Sources Of Business Finance - Class 11 Commerce Business Studies - Extra Questions

Collateral security may be defined as a subsidiary or secondary or additional security besides the primary security when a company obtains a loan or overdraft from a bank or any other financial institution.

1. Preparation of soil. 
2. Ploughing the field.
3. Sowing. 
4. Irrigation.
5. Manuring. 
6. Harvesting

There is a lot of similarities in the two methods as both invest the amount of depreciation and at the end of life of machinery the money is used for replacing the machinery. But a major difference between the two methods is: In Insurance Policy Method, insurance is taken for the required sum and every year in the beginning insurance premium is paid. While in case of Sinking Fund Method, securities are purchased and these investments are made at the end of each year. Insurance Policy Method is less risky because maturity amount will be received certainly but in Sinking Fund Method it can be risky as the market value of securities can change.

Factoring implies a financial arrangement between the factor and client, in which the firm (client) gets advances in return for receivables, from a financial institution (factor). It is a financing technique, in which there is an outright selling of trade debts by a firm to a third party, i.e. factor, at discounted prices.

Financial institutions are also known as development banks because these institutions provide long and medium-term loans for the development and growth of industry.

Meaning: - When a company wants to borrow long term finance then issuing debentures is the most convenient method. Because, debentures can be repaid after a long period such as 10 years. 20 years, etc. the term debenture originates from a Latin word 'debar& meaning 'to owe'. In simple term a debenture is an instrument of credit issued by a company to acknowledge its debt/loan to debenture holder upto a certain sum of money under certain terms and conditions. It is in the form of document known as Debenture Certificate. 
Definition: - According to Companies Act. sec. 2(12) "Debenture includes stock, bonds and any other securities of a company whether constituting a charge on the company's assets or not". 
1.A) On the basis of security offered  
2.Secured Debentures; -the secured debentures are also called as mortgage debentures. They are secured by some charge on the assets or property of the company. The charge may be either fixed charge or floating charge. In case of fixed charge, specific assets are mortgaged as a security for the debentures under floating charges; the debenture holders have a claim over all assets of the company. 
3.Unsecured Debentures: - Even though majority debentures are secured debentures, some debentures may also be unsecured debentures. They do not have any charge on any assets of the company. 
B).On the basis of Basis of redemption 
4.Redeemable Debentures: - Sometimes the debentures are issued for a specific period of time. After the expiry of the specific period the company can repay money to debenture holders. Such debentures are known as Redeemable Debentures. 
5.Irredeemable Debentures: - they are also called as perpetual debentures. The amount of irredeemable debentures. It is retained as a part of the permanent capital of the company. The amount is not paid during the life time of the company. They are paid back as per the convenience of the company. 
C).6.On the basis of transferability 
7.Registered Debentures: - these debentures are recorded in the register of debenture holders. The details recorded are in respect of the name and address of the debenture holder, the number of debentures held and other particulars. 
8.Bearer Debentures: - the bearer debentures are like bearer instruments. They can be transferred by mere delivery of the document or debenture certificate. The interest on such debentures is paid by means of attached coupons. The coupons can be Encashed by the holder as and when each falls. Permission from central Government is required before the issue of Bearer Debentures. 
D)On the basis of Conversion.
7.Convertible Debentures:-Convertible Debentures are those which can ne converted either partly or wholly into equity shares after the completion of a definite period.The rate of interest and date of conversion is decided at the time of issue. The interest is paid up to the date of conversion. on conversion the debenture holders are eligible for dividends and other rights and privileges of shareholders.
8.Non-convertible debentures:-These debentures cannot be converted into equity shares;they are usually redeemed after a certain period of time. The non-convertible debentures may be secured or unsecured.

1. Promise: -Debenture is a written promise by a company that it woes a specified sum of money to the holder of the debenture. 

Public deposits refer to unsecured deposits invited from the public. A business that wants to encourage public deposits will issue an advertisement in the newspaper. Any member of the public can deposit money with the company by filling out the required form.

Retained earnings are also known as ploughing back of profit, retained earning, self financing or internal financing, reserves or surplus.

The term "retain earnings" refers to profit that has not been released after dividend and taxes have been paid. It provides basis of expansion and growth of companies. It is considered the most important source of finance, since it is internally generated, this method of financing is known as self-financing.

The preferential rights enjoyed by the preference shareholders are:

1. Preference over equity shareholders in the payment of dividend from the profits of the company.
2. Preference in the repayment of their investment during winding up of the company.
   

Meaning : When a company wants to borrow long term finance then issuing debenture is the most convenient methods. Because, debenture can be repaid after a long period such as $$10$$ years , $$20$$ years,etc . the term debenture originates from a Latin words 'debare' meaning 'to owe'. In simple term a debenture is an instrument of credit  issued by a company to acknowledge its debt / loan to debenture holder upto a certain sum of money under certain terms and conditions .It is in the form of document known as Debenture Certificate.
Definition :-"an instrument under seal evidencing debt, the essence of it being admission of indebtedness".

Bank or financial institutions may insist on additional assets as collateral security so that the amount of loan can be realized with the help of collateral security in case the amount from the sale of the principal/primary security falls short of the loan money.

Zero-coupon rate debentures are the debentures where coupon is attached with debenture certificates with predetermine rate of interest. Such a rate is either fixed or floating. Its floating rate is based on bank rate and fixed percentage.

1) Debtor and Creditor Relationship: When a customer deposits money with a bank the relationship of debtor and the creditor will be established, in this case, Banker is the Debtor and Customer is the Creditor.

2) Creditor and Debtor: When a bank grants loan and other credit facilities to the customer, the relationship between the banker and customer is reversed, that is Customer is Debtor and Banker is Creditor.

3)Principal and Agent: In some situations, the banker serves as an agent of the customer (principal).

 

Loans can be granted in the form of cash credit, demand loans, short- term loan, overdraft, discounting of bills, etc.

1) Cash credit: Under the cash credit system, the borrower is sanctioned a credit limit up to which he can borrow from the bank. The interest payable by the borrower is calculated on the amount of credit limit actually drawn.

2)Demand loans: Demand loans granted by a bank are those loans that can be recalled on demand by the bank at any time. Short-term loans (like car loans, housing loans, etc.) are given as personal loans against some security. The interest is payable on the entire sum of loans granted.

3)Overdraft:  In case of overdraft facility, an account holder is allowed to withdraw a sum of money in excess of the amount deposited with the bank.  Here, the borrower who has received this facility has to pay interest on the amount overdrawn.

4) Discounting of bills  :. A bill of exchange is drawn by a creditor on the debtor specifying the amount of debt and also the date when it becomes payable. Such bills of exchange are normally issued for a period of 90 months.

1)  Demand Deposits: These deposits refer to those deposits which are repayable by the banks on demand anytime

2) Time Deposits: Time deposits refer to those deposits, in which the amount is deposited with the bank for a fixed period of time.

 

1) Cash credit : Cash credit refers to a loan given to the borrower against his current assets like shares, stocks, bonds, etc.
2) Demand loans  :These loans  can be recalled on demand by the bank at any time. The entire sum of demand loan is credited to the account and interest is payable on the entire sum.

A commercial bank accepts deposits in the form of current, saving and fixed deposits. It collects the surplus balance of the individuals and firms and finances the temporary needs of commercial transactions. The first task is, therefore, the collecting of the savings of the public.

iv. Providing cash credit facility: In this case, the entire sanctioned amount of loan by the bank is not given to the borrowers at a particular time. The borrower is allowed to withdraw the sanctioned amount as and when he requires money. The bank charges interest only on the actual amount withdrawn from the bank.

Commercial Bank performs a variety of functions to satisfy the needs of the various sectors of the economy. 

Bank rate is Quantitative measure of credit control.

Meaning: A bank is a dealer in credit. In the broad sense of the term any institution that accepts deposits from people, who have more cash than they needs immediately, and that gives loans and thereby can create money supply may be called a bank. Commercial banks perform all these functions for earning profit.
Definition:
Prof.Sayers defines as "Commercial banks are institutions whose debts are usually referred to as 'bank deposits' and commonly accepted in final statement of other people's debts"   

Central Bank is the apex body of the monetary and banking system of the nations's economy. 

E-banking facility refers to electronic banking facility where banking services are provided over internet and any sum of money can be transferred from one's account or received into one's account by using electronic cash over internet. Through E-banking, banking services can be availed through internet at anyplace and at anytime.

The primary functions of commercial banks are termed as banking functions.
(I) Accepting Depostis:
The most significant and traditional function of commercial bank is accepting deposits from public. A commercial bank acts as the custodian of public deposits. This function is very important because it helps in the mobilisation of funds from households to businessman for production purposes and provides necessary funds to the bank to create bank money. Commercial banks act as an intermediary by accepting deposits and paying interest on them and giving loans and charging the borrowers interest at a high rate. The difference between the two is the profit of the bank. Commercial bank accepts the following types of deposits:
(a) Demand Deposits (b) Time Deposists
(a) Demand Deposits: The deposits which can be withdrawn on demand, are known as demand deposits. They are of two types - (1) Current Account Deposits (2) Saving Account Deposits.
(1) Current Account Deposits : Current account deposits are usually held by businessmen, industrial enterprises, public bodes for business transactions. Money deposited in current account can be withdrawn in part or full at any time and any number of times by the depositors without any prior notice. Overdraft facilities and agency service are provided by the bank to the current account holders, very low or no interest is paid on these accounts as the banks cannot utilise these short term deposits. Banks may charge certain amount of service charges on account holders.
(2) Saving Account Deposits: Saving account deposits are opened by salaried class or people with fixed income for holding their short term savings, Money deposited in these accounts retain high degree of liquidity. At the same time it earns nominal interest. It is a kind of demand deposits which is generally kept by people for sake of safety.
(b) Time Deposits: These are deposits, which are repayable after a certain period of time. They are of two types - (1) Recurring Deposits (2) Fixed Deposits
(1) Recurring Deposits: These are deposits under which people deposit a fixed amount at regular interval for specified period of time. These deposits encourage savings and carry high rate of interest.
(2) Fixed Deposits: Fixed deposits are time deposits or term deposits, which attract fund for a specific period. It is a time abound deposit as the amount deposited cannot be withdrawn before the maturity of the period. However, loans can be taken from the bank against the security of this deposit, within that period. These deposits earn a higher rate of interest as the bank uses this money for giving loans where the bank earns high interest, so they can also pay high interest to depositors.
(II) Advancing/ Granting Loans:
The second major function of a commercial bank is to make loans and advances out of the money, which comes to it from the public by way of deposits. Direct loans and advances are given to all types of persons particularly to businessmen and investors against personal security, gold, silver and other assets. The profit earning capacity of commercial banks depends on this function of lending. Generally banks grant loans and advances to the borrowers in the following forms:
(1) Loans (2) Cash Credit (3) Overdraft facility (4) Discounting of bills
(1) Loans: Various types of loans and advances are provided by commercial banks, on the basis of time period. They are as follows:
(a) Call loans or Money at call (b) Short Term Loans
(c) Medium Term Loans (d) Long Term Loans
(a) Call loans or Money at Call: Inter-bank loans provided by commercial banks for a period of $$7$$ to $$15$$ are known as call loans.
(b) Short Term Loans: These are provided by commercial bank for a period of not more than two years. The rate of interest is higher than call loans. They are given to businessmen to fulfill their working capital requirement.
(c) Medium Term Loans: The loans are sanctioned for a period of two to five year period. The rate of interest charged for this type of loan is more than the short term loans. Such loans are useful to industries for introducing innovations or for introduction of new methods of production.
(d) Long Term Loans: Loans which are sanctioned for five and more years are known as long term loans. The rate of interest charged is higher than other loans. Such loans help businessmen to introduce permanent changes in the methods of production.
(2) Cash Credit : Cash credit are allowed to any customer. Under this facility, the commercial banks allow the borrowers to withdraw cash to a certain limit in the form of cash credit. This facility is available against personal security or security of goods pledged to the bank. Interest is charged on the amount withdrawn.
(3) Overdraft: It is given to current account holders. Overdraft facility enables, companies, firms and businessmen to withdraw amount over and above their actual balance in their current account. The extra amount withdrawn is treated as loan and interest is charged on it. Such facility is granted against collateral security. There overdraft facility help businessmen to serve transaction purpose or meet their working capital.
(4) Discounting Bills of Exchange or Hundies: This type of lending is very popular with the banks. A Bill of Exchange is a written promise by the debtor to a creditor to pay a specified sum of money after one or three months. If the creditor is in urgent need of money he can present this bill of exchange to the bank for discounting. After discounting or deducting its commission, the bank pays the present price of the bill to the holder. When the bill of exchange matures the bank can recover its payment from the party who signed the bill.

A commercial bank is a financial institution which accepts deposit from people and offers loans for the purpose of consumption or investment. Commercial banks perform agency function for its customers by providing them the following basic facilities at an agreed bank charge depending on the nature of the activity:

• They collect bills, draft, cheques, etc.
• They pay the insurance premium, rent, loan installments, etc.
• They work as a representative of a customer for purchasing or redeeming different types of securities in the stock exchange.
• They also prepare income tax returns, claim tax refunds, etc. on behalf of the customers. 

Overdraft facility refers to a continuous withdrawing facility in which the bank allows the customer to withdraw amount more than what he holds to his credit, but only up to a certain extent. The overdraft facility is provided to current account holders and the borrower has to pledge a fixed asset from the business in order to avail such facilities. 

A d-mat account is an account that allows the investors to hold their shares and bonds in electronic form and also allows them to trade in these shares in the stock market. These types of accounts are offered by the commercial banks as a form of their agency function. Any shares purchased from the stock market are credited into this account and any shares sold in the stock market are debited from this account for a particular investor. 

Any five types of debentures for a company are:

Dr.                            Loss on Issue of 12% Debenture Account                                     Cr.

Date	Particulars	Amount (Rs.)	Date	Particulars	Amount (Rs.)
2015			2016
April 01	To 12% Debentures A/c	42,000	March 31	By Statement of Profit & Loss A/c	14,000
			March 31	By Balance c/d	28,000
		42,000			42,000
2016			2017
April 01	To Balance c/d	28,000	March 31	By Statement of Profit & Loss A/c	14,000
			March 31	By Balance c/d	14,000
		28,000			28,000
2017			2018
April 01	To Balance c/d	14,000	March 31	By Statement of Profit & Loss A/c	14,000
		14,000			14,000

A commercial bank is a financial institution which accepts deposit from people and offers loans for the purpose of consumption or investment. Commercial banks perform general utility function by providing the following facilities to its customers: 

• Issuing traveler cheque: A traveler's cheque is a medium of exchange that can be used in place of hard currency which is denominated in one of a number of major world currencies in fixed amount which is generally used by the people going on vacations to foreign countries. 
• Offering a safe deposit vault: A safe deposit vault also know as a safe deposit box is an individual secured metal container held within a larger safe which is provided to all the bank account holders of all the banks who offers such services in order to keep their valuable things like accessories and important papers safely and securely with the bank. 
• Issuing debit cards and credit cards which are electronic cards that can be used to withdraw money without going to the banks and also to make payments at the time of purchasing any goods and services. 

Commercial bank is a financial institution that\performs agency function for its customers by providing them the following basic facilities at an agreed bank charge depending on the nature of the activity:

• They collect bills, draft, cheques, etc.
• They pay the insurance premium, rent, loan installments, etc.
• They work as a representative of a customer for purchasing or redeeming different types of securities in the stock exchange.
• They also prepare income tax returns, claim tax refunds, etc. on behalf of the customers.

The primary functions of a bank includes the function of accepting deposits and granting advances i.e. accepting deposits of money from the public for the purpose of lending or investment where the depositor can demand for repay through cheque, draft, order or otherwise. These are also known as quantitative functions of a bank. 

Types of advances provided by banks to their customers are: 

Debenture is a document issued by a company as an evidence of debt to its holder, usually arising out of loan and mostly secured by charge on assets of issuing company. A person who purchases debenture of a company is called a debentureholder. Debentureholders are not the owners like shareholders but are creditors of the company. Fund contributed by debentureholders to company is borrowed funds to company received against assets. Debentureholders get fixed rate of interest irrespective of loss or profit to the company as it is compulsory to be paid as per law. They do not enjoy voting rights in the management of the company. Debenture holders being creditors of the company have to be repayed after a specified time period on its maturity.

Renewal of deposits is a process whereby the deposit holder continues with the deposit for an additional time period after the completion of the initial time period of investment.
The additional period can be similar or different from the original time period. Instead of withdrawing the deposit amount this is continued.

• Renewal of deposit must need the following procedures to be completed.

Deposits are accepted from the depositor according to the acceptance of company deposit rules and provisions of the companies Act 1956, This letter is sent by a company immediately after the deposit is received. This letter gives information regarding the amount of deposit, date of deposit, period of deposit etc. A deposit receipt is sent to the depositor along with this letter.

Increase in the bank rate will make the loans more expensive for the commercial banks; thereby pressurizing the banks to increase the rate of lending. The public capacity to take credit will gradually fall by leading to the fall in the volume of credit demanded. The reverse happens in case of a decrease in the bank rate. The increased lending capacity of banks as well as increased public demand of credit will automatically lead to a rise in the volume of the credit. 

Bank rate is an instrument at the hands of RBI to control the money supply. Increase in bank rate will make the loans more expensive for the commercial banks, therefore pressurizing the banks to increase the rate of lending. The public capacity to take credit will gradually fall leading to the fall in the volume of credit demanded. The reverse happens in case of a decrease in the bank rate. The increased lending capacity of banks as well as increased public demand for credit will automatically lead to a rise in the volume of credit. 

$$Central\space Bank$$:

1. Work for the public welfare and economic development of a country. A central bank is governed by the government of a country.

2. Controls and regulates the entries banking system of a country.

3. Does not deal directly with the public. It issue guidelines to commercial banks for the economical development of the country.

 

$$Commercial\space Bank$$:

1. Operates for Profit Motive. The Majority of Stake is held by the government as well as the private sector.

2. Operates under the direct control and supervision of the central bank. In India all the commercial banks works under the guidelines issued by RBI.

3. Deals directly with the Public. It serves the financial requirement of the public by providing short and medium terms loans and depositing and securing money that can be drawn on demand.

Given: Cash reserve ratio= 10%

In order to improve credit situation in India, it is important to provide cheap loans and credit schemes ot rural households. To set up more banks in rural remote areas, making people ware about cooperatives, SHG's. These sources must extend their services in rural areas and try to reach out to all. Providing loans with reasonable interest rate, generating greater awareness among people about formal sources so as to reduce their dependence on informal sector. It will also prevent people from getting exploited through borrowings from informal sources. To serve as building blocks for rural households. This will help people to start up their small business, or trade in certain goods. It can also help farmers to expand cultivation, to diversify their production. People can also set up small scale industries. It can certainly be a an engine of growth. 

1. Depository: -A depository can be defined as 'an institution which transfers the ownership of securities in electronic mode on behalf of its members.' A depository is a nominee of the investors, who keeps the shares on their behalf. Therefore, the depository acts as a custodian of securities 

Meaning: - Company accepts the deposits from the general public on certain terms and conditions. The deposit is accepted for a specific period which is specified in the advertisement. The rules pertaining to the repayment of deposits are also given in companies 
(Acceptance of Deposits) Rules, 1975 revised from time to time are as under. 
(A) Maintenance of Liquid Assets: - Every company should deposit or invest a sum not being less that 15% of the amount of its deposit in 
i) A current account or other deposit account with any scheduled bank or ii) In unencumbered (imaginative/ creative) securities of the central or any state government or 
iii) In unencumbered securities mentioned in Section 20 (a), (d) and (e) of the Indian Trust Act. 
iv) In unencumbered (creative) bond issued by the HDFC bank. 
(B) Repayment of Deposits: -
i) Even/ deposit received by a company should be repaid according to the terms and conditions of the deposits. 
ii) Repayment made before 6 months is not allowed. 
iii) Repayment made between 3 months and 6 months will be allowed without interest on the deposits. 
iv) Repayment after six months will be given 2% less interest than the rate of interest applicable. 
v) A company must intimate the depositor's details of maturity, at least 2 months before the deposit. 
vi) Problem companies are prohibited from making premature repayment Problem Company means a company suffering from lacunas (weak) in administrative, financial, legal aspects. 
vii) Repayment can be made after lock-in-period of 6 months by normal companies. 
viii) In case of death of depositors, premature repayment can be made during the lock-in-period. 

Meaning: -Public deposits are an important source of financing short term requirement of company. Companies generally receive public deposits for the period ranging from 6 months to 36 months. 
Advantages of Accepting Deposits: 
1.The rate of interest payable on deposits is lower than the rate of interest on loan. 
2.The deposit does not create charge on the assets of the company. 
3.It is a simple method of financing as it has very few legal complications and formalities to be fulfilled. 
4.Deposits holders are the creditors of the company. Company can collect huge amount of money without interference of deposit holders in the management of it. 

A bank is an institution which attracts money on deposit for the purpose of being lent to industry or trade. Bankers are not merely moneylenders. A bank lends what it borrows from others. A bank is a buyer and seller of money. A bank earns a margin of profit by lending money which it borrows. "Accepting deposits of money from the public for the purpose of lending and investment."

                                                                        Sunrise Industries Limited

Type of deposit	Receipt No.	Deposit  Amount	Maturity Amount	T.D.S.	Due date/ maturity date
Deposit for 12 months	83556	Rs. 20000/-	Rs. 22000/-	Nil	20th April 2012

Please find enclosed herewith a cheque of Rs.22000 bearing No. 443211 dated 20th April, 2012, drawn on bank of india, Shivaji Park branch, Dadar Mumbai - 28.

• Bonus Shares are shares distributed by a company to its current shareholders as fully paid shares free of charge.
To capitalize a part of the company's retained earnings for the conversion of its share premium account, or distribution of treasury shares. 

• Bonus issues are given to shareholders when companies are short of cash and shareholders expect a regular income.
  
Bonus shares may also be issued to restructure company reserves. Issuing bonus shares does not involve cash flow. It increases the company's share capital but not its net assets.
Companies issue bonus shares to encourage retail participation, especially when the price per share of a company is very high and it becomes tough for new investors to buy shares.

Owner's fund refers to the funds contributed by owners as well as the accumulated profit of the company. This fund is kept by the company, and it is not obliged to repay it. For example equity shares, retained earnings.

Internal sources of finance are those which are generated from within the business. Examples are funds collected from the disposal of surplus inventories, collection of receivables, ploughing back its profit, etc. External sources of funds include those sources that lie outside an organization such as supplies, lenders, and investors.

Trade credit refers to an arrangement whereby a manufacturer is granted credit from the supplier of raw material, inputs, spare parts etc. The suppliers allow their customers to pay their outstanding balance within a credit period.Trade credit is a short-term borrowing instrument with a typical length of three to six months.

Debenture includes debenture stock, bonds, or any other instrument of a company evidencing, whether constituting a charge on the assets of the company or not.

A Mortgage is a legal agreement between the lender and the borrower in which a loan is sanctioned against an immovable asset like a house or a commercial property. The lender keeps the asset as collateral until the borrower repays the total loan amount. The lender also has the right to confiscate the collateral if the borrower fails to repay the loan.

The two methods adopted by commercial banks to advance loans to the general public are as under -
(i) Overdraft - The overdraft facility is allowed to the depositor maintaining a current account with the bank. According to this facility a borrower is allowed to withdraw more amount than what he has deposited. The excess amount so withdrawn has to be repaid to the bank in a short period and that too with interest. The rate of interest is usually charged more than that charged in case of loans.
(ii) Discounting of Bills of Exchange - The banks provide financial help to the merchants and exporters by way of discounting their 'bills of exchange'. However, these merchants and exporters must be the customers of that bank. In such facility, the bank pay the amount of bill presented by the customer, after deducting the usual bank discount. This way, the customer gets the amount of the bill before the date of its maturity. As such, the bank assists its customers to a great extent by accepting their bills and providing them with liquid assets. Usually a bill matures after $$90$$ days or so and then the bank presents it to the acceptor and receives full amount of the bill.

A bill of exchange is a document acknowledging an amount of money owed in consideration of goods received. It is a paper signed by the debtor and the creditor for a fixed amount payable on a fixed date.
Example: suppose A buys goods from B, h may not pay B immediately instead give B a bill of exchange stating the amount of money owed and the time when A will settle the debt. Now, B is in need of money immediately, so he will present this bill to the bank for discounting. The bank will deduct its commission and pay B the present value of the bill. When the bill matures after the specified period, the bank will get payment from A.

 

Two agency functions of a commercial bank:
(i) Collection and making payments for credit instruments: The bank collects the payment of the bills of exchange, promissory notes, cheques etc on behalf of its customers.
(ii) Collection of Dividend - The bank collects the dividends, and interests on shares and debentures as per instructions of its customers.