What are retained earnings? (a) 20 to 40 days (b) 60 to 90 days The bond market is the collective name given to all trades and issues of debt securities. They have a highly complex capital format, including share capital, debt fundDebt FundDebt fund are investments, such as a mutual fund, closed-end fund, ETF, or unit investment trust (UTI), that primarily invest in fixed-income instruments like bonds or other types of a debt security for returns.read more, angel capital, reserves, surplus, etc. The dividend rate can be fixed or floating depending upon the terms of the issue. Debentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. Credit rating agencies, such as Standard and Poor's, typically assign letter grades indicating the underlying creditworthiness. A loss incurring firm has no source called retained earnings. Fixed Deposits: Whats the Difference? Limited Liability. It facilitates the purchase of supplies without immediate payment. Because of this, irredeemable debentures are also known as perpetual debentures. Free PDF download of NCERT Solutions for Class 11 Business Studies Chapter 8 Sources of Business Finance solved by Expert Teachers as per NCERT (CBSE) Book guidelines. Holders of GDR are eligible only for capital appreciation and dividend but no voting rights. 1. (a) Fixed capital of the company (b) Permanent capital of the company While NCDs are the debt taken from the public is an example of the Debenture. A call option allows the holder of the option to buy something at a certain price and on or before a certain date, whereas a put option allows selling. Lease rentals get tax advantage as they are deductible for computing taxable profits. Commercial paper is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. D. subordinated notes. Login details for this Free course will be emailed to you. Business is concerned with production and distribution of goods and services for the satisfaction of needs of society. It is a convenient and continuous source of finance. Return on Investment. The coupon rate is determined, which is the rate of interest that the company will pay the debenture holder or investor. They also have a right to participate in the premium at the time of redemption. Such capital is raised by issuing shares. Answer:Its objective was to coordinate the activities of other financial institutions including commercial banks. Debenture holder is a creditor of the company and cannot take part in the management of the company while a shareholder is the owner of the company. The need of fund arises from the stage when an entrepreneur makes a decision to start a business. Save my name, email, and website in this browser for the next time I comment. Equity shares are long-term financing sources for any company. As fixed charge instruments,debentures put a permanent burden on the earnings. James Chen, CMT is an expert trader, investment adviser, and global market strategist. Another factor that may be of importance is the financial and taxation position of the companys shareholders. Describe in brief the features of equity shares. (c) 9. Total one-time investments incurred to achieve the NFI Forward program were $14 million, a $103,000 increase from 2022 Q3. GDR and ADR are similar to each other except: III. These are different types of debentures which are also categorized as hybrid financing. A bank certificate issued in more than one country for shares in a foreign company. Equity shares are a vital source for raising long-term capital. Stability of sales- An established business which has a growing market and high sales turnover, the company is in position to meet fixed commitments. The use of retained earnings as opposed to new shares or debentures avoids issue costs. Long Answer Type Questions For example, because of taxation considerations, they would rather make a capital profit (which will only be taxed when shares are sold) than receive current income, and then finance through retained earnings would be preferred to other methods. It has a fixed rate of dividend. Another distinct feature of equity shares is limited liability. Debentures represent Question 17. Preference shares have the characteristics of both equity shares and debentures. Redeemable Debentures: You will Learn Basics of Accounting in Just 1 Hour, Guaranteed! Securities: 'Securities' is a general term for a stock exchange investment. The contract specifies features of a debt offering, such as the maturity date, the timing of interest or coupon payments, the method of interest calculation, and other features. A debenture is a type of debt instrument that is not backed by any collateral and usually has a term greater than 10 years. (a) It is permanent source of capital and is not redeemed during the life of the co, Identify sources of finance in the following case and also state one merit for each of the following : (a) is a permanent source of capital. The debenture document, called Debenture deed contains provisions as to payment, of interest and the repayment of principal amount and giving a charge on the assets of a such a company, which may give security for the payment over the some or all the assets of the company. She holds a Bachelor of Science in Finance degree from Bridgewater State University and helps develop content strategies for financial brands. Retained earnings is a permanent source of funds which an organization can avail of. Term Loans 8. (vb) If f. As a source of finance, retained profit is better than other sources. 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It contains well written, well thought and well explained computer science and programming articles, quizzes and practice/competitive programming/company interview Questions. Maturity: Equity shares provide permanent capital to the company and cannot be redeemed during the life time of the company. Identify the source of finance highlighted in the following cases: Identify the source of finance highlighted in the following cases: (i) It refers to that part of profits which is kept as reserves for use in the futu, Identify the source of finance highlighted in the following cases. Difficult procedure: As compared to commercial papers and trade credit, it involves many legal and paper formalities. d. A financial instrument used by private markets to raise capital denominated in either U.S. dollars or Euros. Governments typically issue long-term bondsthose with maturities of longer than 10 years. (c) Working capital requirement (d) Lease financing Companies use debentures as fixed-rate loans and pay fixed interest payments. Answer:Given below are three financial institutions along with their objectives: Question 6. The dividend policy of the company is in practice determined by the directors. Debentures are the companys acknowledgment of the debt borrowed by the particular corporate entity towards the fund provider, i.e., an investor in the form of debt. At the same time, a company that is looking for extra funds will not be expected by investors (such as banks) to pay generous dividends, nor over-generous salaries to owner-directors. When company winds up, preference shares are paid before equity shares. (c ) In case of winding up of the company, the capital is refunded after payment of debentures but before payment of equity shares. Irredeemable (non-redeemable) debentures, on the other hand, do not hold the issuer liable to repay in full by a certain date. Learn more about corporate, government, and municipal bonds. Lets get acquainted with some of the most common types of debentures: There is a type of debentures where the investors have a right to convert their full debenture holdings into equity shares of the company. (ii) This source has characteristics of both equity shares and debentures. These investors may find their debt returning less than what is available from other investments paying the current, higher, market rate. Which deposits are directly raised from the public? Liabilities in financial accounting refer to the amount of money a business owes to the lender. Answer:Global Depository Receipts (GDRs): GDR is an instrument issued by a company to raise funds in some foreign currency and is listed and traded on a foreign stock Like debt has a fixed interest rate, preference shares have fixed dividends, and they also have a preference of payment at the time of liquidation, just as debt holders get. (a) Fixed Capital and Working Capital In such cases, the company which issues partially convertible debenture decides the fixed percentage of debenture that may or may not be converted into company stocks. Because debentures are debt securities, they tend to be less risky than investing in the same company's common stock or preferred shares. Debt fund are investments, such as a mutual fund, closed-end fund, ETF, or unit investment trust (UTI), that primarily invest in fixed-income instruments like bonds or other types of a debt security for returns. For the company, it is mandatory for the company for payment and repayment of interest and debt. Because these debts are not backed by any collateral, however, they are inherently riskier than secured debts. Also, they bought machinery and equipment by issuing non-convertible Debentures (NCDs) of $300 crore. 1 See answer Advertisement Factors determining working capital requirements of a business: Factors determining Fixed Capital Requirements. The three main features of a debenture are the interest rate, the credit rating, and the maturity date. Question 1. In general, debenture holders have a lien in favor of them against all the assets of the company. They are just a right or option to purchase equity that the holder has. Preferred stocks are hybrid securities that have the characteristics of both bonds and stocks. They receive dividends or bonuses when the company distributes its profits. Answer:Following factors responsible for selecting a source of finance: Question 8. The main difference between FCDs and most other convertible debentures is that the issuing company can force conversion into equity. If he is interested in short term investment, then he should choose public deposits. (c) Owners Funds and Borrowed Funds exchange. Welcome to Sarthaks eConnect: A unique platform where students can interact with teachers/experts/students to get solutions to their queries. When debts are issued as debentures, they may be registered to the issuer. In books of accounts they are shown as creditors or ills payable. Name the source of finance, which is available in normal course of purchase of goods. The relative lack of security does not necessarily mean that a debenture is riskier than any other bond. If the shares are cumulative preference shares, the said dividend may be postponed but will have to pay if the following years financials are good. Gordon Scott has been an active investor and technical analyst or 20+ years. (c) 7. Therefore, it is unreasonable to transfer funds to general reserves which are called retained profits if there are exceptionally good profits. C. liability to both you and the bank. Funds required for inventory can be met through it but not others like plant and machinery, land and building or salaries of employees etc. Answer: GDRs have the following features: Question 8. Dividend declared is that portion of profits earned that the companys board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the companys securities. Answer:Equity shareholders get return only when profits is left after paying interest on debentures and fixed return on preference shares. If, for example, because of taxation considerations, they would rather make a capital profit (which will only be taxed when shares are sold) than receive current income, then finance through retained earnings would be preferred to other methods. Lease Financing 7. Shareholders are the Owners of the company. It reduces initial capital for (new) businesses. These requirements are put into place to ensure that these institutions do not take on . A company will issue these to raise capital for its growth and operations, and investors can enjoy regular interest payments that are relatively safer investments than a company's equity shares of stock. This website uses cookies and third party services. What are the preferences given to preference shareholders? Question 15. iii) Equity shares: Rs. For nonconvertible debentures, mentioned above, the date of maturity is also an important feature. (c) Equity shares (d) Public deposits Answer:Equity shareholders get a return only when profits are left after giving interest to debenture holders and preferential dividend to preference shareholders. This article throws light upon the three main types of long term financing. Question 10. 1- Share or Share Capital is a company's owned capital while a Debenture is its obligation to the debt provider or creditor. Answers: . (vb) If f. As a source of finance, retained profit is better than other sources. Bank lending is still mainly short term, although medium-term lending is quite common these days. ABC Ltd. is planning to modernise its plant with latest technology. Short-term instruments include working capital loans, short-term loans.read more that corporates are using to fulfill their capital requirement by giving assets as mortgage/security. Without non-recourse factoring, the company will still have to absorb losses. News and information is available . This source includes raising funds from Issue of debentures, Loans from financial institutions, Public deposits, Trade credit, etc. Both corporations and governments frequently issue debentures to raise capital or funds. This enables the equity shareholders to enjoy the ownership of a firm without risking unlimited liability as is the case in sole-proprietorship or partnership firms. Profit re-invested as retained earnings is profit that could have been paid as a dividend. This rate can be either fixed or floating and depends on the company'scredit ratingor the bond's credit rating. Answer:Short term sources include trade credit, factoring, banks and commercial papers. Why does business enterprise need finance? Explain. Give reasons to support your answer. When the brain reads four answers to a question, the brain performs four commands. Also Read: Advantages and Disadvantages of Preference Shares. VeryShort Answer Type Questions Scope of retained earnings is limited by amount of profits. Each source has its own merits and demerits. Do you agree with this view? An indenture is a legal and binding contract between bond issuers andbondholders. Some well-known hybrid financing instruments are preference shares, convertible debentures, warrants, options, etc. In contrast to secured bonds, which are backed by collateral, unsecured bonds are relatively riskier since they do not offer any sort of backstop of assets if the issuer defaults: they rely solely on the creditworthiness of the issuer. Explain. In weak financial situations, management may consider not paying the dividend to preference shareholders. Foreign Capital. The characteristics are: 1. He is passionate about keeping and making things simple and easy. Merits of Trade Credit. However, it is true that the use of retained earnings as a source of funds does not lead to the payment of cash. T-bonds are nearly risk-free since they're backed by the full faith and credit of the U.S. government. Shareholder carries a preferential right over ordinary equity shares in sharing of profits and also claim over assets of the firm. They are not secured by collateral, yet they are considered risk-free securities. They took the risk of uncertain returns. Corporations also use debentures as long-term loans. List different types of finance. The Standard & Poors system uses a scale that ranges from AAA for excellent rating to the lowest rating of C and D. Anydebt instrument receiving a rating lower than a BB is said to be of speculative grade. You are free to use this image on your website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Difference Between Shares and Debentures (wallstreetmojo.com). Various components of the 'Capital Structure' are raised from time to time to meet the needs of the company and generally consist of: Equity shares, Preference shares, Debt funds (bonds and debentures), Funds borrowed on long-term basis, and Medium-term loans are loans for a period of three to ten years. It makes its procedure difficult. Disclaimer 8. Thus, although, equity shareholders are the real owners of the company, their liability is limited to the value of share they have purchased. It can be declared by the directors of the company out of profits only. * Please provide your correct email id. Equity shares represent the ownership of a company and capital raised by the issue of such shares is known as ownership capital or owner's funds. Investing in shares of a company provides the investor with ownership rights as well as voting rights. What is debenture? Debentures are creditorship securities. Students (upto class 10+2) preparing for All Government Exams, CBSE Board Exam, ICSE Board Exam, State Board Exam, JEE (Mains+Advance) and NEET can ask questions from any subject and get quick answers by subject teachers/ experts/mentors/students. Though only short term or limited needs could be fulfilled by this source. This article has been a guide to the Shares vs. Debentures. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order. Companies dont have to chase up their own debtors. Name two sources of funds under owners fund. Question 5. The holder of the shares is considered the company owner and enjoys various rights under the statutes. Shares are the ownership capital of the company. The promoter group of XYZ floats ABC Ltd by issuing the equity share capital of $500 million by issuing shares of 50 million each for $10. CFA And Chartered Financial Analyst Are Registered Trademarks Owned By CFA Institute. Fully Convertible Debenture: Fully convertible debentures are those debentures which are fully converted into specified number of equity shares after predetermined period at the option of the debenture holders. To safeguard the interest of equity shareholders and enable them maintain their proportional ownership, section 81 of the Companies Act, 1956 provides that whenever a public limited company proposes to increase its subscribed capital by the allotment of further shares, after the expiry of two years from the formation of the company or the expiry of one year from the first allotment of shares in the company, whichever is earlier, such shares must be offered to holders of existing equity shares in proportion, as nearly as circumstances admit, to the capital paid up on these shares. A debenture is a type of bond or other debt instrument that is unsecured by collateral. Question 7. What is the difference between GDR and ADR? Shares are not convertible to debt or such other structure of the capital. Shareholder will get a portion of the profits called dividend which is dependent on the profits of the company. The use of retained earnings avoids the possibility of a change in control resulting from an issue of new shares. Specify the objective of I.D.B.I. Question 1. The corporate tax rate is 50%. (b) Makes the payment on behalf of the client 1,00,000 for investment purposes. For the most part, commercial paper is a very safe investment because the financial situation of a company can easily be predicted over a few months. Answer:Retained Profits: For any company, the amount of earnings retained within the business has a direct impact on the amount of dividends. Should he invest in equity shares, preference shares, public deposits or debentures? Answer:A lease is a contractual agreement, in which the owner of the asset grants the other party the right to use the asset in return for a periodic payment, but retains the title over the property. For the company, it is not mandatory to return the share capital to the shareholders. Securities Contract (Regulation) Act, 1956 defines securities as to include: 1. It has a fixed interest rate with cumulative and non-cumulative features redeemable after a fixed interval, either in installment or lump sum. Name any three special financial institutions and state their objectives. Short-term financing: It does not provide loans for long term as shares and debentures do. Some debentures can convert to equity shares while others cannot. They have voting rights in the meeting of the company and have a control over the working of the company. This is known as fixed capital requirement of an enterprise. It is an important source of finance. Retained earnings are better than other sources of finance because: V. Value Based Questions Answer:(a) Fixed Capital and Working Capital However, the holders of the debenture have the option of holding the loan until maturity and receive the interest payments, or convert the loan into equity shares. The financial need of a business can be categorized in the following ways: Question 2. Preferred stocks have dividend priority over common stock. (d) Generated within the business Business needs to choose right source of finance to make the best use of it. This depends on whose perspective is considered. How and Why. Differentiate between: Shares are ownership securities. Middle term credit sources include loans from banks, public deposits, loans from financial institutions and lease financing. What is factoring? Debentures 5. Debenture holders are the creditor of the company. The value in the case of equity shares can be expressed in various terms like par value, face value, book . Type # 1. Do you agree? In the event of a corporation's bankruptcy, the debenture is paid before common stock shareholders. What is the status of debenture holders? Question 1. Non-recourse factoring allows for insurance against bad debts. Answer:Global Depository Receipts and American Depository Receipts. Retained earnings are not a good source from the values point of view as it is the right of equity shareholders. Question 2. Even at the time of liquidation, equity capital is paid back after meeting all other prior claims including that of preference shareholders. Preference shares are similar to debentures in the sense that the rate of dividend is fixed and preference shareholders do not . The offers that appear in this table are from partnerships from which Investopedia receives compensation. Debentures. Equity shareholders have a residual claim on ownership of companys assets. It may result in higher payout obligations in case the equipment is not found useful and the lessee chooses for premature termination of the lease contact. Problem 7 A Limited has the following capital structure: Equity share capital (2,00,000 shares) Rs. The owner of the asset is called lessor and the party who uses the assets is called lessee. Merits of Lease financing. Multiple Choice Questions These are the debt instrumentThese Are The Debt InstrumentDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. In particular, it is an unsecured or non-collateralized debt issued by a firm or other entity and usually refers to such bonds with longer maturities. Buy backs of listed debt securities convertible into equity shares can be undertaken by . On the downside, firms are likely to force conversion when it is beneficial to existing shareholders rather than FCD investors. Justify your answer. It is one of the two important parts of the balance sheet, followed by assets. But, often, such indirect control is weak and ineffective because of the indifference of most of the shareholders in casting their votes. (a) 2. Name the source of finance, which is available in normal course of purchase of goods. Moreover, the shareholders can participate in stock market trading to increase their investment value. Firm increases the amount of long-term liabilities raising the amount of interest payments to the lenders. (a) Fixed capital requirement (b) Ploughing back of profits Do you agree with this view? Common stock, scrip, owned capital, etc., are the other terms used for Shares. A portion of the net earnings may be retained in the business of ruse in future. Retained Earnings: For any company, the amount of earnings retained within the business has a direct impact on the amount of dividends. Account Disable 12. Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions.