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BUSINESS
sources of finance
| Question | Answer | ||
|---|---|---|---|
| CLASSIFICATION OF SOURCES OF FUNDS A. On the basis of period: | 1. Short Term: less than 1 year ● Trade credit ● Loans from commercial banks | 2. Medium Term(1-5 years ) ● Public deposits ● Loans from financial institutions | 3. Long Term: exceeding five years. For example: ● equity / preference Shares ● Debentures ● Long-term borrowings |
| CLASSIFICATION OF SOURCES OF FUNDS B. On the basis of ownership | 1. Owners' Funds: Funds provided by the owners of the organization are known as Owners' funds. It includes profits that are reinvested into the business. The important sources of owners' funds are ● Retained earnings ● Issue of equity shares. | 2. Borrowed Funds: These are the funds raised through loans and borrowings. This source includes raising funds from ● Issue of debentures, ● Loans from financial institutions, ● Public deposits, ● Trade credit, etc. | |
| C. On the basis of source of generation | 1. Internal Sources: Funds generated from within the organization are known as internal sources. Though only short term or limited needs could be fulfilled by this source. For example: ● retained earnings ● Disposing surplus inventory, etc. | 2. External Sources: Large amounts of money requirements are fulfilled through commercial banks ● Acceptance of Public deposits, ● Raising debentures etc. | |
| list all sources of finance | 1.retained earnings 2. public deposits 3.equity shares 4.prefernce shares 5. debentures 6. loans from banks 7. loans from commercial banks 8.trade credit 9.financial institutions | ||
| Retained Earnings what is it ? merits 4 demerits 3 | When a company earns profit, a certain amount or percentage of those profits is retained within the business for future use and this is known as retained earnings When the business is financed through this source it is known as ploughing back of profit | ● Permanent source of funds. ● No explicit cost involved ● operational flexibility and freedom. ● Enhances the unexpected loss absorption capacity of the business. ● May lead to an increase of the market price of the company's equity shares. | Limitations ● Excess retention of profits may lead to dissatisfaction among shareholders. ● Since the profits keep on fluctuating, it is an uncertain source of funds. ● Opportunity cost remains unrecognized so it may lead to suboptimal use of funds. |
| Trade Credit what is it ? merits 4 demerits 3 | ● It refers to the extension and provision of credit by one one trader to another for the purchase of goods and services, or other supplies without on the spot payment | ● A continuous and a convenient source of funds. ● It is readily available if customer has credit worthiness ● While providing funds, It does not create a charge on assets of the firm . promotes sales | Limitations ● There can be chances of over-trading. ● Fulfils only limited financial needs. ● Costly in comparison to few other sources. |
| Public Deposits\ what is it ? merits 4 demerits 3 | ● A public deposit is money raised from public organizations. They have higher interest rates than bank deposits and may be used for short term and medium term funding requirements. | Merits ● Easy and convenient source of finance. ● Lower costs as compared to banks. ● No charge on the assets of the company is created. ● no voting rights for depositers | Limitations ● Not suitable for new companies. ● Higher dependency on the public exists, thus making this source unreliable. ● It is not suitable in case the deposits are large |
| Equity Shares: what is it ? merits 4 demerits 3 | ● It is one of the most important sources of raising long term capital. ● Equity shareholders are said to be the owners of the company as they invest money into the company and become fractional owners of it. | ● It is suitable for those investors who want high risks high reward ● No burden to the company, as paying a dividend is not compulsory ● It serves as permanent capital as it has to be repaid at the time of liquidation ● shareholders have voting rights | Limitations ● The returns are fluctuating in nature so investors who need steady income may not prefer equity shares. ● It is more of a complicated process and may take longer time to raise funds |
| . Preference Shares what is it ? merits 4 demerits 3 | ● The holders of preference shares hold a preferential position in respect to equity shareholders in two ways: ○ They receive a fixed rate of dividend before any dividend for the equity shareholders. | Merits ● It provides steady income in the form of fixed returns. ● It comparatively bears a lower risk. ● They have preferential rights over equity shareholders. ● It doesn't create any sort of charge against the assets of the company. | Limitations ● It is not suitable for investors aspiring for higher returns. ● The rate of dividend is generally high as compared to that of debentures. ● Dividend paid is not deducted from profits as expenses. |
| Debentures what is it ? merits 4 demerits 3 | ● It is an important source of raising funds or long term debt capital. ● It bears a fixed rate of interest. ● Debenture holders are the creditors of the company. | Merits ● Preferred by investors who want fixed income with lower risk. ● Non dilution of the voting rights as they do not carry voting rights. ● Less costly as compared to that of equity and preference share capital. | ● A permanent burden on the company as they are fixed charge instruments. ● The company has to make provisions for repayment in case of issue of redeemable debentures. ● Debenture holders do not get voting rights |
| Commercial Banks what is it ? merits 4 demerits 3 | ● Commercial Banks are those banks which provide funds to organizations for many purposes as well as various time periods. ● A flexible source as funds can be increased as per requirements | ● They provide banks with timely assistance by providing funds at the time of needs. ● Secrecy of business is maintained. ● An easier source of finance as formalities of issuing of prospectus and underwriting is not required. | ● Generally, the funds are available for a short period of time and renewal becomes a difficult process and is uncertain. ● The company may have to keep assets as security as the banks ask for security assets before issuing such loans. |
| . Financial Institutions what is it ? merits 4 demerits 3 | ● There are numerous financial institutions established by the government of India across the country. ● There are development banks especially established to promote industrial development in the country. | ● Provide long term funds which are not provided by the commercial banks ● Provide various services such as managerial advice, financial and technical advice to the companies. ● Increases the goodwill of the borrowing company in the capital markets. | Limitations ● A rigid criteria is followed to sanction loans. ● Too many legal formalities to follow make it a lengthy process. |
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