Sources of Business Finance
Class 11 Business Studies · Business Studies · Chapter 8
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Summary
Finance is the life blood of business, required to acquire assets, purchase raw materials and meet day-to-day expenses, and the funds available from the entrepreneur are usually insufficient. Sources of funds are classified on three bases: period (long-term exceeding five years, medium-term and short-term), ownership (owner's funds raised through equity shares and retained earnings, and borrowed funds raised through loans) and source of generation (internal sources generated within the business and external sources). The various sources of finance include retained earnings (the ploughing back of profits), trade credit extended by one trader to another, factoring in which a factor manages and collects receivables, lease financing where the owner of an asset grants its use to a lessee for lease rent, public deposits invited from the public, and commercial paper, an unsecured money-market promissory note introduced in 1990. Long-term ownership and loan capital is raised through the issue of equity shares (the risk-bearing ownership capital), preference shares (which carry a preferential right to dividend and repayment) and debentures (the loan capital carrying a fixed rate of interest). Commercial banks and financial institutions (development banks) provide loans for expansion and modernisation. International financing instruments include Global Depository Receipts, American Depository Receipts (issued only to American citizens), Indian Depository Receipts and Foreign Currency Convertible Bonds. The choice of source depends on cost, financial strength, form of organisation, purpose, time period, risk and control.
Meaning and significance of business financeClassification of sources of fundsOwner's funds and borrowed fundsRetained earnings, trade credit and factoringLease financing, public deposits and commercial paperEquity shares, preference shares and debenturesCommercial banks and financial institutionsInternational financing — GDR, ADR and FCCB
Key terms
Business finance
The money or funds required by a business to carry out its various activities, often called the life blood of business.
Retained earnings
The portion of net profits retained and reinvested in the business instead of being distributed as dividend; also called ploughing back of profits.
Trade credit
Credit extended by one trader to another for the purchase of goods and services, appearing as sundry creditors in the buyer's books.
Commercial paper
An unsecured money-market instrument issued as a promissory note by highly rated companies for short-term funds, introduced in India in 1990.
Debentures
Instruments representing the loan capital of a company, held by creditors and carrying a fixed rate of interest.
Global Depository Receipt (GDR)
A negotiable instrument issued abroad against a company's local-currency shares, denominated in US dollars and traded freely.
Extra questions & answers
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Finance is often called the: