Sources of Business Finance Class 11 Notes: CBSE 11th Business Studies Chapter 8, Download PDF

Sources of Business Finance Class 11 Notes: Revision Notes are essential study materials used by students to prepare for their examinations. They can be self-made or referenced. Though it is advised by professors and experts that notes are better if prepared by oneself, we understand that it becomes difficult to take time out for preparing notes, in today’s busy life. Thus, to ensure that students have the best study materials for preparation for examinations, we have brought to you Revision Notes for CBSE Class 11 Business Studies Chapter 8, Sources of Business Finance.\

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Revision Notes for CBSE Class 11 Business Studies Chapter 7

Revision Notes for CBSE Class 11 Business Studies Chapter 8 are presented below:

Financial needs of a business

The financial needs of a business are categorized into two topics:

• Fixed Capital Requirements- In order to start a business, funds are required to purchase fixed assets like land and building, plant and machinery, and furniture and fixtures. This is known as the fixed capital requirements of the enterprise.
• Working Capital Requirements- No matter how small or large a business is, it needs funds for its day-to-day operations. This is known as the working capital of an enterprise, which is used for holding current assets such as stock of material, bills receivables, and for meeting current expenses like salaries, wages, taxes, and rent.

Classification of Sources of Funds

• Period basis- On the basis of the period, sources of funds can be classified into three parts: long-term, medium-term, and short-term. The long-term sources fulfill the financial requirements of an enterprise for a period exceeding 5 years and include sources such as shares and debentures, long-term borrowings, and loans from financial institutions. Where the funds are required for a period of more than one year but less than five years, medium-term sources of finance are used. Short-term funds are those which are required for a period not exceeding one year.
• Ownership basis- On the basis of ownership, the sources can be classified into ‘owner’s funds’ and ‘borrowed funds’.Owner’s funds means funds that are provided by the owners of an enterprise, which may be a sole trader or partners or shareholders of a company.‘Borrowed funds’ on the other hand, refer to the funds raised through loans or borrowings. The sources for raising borrowed funds include loans from commercial banks, loans from financial institutions, issues of debentures, public deposits, and trade credit.
• Source of generation basis- In this sources are categorized on the basis of whether the funds are generated from within the organization or from external sources. Internal sources of funds are those that are generated from within the business. External sources of funds include those sources that lie outside an organization, such as suppliers, lenders, and investors.

Sources of Finance

1.Retained earnings- The retained portion of the net earnings, that hasn’t been distributed amongst the shareholders, is called retained earnings.

  Merits:

• Retained earnings are a permanent source of funds available to an organisation
• It does not involve any explicit cost in the form of interest, dividend or floatation cost
• As the funds are generated internally, there is a greater degree of operational freedom and flexibility
• It enhances the capacity of the business to absorb unexpected losses
• It may lead to an increase in the market price of the equity shares of a company

  Limitations:

• Excessive ploughing back may cause dissatisfaction amongst the shareholders as they would get lower dividends
• It is an uncertain source of funds as the profits of the business are fluctuating
• The opportunity cost associated with these funds is not recognised by many firms. This may lead to sub-optimal use of the funds.

2.Trade Credit- Trade credit is the credit extended by one trader to another for the purchase of goods and services.

Merits:

• Trade credit is a convenient and continuous source of funds
• Trade credit may be readily available in case the credit worthiness of the customers is known to the seller
• Trade credit needs to promote the sales of an organisation
• If an organisation wants to increase its inventory level in order to meet the expected rise in sales volume in the near future, it may use trade credit to, finance the same
• It does not create any charge on the assets of the firm while providing funds.

Limitations:

• The availability of easy and flexible trade credit facilities may induce a firm to indulge in overtrading, which may add to the risks of the firm
• Only a limited amount of funds can be generated through trade credit
• It is generally a costly source of funds as compared to most other sources of raising money

3.Factoring- It is a financial service under which factor renders services such as discounting of bills and providing information about the credit worthiness of prospective clients etc.

Merits:

• Obtaining funds through factoring is cheaper than financing through other means such as bank credit
• With cash flow accelerated by factoring, the client is able to meet his/her liabilities promptly as and when these arise
• Factoring as a source of funds is flexible and ensures a definite pattern of cash inflows from credit sales. It provides security for a debt that a firm might otherwise be unable to obtain
• It does not create any charge on the assets of the firm
• The client can concentrate on other functional areas of business as the responsibility of credit control is shouldered by the factor

Limitations:

• This source is expensive when the invoices are numerous and smaller in amount
• The advance finance provided by the factoring firm is generally available at a higher interest cost than the usual rate of interest
• The factor is a third party to the customer who may not feel comfortable while dealing with it.

4.Lease Financing- It is a renting of an asset for some specified period. The owner of the assets is called the ‘lessor’ while the party that uses the assets is known as the ‘lessee’.

Merits:

• It enables the lessee to acquire the asset with a lower investment
• Simple documentation makes it easier to finance assets
• Lease rentals paid by the lessee are deductible for computing taxable profits
• It provides finance without diluting the ownership or control of business
• The lease agreement does not affect the debt-raising capacity of an enterprise
• The risk of obsolescence is borne by the lesser. This allows greater flexibility for the lessee to replace the asset

Limitations:

• A lease arrangement may impose certain restrictions on the use of assets. For example, it may not allow the lessee to make any alteration or modification to the asset
• Normal business operations may be affected in case the lease is not renewed
• It may result in higher payout obligation in case the equipment is not found useful and the lessee opts for premature termination of the lease agreement
• The lessee never becomes the owner of the asset. It deprives him of the residual value of the asset.

5.Public Deposits- The deposits that are raised by organizations directly from the public are known as public deposits.

Merits:

• The procedure of obtaining deposits is simple and does not contain restrictive conditions as are generally there in a loan agreement
• The cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions
• Public deposits do not usually create any charge on the assets of the company. The assets can be used as security for raising loans from other sources
• As the depositors do not have voting rights, the control of the company is not diluted.

Limitations:

• New companies generally find it difficult to raise funds through public deposits
• It is an unreliable source of finance as the public may not respond when the company needs money
• Collection of public deposits may prove difficult, particularly when the size of deposits required is large.

6.Commercial paper- Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note.

Merits:

(i) A commercial paper is sold on an unsecured basis and does not contain any restrictive conditions

(ii) As it is a freely transferable instrument, it has high liquidity

(iii) It provides more funds compared to other sources. Generally, the cost of CP to the issuing firm is lower than the cost of commercial bank loans

(iv) A commercial paper provides a continuous source of funds. This is because their maturity can be tailored to suit the requirements of the issuing firm. Further, maturing commercial paper can be repaid by selling new commercial paper

(v) Companies can park their excess funds in commercial paper thereby earning some good return on the same.

Limitations:

(i) Only financially sound and highly rated firms can raise money through commercial papers. New and moderately rated firms are not in a position to raise funds through this method

(ii) The size of money that can be raised through commercial paper is limited to the excess liquidity available with the suppliers of funds at a particular time.

(iii) Commercial paper is an impersonal method of financing. As such if a firm is not in a position to redeem its paper due to financial difficulties, extending the maturity of a CP is not possible.

7.Equity shares- Equity share capital is a prerequisite to the creation of a company. Equity shares represent the ownership of a company and thus the capital raised by the issue of such shares is known as ownership capital or owner’s funds.

Merits:

• Equity shares are suitable for investors who are willing to assume the risk for higher returns
• Payment of dividends to the equity shareholders is not compulsory. Therefore, there is no burden on the company in this respect
• Equity capital serves as permanent capital as it is to be repaid only at the time of liquidation of a company. As it stands last in the list of claims, it provides a cushion for creditors, in the event of the winding up of a company
• Equity capital provides credit worthiness to the company and confidence to prospective loan providers
• Funds can be raised through equity issues without creating any charge on the assets of the company. The assets of a company are, therefore, free to be mortgaged for the purpose of borrowings, if the need be
• Democratic control over the management of the company is assured due to the voting rights of equity shareholders.

Limitations:

• Investors who want steady income may not prefer equity shares as equity shares get fluctuating returns
• The cost of equity shares is generally more as compared to the cost of raising funds through other sources
• The issue of additional equity shares dilutes the voting power and earnings of existing equity shareholders
• More formalities and procedural delays are involved while raising funds through the issue of equity shares.

8.Preference Shares- The capital raised by the issue of preference shares is called preference share capital.

Merits:

• Preference shares provide reasonably steady income in the form of a fixed rate of return and safety of investment
• Preference shares are useful for those investors who want a fixed rate of return with comparatively low risk.
• It does not affect the control of equity shareholders over the management as preference shareholders don’t have voting rights
• Payment of a fixed rate of dividend to preference shares may enable a company to declare higher rates of dividend for the equity shareholders in good times
• Preference shareholders have a preferential right of repayment over equity shareholders in the event of the liquidation of a company;
• Preference capital does not create any sort of charge against the assets of a company

Limitations:

• Preference shares are not suitable for those investors who are willing to take risks and are interested in higher returns
• Preference capital dilutes the claims of equity shareholders over assets of the company
• The rate of dividend on preference shares is generally higher than the rate of interest on debentures. As the dividend on these shares is to be paid only when the company earns profit, there is no assured return for the investors. Thus, these shares may not be very attractive to the investors
• The dividend paid is not deductible from profits as an expense. Thus, there is no tax saving as in the case of interest on loans.

9.Debentures- The debenture issued by a company is an acknowledgment that the company has borrowed a certain amount of money, which it promises to repay at a future date.

Merits:

• It is preferred by investors who want fixed income at lesser risk
• Debentures are fixed-charge funds and do not participate in the profits of the company
• The issue of debentures is suitable in the situation when the sales and earnings are relatively stable
• As debentures do not carry voting rights, financing through debentures does not dilute control of equity shareholders on management
• Financing through debentures is less costly as compared to the cost of preference or equity capital as the interest payment on debentures is tax deductible.

Limitations:

• As fixed charge instruments, debentures put a permanent burden on the earnings of a company. There is a greater risk when the earnings of the company fluctuate
• In the case of redeemable debentures, the company has to make provisions for repayment on the specified date, even during periods of financial difficulty
• Each company has a certain borrowing capacity. With the issue of debentures, the capacity of a company to further borrow funds reduces.

10.Commercial Banks- Banks extend loans to firms of all sizes and in many ways, like, cash credits, overdrafts, term loans, purchase/discounting of bills, and the issue of letters of credit commercial banks occupy a vital position as they provide funds for different purposes as well as for different time periods.

Merits:

• Banks provide timely assistance to businesses by providing funds as and when needed by it.
• Secrecy of business can be maintained as the information supplied to the bank by the borrowers is kept confidential
• Formalities such as the issue of prospectus and underwriting are not required for raising loans from a bank. This, therefore, is an easier source of funds
• The loan from a bank is a flexible source of finance as the loan amount can be increased according to business needs and can be repaid in advance when funds are not needed.

Limitations:

• Funds are generally available for short periods and their extension or renewal is uncertain and difficult
• Banks make a detailed investigation of the company’s affairs, financial structure, etc., and may also ask for the security of assets and personal sureties. This makes the procedure of obtaining funds slightly difficult
• In some cases, difficult terms and conditions are imposed by banks. for the grant of a loan. For example, restrictions may be imposed on the sale of mortgaged goods, thus making normal business working difficult.

For complete Revision notes of Class 11 Business Studies Chapter 8, click on the link below.

Also find:

CBSE Class 11 Syllabus 2023-24 (All Subjects)

CBSE Class 11 Deleted Syllabus 2023-24 (All Subjects)

NCERT Class 11 Rationalised Content 2023-2024 (All Subjects)