Question

NCERT Solutions Class 11, Business Studies, Chapter- 8, Sources of Business Finance

In the fast-paced world of business, having access to capital is essential for growth, expansion, and long-term success. The NCERT Class 11 Business Studies curriculum covers various sources of business finance, giving students a clear understanding of how businesses can obtain funds to support their activities and achieve their goals. This article provides a simplified overview of the chapter and includes expert-developed solutions to the exercises, which help clarify complex concepts and follow the latest CBSE guidelines. These solutions are designed to make the material easier to understand and help you prepare effectively for your exams.

In these NCERT Solutions for Class 11 Business Studies, we have discussed all types of NCERT intext questions and exercise questions.

Concepts covered in Class 11 Business Studies chapter- 8 Sources of Business Finance, are :

• Meaning, Nature and Significance of Business Finance
• Period Basis
• Sources of Finance
• Retained Earnings
• International Financing
• Factors Affecting the Choice of the Source of Funds

Our NCERT Solutions for Class 11 Business Studies provide a comprehensive resource for students, featuring in-depth explanations, practice questions, and real-life examples to deepen understanding and aid in effective preparation. Utilizing these solutions helps students develop a solid grasp of business concepts and achieve success in their academic endeavors.

You can now effortlessly access all the solutions and practice questions to jumpstart your studies!

Answer 1

NCERT Solutions Class 11, Business Studies, Chapter- 8, Sources of Business Finance

Short Answer Questions

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

Solution:

Business finance refers to capital funds and credit funds invested in the business.

Businesses need funds due to many reasons:

• A business needs buildings, machinery, furniture etc., to set up operations, and funds are necessary for purchasing all the fixed assets which is called fixed capital requirement.
• Running day-to-day operations such as purchasing raw materials requires regular money, also called working capital requirements.

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

Solution:

The following are some of the sources of long-term funds.

(a) Equity shares: These represent the ownership capital of a company. The holders of such shares enjoy a say in the management and gain higher returns when the company earns higher profits.

(b) Retained earnings: These are the undistributed profits of a business that are retained in the business for future use.

(c) Debentures: Debentures are financial instruments used by companies to raise long-term debt capital. They carry a fixed rate of return and specify a time for repayment.

The following are some of the sources of short-term funds.

(a) Trade credit: It is the amount of credit that is extended by the supplier to the purchaser. It facilitates the purchase of goods on credit.

(b) Banks: Business enterprises can also obtain short-term funds from banks.

(c) Commercial paper: These are credit instruments used by creditworthy firms to obtain short-term finance for their business.

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

Solution:

Basis	Internal Source	External Source
Source	Funds are generated from within the business	Funds are generated from outside sources
Need Fulfillment	The internal source of funds can fulfill only limited needs of the business	Large amount of money can be raised through external sources
Security	Business is not required to provide security	Security required in the form of mortgaging assets

4. What preferential rights are enjoyed by preference shareholders. Explain.

Solution:

Preference shares are shares that provide the shareholders preferential rights regarding the repayment of capital and payment of dividends after a certain specified period of time. Preference shares are issued by a company to raise capital, and the repayment to preference shareholders is made in accordance with the terms specified in Section 80 of the Companies Act, 1956. Preference shareholders are entitled to the following preferential rights.

(a) Preference shares entitle their holders the right to receive dividends of a fixed amount or at a fixed rate.

(b) Preference shares entitle their holders the preferential right to receive repayment of capital invested by them before their equity counterparts at the time of winding up of the company.

5. Name any three special financial institutions and state their objectives.

Solution:

Financial institutions refer to central or state government establishments that exist to finance business operations. These institutions provide long-term finance to firms to help them in their expansion, modernisation, and reorganisation programmes.

The following are the three main financial institutions.

(a) Unit Trust of India (UTI): The UTI was established in 1964 under the Unit Trust of India Act, 1963, with the objective of mobilising the community’s savings and utilising the funds to finance profitable ventures.

(b) Industrial Credit and Investment Corporation of India (ICICI): The ICICI was established as a public limited company in 1955. The main objective of the ICICI was to facilitate the creation, modernisation, and expansion of enterprises in the private sector.

(c) Industrial Finance Corporation of India (IFCI): The IFCI was established in 1948 under the Industrial Finance Corporation Act, 1948, with the objective of facilitating regional development and encouraging new entrepreneurs to enter the priority sectors of the economy.

6. What is the difference between GDR and ADR? Explain.

Solution:

GDR: It stands for Global Depository Receipts. It is a type of bank certificate that acts as shares in foreign companies. It is a mechanism by which a company can raise equity from the international market. These can be traded on all stock exchanges over the world. They are denoted in US dollars. So, it can be easily converted into shares at any time.

ADR: It stands for American Depository Receipts: US-based companies issue these kinds of receipts. These are only traded in the US Securities market and are only sold to US citizens only.

Long Answer Questions

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

Solution:

Trade credit refers to the credit extended by a supplier to a business enterprise, allowing the business to purchase goods or services on credit and defer payment for a certain period of time, typically ranging from 30 to 90 days. The terms of trade credit are usually negotiated between the supplier and the buyer, and may involve discount for early payment of penalties for late payment. Trade credit is an important source of short-term finance for many business, particularly small and medium-sized enterprises (SMEs), as it allows them to manage cash flow and maintain inventory levels without having to use their own funds or seek external financing.

Bank credit, on the other hand, refers to the credit extended by a financial institution, such as a bank or a credit union, to a business enterprise in the form of a loan or a line of credit. Bank credit may be secured or unsecured, and may be offered at a fixed or variable interest rate, depending on the creditworthiness of the borrower and the terms of the loan. Bank credit is a common source of short-term finance for businesses, particularly those that require large amounts of capital for investment or expansion, as it allows them to access funds quickly and at a relatively low cost.

Answer 2

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

Solution:

The following are some of the sources of long-term funds.

(a) Equity shares: These shares represent the ownership capital of a company. The holders of such shares are known as equity share holders and enjoy a say in the management and gain higher returns when the profits are higher. They are also called the owners of the company, or residual owners, since payments to them are made only after paying the external debts or claims.

(b) Retained earnings: Firms generally keep a certain fraction or part of their profits before distributing dividends to their shareholders. These undistributed profits are known as retained earnings because the funds are kept for future use.

(c) Preference shares: These types of shares provide the shareholders a preferential right regarding the repayment of capital and payment of earnings after a certain specified period of time. Such repayment to the preference share holders is made in accordance with the terms specified in Section 80 of the Companies Act, 1956.

(d) Debentures: Debentures are financial instruments used by companies to raise long-term debt capital. They imply that a company has borrowed a certain sum of money which it will repay later to the debenture holders. Just like loans, they carry a fixed rate of return and specify in advance the time for repayment of the debts.

(e) Loans from banks and other financial institutions: Business enterprises can borrow funds for a fixed period of time from banks and financial institutions in return for a fixed periodic payment called interest. The time for repayment of such a loan is fixed and is stated in advance at the time of granting the loan.

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

Solution:

Debentures are financial instruments used by companies to raise long-term debt capital. They imply that the company has borrowed a certain sum of money which it will repay later to the debenture holders. They are considered as fixed income securities as they carry a fixed rate of return and are repayable on a certain pre-specified date in the future.

The following are the advantages of issuing debentures over issuing equity shares.

(a) The issue of equity shares denotes the dilution of ownership of a firm. This is because the equity share holders own specified shares of the company and have voting rights. In contrast, debenture holders do not have any rights in the company. That is, they do not enjoy voting rights or any kind of ownership in the firm. Rather, they are only entitled to a fixed amount as payment. Thus, debentures do not result in any kind of dilution of ownership of the firm. Thus, issuing debentures is more advantageous for a firm than issuing equity shares.

(b) In order to issue shares, a company has to incur huge costs. Besides, it has to pay dividends to its shareholders, which are not tax-deductible. On the other hand, a company receives tax deductions on the interest paid to its debenture holders. Hence, issuing debentures is advantageous for a firm in terms of low costs.

(c) Debentures carry a fixed rate of return. This implies that irrespective of the profit earned, the company has to pay only a fixed interest to its debenture holders. On the other hand, a company that issues shares has to pay dividends to the shareholders, which varies with the profit—i.e., the higher the profit, the higher will be the dividends. Thus, companies prefer to issue debentures if they expect to earn higher profits in a year.

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

Solution:

Public deposits: Organisations raise public deposits directly from the public to finance their short-term as well as medium-term financial requirements. The rate of return on such deposits is generally higher than the return paid on bank deposits. In case a person is interested in investing in a business (by depositing money), then he or she can submit a prescribed form along with the deposit. In return for this sum borrowed, the organisation issues a deposit receipt as a token of acknowledgment of the debt.

Merits of Public Deposits

(a) Raising money by accepting public deposits is a very simple process with few regulations involved.

(b) The cost of raising funds by accepting public deposits is generally lower than the cost involved in borrowing loans from commercial banks.

(c) The depositors do not have any voting or management rights. Thus, acceptance of public deposits does not result in any dilution of ownership of the business.

Demerits of Public Deposits

(a) The amount of money that can be raised from public deposits is limited as it depends on the availability of funds and the willingness of people to invest in the company concerned.

(b) Generally, it is difficult for new companies to raise capital through public deposits as people lack faith in them.

(c) When a firm has huge capital requirements, it may face difficulty in borrowing funds through the issue of public deposits.

Retained Earnings: Firms usually keep a certain part of the profits earned before distributing dividends to their shareholders. These undistributed profits are retained in the business for future use and are known as retained earnings.

Merits of Retained Earnings

(a) As these funds are raised internally, they do not involve any kind of explicit costs, such as floatation cost and interest.

(b) High amounts of retained earnings can lead to an increase in the price of equity shares.

(c) Since these are surplus profits retained in the business, they help in reducing the burden of unexpected losses.

Demerits of Retained Earnings

(a) Retained earnings are an uncertain source of finance as the business profits keep fluctuating from time to time.

(b) In case a firm reinvests a large portion of profits in the business, then very little funds are left for payments to the shareholders, and this creates dissatisfaction among them.

(c) Firms often fail to recognise the opportunity cost of the earnings retained in the business. As a result, these funds are often misused or sub-optimally used.