Business Studies

Sources of Business Finance

Question:

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

Answer:

A large industrial enterprise can raise capital from the following sources.

  1. Equity Shares: Equity shares are the most important source of raising long term capital by a company. They represent the ownership of a company and therefore, the capital raised by issue of these shares is called owner's funds. These shareholders do not get a fixed dividend. They get according to the earnings of the company. They receive what is left after all other claims on the company's income and assets have been settled. They enjoy the reward and also bear the risk of ownership. They have voting rights. Using their voting rights, they get participation in management of the company.
  2. Preference Shares: Preference shareholders are called so because they enjoy some preferential rights over equity shares. They get dividend at a fixed rate and dividend is given on these shares before any dividend on equity shares. When company winds up, preference shares are paid before equity shares. Preference shares also have a right to participate in excess profits left after payment being made to equity shares. They also have a right to participate in the premium at the time of redemption. In lieu of these preferential rights, their voting rights are taken i.e. they are not eligible for voting. Preference shares have some characteristics of equity shares as well as debentures. They are safer investment with stable return from investor's point of view and free from control from owner's point of view.
  3. Debentures: Debenture is an acknowledgement by a company that the company has borrowed certain amount from the debenture holder which it promises to pay on a specific date. It is an important source for raising long term debt capital. Debentures bear a fixed rate of interest. In recent times, issue of zero interest debentures has also become popular which do not carry any explicit rate of interest. But they are issued at discount and redeemed at a premium or at par. It is the return on the debenture. Public issue of debentures requires that issue of debentures should be rated by a credit rating agency like CRISIL (Creditrating and Information Services of India Limited).
  4. Loans from Financial Institutions: The government has established many financial institutions like LIC, IDBI, ICICI etc all over the country to provide finance to these organizations. These institutions are established by central and state government both. These institutions provide owned capital as well as borrowed capital for long term and short term requirements. They provide financial and technical advice and consultancy to business firms. Obtaining loan from a financial institution increases goodwill of a company. These sources are available even during depression. Loans can be repaid in easy instalments.
  5. Loans from Commercial Banks: Borrowings from banks are an important source of finance to companies. Bank lending is still mainly short term, although medium- term lending is quite common these days. The rate of interest charged on medium- term bank lending to large companies will be a set margin, with the size of the margin depending on the credit standing and risk of the borrower. A loan may have a fixed rate of interest or a variable interest rate, so that the rate of interest charged will be adjusted every three, six, nine or twelve months in line with recent movements in the Base Lending Rate. Short term lending may be in the form of:
    (i) An overdraft, which a company should keep within a limit set by the bank. Interest is charged (at a variable rate) on the amount by which the company is overdrawn from day to day.
    (ii) A short-term loan, for up to three years.
    (iii) Medium-term loans are loans for a period of three to ten years.
  6. Retained Earnings: For any company, the amount of earnings retained within the business has a direct impact on the amount of dividends. Profit re-invested as retained earnings is profit that could have been paid as a dividend. The management of many companies believes that retained earnings are funds which do not cost anything, although this is not true. However, it is true that the use of retained earnings as a source of funds does not lead to a payment of cash. In practice, the dividend policy of the company is determined by the directors. From their standpoint, retained earnings are an attractive source of finance because investment projects can be undertaken without involving either the shareholders or any outsiders. The use of retained earnings as opposed to new shares or debentures avoids issue costs. The use of retained earnings avoids the possibility of a change in control resulting from an issue of new shares. Another factor that may be of importance is the financial and taxation position of the company's shareholders. For example, because of taxation considerations, they would rather make a capital profit (which will only be taxed when shares are sold) than receive current income, then finance through retained earnings would be preferred to other methods.
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Sources of Business Finance

Q 1.

Write a note on international sources of finance.

Q 2.

What is a commercial paper? What are its advantages and limitations?

Q 3.

Name two sources of funds under owner's fund.

Q 4.

What is factoring?

Q 5.

In leasing agreement what right is given to lessee?

Q 6.

Explain in detail the types of debenture a company can issue.

Q 7.

Which deposits are directly raised from the public?

Q 8.

Why does business enterprise need finance?

Q 9.

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

Q 10.

Differentiate between a share and a debenture.

Q 11.

What advantage does issue of debentures provide over the issue of equity shares?

Q 12.

State two factors affecting the working capital requirement of a firm.

Q 13.

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

Q 14.

Specify the objective of I.D.B.I.

Q 15.

What is lease financing? Discuss its merits and demerits.

Q 16.

Give the full form of GDR and ADR.

Q 17.

Discuss the financial instruments used in international financing.

Q 18.

What is factoring? Discuss its pros and cons.

Q 19.

Who regulates the acceptance of public deposits?

Q 20.

Why is equity share capital called Risk Capital'?

Q 21.

What do you mean by discounting of bills of exchange?

Q 22.

State the meaning of finance. What factors determine working capital and fixed capital requirements of a business?

Q 23.

Preference shares are preferred by company but not by investors. Why?

Q 24.

Name any three special financial institutions and state their objectives.

Q 25.

What are public deposits?

Q 26.

What are Indian depository receipts (IDRs)?

Q 27.

Why preferences are given to preferential shares?

Q 28.

State various sources of short and medium term funds.

Q 29.

What is the status of debenture holders?

Q 30.

Describe in brief the features of equity shares.

Q 31.

Explain different types of preference shares which can be issued by a company.

Q 32.

Name zones of the Lessors and Lessees in India.

Q 33.

Retained earnings are not a good source from the values point of view as it is the right of equity shareholders. Do you agree? Justify your answer.

Q 34.

Mr. John has ? 1,00,000 for investment purposes. Should he invest in equity shares, preference shares, public deposits or debentures? Justify your answer.

Q 35.

What are the two important functions of factors?

Q 36.

Who are called the owners of a company?

Q 37.

What are the preferences given to preference shareholders?

Q 38.

State two factors affecting the fixed capital requirement of a firm.

Q 39.

What preferential rights are enjoyed by preference shareholders? Explain.

Q 40.

What are retained profits? Discuss their advantages and disadvantages.

Q 41.

What is a trade credit?

Q 42.

What is debenture?

Q 43.

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

Q 44.

Describe briefly the factors responsible for selecting a source of finance.

Q 45.

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

Q 46.

Preference shares are not suitable for which kind of investors?

Q 47.

As a source of finance retained profit is better than other sources. Do you agree with this view? Give reasons for your answer.

Q 48.

Write a short note on the features of GDRs.

Q 49.

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

Q 50.

State various sources of long term funds.