One app for all your study abroad needs
This chapter discusses various sources from which a business can raise funds to meet its financial requirements. It classifies sources of finance on the basis of period, ownership, and source of generation. The chapter explains equity shares, preference shares, debentures, commercial banks, financial institutions, commercial paper, retained earnings, trade credit, factoring, lease financing, public deposits, and international financing options like ADR, GDR and FDI. These notes summarise key concepts from Chapter 8 of the NCERT textbook Business Studies for effective revision. You can also download the free PDF for quick reference.
Contents
Explore Notes of Class 11: Business Studies
Introduction
Business needs finance for acquiring fixed assets (long-term) and for day-to-day operations (short-term). The financial requirements depend upon factors like the nature of business, scale of operations and production technology used. Finance is required at every stage, from promotion to expansion and diversification.
- Examples: A manufacturing company needs long-term funds for plant and machinery, while a trading firm needs short-term funds for inventory.
- Key factors affecting financial needs: Cost of fixed assets, nature of business, technology used, and scale of operations.
Classification of Sources of Finance
Sources of funds can be classified on three bases:
1. On the basis of the Period
- Long-term sources (more than 5 years): Equity shares, preference shares, debentures, and long-term loans from financial institutions.
- Medium-term sources (1–5 years): Lease financing, public deposits, loans from banks.
- Short-term sources (less than 1 year): Trade credit, factoring, commercial paper, bank credit.
2. On the basis of Ownership
- Owner’s funds: Equity shares, retained earnings.
- Borrowed funds: Debentures, loans from banks and financial institutions, public deposits.
3. On the basis of the Source of Generation
- Internal sources: Retained earnings, depreciation funds.
- External sources: Issue of shares and debentures, loans, public deposits, etc.
Sources of Finance: Owner’s Funds
Owner’s funds refer to the funds that are provided by the owners of the business. These funds belong to the owners permanently. Owner’s funds include equity shares and retained earnings. Here, we have mentioned the details on both.
Equity shares represent permanent capital and ownership in the company. Shareholders get voting rights and share in profits through dividends.
- Meaning: Capital raised by issuing equity shares; not redeemable during the lifetime of the company.
- Features: Voting rights, no fixed dividend, residual claimants, permanent capital.
- Merits: No fixed burden, permanent source, increases creditworthiness, and no charge on assets.
- Limitations: High cost, risk of over-capitalisation, dilution of control, speculative trading.
Retained Earnings
Retained earnings refer to the total portion of a company’s profits that is not distributed as dividends to shareholders but is retained by the company for reinvestment in its core business or to pay debt.
- Meaning: Undistributed profits reinvested in the business.
- Merits: Cheapest source, no cost, no dilution of control, and increases financial strength.
- Limitations: Over-cautious approach may lead to dissatisfaction among shareholders, opportunity costs, and misuse by management.
Sources of Finance: Borrowed Funds
Borrowed funds refer to the funds raised through loans or borrowings. These funds are not contributed by the owners but are raised from outsiders who are creditors of the company. The company has to pay a fixed interest on these funds. It includes various sources of finance as mentioned below:
Debentures
Debentures are written acknowledgements of debt with a promise to pay principal and interest. They have a fixed rate of interest and are redeemable after a fixed period.
- Meaning: A long-term debt instrument issued under the common seal of the company.
- Types: Secured (mortgaged), unsecured, convertible, non-convertible, registered, bearer.
- Features: Fixed rate of interest, no voting rights, redeemable after a fixed period.
- Merits: Cheaper than equity, no dilution of control, tax-deductible interest, and trading on equity.
- Limitations: Fixed obligation, charge on assets (in case of secured debentures), permanent burden in depression.
Shares that enjoy preferential rights regarding dividends and repayment of capital are known as preference shares.
- Types: Cumulative, non-cumulative, participating, non-participating, convertible, non-convertible, redeemable, and irredeemable.
- Features: Fixed dividend rate, preferential payment, no voting rights (except in special cases).
- Merits: No dilution of control, fixed burden, no charge on assets, flexible capital structure.
- Limitations: Not suitable for risk-takers, fixed obligation, not tax-deductible.
Public Deposits
Public Deposits are invited by companies directly from the public for periods ranging from 6 months to 3 years at a rate of interest higher than bank deposits.
- Features: Higher interest than banks, unsecured, maximum 36 months, regulated by the RBI.
- Merits: Simple procedure, low cost, no dilution of control, no charge on assets.
- Limitations: Unreliable for long-term, difficult for new companies, and limited amount.
Loans from Commercial Banks
Short-term and medium-term loans are provided by commercial banks, which are usually against security, for working capital or fixed assets.
- Features: Fixed period, interest payable, secured or unsecured.
- Merits: Timely availability, flexible repayment, secrecy maintained, and low cost.
- Limitations: Strict conditions, time-consuming documentation, charge on assets.
Loans from Financial Institutions
Long-term loans are provided by institutions like IFCI, IDBI, ICICI, SFC, etc. They are generally given for 5–20 years at concessional rates.
Features: 5–20 years, low interest, convertible option sometimes.
Merits: Large amount, long period, technical advice, easy instalments.
Limitations: Many restrictions, lengthy procedure, and difficult terms.
Other Sources
There are other sources of borrowed funds as well, which are listed below:
- Trade Credit: Credit extended by suppliers for the purchase of goods (30–90 days).
- Factoring: The sale of book debts to a factor who collects them and charges a fee.
- Lease Financing: Leasing assets instead of purchasing them; the lessor retains ownership.
- Commercial Paper (CP): Unsecured promissory note issued by large creditworthy companies for 15 days to 1 year.
International Financing
When a company needs large amounts of funds that are not easily available within the country, or when it wants to access foreign capital markets, it raises funds from international sources. These are external sources of finance obtained from abroad.
Here are the sources of International Financing
- Commercial Banks
- International Agencies and Development Banks
- International Capital Markets
a. Global Depository Receipts (GDR)- They are issued by an Indian company to an overseas depository bank (usually in Europe).
- The depository bank then issues depository receipts to global investors.
- Each GDR represents a certain number of underlying equity shares of the Indian company.
- Traded on foreign stock exchanges (e.g., London Stock Exchange).
b. American Depository Receipts (ADR)
- Similar to GDR, but issued and traded in the United States (on New York Stock Exchange or NASDAQ).
- Indian companies like Infosys, ICICI Bank, etc., have used ADRs.
c. Foreign Currency Convertible Bonds (FCCB)
- Bonds issued in foreign currency that can be converted into equity shares or depository receipts after a certain period at a pre-determined price.
4. Foreign Direct Investment (FDI)
Also Read: NCERT Class 11 Sociology Chapter 3: Understanding Social Institutions Notes (Free PDF)
Important Definitions in NCERT Notes Class 11 Business Studies Chapter 8: Sources of Business Finance
This section lists key terms for clarity and revision:
- Equity Shares: Shares that carry voting rights and a residual claim on profits and assets.
- Retained Earnings: Portion of profit not distributed as a dividend and reinvested in the business.
- Debentures: Acknowledgement of debt with promise to pay interest and principal.
- Preference Shares: Shares having a preferential right to dividends and repayment of capital.
- Public Deposits: Deposits accepted directly the public directly by companies.
- Commercial Paper: Short-term, unsecured promissory note issued by companies with a high credit rating.
- Trade Credit: Credit granted by one trader to another for the purchase of goods.
- Factoring: Service of managing and financing receivables by a factor.
- Lease Financing: Contract for the use of an asset where the lessor retains ownership.
- GDR/ADR: Receipts issued by overseas banks representing shares of an Indian company.
Explore Solutions of Class 11: Business Studies
Related Reads
Explore Notes of Other Subjects of NCERT Class 11
FAQs
Owner’s funds belong to shareholders (equity shares, retained earnings), carry no fixed obligation, and give ownership rights. Borrowed funds are loans/debentures, carry fixed interest, and do not give ownership rights.
The merits of equity shares are permanent capital, no fixed burden of dividend, and no charge on assets.
Retained earnings are considered the cheapest source of finance because of no flotation cost, no interest/dividend obligation, and no dilution of control.
Shares represent ownership in the company with voting rights and variable dividends. Debentures are loans with fixed interest, no voting rights, and must be repaid after a fixed period.
Public deposits are for a short period only (max 3 years), the amount is limited, new companies find it difficult, and people may not trust the company.
For NCERT study material, follow NCERT Notes and Solutions Class 11 Business Studies by Leverage Edu now.
