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Sources of Business Finance – Class 11 Business Studies notes, important questions and MCQs

NCERT Class 11 Business Studies, chapter 7. Notes, key terms, important questions with answers and MCQs.

Chapter overview

Business finance is the money needed to start, run and expand a business. It is required for fixed capital (long-term assets) and working capital (day-to-day operations). Funds can be raised from owners or borrowed, for short, medium or long periods, from internal or external sources. The choice depends on cost, risk, control, flexibility and the purpose of funds.

Classification of sources

By period: long-term (more than 5 years), medium-term (1 to 5 years) and short-term (up to 1 year).
By ownership: owners' funds (equity shares, retained earnings) and borrowed funds (debentures, loans, public deposits, trade credit).
By generation: internal sources (retained earnings, collection of receivables) and external sources (shares, debentures, loans).

Important sources

Equity shares: owners' capital with voting rights and residual claim on profit and assets; no fixed burden but dilutes control.
Preference shares: fixed dividend and preference in repayment, usually without voting rights.
Debentures: borrowed capital with fixed interest, often secured on assets; debenture holders are creditors.
Retained earnings (ploughing back of profit), loans from banks and financial institutions, public deposits, trade credit, factoring, lease financing and commercial paper.

International sources and choosing a source

Companies can raise funds abroad through ADRs (American Depository Receipts), GDRs (Global Depository Receipts), foreign currency convertible bonds and loans from foreign banks.
Factors in choosing: cost, financial strength and risk, form of organisation, purpose and time period, effect on control, tax benefits and flexibility.

Key terms

Fixed capital: funds invested in long-term assets such as land, buildings and machinery
Working capital: funds needed for day-to-day operations such as buying raw materials and paying wages
Equity share: a share representing ownership with voting rights and a residual claim on profits
Debenture: an instrument acknowledging a long-term loan to a company, carrying fixed interest
Trade credit: credit given by one trader to another for purchase of goods

Important questions with answers

Distinguish between equity shares and debentures.2 marks

Equity shares represent ownership; equity shareholders have voting rights, receive dividends only when there is profit and have a residual claim on assets. Debentures represent borrowed capital; debenture holders are creditors, receive fixed interest whether there is profit or not, usually have no voting rights and are repaid before shareholders.

What are the merits of retained earnings as a source of finance?3 marks

Retained earnings are an internal source that involves no cost of issue, no fixed charge and no dilution of control. They are a permanent source of funds, increase the company's capacity to absorb unexpected losses, and may lead to a rise in the share price and future growth.

Explain the various sources of business finance and the factors affecting the choice of a source.5 marks

Business finance can be classified by period into long-term, medium-term and short-term; by ownership into owners' funds and borrowed funds; and by generation into internal and external sources. Equity shares provide permanent capital without fixed charges, and shareholders are owners with voting rights and a residual claim. Preference shares carry a fixed dividend and priority in repayment. Retained earnings are profits ploughed back, without cost or loss of control. Debentures are long-term loans with fixed interest, often secured, which do not dilute control and whose interest is tax-deductible. Loans from commercial banks and financial institutions provide medium and long-term funds. Public deposits are accepted directly from the public for fixed periods. Trade credit, factoring, bank overdrafts and commercial paper meet short-term needs, and lease financing allows use of assets without buying them. Companies may also raise funds abroad through ADRs, GDRs and foreign currency convertible bonds. The choice of source depends on cost, the company's financial strength and risk, the form of organisation, the purpose and time period of funds, the effect on control, tax benefits and flexibility, so a balanced mix of sources is usually best.

Quick revision

Long, medium, short term.
Owners' funds vs borrowed funds; internal vs external.
Equity, preference, debentures, retained earnings, loans, trade credit.
ADR, GDR, FCCB for international funds.

Exam tips

Make a table: owner's funds vs borrowed funds, with cost, risk and control.
Remember that equity holders are owners while debenture holders are creditors.

Practice MCQs

Funds needed for day-to-day operations are called
1. fixed capital
2. share capital
3. working capital
4. reserve capital
Show answer
Answer: (c) working capital. They pay for raw materials and wages.
The real owners of a company are
1. debenture holders
2. bankers
3. creditors
4. equity shareholders
Show answer
Answer: (d) equity shareholders. They have voting rights.
Debenture holders receive
1. dividend
2. no return
3. fixed interest
4. share in control
Show answer
Answer: (c) fixed interest. They are creditors.
Ploughing back of profits is also called
1. leasing
2. trade credit
3. factoring
4. retained earnings
Show answer
Answer: (d) retained earnings. It is an internal source.
Credit given by a supplier to a buyer for purchase of goods is
1. bank loan
2. public deposit
3. trade credit
4. equity
Show answer
Answer: (c) trade credit. It is a short-term source.
Shares with a fixed dividend and priority in repayment are
1. equity shares
2. preference shares
3. debentures
4. bonds only
Show answer
Answer: (b) preference shares. Holders usually have no voting rights.
Why might a company prefer debentures to equity shares for raising funds
1. to dilute control
2. to avoid fixed charges
3. to retain control and get tax benefit on interest
4. to share profits
Show answer
Answer: (c) to retain control and get tax benefit on interest. Interest is tax-deductible and holders do not vote.
Selling receivables to a specialised agency to get immediate cash is
1. leasing
2. commercial paper
3. trade credit
4. factoring
Show answer
Answer: (d) factoring. The factor collects from debtors.

All chapters of Class 11 Business Studies

Written by Kundali IQ from standard, well-established facts to help with revision. This is not an official NCERT publication; always read your textbook too.