CHAPTER - 7
SOURCES OF BUSINESS FINANCE
• Introduction:
Business cannot be run without money. Funds required to carry out business is called Business
Finance. This chapter throws light on how the finances for the business can be arranged, what
are the sources of funding and what terms and conditions are governed with each type of
funding.
• Sources of Funds :
• Share: The amount of capital to be raised from public is divided into units of equal values.
These units are known as SHARE.
Equity (Ordinary) shares are those which do not carry any special or preferential rights.
Equity Share
Merits Demerits
1 Convenience Low dividend
2 No charge on assets Uncertain
3 No obligation Unbalanced growth
4 Dependable Misuse and Speculation
5 Growth and Expansion
Debenture: It constitutes the borrowed funds of the company.
It is an acknowledgement of debt.
Merits Demerits
1 Regular return Charge on assets
2 Safety of investment No voting rights
3 Economic sources Permanent burden of interests
4 Flexibility
5 Tax relief
• Differences between Shares and Debentures
BASIS SHARES DEBENTURES
1.Types of funds Owner's funds Borrowed funds
2.Return Flexible Fixed
3.Voting rights Available No voting rights
4.Status of holders Owners of the company Creditors of the company
5. Redemption Not redeemable Mostly Redeemable
6.Charge No charge on assets Charge on assets
7. Degree of risk for holders High Low
Public deposits:
Refers to the unsecured deposits invited by companies from the public. It can invite for a period
of six months to 3 years. Public deposit cannot exceed 25% of its share capital & resources.
MERITS DEMERITS
Simplicity Uncertainty
Economical Temporary finance
Unsuitable for new
No charge on assets company
No loss on control
• Lease financing: A lease is a contractual agreement whereby the owner of an asset grants
rights to use the asset to other party for rent.
• Short term funds:
1. Trade credit: refers to the credit extended by one trader to another for purchasing goods or
service. Small and new firms are usually more dependent on trade credit.
2. Factoring: It has emerged as a popular source of short term finance. It is a financial service
where by the factor responsible for all credit control and debt collection from the buyers and
provides protection against any bad debt losses to the firm.
Two methods of Factoring
Resource factoring
Non- Recourse factoring
3. Commercial Paper (C.P.): It is an unsecured promissory note issued by firm to raise funds for
a short period says 90 days to 364 days. Only firms having good credit rating can issue the C.P.
• Loans From Commercial Banks
Business can raise finance from commercial banks in the following ways:
Term Loan Cash Credit Discount of Bill Overdraft
For Medium Term Interest is charged on Bank provides short Current Account
the Amount actually term finance in holders is allowed to
withdrawn exchange for bill. overdraw his
account.
• Loans from financial Institutions:
Institutional finance means finance arranged from financial institutions other than commercial
banks like IFCI, ICICI, IDBI, SFI etc.
• International Sources of Finance:
Financial institutions and investors in foreign countries can invest in the shares and debentures
of Indian companies. Two main instruments used by Indian companies to tap international
sources of finance are:
• Factors affecting choice of Source of Funds
Long term finance is raised through shares and
debentures.
1 TIME PERIOD
Short term finance is raised through trade credit,
commercial paper, etc.
2 RISK There is least risk on Equity shares as the capital need not
be repaid. But in case of loan, interest has to be paid
Issue of equity shares may lead to dilution of control but
3 CONTROL
debt involves no dilution of control.
Stability of earnings are important because loan should be
4 EARNINGS
raised only when earning are sufficient.
Interest on debenture is tax deductible.
5 TASK IMPACT
Dividend is not tax deductible.
VSA (Very short Answer type questions ) (1mark)
1. What is commercial paper?
2. What is ADR?
3. What is meant by convertible debenture?
4. Explain the term ‘Factoring’?
SA (Short Answer type questions ) (3 or 4 marks)
1. Describe the various types of finance?
2. Explain three sources of owned funds.
3. Explain any two types of preference shares.
4. Explain the advantages of equity share.
LA (Long Answer type questions ) (5 or 6 marks)
1. Distinguish between Equity shares and Preference shares.
2. What are retained profits? Discuss their merits and demerits.
3. Explain the disadvantages of shares.
4. Explain the merits and demerits of public deposits.
HOTS
1. Name the capital invested in permanent assets.
2. What is self financing?
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3. Name the agreement where by the owner of the asset grants another party the right to
use the asset in return for a periodic payment.
4. Name the funds needed for day to day operations of business.
• Gist of the Lesson:
Finance is the life blood of business.
Business finance is of three types – Long term, Medium term, Short term
There are two sources of business finance – Owned funds, Borrowed funds
Shares are of two types – Equity and Preference shares
Retained profits refer to the undistributed profits which are re-invested in business.
Debentures are creditor ship security.
ADRS and GDRS are the main International sources of finance.
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