Worksheet Solutions: Sources of Business Finance | Business Studies (BST) Class 11 - Commerce PDF Download

Multiple Choice Questions

Q2: What is the primary purpose of retained earnings in a business?
(a) To pay dividends to shareholders
(b) To reinvest in the business
(c) To purchase fixed assets
(d) To repay loans
Ans: (b) To reinvest in the business

Q3: Which source of finance is typically used for short-term requirements?
(a) Equity Shares
(b) Debentures
(c) Trade Credit
(d) Retained Earnings
Ans: (c) Trade Credit

Q4: Which of the following is NOT a factor influencing the choice of finance source?
(a) Cost of funds
(b) Control over business
(c) Number of employees
(d) Purpose of funds
Ans: (c) Number of employees

Q5: What type of financing do commercial banks primarily provide?
(a) Long-term financing
(b) Equity financing
(c) Short-term financing
(d) Merchant financing
Ans: (c) Short-term financing

Fill in the Blanks

Q2: __________ refers to funds raised through loans from banks and financial institutions.
Ans: Borrowed Funds

Q3: The capital raised by a company through the issuance of shares is termed __________.
Ans: Share Capital

Q4: __________ financing involves renting an asset instead of purchasing it outright.
Ans: Lease

Q5: __________ are issued in the money market for short-term financing needs.
Ans: Commercial Papers

True or False

Q2: Trade credit is a long-term financing option.
Ans: False

Q3: Debenture holders have voting rights in the company.
Ans: False

Q4: Factoring is a method to improve cash flow by selling receivables.
Ans: True

Q5: Public deposits are an unreliable source of finance for new companies.
Ans: True

Match the Following

Ans:

• 1) - B) Ownership Capital
• 2) - A) Fixed income security
• 3) - C) Internal financing
• 4) - D) Short-term financing
• 5) - E) Asset rental agreement

Short Answer Questions

Q2: What are the two main types of capital requirements for a business?
Ans: The two main types of capital requirements are fixed capital and working capital. Fixed capital is used to buy long-term assets like buildings or machinery. Working capital is used for daily operations, like buying materials and paying salaries.

Q3: What is trade credit?
Ans: Trade credit is when a business buys goods and agrees to pay for them later, instead of paying right away. This helps businesses get the supplies they need without having to pay cash immediately, making it easier to manage their money.

Q4: What is retained earnings?
Ans: Retained earnings is the money that a business keeps from its profits instead of paying it out as dividends to shareholders. This money is used to help the business grow or pay for new projects without needing to borrow money.

Q5: Why might a business choose to get a loan from a bank?
Ans: A business might choose to get a loan from a bank because it can provide a large amount of money quickly. Banks also offer flexible repayment plans, making it easier for the business to pay back the loan over time.

Q1: Discuss the various sources of business finance available to entrepreneurs looking to start or expand their businesses. Include a detailed explanation of the advantages and limitations of at least three different sources.
Ans: Business finance is essential for any entrepreneur aiming to start or expand their business. There are several sources from which funds can be procured, each with its own advantages and limitations. Here, we will discuss three common sources: retained earnings, bank loans, and issuing shares.
Retained Earnings: This refers to the portion of net profits that a company retains for reinvestment instead of distributing it as dividends.

• Advantage: One of the main benefits of retained earnings is that it does not involve any additional cost such as interest or dividends. This makes it a cost-effective source of finance.
• Advantage: Retained earnings provide financial flexibility, as the company can use these funds without any restrictions imposed by external lenders.
• Advantage: By reinvesting profits, a business can enhance its capacity to absorb unexpected losses, which can be crucial during economic downturns.
• Limitation: On the downside, excessive reinvestment may lead to lower dividends for shareholders, potentially causing dissatisfaction among them.
• Limitation: The availability of retained earnings is uncertain because it depends on the company's profitability, which can fluctuate.

Bank Loans: Banks offer loans for various purposes, including purchase of equipment or working capital.

• Advantage: Bank loans can be tailored to meet the specific financial needs of a business, whether for short-term or long-term requirements.
• Advantage: They often come with lower interest rates compared to other sources, making them an attractive option for many businesses.
• Advantage: The process of obtaining a bank loan is generally straightforward, with fewer formalities compared to issuing shares or bonds.
• Limitation: However, bank loans need to be repaid within a specified period, which can put pressure on cash flow, especially for new businesses.
• Limitation: Banks typically require collateral, which can be a barrier for small businesses lacking sufficient assets to secure a loan.

Issuing Shares: Companies can raise capital by issuing equity shares to investors.

• Advantage: Issuing shares does not create a repayment obligation, as investors receive dividends only when the company makes profits.
• Advantage: This source of finance can provide substantial amounts of capital, which is beneficial for large-scale projects or expansions.
• Advantage: Equity finance enhances the company's credibility in the market, which can attract further investment opportunities.
• Limitation: A major drawback is that issuing new shares dilutes the ownership of existing shareholders, which can lead to conflicts over control of the company.
• Limitation: The process of issuing shares can be complex and time-consuming, involving significant regulatory requirements and costs.

In conclusion, the choice of financing sources depends on various factors such as the purpose of funding, the financial health of the business, and the level of risk the entrepreneur is willing to take. Understanding the advantages and limitations of each source helps entrepreneurs make informed decisions to support their business goals.

Q2: Explain the factors that influence the choice of source of finance for a business. Provide detailed explanations for at least five factors that entrepreneurs should consider.
Ans: Choosing the right source of finance is crucial for any business. Entrepreneurs must consider various factors to determine which source best meets their needs. Here are five significant factors to consider:
Cost of Finance: The overall cost of obtaining and using funds is a primary concern for entrepreneurs.

• Explanation: This includes not only the interest rates or dividends but also any additional costs associated with obtaining the funds, such as fees or administrative costs.
• Explanation: Businesses must analyze whether the expected returns from using the funds will exceed the costs involved, ensuring profitability.

Financial Strength and Stability: The financial health of the business plays a vital role in determining financing options.

• Explanation: A financially stable business is more likely to qualify for loans or attract investors, as lenders and shareholders look for assurance of repayment or returns.
• Explanation: Companies with fluctuating earnings may need to be cautious about taking on fixed charges such as loans, as these can increase financial risks.

Form of Organisation: The type of business structure influences available financing options.

• Explanation: For example, sole proprietorships and partnerships cannot issue shares, limiting their options compared to corporations.
• Explanation: Understanding legal constraints is essential, as different forms of organization have different rights and obligations regarding raising capital.

Purpose and Time Period of Funding: Entrepreneurs should match the source of finance with the intended use of funds.

• Explanation: Short-term needs, such as inventory purchases, might be best suited for trade credit or bank overdrafts, while long-term projects require more stable sources like equity or long-term loans.
• Explanation: Aligning the time frame of finance with the business's cash flow cycle ensures that repayment schedules are manageable.

Risk Profile: The perceived risks associated with different sources of finance should be assessed.

• Explanation: Entrepreneurs need to evaluate how each financing option impacts their overall business risk, especially in terms of repayment obligations and financial stability.
• Explanation: For instance, equity financing carries less risk in terms of repayments compared to debt financing, where regular interest payments are mandatory even during losses.

In summary, the decision on the source of finance is multi-faceted, requiring careful consideration of costs, financial stability, organizational structure, purpose, and risk. By analyzing these factors, entrepreneurs can make strategic choices that align with their business objectives.