How to Use This Solutions Page
1. Attempt NCERT questions on your own before checking. 2. Focus on classification diagrams and comparison tables. 3. For case studies, identify the financing need and recommend the source with reasons.
Key Concepts Recap
- Owned funds: Equity (permanent, voting, highest risk), Preference (fixed dividend, redeemable), Retained earnings (zero flotation cost).
- Borrowed funds: Debentures (fixed interest, tax deductible), Term loans (3–15 years), Public deposits.
- Short-term: Bank overdraft, cash credit, trade credit, commercial paper, factoring.
- Key distinctions: Equity vs Preference, Debentures vs Shares, Lease vs Hire Purchase.
- Choice factors: Cost, risk, control, duration, flexibility, tax benefit, creditworthiness.
Intext Questions
Q: Are debenture holders owners of the company?
Q: What is the difference between cumulative and non-cumulative preference shares?
Chapter-End Exercise Solutions
Q1: Define business finance. Why does a business need finance?
Business finance is the money required for carrying out business activities — starting, running, and expanding a business.
Why a business needs finance: 1. To start the business — purchasing land, building, machinery, and raw materials. 2. To run daily operations — paying wages, electricity bills, and buying raw materials (working capital). 3. To expand and grow — entering new markets, launching new products, buying new machinery. 4. To meet contingencies — unexpected losses, repairs, or economic downturns. 5. To repay debt — meeting interest and principal obligations on borrowed funds.
Q2: Classify the sources of business finance.
Based on Ownership: 1. Owned funds — equity shares, preference shares, retained earnings. 2. Borrowed funds — debentures, bank loans, public deposits.
Based on Source: 1. Internal sources — retained earnings, depreciation provisions. 2. External sources — shares, debentures, loans, trade credit.
Based on Period: 1. Long-term — equity shares, debentures, term loans. 2. Medium-term — preference shares, lease financing, hire purchase. 3. Short-term — bank overdraft, trade credit, commercial paper.
Based on Generation: 1. Domestic — Indian banks, Indian capital markets. 2. International — FDI, ADRs, GDRs, foreign loans.
Q3: What are equity shares? State their features, merits, and limitations.
Equity shares are shares that represent ownership in a company. Equity shareholders are the real owners; they bear the highest risk and get dividends only after all other claims are met.
Features: 1. Permanent capital — not refundable during the company's life. 2. Highest risk — last to receive dividend and repayment. 3. Voting rights — elect the board of directors. 4. No fixed dividend — depends on profits. 5. Residual claimants — paid after preference shareholders and creditors.
Merits: 1. No obligation for fixed dividend — paid only when profits are sufficient. 2. Permanent capital — no repayment pressure. 3. No charge on assets — company can raise further loans. 4. Increases creditworthiness — equity base shows financial strength.
Limitations: 1. Costliest source — shareholders expect high returns. 2. Dilution of control — new shareholders get voting rights. 3. Risk of takeover — acquiring majority shares gives control. 4. Market fluctuations — share price affects company image.
Q4: What are preference shares? How are they different from equity shares?
Preference shares carry a preferential right to dividend (at a fixed rate) and to repayment of capital during liquidation, before equity shareholders.
Difference:
| Basis | Equity Shares | Preference Shares |
|---|---|---|
| Dividend | Variable; paid after preference | Fixed rate; paid first |
| Voting rights | Yes | Usually no (except when dividend is in arrears) |
| Risk | Highest | Moderate |
| Repayment | Last during liquidation | Before equity |
| Nature | Permanent capital | Redeemable (usually) |
| Control | Voting control | No voting control |
| Return | Dividend + capital appreciation | Fixed dividend only |
Q5: What are debentures? Discuss their types and merits.
A debenture is a document acknowledging a debt — the company borrows money from the public and promises to pay a fixed rate of interest and repay the principal on maturity.
Types: 1. Secured (Mortgage) — backed by company assets. 2. Unsecured (Naked) — no asset backing. 3. Convertible — can be converted into equity shares. 4. Non-convertible — cannot be converted. 5. Registered — recorded in company's register; transfer by instrument. 6. Bearer — ownership by possession; transfer by delivery. 7. Redeemable — repaid after a fixed period. 8. Zero coupon — no interest; issued at deep discount, redeemed at face value.
Merits: 1. Fixed interest — attracts conservative investors. 2. No dilution of control — debenture holders have no voting rights. 3. Tax deductible — interest reduces taxable income. 4. Cheaper than equity — lower cost due to lower investor risk.
Limitations: 1. Obligation to pay interest even during losses. 2. Creates charge on assets (secured debentures). 3. Increases financial risk — debt-equity ratio rises. 4. Repayment obligation on maturity.
Q6: Explain retained earnings as a source of finance.
Retained earnings are the portion of net profit not distributed as dividend, kept in the business for future use.
Merits: 1. No cost of raising — no issue expenses, underwriting commission, or floatation cost. 2. No dilution of control — existing shareholders' ownership remains unchanged. 3. Positive signal — indicates business is profitable and can self-finance. 4. Flexible — can be used as per business needs without restrictions.
Limitations: 1. Limited by profits — cannot raise more than what the business earns. 2. Opportunity cost — shareholders forego dividend; they expect a return on retained earnings too. 3. May lead to mismanagement — easy money without scrutiny may be used inefficiently. 4. Shareholder dissatisfaction — some shareholders prefer current dividend over future growth.
Q7: What are the factors affecting the choice of a source of finance?
| Factor | Consideration |
|---|---|
| Cost | Interest on debt vs expected dividend on equity; debt is cheaper but has repayment obligation |
| Risk | More debt increases financial risk; equity has no fixed obligation |
| Control | Equity dilutes control; debt does not affect ownership |
| Duration | Long-term needs → equity, debentures; short-term → overdraft, trade credit |
| Flexibility | Can the source be repaid early or adjusted? Bank loans are flexible; debentures less so |
| Tax benefit | Interest on debt is tax deductible; dividend on equity is not |
| Creditworthiness | Excessive debt reduces future borrowing capacity |
| Form of organisation | Only companies can issue shares/debentures; sole proprietorships rely on personal funds and loans |
Q8: Distinguish between lease financing and hire purchase.
| Basis | Lease Financing | Hire Purchase |
|---|---|---|
| Ownership | Remains with lessor throughout | Transfers to buyer after last installment |
| Nature | Right to use an asset | Installment buying of an asset |
| Depreciation | Claimed by lessor | Claimed by buyer/hirer |
| Return of asset | Return at end of lease term | Buyer keeps the asset |
| Maintenance | Lessor's responsibility (usually) | Buyer's responsibility |
| Example | Leasing factory machinery | Buying a car on installments |
Internal Links
- [Chapter 8 Guide — Sources of Business Finance](/school/cbse/class/11/business-studies/cbse-sources-of-business-finance)
- [All Class 11 Business Studies Solutions](/school/cbse/class/11/business-studies/solutions)
- [Class 11 Business Studies Subject Guide](/school/cbse/class/11/business-studies)