Sources of Business Finance — Exercise Solutions

Comprehensive solutions for TN State Board Class 11 Commerce Chapter 19: Sources of Business Finance. Covers MCQs, very short answers, short answers, and long answers with exam tips.

I. Choose the Correct Answer (MCQ)

Q1. What is defined as the provision of money at the time when it is required?

(a) Finance ✓ (b) Bank (c) Cash management (d) None of these

Q2. Internal sources of capital are those that are ………

(a) Generated through outsiders such as suppliers (b) Generated through loans from commercial banks (c) Generated through the issue of shares (d) Generated within the business ✓

Q3. Debenture holders are entitled to a fixed rate of ………

(a) Dividend (b) Profits (c) Interest ✓ (d) Ratios

Q4. Public deposits are the deposits which are raised directly from ………

(a) The public ✓ (b) The directors (c) The auditors (d) The owners

Q5. Equity shareholders are the ……… of a company

(a) Creditors (b) Owners ✓ (c) Debtors (d) Employees

Note: The textbook lists "c. Debtors" as the answer, but equity shareholders are conventionally and correctly classified as owners of the company.

Q6. Funds required for purchasing current assets is an example for

(a) Fixed Capital Requirement (b) Ploughing back of Profits (c) Working Capital Requirement ✓ (d) Lease Financing

Q7. Which of the following holder is given voting right?

(a) Debentures (b) Preference Shares (c) Equity shares ✓ (d) Bonds

Q8. It may be wise to finance fixed assets through ………

(a) Creditors (b) Long term debts ✓ (c) Bank Overdraft (d) Bills Discounting

Additional MCQs

Q1 (Additional). Long term finance ………

(a) more than 5 years ✓ (b) above 1 year but below 5 years (c) more than one year but below 3 years (d) within one year

Q2 (Additional). Funds required for purchasing current assets is an example of ………

(a) Fixed Capital requirement (b) Ploughing back of profit (c) Working capital requirement ✓ (d) Lease financing

Q3 (Additional). Business people hypothecate goods or equipment to get ……… type of loan.

(a) Hypothecation ✓ (b) Pledge (c) Trade credit (d) Bank overdraft

Q4 (Additional). Debentures are treated as ………

(a) Fixed Capital (b) Permanent Capital (c) Fluctuating Capital (d) Loan Capital ✓

Q5 (Additional). Source of Medium Term Finance is ………

(a) share (b) debentures (c) Bank overdraft (d) lease finance ✓

Q6 (Additional). ……… is an unsecured money market instrument in the form of the promissory note.

(a) Pledge (b) Trade Credit (c) Commercial paper ✓ (d) Mortgage

Q7 (Additional). Which one are the owner's funds?

(a) Debentures (b) Loan from banks (c) Equity shares ✓ (d) Commercial papers

Q8 (Additional). Which of the following holder are not having voting rights?

(a) Debentures (b) Equity Shares (c) Preference Shares ✓ (d) Bonds

Q9 (Additional). Which one of the following is the tax-free investment option?

(a) Equity Share Purchase (b) Real Estate (c) Investments in Gold (d) Public Provident Fund ✓

Q10 (Additional). The period for opening a Recurring Deposit is ………

(a) 1-10 years ✓ (b) 1 year only (c) 5-10 years (d) 10 years only

II. Very Short Answer Questions

Q1. Write short notes on debentures.

Debentures are an important instrument for raising long-term debt capital. A company can raise funds through the issue of debentures, which bear a fixed rate of interest. Debenture holders are creditors of the company, not owners. They receive interest at fixed intervals regardless of whether the company earns profit or not.

Q2. What do you mean by public deposits?

It is a method of inviting public deposits by giving advertisements in the media by the companies. It offers deposit schemes for a longer tenure. The interest rates offered by companies on public deposits are higher than the bank, which attracts depositors.

Q3. Name any two sources of funds classified under borrowed funds.

1. Debentures 2. Loan from banks

Q4. Name any two internal sources of business finance.

1. Capital by the owners (start-up or additional capital) 2. Debt Collection

Q5. State any two factors that affect the choice of source of finance.

1. Cost 2. Financial capacity of the firms

Q6 (Additional). What do you mean by Bonds?

Bonds are an ideal investment option for investors wanting to invest safely. They are issued by government and public and private sector companies and financial institutions. Bonds provide a fixed return and are considered a secure investment.

Q7 (Additional). What is Trade Credit?

Trade credit is the credit extended by one trader to another for purchasing goods and services. It is a simple and convenient method of raising short-term finance. The purchaser need not pay money immediately after purchase.

Q8 (Additional). What is Commercial Paper (CP)?

Commercial paper is an unsecured money market instrument in the form of a promissory note. It was introduced in India in 1990 under Section 45W of the RBI Act. Corporates, Primary Dealers, and All India Financial Institutions are eligible to issue it for raising short-term funds.

Q9 (Additional). What are the three important terms used in the process of Lease Financing?

The firm owning the asset is called Lessor, the enterprise hiring the asset is called Lessee, and the contract is called Lease.

Q10 (Additional). Define Share.

The Indian Companies Act 2013 defines a share as "To be a share in the share capital of a company." It represents a unit of ownership in the company.

Q11 (Additional). Who is called a shareholder?

The person holding a share is called a shareholder who has an interest in the assets and profits of the company.

Q12 (Additional). Define Savings.

Saving is defined as the difference between income and consumption. It is the portion of income that is not spent on consumption and is available for investment.

III. Short Answer Questions

Q1. Define Business finance.

In the words of R.C. Osborn, "The finance function is the process of acquiring and utilizing funds by a business."

Q2. What is a pledge?

A customer transfers possession of an article with the creditor (banker) and receives a loan. Till repayment, the article is under the creditor's custody. If the debtor fails to refund the loan, the creditor will auction the pawned article and adjust the outstanding loan from sale proceeds.

Q3. List sources of raising long-term and short-term finance.

Short-term finance sources: 1. Loans and Advances 2. Bank Overdraft 3. Discounting Bills of Exchange 4. Trade credit 5. Pledge 6. Hypothecation 7. Mortgage 8. Loans Against Securities 9. Clear loan 10. Commercial paper (CP) 11. Hire purchase finance 12. Factoring

Long-term finance sources: 1. Shares 2. Debentures 3. Retained earnings 4. Public deposits 5. Long term loan from commercial banks 6. Loans from financial institutions

Q4. For which purpose fixed capital is needed in business?

Business enterprises need finance for fixed and working capital requirements. Fixed capital requirements include the purchase of plant, machinery, furniture, fixtures, vehicles, and other long-term assets that are used in the business over a period of years.

Q5. What do you mean by the working capital requirement of a business?

Working capital is the amount needed for meeting day-to-day expenses of the business. Requirements include purchase of raw materials, payment of salary and wages, and operating expenses like telephone bills, carriage inward and outward, electricity charges, premium, stationery, etc.

Q6 (Additional). Mention any three significance of business finance.

1. A firm with adequate business finance can easily start any business venture. 2. Business finance helps the organization purchase raw materials from suppliers easily to produce goods. 3. The business firm can meet financial liabilities like prompt payment of salary, wages, expenses, etc., in time with sound financial support.

Q7 (Additional). Write a short note on Commercial Paper (CP).

Commercial paper is an unsecured money market instrument in the form of a promissory note. Corporates, Primary Dealers, and All India Financial Institutions are eligible to issue it. It was introduced in India in 1990 under Section 45W of the RBI Act. It is issued by a firm to raise short-term funds, with maturities between a minimum of 7 days and a maximum of up to one year from the date of issue.

Q8 (Additional). Explain the types of shares.

1. Equity Shares: The most important source of raising long-term capital. These shares do not carry any special or preferential rights regarding dividend payment and capital repayment at winding up. Equity shareholders enjoy more voting rights in proportion to shares held and take part in company management.

2. Preference Shares: These shares enjoy priority regarding dividend payment at a fixed rate out of net profits. They receive dividend every year before any dividend is paid to equity shareholders. They have the right to get settlement before equity shareholders at liquidation. However, they do not have voting rights.

IV. Long Answer Questions

Q1. List out the various sources of financing.

Sources of business finance can be classified into three categories:

On the basis of Period: 1. Short-term finance 2. Medium-term finance 3. Long-term finance

On the Basis of Ownership: 1. Owner's Fund 2. Borrowed Fund

On the Basis of Generation of Funds: 1. Internal sources 2. External sources

Q2. What are the different types of short-term finances given by commercial banks?

1. Loans and Advances: A direct advance made in a lump sum credited to a separate loan account. The borrower can withdraw the entire amount in cash immediately.

2. Bank Overdraft: An arrangement whereby the bank allows customers to overdraw from their current deposit account within a specified limit. Interest is charged only on the amount overdrawn.

3. Discounting Bills of Exchange: When goods are sold on credit, suppliers draw bills of exchange upon customers who are required to accept it. The bank discounts the bill and credits the amount after deducting discounting charges.

4. Trade Credit: Credit extended by one trader to another for purchasing goods and services. The purchaser need not pay money immediately after purchase.

5. Pledge: A customer transfers possession of an article with the creditor (banker) and receives a loan. If the debtor fails to repay, the creditor auctions the article and adjusts the outstanding loan from sale proceeds.

6. Hypothecation: A loan taken by depositing a document of title to property with the banker. Physical possession remains with the borrower. If repayment fails, the hypothecated article is sold in auction by the banker.

Q3. Write short notes on Retained Earnings and Lease Financing.

Retained Earnings: Refers to retaining a part of net profit year after year and reinvesting in the business. It is also termed as "ploughing back of profit." A profit-making company retains a portion of net profit to finance growth and expansion. It is described as the most convenient and economical method of finance.

Lease Financing: Denotes procurement of assets through lease. Leasing refers to owning an asset by an individual or corporate body, given for use to another enterprise on a rental basis. The firm owning the asset is called Lessor and the hiring enterprise is called Lessee. The contract is called Lease. Terms like lease period, rent, payment mode, and maintenance allocation are mentioned in the lease contract.

Q4. Write short notes on Owner's funds and Borrowed funds.

Owner's Funds: Funds provided by the owner of the enterprise — whether an individual, partners, or shareholders. Profits reinvested (ploughing back of profit or retained earnings) come under owner's funds. These funds are not required to be refunded during the business's lifetime. They provide the owner the right to control management of the enterprise.

Borrowed Funds: Funds raised through loans or borrowings. Examples include debentures, loans from banks and financial institutions, public deposits, trade credit, lease financing, commercial papers, factoring, etc. These provide a specific period before which the fund must be returned. The borrower is under legal obligation to pay interest at a given rate at regular intervals. Generally obtained on the security of certain assets like bonds, land, building, stock, vehicles, machinery, documents of title to goods, etc.

Q5. Explain any four personal investment avenues.

1. Public Provident Fund (PPF): The safest long-term investment option in India, totally tax-free. PPF account can be opened in a bank or post office. Money cannot be withdrawn before 15 years, and the investor earns compound interest. A loan can be taken against the PPF account during financial difficulties.

2. Mutual Funds: Individual investors wanting to invest in equities and bonds with a balance of risk and return can invest in mutual funds. A systematic investment plan is one of the best investment options in India.

3. Unit Linked Insurance Plans (ULIP): A life insurance-linked product providing risk cover along with investment options in qualified investments such as stocks, bonds, or mutual funds.

4. Post Office Saving Schemes: Various types exist — Savings Account, Recurring Deposit, Fixed Deposit, Monthly Income Account Scheme, Senior Citizens Saving Scheme, PPF, National Savings Certificates, Kisan Vikas Patra, and Sukanya Samriddhi Account. Investors can choose appropriate schemes as per needs. These are the safest investments.

Q6 (Additional). Briefly explain the features of Business finance.

• Business finance comprises all types of funds — short, medium, and long term — used in business.
• The volume of business finance required varies from one enterprise to another depending on its nature and size. Small and medium enterprises require relatively lower levels than large-scale enterprises.
• The amount required differs from one period to another — it is heavy during peak season and at a low level during dull season.
• The amount of business finance determines the scale of operations of business enterprises.

Q7 (Additional). What are the differences between internal and external sources of raising funds?

Q8 (Additional). What is the significance of Business Finance?

• A firm with adequate business finance can easily start any business venture.
• Business finance helps purchase raw materials from suppliers easily to produce goods.
• The business firm can meet financial liabilities like prompt payment of salary, wages, and expenses in time with sound financial support.
• Sound financial support enables enterprises to meet unexpected or uncertain risks from the business environment efficiently — such as economic slowdown, trade cycles, severe competition, shifts in consumer preference.
• A sound financial position empowers the enterprise to attract talented manpower and introduce the latest technology.

Q9 (Additional). "Saving leads to the economic development of a country" — Justify the statement.

Yes. Money invested in various avenues helps in economic development. Reasons include:

• Money invested in bank deposits facilitates employment generation in various sectors and poverty alleviation.
• Savings invested in bank deposits lead to credit creation, which promotes industrial and agricultural development.
• Savings invested in government bonds and various institutions help build and strengthen infrastructure facilities.
• A country with higher savings can more easily face consequences of economic recession.
• Bad consequences of inflation can be met easily with strong savings, controlling the evil effects of soaring prices.

Q10 (Additional). Explain any five factors influencing the choice of Business Finance.

1. Cost: Enterprises must analyze the cost of mobilizing and utilizing funds. Where interest rates are relatively lower, public deposits, debentures, term loans, etc., may be desirable options.

2. Financial Capacity of the Firm: Financially sound enterprises can pay interest promptly and return capital on time. Such enterprises can go for borrowed sources. If the firm is not financially stable, it must depend on owned sources.

3. Time Period: The period for which finance is required determines the suitable source. Short-term needs suit bank overdraft, cash credit, bill discounting, mortgage, pledge, leasing, hire purchase, factoring, etc. Longer period needs can be met through issue of shares, debentures, bonds, term loans, etc.

4. Control: Equity shareholders are real owners and exercise complete control over management. If existing shareholders don't want to lose control, they should not issue more equity shares. Borrowed sources don't disturb control exercised by management, making them suitable for maintaining administrative control.

5. Stage of Development: A new enterprise finds it harder to mobilize finance and may rely on owned sources initially. Once established, it can tap borrowed sources and offer assets as security.

6. Credit Worthiness of Firms: Some sources like debentures and creditors require mortgaging assets, which hurts creditworthiness in the financial market. Sources like share capital, retained earnings, and unsecured loans don't require mortgaging assets, maintaining a good image in the financial market.

Common Mistakes to Avoid

1. Equity shareholders are OWNERS, not debtors — The textbook lists "c. Debtors" for Q5 in the MCQ section, but equity shareholders are conventionally owners of the company. 2. Debentures = Borrowed funds, NOT owned funds — Debentures carry a fixed rate of interest and are debt instruments. 3. Preference shares vs Equity shares — Preference shares have fixed dividends and priority at liquidation but NO voting rights. Equity shares have voting rights but variable dividends. 4. Working capital ≠ Fixed capital — Working capital is for day-to-day expenses (raw materials, salaries); fixed capital is for long-term assets (plant, machinery). 5. Retained earnings = Internal source — Ploughing back of profits is the most convenient and economical method of internal finance. 6. Commercial Paper is short-term — It is an unsecured money market instrument with maturity of 7 days to 1 year.

Exam Checklist

• [ ] Can classify sources of finance by period, ownership, and generation
• [ ] Can list short-term finance sources (bank overdraft, trade credit, pledge, hypothecation, etc.)
• [ ] Can list long-term finance sources (shares, debentures, retained earnings, public deposits)
• [ ] Can explain types of shares (equity vs preference)
• [ ] Can define debentures, public deposits, commercial paper
• [ ] Know 6 factors influencing choice of business finance
• [ ] Can explain 4 personal investment avenues (PPF, Mutual Funds, ULIP, Post Office Schemes)
• [ ] Can distinguish internal vs external sources of funds
• [ ] Can distinguish owner's funds vs borrowed funds