Sources of Business Finance

Concept Explanation: Business finance refers to the money required by a business to start, operate, and expand its activities. It is essential for smooth operations, growth, and risk management.

Key Definitions / Features:

• Business Finance: Funds needed for business activities.
• Owners' Funds: Capital invested by the owners, including equity shares, preference shares, and retained earnings.
• Borrowed Funds: Funds borrowed from external sources like loans, debentures, public deposits, trade credit, and inter-corporate deposits.

Illustrative Example: A company may raise capital by issuing equity shares to owners and also take loans from banks to finance expansion.

Practice Set:

• Level 1: Define business finance and list its two main sources.
• Level 2: Explain the difference between owners' funds and borrowed funds with examples.
• Level 3: Case study: A business plans to expand but has limited retained earnings. Suggest suitable sources of finance and justify your choice.

Answer Key:

• Business finance is the money required to start and run a business.
• Main sources: Owners' funds and borrowed funds.
• Owners' funds include equity shares, preference shares, and retained earnings; borrowed funds include loans, debentures, and trade credit.
• For expansion with limited retained earnings, the business can issue equity shares or take loans depending on cost and control considerations.

Quick Reference: Business finance = Owners' funds + Borrowed funds.

Glossary:

• Equity Shares: Ownership shares with voting rights.
• Preference Shares: Shares with fixed dividends and priority over equity shares.
• Retained Earnings: Profits kept in the business for future use.
• Debentures: Long-term debt instruments with fixed interest.
• Trade Credit: Credit extended by suppliers.

Importance and Need for Business Finance

Concept Explanation: Finance is the lifeblood of business, necessary for starting, operating, expanding, and promoting business activities.

Key Definitions / Features:

• Importance: Helps in financial planning, managing cash flow, strategic planning, and promotion.
• Need: Required to start business, run daily operations, and modernize or expand.
• Financial Needs Classification: Fixed capital (long-term assets) and working capital (day-to-day expenses).

Illustrative Example: A business needs fixed capital to buy machinery and working capital to pay salaries and purchase raw materials.

Practice Set:

• Level 1: What are the two main classifications of financial needs?
• Level 2: Explain why finance is important for promotion activities.
• Level 3: Discuss how strategic planning is linked to business finance.

Answer Key:

• Fixed capital and working capital.
• Promotion requires funds for marketing and market research to increase product awareness.
• Strategic planning uses finance to project costs and allocate resources for achieving business goals.

Quick Reference: Finance supports operations, growth, and marketing.

Glossary:

• Fixed Capital: Investment in long-term assets.
• Working Capital: Funds for daily business expenses.
• Strategic Planning: Long-term business planning.

Owners' Fund: Meaning, Merits and Limitations

Concept Explanation: Owners' funds are the capital invested by the owners of the business, primarily through shares and retained earnings.

Key Definitions / Features:

• Share Capital: Capital raised by issuing shares.
• Equity Shares: Represent ownership with voting rights; dividends depend on company profits.
• Preference Shares: Fixed dividend and priority in repayment during liquidation.
• Retained Earnings: Profits retained in the business for future use, also called ploughing back of profits.

Illustrative Example: A company issues equity shares to raise capital and retains some profits to finance expansion.

Practice Set:

• Level 1: Define equity shares and preference shares.
• Level 2: Explain the advantages of retained earnings as a source of finance.
• Level 3: Discuss the limitations of owners' funds.

Answer Key:

• Equity shares represent ownership with variable dividends; preference shares have fixed dividends and priority.
• Retained earnings do not require repayment or interest and strengthen financial position.
• Limitations include limited availability and dilution of control when issuing new shares.

Quick Reference: Owners' funds = Equity shares + Preference shares + Retained earnings.

Glossary:

• Shareholder: Owner of shares.
• Dividend: Return to shareholders.
• Ploughing Back: Retaining profits for reinvestment.

Borrowed Funds

Concept Explanation: Borrowed funds are monies raised through loans or borrowings that must be repaid with interest within a specified period.

Key Definitions / Features:

• Debentures: Long-term debt instruments with fixed interest.
• Bonds: Secured non-convertible debt issued by government or institutions.
• Financial Institutions: Provide owned and loan capital to promote industrial development.
• Commercial Banks: Offer various loan facilities like cash credits, overdrafts, and term loans.
• Public Deposits: Funds raised directly from the public with higher interest rates.
• Trade Credit: Credit allowed by suppliers for purchases without immediate payment.
• Inter-Corporate Deposits (ICD): Short-term unsecured deposits between companies.

Illustrative Example: A company issues debentures to raise long-term funds and takes a loan from a bank for working capital.

Practice Set:

• Level 1: List any three sources of borrowed funds.
• Level 2: Explain the features of debentures.
• Level 3: Discuss the advantages and risks of using borrowed funds.

Answer Key:

• Sources include loans from banks, debentures, and public deposits.
• Debentures carry fixed interest and must be repaid at maturity.
• Advantages: additional funds without diluting ownership; Risks: obligation to pay interest and repay principal, financial risk.

Quick Reference: Borrowed funds = Loans + Debentures + Public deposits + Trade credit + ICD.

Glossary:

• Debenture: Debt instrument with fixed interest.
• Financial Institution: Organization providing finance.
• Trade Credit: Supplier credit facility.
• Inter-Corporate Deposit: Short-term loan between companies.

Key Terms

• Finance: Funds or capital required to meet the needs of an organisation.
• Business Finance: Acquisition and utilisation of funds to meet financial needs and objectives.
• Fixed Capital: Capital for long-term investment in fixed assets.
• Working Capital: Capital for current assets and day-to-day expenses.
• Owner’s Fund: Funds provided by owners and invested for long duration.
• Borrowed Fund: Funds raised through loans with fixed interest and repayment terms.
• Financial Risk: Risk of inability to pay interest or repay borrowed amount.
• Share: Smallest unit of company capital.
• Equity Share Capital: Capital raised by issuing equity shares.
• Shareholders: Investors holding shares.
• Preference Share Capital: Capital raised by issuing preference shares.
• Primary Market: Market for newly issued securities.
• Residual Owners: Equity shareholders receiving income after creditors.
• Dividend: Return paid to shareholders.
• Capital Structure: Composition of long-term capital showing debt and equity proportions.
• Retained Earnings: Profits retained for future use.