shares after a specified period. (C)</p> Signup and view all the answers

What is the primary feature of first debentures?

<p>They are repaid before other debentures. (A)</p> Signup and view all the answers

Which statement reflects a typical requirement when acquiring funds from banks?

<p>Banks require confidentiality of business information. (A)</p> Signup and view all the answers

What is a characteristic of non-convertible debentures?

<p>They cannot be converted into equity shares. (D)</p> Signup and view all the answers

What is one of the responsibilities of a factor in a factoring arrangement?

<p>Collects the client’s debt (D)</p> Signup and view all the answers

What is the typical maturity period of a commercial paper?

<p>90 to 364 days (C)</p> Signup and view all the answers

Which of the following describes internal sources of capital?

<p>Generated within the business (C)</p> Signup and view all the answers

Which of the following is a primary advantage of issuing debentures over issuing equity shares?

<p>Avoids dilution of ownership (B)</p> Signup and view all the answers

What is one disadvantage of public deposits as a method of business finance?

<p>Higher interest rates (B)</p> Signup and view all the answers

What distinguishes trade credit from bank credit as sources of short-term finance for businesses?

<p>Trade credit typically doesn't involve immediate cash transactions (B)</p> Signup and view all the answers

What type of financing instrument is a commercial paper?

<p>Short-term liability (A)</p> Signup and view all the answers

Which type of shareholder enjoys preferential rights?

<p>Preference shareholders (B)</p> Signup and view all the answers

Flashcards

Business Finance

The process of funding a business's activities, from startup to growth.

Sources of Business Finance

Different ways a business can obtain needed money.

Initial Capital

The starting funds invested in a business by its owner(s).

Financial Needs

The amount of money a business needs for operations.

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Working Capital

Funds required for day-to-day business operations (e.g., raw materials).

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Fixed Assets

Items like machinery and furniture that a business buys to use in its operations.

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Business Growth

The expansion of a business's operations, which may require additional funding.

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Adequate Funds

Sufficient money to run the business smoothly and efficiently

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Commercial Paper (CP)

An unsecured promissory note issued by a firm to raise short-term funds (90 days to 364 days).

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Limitations of Commercial Paper

Only financially strong companies can use it; limited funds available, and no flexibility for extending maturities.

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Share Capital

Capital raised by issuing shares, divided into small units (shares).

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Share

A small unit of ownership in a company.

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Shareholder

A person who holds shares in a company.

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Nominal Value of a share

The face value or stated value of a share.

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Equity Shares

Shares representing ownership in a company, paid based on earnings and enjoy voting rights and limited liability.

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Residual Owners

Shareholders who receive what's left after all debts and creditors are paid.

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Debenture Return

The difference between the face value of a debenture and its purchase price, representing the investor's profit.

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Debenture Merit: Fixed Income

Investors prefer debentures because they offer a guaranteed, fixed income with lower risk than other investments.

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Debenture Merit: Fixed Charge

Debentures are fixed charge funds, meaning they don't share in the company's profits.

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Debenture Merit: Stable Sales

Issuing debentures is suitable when a company has consistent sales and earnings.

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Debenture Merit: Control

Debentures don't carry voting rights, so issuing them doesn't dilute shareholder control of a company.

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Debenture Merit: Cost Savings

Financing through debentures is often less expensive because interest payments are tax deductible.

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Commercial Bank Role

Commercial banks play a crucial role by providing funds for various business purposes and timeframes.

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Bank Loan Features

Commercial bank loans can be customized, have flexible repayment terms, and require security or a charge on assets.

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Bank Loan Advantages

Commercial banks offer timely financing, maintain business secrecy, and have less paperwork than other sources.

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Bank Loan Disadvantages

Bank loans typically have short term limits, require thorough company assessments, and may demand security or guarantees.

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Secured Debentures

Debentures backed by specific company assets, representing a claim on those assets in case of default.

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Unsecured Debentures

Debentures not backed by any specific assets. Investors rely on the company's overall financial strength.

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Registered Debentures

Debentures recorded in the company's register, allowing for transfer through legal documents.

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Bearer Debentures

Debentures transferable by delivery, making ownership easily exchanged.

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Convertible Debentures

Debentures that can be exchanged for equity shares after a set time period.

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Non-Convertible Debentures

Debentures that cannot be converted into equity shares. They remain fixed-income securities.

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Fixed Capital

Funds required for purchasing long-term assets like machinery, buildings, and land, which a business uses for its operations over several years.

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What are the different sources of funds for a business?

Businesses can obtain funds from various sources, broadly categorized as owned capital, borrowed capital, internal sources, and external sources.

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Borrowed Capital

Funds obtained from external sources like loans, bonds, or other borrowings. These funds need to be repaid later with interest.

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Owned Capital

Funds provided by the owners of the business, either through initial investment or retained earnings.

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Short-term Sources

Financial resources used for a period less than a year, often for managing day-to-day operations, for example, account receivables or bill discounting.

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Long-term Sources

Financial resources used for a period exceeding 5 years, usually for financing large investments like building factories or new equipment.

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Restrictive Conditions

Specific limitations or terms imposed on a business when obtaining borrowed capital, often related to financial performance or asset management.

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Factoring arrangement

A financial arrangement where a business sells its receivables to a factor, who collects the debt and charges a fee. The factor assumes the risk of bad debts.

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Maturity period of commercial paper

The time frame within which a commercial paper must be repaid. Typically ranges between 60 to 90 days.

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Internal sources of capital

Funds generated within the business itself, such as retained earnings or profits, without needing outside investment.

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Preference shares

Shares that offer a fixed dividend payment to shareholders before common shareholders receive any dividends. They have a preference in paying dividends.

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GDR vs. ADR

GDR (Global Depository Receipt) is a share issued by a foreign company to raise funds in international markets, while ADR (American Depository Receipt) represents shares of a foreign company traded on U.S. stock exchanges.

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Trade credit as short-term finance

A source of short-term financing where a business is granted a period of time to pay its suppliers for goods and services purchased, based on their relationship and creditworthiness.

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Bank credit as short-term finance

Short-term financing provided by a commercial bank to businesses through loans or lines of credit for various operational needs.

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Merits of public deposits

Public deposits offer a business a low-cost and flexible way to raise long-term funding directly from the public through issuing bonds or debt securities.

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Study Notes

Learning Objectives

  • State the meaning, nature, and importance of business finance.
  • Classify the various sources of business finance.
  • Evaluate merits and limitations of various sources of finance.
  • Identify the factors that affect the choice of an appropriate source of finance.

Introduction

  • Business requires money for activities.
  • Finance is the lifeblood of any business.
  • Sufficient funds are essential for business operations.
  • Entrepreneurs need additional funds beyond initial capital.
  • Various methods exist for obtaining funds, each with advantages and limitations.
  • The appropriate method depends on factors like purpose and duration.

Classification of Sources of Funds

  • Based on the period:
    • Long-term: > 5 years (shares, debentures, long-term loans)
    • Medium-term: 1-5 years (loans from banks, public deposits)
    • Short-term: < 1 year (trade credit, factoring)
  • Based on ownership:
    • Owner's funds: equity shares, retained earnings
    • Borrowed funds: loans from banks, debentures, commercial papers
  • Based on source of generation:
    • Internal: retained earnings, accumulated profits
    • External: loans, credit, investments

Sources of Finance

  • Retained Earnings: Profits reinvested, no explicit cost, but uncertain as profits fluctuate.
  • Trade Credit: Convenient, continuous, easily available to creditworthy customers.
  • Factoring: Discounting bills, collection of debts (recourse/non-recourse). Flexible, secure cash flow.
  • Lease Financing: Renting an asset, reduces upfront investment.
  • Public Deposits: Higher interest rate than banks.
  • Commercial Paper (CP): Unsecured promissory notes (short-term), high liquidity.
  • Debentures: Long-term debt, fixed interest payments, but can create financial burden.
  • Commercial Banks: Flexible, timely assistance, but formalities and conditions may apply.
  • Financial Institutions: long-term finance options, often involve more technical assistance and managerial support.
  • International Financing: Loans, GDRs, ADRs, and FCCBs are options in international markets.

Factors Affecting the Choice of Funds

  • Cost: Procurement and utilization costs.
  • Financial Strength and Stability: Ability to repay principal and interest.
  • Form of Organization: Legal constraints on the business structure.
  • Purpose and Time Period: Long-term vs short-term funding.
  • Risk Profile: Assessing the risk of each different option.
  • Tax Benefits: Tax deductible sources are preferred (e.g., interest on loans).
  • Control: Level of control that stakeholders desire.

Issue of Shares (Equity Shares and Preference Shares)

  • Equity Shares: Reflect ownership, fluctuating dividends based on profit. Limited risks for investors. Higher returns but no fixed payments.
  • Preference Shares: Fixed rate of dividend, prior claim on assets during liquidation, lower risk than equity but lower growth potential. No voting rights.

Debentures

  • Represent borrowing, fixed interest payments, less costly than preference shares.

Intercorporate Deposits (ICDs)

  • Short-term deposits between corporations. Higher than bank rates.

International Financing

  • Global funding options: commercial banks, international agencies, capital markets (GDRs, ADRs, FCCBs).

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NCERT Class 11 Business Studies Chapter 8: Sources of Business Finance PDF

Description

This quiz covers the fundamental concepts of business finance, including its meaning, importance, and classification of various sources. Evaluate the merits and limitations of each source and identify key factors to consider when choosing an appropriate financing method. Test your knowledge on the essential components necessary for effective financial management.

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