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?

When an entrepreneur decides to start a business Signup and view all the answers

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

Payment for raw materials and salaries Signup and view all the answers

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

Business operations on credit Signup and view all the answers

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

To make informed funding decisions Signup and view all the answers

What can trigger the need for funds during business expansion?

Funding for new technology Signup and view all the answers

What is the primary characteristic of commercial paper?

It is an unsecured promissory note. Signup and view all the answers

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

Only financially sound and highly rated firms. Signup and view all the answers

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

Between 90 days to 364 days. Signup and view all the answers

Which of the following is a limitation of commercial paper?

The size of money raised is dependent on available liquidity. Signup and view all the answers

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

Shareholders Signup and view all the answers

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

They bear the risk of ownership after all claims are settled. Signup and view all the answers

What signifies the nominal value of a share?

The fixed value assigned to each share upon issuance. Signup and view all the answers

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

Elimination of debt obligations. Signup and view all the answers

What is the primary reason investors prefer debentures?

They provide fixed income with lower risk. Signup and view all the answers

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

It reduces the company's capacity to borrow further. Signup and view all the answers

What is a key characteristic of debentures regarding voting rights?

Debenture holders do not have voting rights. Signup and view all the answers

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

The characteristics of the firm and economic interest rates. Signup and view all the answers

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

Interest payments on debentures are tax deductible. Signup and view all the answers

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

Medium to short-term loans. Signup and view all the answers

How can a bank loan be repaid?

In either lump sum or installments. Signup and view all the answers

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

It is intended for short periods. Signup and view all the answers

What type of capital is required for purchasing fixed assets?

Fixed capital Signup and view all the answers

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

Long-term sources Signup and view all the answers

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

Owner's funds Signup and view all the answers

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

Internal sources Signup and view all the answers

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

More than 1 year but not exceeding 5 years Signup and view all the answers

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

Geographic origin Signup and view all the answers

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

Working capital Signup and view all the answers

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

Borrowed capital Signup and view all the answers

What advantage do banks provide businesses when raising funds?

They provide timely assistance as needed. Signup and view all the answers

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

Funds are generally available for short periods with uncertain renewal. Signup and view all the answers

What distinguishes secured debentures from unsecured debentures?

Secured debentures create a charge on the company's assets. Signup and view all the answers

How are registered debentures different from bearer debentures?

Registered debentures are recorded in the company's register. Signup and view all the answers

Convertible debentures can be characterized by which feature?

They can be converted into equity shares after a specified period. Signup and view all the answers

What is the primary feature of first debentures?

They are repaid before other debentures. Signup and view all the answers

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

Banks require confidentiality of business information. Signup and view all the answers

What is a characteristic of non-convertible debentures?

They cannot be converted into equity shares. Signup and view all the answers

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

Collects the client’s debt Signup and view all the answers

What is the typical maturity period of a commercial paper?

90 to 364 days Signup and view all the answers

Which of the following describes internal sources of capital?

Generated within the business Signup and view all the answers

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

Avoids dilution of ownership Signup and view all the answers

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

Higher interest rates Signup and view all the answers

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

Trade credit typically doesn't involve immediate cash transactions Signup and view all the answers

What type of financing instrument is a commercial paper?

Short-term liability Signup and view all the answers

Which type of shareholder enjoys preferential rights?

Preference shareholders Signup and view all the answers

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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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.