Sources Of Business Finance | Long Questions | Business Studies | 1st Year / Class 11 – Commerce | AHSEC (Assam)

Q. Explain retained earnings and public deposit as sources of corporate finance in India. (4+4=8) (2015)

-> Retained Earnings- A company generally does not distribute all its earnings amongst the shareholders but retained and used in business is called retained earnings. A portion of the net earnings may be returned in the business for use in the future. It is also referred to as ploughing back of profits. This is one of the most important sources of internal financing used for fixed as well as working capital.

Advantages of Retained earnings:-

1. Retained Earnings is a cheaper source of financing.

2. Retained earnings strengthen the financial position of a business and thereby give financial stability to the business.

3.  Retained Earnings may lead to increase in the market price of the equity shares of a company.

4. Retained Earnings strengthen the financial position of a company and appreciate the capital which ultimately increases the market value of shares.

Disadvantages of Retained Earnings:-

1. If the purpose for utilization of retained earnings is not clearly stated, it may lead to careless spending of funds.

2. It is an uncertain source of funds as the profits of business are fluctuating.

3. Retained Earnings does not allow shareholders to enjoy full benefit of the actual earnings of the company.

Public deposits- Public deposit refers to the unsecured deposits invited by companies from the public. It can be invited for a period of six months to 3 years. Public deposit cannot exceed 25% of its share capital & resources.

Merits of Public Deposits:–

1. The system is very simple in raising the loans.

2. It is a cheap method of raising working capital.

3. Public deposits keep the capital structure elastic.

4. Deposits are usually unsecured.

Demerits of Public Deposits:-

1. It is very difficult for the new companies to rely on public deposits.

2. It is very uncertain and unreliable.

3. It is unhealthy for the Capital market.

Q. What is preference share? What are the different types of preference share? (2+6=8) (2015/2017)

-> Preference shares are those which carry a preference over dividend and return on capital. The dividend rate on preference shares is fixed. The preference shareholders get the dividend on fixed and out of net profits of a company prior to distribution of dividend on equity shares.

Types of Preference share:- 

1. Cumulative and Non-Cumulative- The preference shares which enjoy the right to accumulate unpaid dividends in the future years, in case the same is not paid during a year are known as cumulative preference shares. On the other hand, on non-cumulative shares, the dividend is not accumulated if it is not paid in a particular year.

2. Participating and Non-Participating- Preference shares which have a right to participate in the further surplus of a company shares which after dividend at a certain rate has been paid on equity shares are called participating preference shares. The non-participating preference is such which do not enjoy such rights of participation in the profits of the company.

3. Convertible and Non-Convertible- Preference shares that can be converted into equity shares within a specified period of time are known as convertible preference shares. On other hand, non-cumulative shares are such that they cannot be converted into equity shares.

Q. Distinguish between shares and debentures. (5mark) (2016)

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Q. What is debenture? State the merits and demerits of debenture as a source of finance. (2+6=8) (2016)

-> Debenture is an important instrument for raising long term debt capital. A company can raise funds through issue of debentures, which bear a fixed rate of interest. 

Features of Debentures:

1) The debentures are the borrowed funds of the company.

2) The holder of debentures is known as debenture holder.

3) Debenture holders get the interest.

4) The holders of debentures do not have any voting rights.

5) Debentures can be repaid by the company.

Merits of Debentures:-

1. It is preferred by investors who want fixed income at lesser risk.
2. Debentures are fixed charge funds and do not participate in profits of the company.
3. The issue of debentures is suitable in the situation when the sales and earnings are relatively stable.
4. As debentures do not carry voting rights, financing through debentures does not dilute control of equity shareholders on management.

Demerits of Debentures:-

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

Q. What is share? Explain its features. (2+6=8) (2017)

-> When a capital of a firm is divided into a certain number of units these units are called shares. The share of a company is a movable property, transferable in the manner provided by the articles of the company. The capital of a company is divided into shares which are collectively called ‘Share Capital’. The share capital is regarded as owned capital. It is a permanent source of finance.

Broadly, there are two—equity shares and preference shares.

Equity shares: Equity shares are also referred to as ordinary shares. They are one of the most common kinds of shares. These stocks are documents that give investors ownership rights of the company. Equity shareholders bear the highest risk. Owners of these shares have the right to vote on various company matters. Equity shares are also transferable and the dividend paid is a proportion of profit. One thing to note, equity shareholders are not entitled to a fixed dividend. The liability of an equity shareholder is limited to the amount of their investment. However, there are no preferential rights in holding.

Equity shares are classified as per the type of share capital.

Authorised share capital: This is the maximum amount of capital a company can issue. It can be increased from time to time. For this, a company needs to conform to some formalities and also pay required fees to legal entities.

Issued share capital: This is the portion of authorised capital which a company offers to its investors.

Subscribed share capital: This refers to the portion of issued capital upon which investors accept and agree.

Paid-up capital: This refers to the portion of the subscribed capital for which the investors pay. Since most companies accept the entire subscription amount at one goes, issued, subscribed, and paid capital are the same thing.

There are a few other types of shares.

Right share: These are the kind of shares a company issues to its existing investors. Such stocks are issued to protect the ownership rights of existing shareholders.

Bonus share: Sometimes, companies may issue shares to their shareholders as a dividend. Such stocks are called bonus shares.

Sweat equity share: When employees or directors perform their role exceptionally well, sweat equity shares are issued to reward them.

Preference shares: Preference shares are those which carry a preference over dividend and return on capital. The dividend rate on preference shares is fixed. The preference shareholders get the dividend on fixed and out of net profits of a company prior to distribution of dividend on equity shares.

Types of Preference share:- 

1. Cumulative and Non-Cumulative- The preference shares which enjoy the right to accumulate unpaid dividends in the future years, in case the same is not paid during a year are known as cumulative preference shares. On the other hand, on non-cumulative shares, the dividend is not accumulated if it is not paid in a particular year.

2. Participating and Non-Participating- Preference shares which have a right to participate in the further surplus of a company shares which after dividend at a certain rate has been paid on equity shares are called participating preference shares. The non-participating preference is such which do not enjoy such rights of participation in the profits of the company.

3. Convertible and Non-Convertible- Preference shares that can be converted into equity shares within a specified period of time are known as convertible preference shares. On other hand, non-cumulative shares are such that they cannot be converted into equity shares.

Q. What is debenture? State four different types of debenture. (2+6=8) (2018)

-> Debenture is an important instrument for raising long term debt capital. A company can raise funds through issue of debentures, which bear a fixed rate of interest. 

Features of Debentures:

1) The debentures are the borrowed funds of the company.

2) The holder of debentures is known as debenture holder.

3) Debenture holders get the interest.

4) The holders of debentures do not have any voting rights.

5) Debentures can be repaid by the company.

Four different types of debenture are:-

1. From the Point of view of Security

• Secured Debentures: Secured debentures are that kind of debentures where a charge is being established on the properties or assets of the enterprise for the purpose of any payment. The charge might be either floating or fixed. The fixed charge is established against those assets which come under the enterprise’s possession for the purpose to use in activities not meant for sale whereas floating charge comprises all assets excluding those accredited to the secured creditors. A fixed charge is established on a particular asset whereas a floating charge is on the general assets of the enterprise.
• Unsecured Debentures: They do not have a particular charge on the assets of the enterprise. However, a floating charge may be established on these debentures by default. Usually, these types of debentures are not circulated.

2. From the Point of view of Tenure

• Redeemable Debentures: These debentures are those debentures that are due on the cessation of the time frame either in a lump-sum or in instalments during the lifetime of the enterprise. Debentures can be reclaimed either at a premium or at par.
• Irredeemable Debentures: These debentures are also called as Perpetual Debentures as the company doesn’t give any attempt for the repayment of money acquired or borrowed by circulating such debentures. These debentures are repayable on the closing up of an enterprise or on the expiry (cessation) of a long period.

3. From the Point of view of Convertibility

• Convertible Debentures: Debentures which are changeable to equity shares or in any other security either at the choice of the enterprise or the debenture holders are called convertible debentures. These debentures are either entirely convertible or partly changeable
• Non-Convertible Debentures: The debentures which can’t be changed into shares or in other securities are called Non-Convertible Debentures. Most debentures circulated by enterprises fall in this class.

4. From Coupon Rate Point of view

• Specific Coupon Rate Debentures: Such debentures are circulated with a mentioned rate of interest, and it is known as the coupon rate.
• Zero-Coupon Rate Debentures: These debentures don’t normally carry a particular rate of interest. In order to restore the investors, such types of debentures are circulated at a considerable discount and the difference between the nominal value and the circulated price is treated as the amount of interest associated with the duration of the debentures.

5. From the view Point of Registration

• Registered Debentures: These debentures are such debentures within which all details comprising addresses, names and particulars of holding of the debenture holders are filed in a register kept by the enterprise. Such debentures can be moved only by performing a normal transfer deed.
• Bearer Debentures: These debentures are debentures which can be transferred by way of delivery and the company does not keep any record of the debenture holders Interest on debentures is paid to a person who produces the interest coupon attached to such debentures.

Q. Discuss some of the sources of long term capital. (8marks) (2019)

-> The sources of long term capital are stated below:-

1. Issue of shares- The owned capital of a company is divided into a large number of small equal parts. Each such part is known as share.
2. Debenture- Debentures denote borrowing by a company and represent its loan capital.
3. Underwriting- When a company makes an issue of shares or debentures, it is not quite sure that the public will subscribe for the entire issue.
4. Public deposit- It implies any money received by a non-banking company by way deposit or loan from the public including the employees, customers and shareholders of the company, other than in the form of shares and debentures.
5. Hire Purchase- Hire Purchase is a type of instalment credit under which the high purchaser is called the hirer.
6. Institutional Financing- The government has set-up a number of special financial institutions in the country to provide long-term finance to business enterprises.
7. Ploughing back of Profit- Retained earnings represent that portion of a company’s net profit which is kept in business for investment purposes and not distributed among the shareholders as dividend.

Q. What is share? Discuss the differences between shares and debentures. (8marks) (2019)

-> When a capital of a firm is divided into a certain number of units these units are called shares. The share of a company is a movable property, transferable in the manner provided by the articles of the company. The capital of a company is divided into shares which are collectively called ‘Share Capital’. The share capital is regarded as owned capital. It is a permanent source of finance.

Broadly, there are two—equity shares and preference shares.

Equity shares: Equity shares are also referred to as ordinary shares. They are one of the most common kinds of shares. These stocks are documents that give investors ownership rights of the company. Equity shareholders bear the highest risk. Owners of these shares have the right to vote on various company matters. Equity shares are also transferable and the dividend paid is a proportion of profit. One thing to note, equity shareholders are not entitled to a fixed dividend. The liability of an equity shareholder is limited to the amount of their investment. However, there are no preferential rights in holding.

Equity shares are classified as per the type of share capital.

Authorised share capital: This is the maximum amount of capital a company can issue. It can be increased from time to time. For this, a company needs to conform to some formalities and also pay required fees to legal entities.

Issued share capital: This is the portion of authorised capital which a company offers to its investors.

Subscribed share capital: This refers to the portion of issued capital upon which investors accept and agree.

Paid-up capital: This refers to the portion of the subscribed capital for which the investors pay. Since most companies accept the entire subscription amount at one goes, issued, subscribed, and paid capital are the same thing.

There are a few other types of shares.

Right share: These are the kind of shares a company issues to its existing investors. Such stocks are issued to protect the ownership rights of existing shareholders.

Bonus share: Sometimes, companies may issue shares to their shareholders as a dividend. Such stocks are called bonus shares.

Sweat equity share: When employees or directors perform their role exceptionally well, sweat equity shares are issued to reward them.

Preference shares: Preference shares are those which carry a preference over dividend and return on capital. The dividend rate on preference shares is fixed. The preference shareholders get the dividend on fixed and out of net profits of a company prior to distribution of dividend on equity shares.

Types of Preference share:- 

1. Cumulative and Non-Cumulative- The preference shares which enjoy the right to accumulate unpaid dividends in the future years, in case the same is not paid during a year are known as cumulative preference shares. On the other hand, on non-cumulative shares, the dividend is not accumulated if it is not paid in a particular year.

2. Participating and Non-Participating- Preference shares which have a right to participate in the further surplus of a company shares which after dividend at a certain rate has been paid on equity shares are called participating preference shares. The non-participating preference is such which do not enjoy such rights of participation in the profits of the company.

3. Convertible and Non-Convertible- Preference shares that can be converted into equity shares within a specified period of time are known as convertible preference shares. On other hand, non-cumulative shares are such that they cannot be converted into equity shares.

The differences between shares and debentures:-