Previous Year Short & Long Questions With Answers: Sources of Business Finance | Business Studies (BST) Class 11 - Commerce PDF Download

Short Answer Type Questions

Q1: What is the difference between GDR and ADR? Explain.
Ans: GDR or Global Depository Receipts: Shared receipts from depository banks for company shares. GDR are quickly convertible into shares at any moment and are marked in US dollars. They are eligible for listing and trading on all international stock markets.
ADR or American Depository Receipts: These receipts, issued by US-based businesses, are exchanged on the market like other securities. The central limiting aspect is that US persons may only purchase these receipts, and trading is only permitted on the US Securities Market.

Q2: What is Business Finance? Why do Businesses need funds? Explain.
Ans: A company’s ability to raise the capital it needs to function is what is known as business finance.
Finance is essential to business for three key reasons:

• To buy equipment, land, buildings, and other fixed assets (Fixed capital requirements).
• The smooth running of the business’s daily activities (Working capital requirements)
• Expansion, development, and diversification.

Q3: Write the advantages of sharing and define them.
Ans: A corporation needs a significant investment, or capital, to launch a business. Since it is difficult for a single person to raise such a significant sum of money, the total sum is divided into fractional units called shares, and everyone who owns shares is referred to as a shareholder.

Some advantages of shares are:

• It acts as permanent capital since it must be paid back during liquidation.
• Shareholders’ voting rights give them democratic power over how the business is run.
• Establishing a company’s creditworthiness and instilling confidence in potential lenders is done through equity capital.

Q4: Discuss the financial instruments used in international financing.
Ans: Most foreign finance uses these three financial instruments:

• Foreign Currency Convertible Bonds or FCCB: These are debt instruments that, after a set amount of time, may be converted into depository receipts and equity shares. The terms of conversion and price are predetermined and returns on such securities are fixed beforehand and are thus lower than returns on non-convertible securities.
• Global Depository Receipts or GDR: Shared receipts from depository banks for corporate stock. GDR are quickly convertible into shares at any moment and are marked in US dollars. They are eligible for listing and trading on all international stock markets.
• American Depository Receipts or ADR: These receipts, issued by US-based businesses, are exchanged on the market like other securities. The central limiting aspect is that US persons may only purchase these receipts, and trading is only permitted on the US Securities Market.

Q5: List any three equities’ share capital limitations.
Ans: The three limitations on equity share capital are as follows:

• Investors who want a consistent income may not favor equity shares due to the shifting nature of the returns.
• Comparing stock shares to other types of funding, the cost of equity share financing is exceptionally high.
• The procedure is more complex and might take longer to generate money.
• The issue of additional equity shares dilutes present equity owners’ earnings and voting power.

Q6: List sources of raising long-term and short-term finance.
Ans: Long-term sources of finance include:

• Debentures
• Preference shares
• Equity Shares
• Retained earnings
• Loans from banks and other financial institutions

Short-term financing sources include:

• Trade credit
• Short-term loans from banks
• Commercial papers

Long Answer Type Questions

Q1: Explain trade credit and bank credit as sources of short-term finance for business enterprises.
Ans: Trade Credit: It describes granting credit to another trader for acquiring products, services, or other commodities without immediate payment.
Organisations typically utilise this as short-term finance. Depending on prior performance and industry norms, trade credit conditions might differ from person to person and from industry to industry.

Advantages of Trade Credit:

• A reliable and practical source of money.
• If the vendor is aware of your creditworthiness, it is easily accessible.
• In the event of a surge in sales volume, it aids in raising inventory levels.
• Supplying cash does not place a charge on the company’s assets.

Limitations of Trade Credit:

• Overtrading has a chance to happen.
• Only meets a few of your financial necessities.
• Expensive compared to some other suppliers.

Bank Credit: Bank credit refers to a loan given by a bank to a company. The current economic interest rate often determines the bank’s loan interest rate. The borrower must mortgage assets with the bank to secure the loan.

Advantages of Bank Credit:

• The business is conducted in secrecy.
• Underwriting is a more straightforward funding source, and prospectus issuance requirements are unnecessary.
• Because the loan amount may be adjusted based on the borrower’s business needs, bank credit affords the borrower flexibility.

Limitations of Bank Credit:

• The funds are often only accessible for a certain period and renewing them becomes challenging and risky.
• Because banks need security assets before making such loans, the corporation could need to hold onto assets as collateral.
• The terms and restrictions that banks impose can occasionally be rather tricky.
• The conditions set by banks are usually very restrictive; for instance, a bank may restrict the borrower’s ability to sell assets mortgaged to it.

Q2: Name any three financial institutions and state their objectives.
Ans: Unit Trust of India: Unit Trust of India, sometimes known as UTI, was created in 1964 due to the Unit Trust of India Act of 1963. The purpose of establishing UTIs was to encourage saving and available direct funds toward investments in successful companies.
Life Insurance of India: The Life Insurance Corporation of India, also known as LIC, was established in 1956 due to the LIC Act, which nationalised all existing insurance firms. The goal is to promote saving as insurance premiums and invest it in the form of loans to industrial units.
Industrial Finance Corporation of India: Under the terms of the Industrial Finance Corporation Act, 1948, the Industrial Finance Corporation of India, often known as IFCI, was founded. Its goal was to support balanced regional development and inspire business owners to investigate emerging economic areas. It contributed to the development of management education.

Q3: Describe the concept of finance and the role it plays in business.
Ans: Business is concerned with producing and distributing products and services to meet societal requirements, highlighting business finance’s importance. Business needs money to carry out a variety of tasks. Business is fuelled by finance.
No business entity can conduct its activities successfully without the appropriate amount of money available at the appropriate cost and timing. The creation and sale of services and goods are not feasible without funding.
A business enterprise’s success is mainly dependent on this. Based on how it raises, uses, and distributes its funding. Finance is essential in business.

• For launching a business.
• For carrying out current operations and the purchase of current and fixed assets.
• For corporate modernisation, development, and expansion.

Due to the growth in firm size, adoption of capital-intensive practices, lack of funding, and escalating competitiveness, business finance has become more critical in modern business.

The advantages of having adequate finance  for a commercial enterprise are as follows:

• The business can timely pay its liabilities. Payment of debts on time helps in improving credit status. Consequently, the business may readily borrow money as needed.
• The company can seize commercial chances. For instance, it can pay less for supplies when purchased in bulk.
• The company can do operations without any hiccups.
• The company might upgrade the effectiveness of its operations by replacing its equipment and machinery in due time.
• The company may handle recessions, trade cycles, and other crises more confidently and readily.
• With the development and growth of the firm, more fixed and working capital is needed. Sometimes more money is needed to upgrade the technology being used, lowering the cost of operations or manufacturing.

Q4: What is a commercial paper? What are its advantages and limitations?
Ans: Since 1990, India has employed commercial papers, which are unsecured promissory notes. Highly regarded corporate purchasers utilise it as a promissory note. It helps them meet their short-term financial needs and can be granted for any period between seven days and a year. Primary dealers can raise commercial papers, foreign institutional investors (FIIs), non-resident Indians (NRIs), and all-Indian financial institutions.

A single company distributes it to other enterprises, insurance providers, pension funds, and banks. The amount that CP raises is typically relatively large. Because the CP is entirely unsecured, it can only be granted by businesses with a strong credit standing. The Reserve Bank of India governs the issuing of CP.

Advantages of Commercial paper are:

• Commercial paper is provided unsecured; therefore, it has no restrictive limitations.
• It provides more money than alternative sources.
• For the issuing firm, the cost of commercial bank loans is sometimes higher than that of CP.
• Commercial papers offer a steady flow of financing since their maturity may be tailored to the needs of the issuing company.
• Businesses can invest their extra funds in commercial paper and make a healthy profit.

Limitations of Commercial paper:

• Only financially sound and well-rated businesses can utilise commercial papers to raise capital. This strategy is inappropriate for new or modestly rated enterprises since it is insecure.
• The amount of money raised by selling commercial paper is limited.
• Commercial paper is an impersonal type of funding, and it is impossible to prolong its maturity if a firm faces financial difficulties preventing it from redeeming its paper.

Q5: Discuss the source from which a large industrial enterprise can raise capital for financing modernization and expansion.
Ans: Some options for long-term finance include the following sources:

• Retained earnings: Companies frequently retain a portion of their earnings before distributing dividends to shareholders. As the money is preserved for future use, these undistributed gains are known as retained earnings.
• Equity shares: The ownership capital of a firm is represented by these shares. These investors, known as equity shareholders, have a voice in management and gain from more significant returns during profitable periods. Since payments are made to them only after external obligations or claims have been settled, they are often referred to as the company’s owners or residual owners.
• Bank and other financial institution loans: For a certain length of time, businesses can borrow money from banks and other financial organisations in exchange for a predetermined monthly payment known as interest. Such a loan has a set payback duration at the loan acceptance time.
• Debentures: Long-term debt capital raising financial instruments used by businesses include debentures. They indicate that a company has taken out a loan for a specific sum of money, which it will eventually pay back to the holders of debentures. They are subject to a fixed rate of return and a deadline for debt repayment. The company’s debtors are known as the holders of debentures.
• Preference shares: As the name implies, these shareholders occupy a privileged position about receiving a fixed dividend rate before any payout for equity shareholders and obtaining the capital of liquidation immediately following the payment to the company’s creditors.

Q6: What preferential rights are enjoyed by preference shareholders? Explain.
Ans: The  preferential rights enjoyed by the  preference shareholders are as follows:

• Preference in repayment: Preference shares are distributed first once a corporation dissolves, then equity shares.
• Preference in case of dissolution: In the case of a company’s liquidation, they are given precedence over equity owners for the share capital repayment.
• Preference in dividend: Dividends on these shares are paid before dividends on equity shares and are paid at a predetermined rate.
• Excess profits: After equity shares have been paid out, preference shares are entitled to a portion of any remaining earnings.

Q7: Describe the meaning of lease finance. Briefly describe its advantages and disadvantages.
Ans: In a lease, the owner of the item offers the other party the right to use it for a predetermined time in exchange for payment from the first party. The party using the assets is referred to as the lessee, while the asset’s owner is the lessor.
A crucial tool for the company’s modernisation and diversification is lease finance. Such finance is more frequently used to buy assets like computers and electronic equipment, which become outmoded quickly due to the rapid technological changes.

Advantages of lease-financing are:

• It makes it possible for the lessee to buy the asset for less investment.
• It offers finance while maintaining full ownership and management of the company.
• The ability of a business to raise debt is unaffected by a leasing arrangement.
• The lesser bears the danger of obsolescence. This gives the lessee more freedom to replace the asset.

Disadvantages of lease financing are:

• Restrictions may be included in a lease agreement to prevent the lessee from changing or modifying the asset.
• If the equipment is not proven beneficial and the lessee ends the lease early, it might result in a more outstanding payback obligation.
• The assets never actually belong to the lessee. He loses the remaining value of the assets as a result.

Q8: Discuss the financial instruments used in international financing.
Ans: Most foreign finance uses these three financial instruments:

• Foreign Currency Convertible Bonds or FCCB: These are debt instruments that, after a set amount of time, may be converted into depository receipts and equity shares. The terms of conversion and price are predetermined and returns on such securities are fixed beforehand and are thus lower than returns on non-convertible securities.
• Global Depository Receipts or GDR: Shared receipts from depository banks for corporate stock. GDR are quickly convertible into shares at any moment and are marked in US dollars. They are eligible for listing and trading on all international stock markets.
• American Depository Receipts or ADR: These receipts, issued by US-based businesses, are exchanged on the market like other securities. The central limiting aspect is that US persons may only purchase these receipts, and trading is only permitted on the US Securities Market.

Q9: What advantages does the issue of debentures provide over the issue of equity shares?
Ans: Long-term debt capital raising financial instruments used by businesses include debentures. They indicate that a company has taken out a loan for a specific sum of money, which it will eventually pay back to the holders of debentures. They are subject to a fixed rate of return and a deadline for debt repayment. Debenture holders are frequently referred to as the company’s creditors.

The advantages of debentures over equity shares are:

• Fixed interest: The interest rate on debentures is fixed. This implies that the corporation is only obligated to pay its debenture holders a set interest rate, regardless of profit. On the other hand, a business that issues shares is compelled to pay dividends to its shareholders. These pay-outs fluctuate according to earnings, the more significant the profit, the higher the dividends.
• No dilution of ownership: When equity shares are issued, the firm’s ownership is diluted. This is true because equity shareholders have the power to vote and own certain shares of the firm. On the other hand, holders of debentures are not considered corporate owners. In other words, they don’t have any ownership or vote rights in the business. Instead, they are only eligible for a certain amount of compensation. Debentures thus have no impact on the ownership structure of the company. As a result, a corporation should issue debentures rather than stock shares.
• Tax-deductible expense: For a corporation to issue shares, considerable costs must be incurred. Additionally, it must pay its investors non-deductible dividends. On the other hand, the interest paid to debenture holders can be deducted by a company from its taxable income. Consequently, a corporation can save money by issuing debentures.

Q10: What are the primary factors influencing the selection of the funding source?
Ans: Each business enterprise has unique financial demands. Some people require short-term or long-term financing. Some people desire enormous sums of money, while others desire smaller amounts. Because there is less idle capital, short-term borrowing has the advantage of lower costs, while long-term borrowing is considered necessary for many reasons. Every source of funding has its restrictions. Therefore, it is best to employ various sources rather than just depending on one.

The decision for the business is challenging because of the following elements that influence the selection of this combination:

• Purpose and period: Businesses should plan how long they need the finances. For long-term financing, the issuance of shares and debentures is preferable. Short-term financing can be handled by borrowing money at a low-interest rate through commercial paper, trade credit, etc. To connect the source with the use, it is necessary to consider why funds are needed.
• Risk profile: Businesses should assess the risk associated with each funding source.
• Cost: When choosing the funding source, the expenses associated with obtaining and using the funds should be considered.
• Control: The control and influence of the owner on a company’s management may be impacted by a specific funding source. When choosing a source, a company should consider how much control they are ready to cede over the enterprise.
• Form of organisation and legal status: The choice of a fund-raising source is influenced by the structure of the organisation and its legal status. For instance, a sole proprietorship is not permitted to borrow money by selling shares to the public. Only joint-stock corporations can raise money in this manner.
• Financial strength and stability of operations: When choosing a funding source, a company’s financial health is crucial. The company must be financially stable to repay the loan and generate a consistent income stream.
• Flexibility and ease: When other solutions are easily accessible, a corporate organisation may choose not to borrow money from banks and other financial organisations due to restrictive clauses, extensive inquiry, and documentation, for instance.
• Tax benefits: The advantages of various funding sources may also be considered. For instance, although interest paid on debentures and loans is tax-deductible, dividends on preferred shares are not.
• Effects on creditworthiness: A company’s creditworthiness in the market may be impacted by its reliance on certain suppliers. For instance, the issuance of secured debentures may negatively impact the interests of unsecured creditors and their willingness to provide additional loans to the company.

Q11: Briefly describe the different forms of business finance and how they are used.
Ans: The following are the types of business finance and its uses:

The types of finance utilised in a business vary depending on their nature and purpose-

• Long-term finance: Long-term sources meet an enterprise’s financial needs for over five years. Long-term fund-raising is referred to as long-term funding. These funds are invested in fixed assets including real estate, buildings, machinery, plants, furnishings, and fixtures. Assets that must be used permanently and are not intended for sale are fixed assets. For a company’s ongoing demands, long-term financing is employed. It is continually employed to produce income.

Such financing cannot be removed from the company without doing so in a way that reduces or eliminates its activities. Shareholders, debenture holders, financial institutions, and retained earnings are sources of long-term financing. The kind and scale of the firm determine how much long-term funding is needed. For instance, a factory needs more long-term capital than retail does.

• Medium-term finance: This funding is necessary to repay assets and investments in long-term working capital. Additionally, it is employed for growth and modernisation. It is elevated for an amount of time that is greater than one year but less than five years. Debenture holders, financial institutions, public deposits, and commercial banks are sources of medium-term financing.
• Short-term finance: Short-term finances are needed for a time frame that is less than a year. It is used to address the business’s immediate demands. It also goes by the name “working capital.” Working capital is the money needed to cover a company’s ongoing expenses, such as purchasing supplies and paying rent, taxes, freight, and other costs. Public deposits, commercial banks, trade credit, factoring, client advances, etc., are used to raise short-term capital.