CLASS XI: EXAM Q&A HUB
Unit 7: Sources of Business Finance
Interactive Direct Questions & Answers
Click on any question below to reveal the point-wise answer.
Q1. What is Business Finance? State its importance. 3 MARKS
Business finance refers to the money required for carrying out all business activities. It is called the lifeblood of business.
It is important because funds are needed to purchase fixed assets (like machinery), meet day-to-day expenses (like buying raw materials), and fund future growth.
Q2. Define Retained Earnings. 3 MARKS
Retained earnings refer to that portion of a company's net profit which is not distributed as dividends to shareholders. Instead, it is kept aside and reinvested into the business for future expansion. It is considered an internal, permanent source of owners' funds.
Q3. Distinguish between Owners' Funds and Borrowed Funds. 4 MARKS
- Meaning: Owners' funds are contributed by the shareholders. Borrowed funds are raised through loans or credit from outsiders.
- Reward: Owners receive a share of the profits (dividends). Lenders receive a fixed, regular rate of interest.
- Risk Level: Owners bear the primary risk of business failure. Lenders face lower risk as their repayment is legally prioritized.
- Control: Owners have voting rights and control the management. Lenders have no voting rights.
Q4. Explain the concept of Equity Shares. State two merits. 4 MARKS
Equity shares represent the primary ownership capital of a company. Those who buy these shares are the true owners and bear the highest risk of the business.
Merits:
- Permanent Capital: The company does not have to refund this money during its lifetime.
- No Fixed Burden: Dividends are paid strictly only if the company earns a profit. There is no compulsory financial burden.
Q5. Discuss Preference Shares. How do they differ from Equity Shares? 6 MARKS
Preference shares are those shares that carry special preferential rights regarding the payment of dividends and the repayment of capital when the company closes down.
Differences from Equity Shares:
- Dividend Rate: Preference shares carry a fixed, predetermined rate of dividend. Equity shares have a fluctuating dividend rate based on remaining profits.
- Voting Rights: Preference shareholders generally do not have voting rights in management. Equity shareholders have full voting rights.
- Risk Profile: Preference shares are much less risky because their dividend payment is prioritized. Equity shares are highly risky.
- Appeal: Preference shares attract cautious investors who want steady income. Equity shares attract bold investors seeking high capital growth.
Q6. What are Borrowed Funds? Give two examples. 3 MARKS
Borrowed funds are the finances raised by a business through loans or credit from external parties. They carry a fixed rate of interest and must be repaid after a specific time period.
Examples: Issuing Debentures to the public, or taking a Term Loan from a commercial bank.
Q7. State the meaning of Public Deposits. 3 MARKS
Public deposits are funds raised directly by a company from the general public. The rates of interest offered on them are generally higher than bank deposits. They are unsecured loans and are strictly regulated by the Reserve Bank of India.
Q8. Define Debentures. State their main features. 4 MARKS
A debenture is a formal written acknowledgment of debt issued by a company under its common seal, containing a strict contract for the repayment of principal and interest.
Features:
- Fixed Return: They carry a fixed rate of interest, which is a compulsory legal payment regardless of profits.
- Security: They are generally secured by a mortgage or charge on the physical assets of the company.
- Creditor Status: Debenture holders are strictly creditors, not owners, and have zero voting rights.
Q9. Explain Loans from Commercial Banks as a source of finance. 4 MARKS
Commercial banks provide vital short and medium-term loans to businesses to meet working capital requirements.
Features:
- Flexibility: The exact loan amount and repayment schedule can be heavily tailored to the firm's specific needs.
- Secrecy: Banks maintain strict legal confidentiality of the borrowing firm's financial information.
- Security: Banks typically require solid collateral security (like factory land or stock) before granting the loan.
Q10. Discuss the role of Financial Institutions in providing finance. State their merits. 6 MARKS
Financial institutions (like IFCI, SFCs, LIC) are established by the Central or State governments specifically to provide massive long-term finance to industrial enterprises. They are often called "Development Banks."
Merits:
- Long-Term Capital: They provide large-scale, long-term funds which are often difficult to raise from standard commercial banks.
- Managerial Advice: Besides providing money, they provide expert technical, managerial, and financial advice to the borrowing companies.
- Goodwill: Getting a major loan approved by a reputed financial institution instantly increases the goodwill and creditworthiness of the company in the market.
- Flexible Repayment: They offer easy, phased installment schemes, which heavily reduces the immediate financial burden on new businesses.
Q11. What is Trade Credit? 3 MARKS
Trade credit is the credit automatically extended by one trader to another for the purchase of goods and services. It facilitates the purchase of raw supplies without making an immediate cash payment. It is a vital source of short-term financing.
Q12. What is an Inter Corporate Deposit (ICD)? 3 MARKS
Inter Corporate Deposits (ICDs) are unsecured short-term deposits made by one registered company with another company. They are strictly regulated by the Companies Act and generally carry a higher interest rate than standard bank loans.
Q13. Discuss the specific merits of Trade Credit as a source of finance. 4 MARKS
Trade credit is highly beneficial for daily business operations because:
- Convenience: It is a continuous, natural, and highly convenient source of funds available seamlessly during regular business transactions.
- Promotes Sales: It helps in significantly promoting the sales volume of the supplier while allowing the buyer time to manage their cash flow.
- No Security: It does not require any physical factory asset to be mortgaged or pledged.
Q14. Explain the concept of Inter Corporate Deposits (ICD) and discuss its major features. 6 MARKS
Inter Corporate Deposits (ICDs) represent a specialized money market where companies with surplus funds directly lend to other companies facing a sudden shortage of funds. This borrowing is strictly between registered companies; individuals cannot participate.
Major Features:
- Short-Term Nature: ICDs are primarily used to solve immediate, short-term working capital problems. The lending period usually ranges from a few days to six months.
- Unsecured: These deposits are completely unsecured. No assets are pledged as security. Therefore, only companies with very high financial ratings can successfully borrow through ICDs.
- Complete Secrecy: Unlike a public issue of shares or debentures, the financial transaction is kept strictly confidential between the two corporate entities.
- High Risk & Return: Because they are completely unsecured, the lending company assumes a higher level of risk. Thus, it demands a higher rate of interest compared to standard commercial bank rates.
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