Today we are going to discuss the new chapter of business studies CBSE class 11 that is the sources of business finance.
Also, we are going to give you study notes, video lectures, and also PDF of handly lecture notes. Firstly, I want to share with you what are all the topics which we are going to cover in this article. Also, you can watch all the chapters videos on my YouTube channel by clicking here.
Topics covered of under sources of business finance are as follows:-
- sources of business finance basics concepts (What is shares)
- Equity and preference shares
- GDR, ADR, IDR
- Borrowed Funds
- Trade credit
- Difference between shares & debentures
- commercial banks
- financial institutions
- Inter-corporate deposits
- Case study of sources of business finance
Sources of Business Finance
Sources of finance are of two types –
A) Owner’s fund – Funds invested by owner itself in the company is called Owner’s fund.
- Equity shares
- Preference shares
- Retained earnings
B) Borrower’s fund – Funds invested by borrower in a company is called Borrower’s fund.
- A loan from a financial institution
- A loan from commercial banks
- Public deposits
- Trade credits
- Inter-corporate deposits
Equity & Preference Share
Customer’s point of view
Companies point of view
ADR, GRD, IDR & Retained Earnings
IDR (Indian Depository Receipt) – It is also known as BhDR(Bharat Depository Receipt). When any foreign companies or foreign individuals with the help of Indian depository or Indian banks invest, in Indian stock exchange, in an Indian company, in India currency, then investors received a receipt called Indian depository receipts.
ADR(American depository receipt) – When any foreign companies or foreign individuals with the help of American depository or American banks invest, in American stock exchange, in an American company, in American currency, the investors received a receipt called American depository receipts.
Depository receipts –
1) Investors got no voting rights.
2) First Indian company to issue GDR was reliance.
3) SCB is the first global company to file an issue of IDR.
Retained earning -It is also known as self-financing/reserves/surplus. When there is a profit to the company, the company sets aside funds also called released earning. This released earning when again invested by the company, then it is called as Ploughing back of profit. This self earning by the company is also called as self-financing.
Features of retained earning
1) There is cushion of security, means it provides comfort/safety/protection when the company is in the loss/debt.
2) It raises funds for new and innovative projects. It also helps in growth and expansion of business.
3) It involves no legal formalities.
4) It has no floatation cost. The company needs money for advertisement, prospectus, underwriting which is known as floatation cost.
5) There is no control of other people, the company only controls its all profits.
Advantages of retained earning
1) It is the most dependable source for the company. The company takes the use of this money of retained earning whenever required.
2) There is no floatation cost involved.
3) No foreign controls involved.
4) This also increases the goodwill, means increases the bank and financial strength to the company.
5) There is no fixed liability involved.
Disadvantages of retained earning
1) Sometimes there is careless use of this retained earning money by the company.
2) There is also dissatisfaction among shareholders.
3) It also involves the overcapitalization of money as the company needs money for dividends of debentures and shareholders.
Borrowed funds includes banks, financial institutions, debentures, public deposits.
It involves no separate legal identity(sole proprietorship).
1) Concept – Whenever a business owner borrows money from Borrower’s funds then they have to pay the principal amount plus some extra money which is called interest amount which acts as a profit for this fund.
2) Collateral/Security/Mortgage – Whenever the borrower funds give money they want some property as security from the owner.
3) Process of payment – Profit made by the company is distributed between borrowed funds, tax, retain, Owner’s fund.
Features of borrowed funds –
1) Borrowed funds are for fixed time only.
2) In Borrower’s fund, the loan amount should be smaller than the security amount submitted by the owner.
3) It also involves regular payment of interest.
4) Borrower funds are creditor for any business or individual. They cannot control the business.
Borrowers funds can do short term finance only.
“When traders buys goods on credit to pay on future date is called trade credit. “
Merits of trade credit –
1) It is easily available in the market.
2) It is flexible because no rigid rules and regulations are required.
3) No floatation cost. The cost for raising funds is not required.
Limitations of trade credit –
1) It leads to increase in price of the products.
2) Supplier can take legal action on buyer for not making payment on time.
Debentures are a financial instrument issued by the company under its common seal (signature) acknowledging a debt having terms if repayment of principal as well as interest at a fixed rate.
Debentures are part of borrowed funds, they are generally long term source of finance.
So, debenture holders are creditors of company.
Interest on debentures also known as coupon rate.
Interest on debentures charged against people which results in reduce liability of tax.
Features of debentures –
1) They are part of borrowed funds.
2) They have fixed rate of interest. The rate is decided by company in annual meetings.
3) Compulsory payment of interest no matter whether the company is in loss or profit.
4) This also involves security.
5) This is redeemable means repay in fixed time.
6) No voting rights involved to the foreign people.
7) Appointment of trustees. A large number of debentures issued by the company, then they have a duty to assign trustees.
Advantages of debentures –
1) It costs low to issue debentures than shares by the company.
2) They are cheaper source of finance.
3) No division of control.
4) Attracts large number of investors.
5) It have flexibility also because it can be raised easily.
6) It also involves low rate of interest.
7) Interest is treated as expense.
Limitations/Demerits of debentures –
1) Fixed Obligations as company have to pay the debentures in case of loss also.
2) Reduction in credibility.
3) Charge on assets.
4) They also got no voting rights.
Concept of commercial is same as borrowed funds.
Commercial banks give short term loans(up to 3 months), medium-term loans(3-12 months or less than 1 year ) and long term loans(more than 1 year) also.
Merits of commercial banks –
1) It is easily available.
2) They maintains secrecy about the business.
3) It is also economical.
Demerits of commercial banks –
1) Investigation of company’s affairs before issuing loan.
2) Banks may put restrictions and difficult terms and conditions.
Financial institutions are also called lending institutions or development banks.
These institutions are set up by the government especially for financial assistance for industries/business enterprises.
Merits of financial institutions –
1) They have low rate of interest.
2) They gives managerial advice also.
3) Financial institutions also subscribes companies shares & debentures.
4) Underwriters undertake issues of share & debentures.
5) Guarantee of loan to the customers.
6) They also provides loan in foreign currency. Provides capital goods from abroad to industries.
Limitations of Financial institutions –
1) Many formalities involved before taking the loan.
2) Sometimes they put restrictions on dividend payment.
3) Restricting power of company by appointing BoD(Board of Directors).
When one company helps another company financially then it is called as inter corporate deposits.
They are of three types –
1) Three month deposit
- Loan for 3 months
- The interest charged is 12%.
2) Six month deposit
- Loan for 6 months.
- The interest charged is 15%.
3) Call deposits –
- It can be withdrawn by the lender by giving one day notice.
- The interest charged is 10%.
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