What is Business?

Meaning Definitions Features of Business

Human beings are continuously engaged in some activity or other in order to satisfy their unlimited wants. Every day
we come across the word 'business' or 'businessman' directly or indirectly. Business has become essential part of
modern world
Business is an economic activity, which is related with continuous and regular production and distribution of goods
and services for satisfying human wants.
All of us need food, clothing and shelter. We also have many other household requirements to be satisfied in our daily
lives. We met these requirements from the shopkeeper. The shopkeeper gets from wholesaler. The wholesaler gets
from manufacturers. The shopkeeper, the wholesaler, the manufacturer are doing business and therefore they are called
as Businessman.

Definitions of Business
Stephenson defines business as, "The regular production or purchase and sale of goods undertaken with an objective of
earning profit and acquiring wealth through the satisfaction of human wants."
According to Dicksee, "Business refers to a form of activity conducted with an objective of earning profits for the
benefit of those on whose behalf the activity is conducted."
Lewis Henry defines business as, "Human activity directed towards producing or acquiring wealth through buying and
selling of goods."
Thus, the term business means continuous production and distribution of goods and services with the aim of earning
profits under uncertain market conditions.

BUSINESS

Imagine you want to do business. Which are you interested in? For example, you want to get into InfoTech industry.
What can you do in this industry? Which one do you choose? The following are the alternatives you have on hand:

 You can bye and sell

 You can set up a small/medium/large industry to manufacture
 You can set up a workshop to repair
 You can develop software
 You can design hardware
 You can be a consultant/trouble-shooter
 If you choose any one or more of the above, you have chosen the line of activity. The next step for you is to
decide whether.
 You want to be only owner (It means you what to be sole trader) or
 You want to take some more professionals as co-owners along with you (If means you what to from partnership
with others as partners) or
 You want to be a global player by mobilizing large resources across the country/world
 You want to bring all like-minded people to share the benefits of the common enterprise (You want to promote
a joint stock company) or
 You want to involve government in the IT business (here you want to suggest government to promote a public
enterprise!)
 To decide this, it is necessary to know how to evaluate each of these alternatives.
 Factors affecting the choice of form of business organization
  Before we choose a particular form of business organization, let us study what factors affect such a choice?
The following are the factors affecting the choice of a business organization:
 Easy to start and easy to close: The form of business organization should be such that it should be easy to close.
There should not be hassles or long procedures in the process of setting up business or closing the same.
 Division of labour: There should be possibility to divide the work among the available owners.
 Large amount of resources: Large volume of business requires large volume of resources. Some forms of
business organization do not permit to raise larger resources. Select the one which permits to mobilize the large
resources.
 Liability: The liability of the owners should be limited to the extent of money invested in business. It is better if
their personal properties are not brought into business to make up the losses of the business.
 Secrecy: The form of business organization you select should be such that it should permit to take care of the
business secrets. We know that century old business units are still surviving only because they could
successfully guard their business secrets.
 Transfer of ownership: There should be simple procedures to transfer the ownership to the next legal heir.
 Ownership, Management and control: If ownership, management and control are in the hands of one or a small
group of persons, communication will be effective and coordination will be easier. Where ownership,
management and control are widely distributed, it calls for a high degree of professional’s skills to monitor the
performance of the business.
 Continuity: The business should continue forever and ever irrespective of the uncertainties in future.
 Quick decision-making: Select such a form of business organization, which permits you to take decisions
quickly and promptly. Delay in decisions may invalidate the relevance of the decisions.
 Personal contact with customer: Most of the times, customers give us clues to improve business. So choose
such a form, which keeps you close to the customers.
 Flexibility: In times of rough weather, there should be enough flexibility to shift from one business to the other.
The lesser the funds committed in a particular business, the better it is.
 Taxation: More profit means more tax. Choose such a form, which permits to pay low tax.
 These are the parameters against which we can evaluate each of the available forms of business organizations.
Features of Business
Characteristics or features of business are discussed in following points :-
1. Exchange of goods and services
All business activities are directly or indirectly concerned with the exchange of goods or services for money or
money's worth.
2. Deals in numerous transactions
In business, the exchange of goods and services is a regular feature. A businessman regularly deals in a number of
transactions and not just one or two transactions.
3. Profit is the main Objective
The business is carried on with the intention of earning a profit. The profit is a reward for the services of a
businessman.
4. Business skills for economic success
Anyone cannot run a business. To be a good businessman, one needs to have good business qualities and skills. A
businessman needs experience and skill to run a business.
5. Risks and Uncertainties
Business is subject to risks and uncertainties. Some risks, such as risks of loss due to fire and theft can be insured.
There are also uncertainties, such as loss due to change in demand or fall in price cannot be insured and must be borne
by the businessman.
6. Buyer and Seller
Every business transaction has minimum two parties that is a buyer and a seller. Business is nothing but a contract or
an agreement between buyer and seller.
7. Connected with production
Business activity may be connected with production of goods or services. In this case, it is called as industrial activity.
The industry may be primary or secondary.
8. Marketing and Distribution of goods
Business activity may be concerned with marketing or distribution of goods in which case it is called as commercial
activity.
9. Deals in goods and services
In business there has to be dealings in goods and service.
Goods may be divided into following two categories :-
Consumer goods : Goods which are used by final consumer for consumption are called consumer goods e.g. T.V.,
Soaps, etc.
Producer goods : Goods used by producer for further production are called producers goods e.g. Machinery,
equipments, etc. Services are intangible but can be exchanged for value like providing transport, warehousing and
insurance services, etc.
10. To Satisfy human wants
The businessman also desires to satisfy human wants through conduct of business. By producing and supplying various
commodities, businessmen try to promote consumer's satisfaction.
11. Social obligations
Modern business is service oriented. Modern businessmen are conscious of their social responsibility. Today's business
is service-oriented rather than profit-oriented.

SOLE TRADER
The sole trader is the simplest, oldest and natural form of business organization. It is also called sole proprietorship.
‘Sole’ means one. ‘Sole trader’ implies that there is only one trader who is the owner of the business.
It is a one-man form of organization wherein the trader assumes all the risk of ownership carrying out the business with
his own capital, skill and intelligence. He is the boss for himself. He has total operational freedom. He is the owner,
Manager and controller. He has total freedom and flexibility. Full control lies with him. He can take his own decisions.
He can choose or drop a particular product or business based on its merits. He need not discuss this with anybody. He
is responsible for himself. This form of organization is popular all over the world. Restaurants, Supermarkets, pan
shops, medical shops, hosiery shops etc.
Features
 It is easy to start a business under this form and also easy to close.
 He introduces his own capital. Sometimes, he may borrow, if necessary
 He enjoys all the profits and in case of loss, he lone suffers.
 He has unlimited liability which implies that his liability extends to his personal properties in case of
loss.
 He has a high degree of flexibility to shift from one business to the other.
  Business secretes can be guarded well
 There is no continuity. The business comes to a close with the death, illness or insanity of the sole
trader. Unless, the legal heirs show interest to continue the business, the business cannot be restored.
 He has total operational freedom. He is the owner, manager and controller.
 He can be directly in touch with the customers.
 He can take decisions very fast and implement them promptly.
 Rates of tax, for example, income tax and so on are comparatively very low.
Advantages
 The following are the advantages of the sole trader from of business organization:
 Easy to start and easy to close: Formation of a sole trader from of organization is relatively easy even closing
the business is easy.
 Personal contact with customers directly: Based on the tastes and preferences of the customers the stocks can
be maintained.
 Prompt decision-making: To improve the quality of services to the customers, he can take any decision and
implement the same promptly. He is the boss and he is responsible for his business Decisions relating to growth
or expansion can be made promptly.
 High degree of flexibility: Based on the profitability, the trader can decide to continue or change the business,
if need be.
 Secrecy: Business secrets can well be maintained because there is only one trader.
 Low rate of taxation: The rate of income tax for sole traders is relatively very low.
 Direct motivation: If there are profits, all the profits belong to the trader himself. In other words. If he works
more hard, he will get more profits. This is the direct motivating factor. At the same time, if he does not take
active interest, he may stand to lose badly also.
 Total Control: The ownership, management and control are in the hands of the sole trader and hence it is easy
to maintain the hold on business.
 Minimum interference from government: Except in matters relating to public interest, government does not
interfere in the business matters of the sole trader. The sole trader is free to fix price for his products/services if
he enjoys monopoly market.
 Transferability: The legal heirs of the sole trader may take the possession of the business.
Disadvantages
The following are the disadvantages of sole trader form:
 Unlimited liability: The liability of the sole trader is unlimited. It means that the sole trader has to bring his
personal property to clear off the loans of his business. From the legal point of view, he is not different from his
business.
 Limited amounts of capital: The resources a sole trader can mobilize cannot be very large and hence this
naturally sets a limit for the scale of operations.
 No division of labour: All the work related to different functions such as marketing, production, finance,
labour and so on has to be taken care of by the sole trader himself. There is nobody else to take his burden.
Family members and relatives cannot show as much interest as the trader takes.
 Uncertainty: There is no continuity in the duration of the business. On the death, insanity of insolvency the
business may be come to an end.
 Inadequate for growth and expansion: This from is suitable for only small size, one-man-show type of
organizations. This may not really work out for growing and expanding organizations.
 Lack of specialization: The services of specialists such as accountants, market researchers, consultants and so
 on, are not within the reach of most of the sole traders.
 More competition: Because it is easy to set up a small business, there is a high degree of competition among
the small businessmen and a few who are good in taking care of customer requirements along can service.
 Low bargaining power: The sole trader is the in the receiving end in terms of loans or supply of raw materials.
He may have to compromise many times regarding the terms and conditions of purchase of materials or
borrowing loans from the finance houses or banks.

PARTNERSHIP
Partnership is an improved from of sole trader in certain respects. Where there are like-minded persons with
resources, they can come together to do the business and share the profits/losses of the business in an agreed
ratio. Persons who have entered into such an agreement are individually called ‘partners’ and collectively
called ‘firm’. The relationship among partners is called a partnership.
Indian Partnership Act, 1932 defines partnership as the relationship between two or more persons who
agree to share the profits of the business carried on by all or any one of them acting for all.
Features
 Relationship: Partnership is a relationship among persons. It is relationship resulting out of an agreement.
 Two or more persons: There should be two or more number of persons.
 There should be a business: Business should be conducted.
 Agreement: Persons should agree to share the profits/losses of the business
 Carried on by all or any one of them acting for all: The business can be carried on by all or any one
of the persons acting for all. This means that the business can be carried on by one person who is the
agent for all other persons. Every partner is both an agent and a principal. Agent for other partners and
principal for himself. All the partners are agents and the ‘partnership’ is their principal.
The following are the other features:
 Unlimited liability: The liability of the partners is unlimited. The partnership and partners, in the eye
of law, and not different but one and the same. Hence, the partners have to bring their personal assets
to clear the losses of the firm, if any.
 Number of partners: According to the Indian Partnership Act, the minimum number of partners
should be two and the maximum number if restricted, as given below:
o 10 partners is case of banking business
o 20 in case of non-banking business
 Division of labour: Because there are more than two persons, the work can be divided among the
partners based on their aptitude.
 Personal contact with customers: The partners can continuously be in touch with the customers to
monitor their requirements.
 Flexibility: All the partners are likeminded persons and hence they can take any decision relating to
business.
Partnership Deed
The written agreement among the partners is called ‘the partnership deed’. It contains the terms and
conditions governing the working of partnership. The following are contents of the partnership deed.
 Names and addresses of the firm and partners
 Nature of the business proposed
 Duration
 Amount of capital of the partnership and the ratio for contribution by each of the partners.
  Their profit sharing ration (this is used for sharing losses also)
 Rate of interest charged on capital contributed, loans taken from the partnership and the amounts
drawn, if any, by the partners from their respective capital balances.
 The amount of salary or commission payable to any partner
 Procedure to value good will of the firm at the time of admission of a new partner, retirement of death
of a partner
 Allocation of responsibilities of the partners in the firm
 Procedure for dissolution of the firm
 Name of the arbitrator to whom the disputes, if any, can be referred to for settlement.
 Special rights, obligations and liabilities of partners(s), if any.
KIND OF PARTNERS
The following are the different kinds of partners:
 Active Partner: Active partner takes active part in the affairs of the partnership. He is also called
working partner.
 Sleeping Partner: Sleeping partner contributes to capital but does not take part in the affairs of the
partnership.
 Nominal Partner: Nominal partner is partner just for namesake. He neither contributes to capital nor
takes part in the affairs of business. Normally, the nominal partners are those who have good business
connections, and are well places in the society.
 Partner by Estoppels: Estoppels means behavior or conduct. Partner by estoppels gives an
impression to outsiders that he is the partner in the firm. In fact be neither contributes to capital, nor
takes any role in the affairs of the partnership.
 Partner by holding out: If partners declare a particular person (having social status) as partner and
this person does not contradict even after he comes to know such declaration, he is called a partner by
holding out and he is liable for the claims of third parties. However, the third parties should prove they
entered into contract with the firm in the belief that he is the partner of the firm. Such a person is
called partner by holding out.
 Minor Partner: Minor has a special status in the partnership. A minor can be admitted for the
benefits of the firm. A minor is entitled to his share of profits of the firm. The liability of a minor
partner is limited to the extent of his contribution of the capital of the firm.
Right of partners
Every partner has right
 To take part in the management of business
 To express his opinion
 Of access to and inspect and copy and book of accounts of the firm
 To share equally the profits of the firm in the absence of any specific agreement to the contrary
 To receive interest on capital at an agreed rate of interest from the profits of the firm
 To receive interest on loans, if any, extended to the firm.
 To be indemnified for any loss incurred by him in the conduct of the business
 To receive any money spent by him in the ordinary and proper conduct of the business of the firm.
Advantages
The following are the advantages of the partnership from:
 Easy to form: Once there is a group of like-minded persons and good business proposal, it is easy to
 start and register a partnership.
 Availability of larger amount of capital: More amount of capital can be raised from more number of
partners.
 Division of labour: The different partners come with varied backgrounds and skills. This facilities
division of labour.
 Flexibility: The partners are free to change their decisions, add or drop a particular product or start a
new business or close the present one and so on.
 Personal contact with customers: There is scope to keep close monitoring with customers
requirements by keeping one of the partners in charge of sales and marketing. Necessary changes can
be initiated based on the merits of the proposals from the customers.
 Quick decisions and prompt action: If there is consensus among partners, it is enough to implement
any decision and initiate prompt action. Sometimes, it may more time for the partners on strategic
issues to reach consensus.
 The positive impact of unlimited liability: Every partner is always alert about his impending danger
of unlimited liability. Hence he tries to do his best to bring profits for the partnership firm by making
good use of all his contacts.

Disadvantages:
The following are the disadvantages of partnership:
 Formation of partnership is difficult: Only like-minded persons can start a partnership. It is
sarcastically said,’ it is easy to find a life partner, but not a business partner’.
 Liability: The partners have joint and several liabilities beside unlimited liability. Joint and several
liability puts additional burden on the partners, which means that even the personal properties of
the partner or partners can be attached. Even when all but one partner become insolvent, the
solvent partner has to bear the entire burden of business loss.
 Lack of harmony or cohesiveness: It is likely that partners may not, most often work as a group
with cohesiveness. This result in mutual conflicts, an attitude of suspicion and crisis of confidence.
Lack of harmony results in delay in decisions and paralyses the entire operations.
 Limited growth: The resources when compared to sole trader, a partnership may raise little more.
But when compare to the other forms such as a company, resources raised in this form of
organization are limited. Added to this, there is a restriction on the maximum number of partners.
 Instability: The partnership form is known for its instability. The firm may be dissolved on death,
insolvency or insanity of any of the partners.
 Lack of Public confidence: Public and even the financial institutions look at the unregistered firm
with a suspicious eye. Though registration of the firm under the Indian Partnership Act is a solution
of such problem, this cannot revive public confidence into this form of organization overnight. The
partnership can create confidence in other only with their performance.
JOINT STOCK COMPANY
The joint stock company emerges from the limitations of partnership such as joint and several liability,
unlimited liability, limited resources and uncertain duration and so on. Normally, to take part in a business, it
may need large money and we cannot foretell the fate of business. It is not literally possible to get into
business with little money. Against this background, it is interesting to study the functioning of a joint stock
company. The main principle of the joint stock company from is to provide opportunity to take part in
business with a low investment as possible say Rs.1000. Joint Stock Company has been a boon for investors
with moderate funds to invest.
The word ‘ company’ has a Latin origin, com means ‘ come together’, pany means ‘ bread’, joint stock
company means, people come together to earn their livelihood by investing in the stock of company jointly.
Company Defined
Lord justice Lindley explained the concept of the joint stock company from of organization as ‘an
association of many persons who contribute money or money’s worth to a common stock and employ it for
a common purpose.

Features
This definition brings out the following features of the company:
 Artificial person: The Company has no form or shape. It is an artificial person created by law. It is
intangible, invisible and existing only, in the eyes of law.
 Separate legal existence: it has an independence existence, it separate from its members. It can
acquire the assets. It can borrow for the company. It can sue other if they are in default in payment of
dues, breach of contract with it, if any. Similarly, outsiders for any claim can sue it. A shareholder is
not liable for the acts of the company. Similarly, the shareholders cannot bind the company by their
acts.
 Voluntary association of persons: The Company is an association of voluntary association of
persons who want to carry on business for profit. To carry on business, they need capital. So they
invest in the share capital of the company.
 Limited Liability: The shareholders have limited liability i.e., liability limited to the face value of
the shares held by him. In other words, the liability of a shareholder is restricted to the extent of his
contribution to the share capital of the company. The shareholder need not pay anything, even in
times of loss for the company, other than his contribution to the share capital.
 Capital is divided into shares: The total capital is divided into a certain number of units. Each unit
is called a share. The price of each share is priced so low that every investor would like to invest in
the company. The companies promoted by promoters of good standing (i.e., known for their
reputation in terms of reliability character and dynamism) are likely to attract huge resources.
 Transferability of shares: In the company form of organization, the shares can be transferred from
one person to the other. A shareholder of a public company can cell sell his holding of shares at his
will. However, the shares of a private company cannot be transferred. A private company restricts
the transferability of the shares.
 Common Seal: As the company is an artificial person created by law has no physical form, it cannot
sign its name on a paper; so, it has a common seal on which its name is engraved. The common seal
should affix every document or contract; otherwise the company is not bound by such a document or
contract.
 Perpetual succession: ‘Members may comes and members may go, but the company continues for
ever and ever’ A. company has uninterrupted existence because of the right given to the shareholders
to transfer the shares.
 Ownership and Management separated: The shareholders are spread over the length and breadth
of the country, and sometimes, they are from different parts of the world. To facilitate
administration, the shareholders elect some among themselves or the promoters of the company as
directors to a Board, which looks after the management of the business. The Board recruits the
managers and employees at different levels in the management. Thus the management is separated
 from the owners.
 Winding up: Winding up refers to the putting an end to the company. Because law creates it, only
law can put an end to it in special circumstances such as representation from creditors of financial
institutions, or shareholders against the company that their interests are not safeguarded. The
company is not affected by the death or insolvency of any of its members.
 The name of the company ends with ‘limited’: it is necessary that the name of the company ends
with limited (Ltd.) to give an indication to the outsiders that they are dealing with the company with
limited liability and they should be careful about the liability aspect of their transactions with the
company.
Formation of Joint Stock company
There are two stages in the formation of a joint stock company. They are:
 To obtain Certificates of Incorporation
 To obtain certificate of commencement of Business
Certificate of Incorporation: The certificate of Incorporation is just like a ‘date of birth’ certificate. It
certifies that a company with such and such a name is born on a particular day.
Certificate of commencement of Business: A private company need not obtain the certificate of
commencement of business. It can start its commercial operations immediately after obtaining the certificate
of Incorporation.
The persons who conceive the idea of starting a company and who organize the necessary initial resources are called
promoters. The vision of the promoters forms the backbone for the company in the future to reckon with.
The promoters have to file the following documents, along with necessary fee, with a registrar of joint stock
companies to obtain certificate of incorporation:
 Memorandum of Association: The Memorandum of Association is also called the
charter of the company. It outlines the relations of the company with the outsiders. If
furnishes all its details in six clause such as (ii) Name clause (II) situation clause (iii)
objects clause (iv) Capital clause and (vi) subscription clause duly executed by its
subscribers.
 Articles of association: Articles of Association furnishes the byelaws or internal rules
government the internal conduct of the company.
 The list of names and address of the proposed directors and their willingness, in writing
to act as such, in case of registration of a public company.
 A statutory declaration that all the legal requirements have been fulfilled. The declaration
has to be duly signed by any one of the following: Company secretary in whole practice,
the proposed director, legal solicitor, chartered accountant in whole time practice or
advocate of High court.
The registrar of joint stock companies peruses and verifies whether all these documents are in order or not. If
he is satisfied with the information furnished, he will register the documents and then issue a certificate of
incorporation, if it is private company, it can start its business operation immediately after obtaining
certificate of incorporation.
Advantages
The following are the advantages of a joint Stock Company
1. Mobilization of larger resources: A joint stock company provides opportunity for the investors to
invest, even small sums, in the capital of large companies. The facilities rising of larger resources.
2. Separate legal entity: The Company has separate legal entity. It is registered under Indian
 Companies Act, 1956.
3. Limited liability: The shareholder has limited liability in respect of the shares held by him. In no
case, does his liability exceed more than the face value of the shares allotted to him.
4. Transferability of shares: The shares can be transferred to others. However, the private company
shares cannot be transferred.
5. Liquidity of investments: By providing the transferability of shares, shares can be converted into cash.
6. Inculcates the habit of savings and investments: Because the share face value is very low, this
promotes the habit of saving among the common man and mobilizes the same towards investments in
the company.
7. Democracy in management: the shareholders elect the directors in a democratic way in the general
body meetings. The shareholders are free to make any proposals, question the practice of the
management, suggest the possible remedial measures, as they perceive, The directors respond to the
issue raised by the shareholders and have to justify their actions.
8. Economics of large scale production: Since the production is in the scale with large funds at
9. Continued existence: The Company has perpetual succession. It has no natural end. It continues
forever and ever unless law put an end to it.
10. Institutional confidence: Financial Institutions prefer to deal with companies in view of their
professionalism and financial strengths.
11. Professional management: With the larger funds at its disposal, the Board of Directors recruits
competent and professional managers to handle the affairs of the company in a professional manner.
12. Growth and Expansion: With large resources and professional management, the company can earn
good returns on its operations, build good amount of reserves and further consider the proposals for
growth and expansion.
13. All that shines is not gold. The company from of organization is not without any disadvantages. The
following are the disadvantages of joint stock companies.
Disadvantages
1. Formation of company is a long drawn procedure: Promoting a joint stock company involves a
long drawn procedure. It is expensive and involves large number of legal formalities.
2. High degree of government interference: The government brings out a number of rules and
regulations governing the internal conduct of the operations of a company such as meetings, voting,
audit and so on, and any violation of these rules results into statutory lapses, punishable under the
companies act.
3. Inordinate delays in decision-making: As the size of the organization grows, the number of levels in
organization also increases in the name of specialization. The more the number of levels, the more is
the delay in decision-making. Sometimes, so-called professionals do not respond to the urgencies as
required. It promotes delay in administration, which is referred to ‘red tape and bureaucracy’.
4. Lack or initiative: In most of the cases, the employees of the company at different levels show slack
in their personal initiative with the result, the opportunities once missed do not recur and the company
loses the revenue.
5. Lack of responsibility and commitment: In some cases, the managers at different levels are afraid to
take risk and more worried about their jobs rather than the huge funds invested in the capital of the
company lose the revenue.
6. Lack of responsibility and commitment: In some cases, the managers at different levels are afraid to
take risk and more worried about their jobs rather than the huge funds invested in the capital of the
company. Where managers do not show up willingness to take responsibility, they cannot be
 considered as committed. They will not be able to handle the business risks.
PUBLIC ENTERPRISES
Public enterprises occupy an important position in the Indian economy. Today, public enterprises provide the
substance and heart of the economy. Its investment of over Rs.10,000 crore is in heavy and basic industry,
and infrastructure like power, transport and communications. The concept of public enterprise in Indian dates
back to the era of pre-independence.
Genesis of Public Enterprises
In consequence to declaration of its goal as socialistic pattern of society in 1954, the Government of India
realized that it is through progressive extension of public enterprises only, the following aims of our five
years plans can be fulfilled.
 Higher production
 Greater employment
 Economic equality, and
 Dispersal of economic power
The government found it necessary to revise its industrial policy in 1956 to give it a socialistic bent.
Need for Public Enterprises
The Industrial Policy Resolution 1956 states the need for promoting public enterprises as follows:
 To accelerate the rate of economic growth by planned development
 To speed up industrialization, particularly development of heavy industries and to expand public
sector and to build up a large and growing cooperative sector.
 To increase infrastructure facilities
 To disperse the industries over different geographical areas for balanced regional development
 To increase the opportunities of gainful employment
 To help in raising the standards of living
 To reducing disparities in income and wealth (By preventing private monopolies and curbing
concentration of economic power and vast industries in the hands of a small number of individuals)
Achievements of public Enterprises
The achievements of public enterprise are vast and varied. They are:
1. Setting up a number of public enterprises in basic and key industries
2. Generating considerably large employment opportunities in skilled, unskilled, supervisory and
managerial cadres.
3. Creating internal resources and contributing towards national exchequer for funds for development
and welfare.
4. Bringing about development activities in backward regions, through locations in different areas of the
country.
5. Assisting in the field of export promotion and conservation of foreign exchange.
6. Creating viable infrastructure and bringing about rapid industrialization (ancillary industries
developed around the public sector as its nucleus).
7. Restricting the growth of private monopolies
8. Stimulating diversified growth in private sector
9. Taking over sick industrial units and putting them, in most of the vases, in order,
10. Creating financial systems, through a powerful networking of financial institutions, development and
promotional institutions, which has resulted in social control and social orientation of investment,
credit and capital management systems.
 11. Benefiting the rural areas, priority sectors, small business in the fields of industry, finance, credit,
services, trade, transport, consultancy and so on.
12. Let us see the different forms of public enterprise and their features now.
Forms of public enterprises
Public enterprises can be classified into three forms:
 Departmental undertaking
 Public corporation
 Government company
These are explained below Departmental Undertaking
This is the earliest from of public enterprise. Under this form, the affairs of the public enterprise are carried
out under the overall control of one of the departments of the government. The government department
appoints a managing director (normally a civil servant) for the departmental undertaking. He will be given the
executive authority to take necessary decisions. The departmental undertaking does not have a budget of its
own. As and when it wants, it draws money from the government exchequer and when it has surplus money,
it deposits it in the government exchequer. However, it is subject to budget, accounting and audit controls.
Examples for departmental undertakings are Railways, Department of Posts, All India Radio, Doordarshan,
Defense undertakings like DRDL, DLRL, ordinance factories, and such.
Features
1. Under the control of a government department: The departmental undertaking is not an
independent organization. It has no separate existence. It is designed to work under close control of a
government department. It is subject to direct ministerial control.
2. More financial freedom: The departmental undertaking can draw funds from government account
as per the needs and deposit back when convenient.
3. Like any other government department: The departmental undertaking is almost similar to any
other government department
4. Budget, accounting and audit controls: The departmental undertaking has to follow guidelines (as
applicable to the other government departments) underlying the budget preparation, maintenance of
accounts, and getting the accounts audited internally and by external auditors.
5. More a government organization, less a business organization . The set up of a departmental
undertaking is more rigid, less flexible, slow in responding to market needs.
Advantages
1. Effective control: Control is likely to be effective because it is directly under the Ministry.
2. Responsible Executives: Normally the administration is entrusted to a senior civil servant. The
administration will be organized and effective.
3. Less scope for mystification of funds: Departmental undertaking does not draw any money more
than is needed, that too subject to ministerial sanction and other controls. So chances for mis-
utilisation are low.
4. Adds to Government revenue: The revenue of the government is on the rise when the revenue of the
departmental undertaking is deposited in the government account.

Disadvantages
1. Decisions delayed: Control is centralized. This results in lower degree of flexibility. Officials in the
lower levels cannot take initiative. Decisions cannot be fast and actions cannot be prompt.
2. No incentive to maximize earnings: The departmental undertaking does not retain any surplus with
it. So there is no inventive for maximizing the efficiency or earnings.
 3. Slow response to market conditions: Since there is no competition, there is no profit motive; there is
no incentive to move swiftly to market needs.
4. Redtapism and bureaucracy: The departmental undertakings are in the control of a civil servant and
under the immediate supervision of a government department. Administration gets delayed
substantially.
5. Incidence of more taxes: At times, in case of losses, these are made up by the government funds
only. To make up these, there may be a need for fresh taxes, which is undesirable.

Any business organization to be more successful needs to be more dynamic, flexible, and responsive to
market conditions, fast in decision marking and prompt in actions. None of these qualities figure in the
features of a departmental undertaking. It is true that departmental undertaking operates as a extension to the
government. With the result, the government may miss certain business opportunities. So as not to miss
business opportunities, the government has thought of another form of public enterprise, that is, Public
corporation.

PUBLIC CORPORATION
Having released that the routing government administration would not be able to cope up with the demand of
its business enterprises, the Government of India, in 1948, decided to organize some of its enterprises as
statutory corporations. In pursuance of this, Industrial Finance Corporation, Employees’ State Insurance
Corporation was set up in 1948.
Public corporation is a ‘right mix of public ownership, public accountability and business management for
public ends’. The public corporation provides machinery, which is flexible, while at the same time retaining
public control.
Definition
A public corporation is defined as a ‘body corporate create by an Act of Parliament or Legislature and
notified by the name in the official gazette of the central or state government. It is a corporate entity having
perpetual succession, and common seal with power to acquire, hold, dispose off property, take legal action
and be take legal action by its name”. Examples of a public corporation are Life Insurance Corporation of
India, Unit Trust of India, Industrial Finance Corporation of India, Damodar Valley Corporation and others.
Features
1. A body corporate: It has a separate legal existence. It is a separate company by itself. If can raise
resources, buy and sell properties, by name sue and be sued.
2. More freedom and day-to-day affairs: It is relatively free from any type of political interference. It
enjoys administrative autonomy.
3. Freedom regarding personnel: The employees of public corporation are not government civil
servants. The corporation has absolute freedom to formulate its own personnel policies and
procedures, and these are applicable to all the employees including directors.
4. Perpetual succession: A statute in parliament or state legislature creates it. It continues forever and
till a statue is passed to wind it up.
5. Financial autonomy: Through the public corporation is fully owned government organization, and
the initial finance are provided by the Government, it enjoys total financial autonomy, Its income and
expenditure are not shown in the annual budget of the government, it enjoys total financial autonomy.
Its income and expenditure are not shown in the annual budget of the government. However, for its
freedom it is restricted regarding capital expenditure beyond the laid down limits, and raising the
capital through capital market.
 6. Commercial audit: Except in the case of banks and other financial institutions where chartered
accountants are auditors, in all corporations, the audit is entrusted to the comptroller and auditor
general of India.
7. Run on commercial principles: As far as the discharge of functions, the corporation shall act as far
as possible on sound business principles.
Advantages
1. Independence, initiative and flexibility: The corporation has an autonomous set up. So it is
independent, take necessary initiative to realize its goals, and it can be flexible in its decisions as
required.
2. Scope for Redtapism and bureaucracy minimized: The Corporation has its own policies and
procedures. If necessary they can be simplified to eliminate redtapism and bureaucracy, if any.
3. Public interest protected: The corporation can protect the public interest by making its policies more
public friendly, Public interests are protected because every policy of the corporation is subject to
ministerial directives and board parliamentary control.
4. Employee friendly work environment: Corporation can design its own work culture and train its
employees accordingly. It can provide better amenities and better terms of service to the employees
and thereby secure greater productivity.
5. Competitive prices: the corporation is a government organization and hence can afford with
minimum margins of profit, It can offer its products and services at competitive prices.
6. Economics of scale: By increasing the size of its operations, it can achieve economics of large-scale
production.
7. Public accountability: It is accountable to the Parliament or legislature; it has to submit its annual
report on its working results.
Disadvantages
1. Continued political interference: the autonomy is on paper only and in reality, the continued.
2. Misuse of Power: In some cases, the greater autonomy leads to misuse of power. It takes time to
unearth the impact of such misuse on the resources of the corporation. Cases of misuse of power
defeat the very purpose of the public corporation.
3. Burden for the government: Where the public corporation ignores the commercial principles and
suffers losses, it is burdensome for the government to provide subsidies to make up the losses.

Government Company
Section 617 of the Indian Companies Act defines a government company as “any company in which not less
than 51 percent of the paid up share capital” is held by the Central Government or by any State Government
or Governments or partly by Central Government and partly by one or more of the state Governments and
includes and company which is subsidiary of government company as thus defined”.
A government company is the right combination of operating flexibility of privately organized companies
with the advantages of state regulation and control in public interest.
Government companies differ in the degree of control and their motive
also. Some government companies are promoted as
 industrial undertakings (such as Hindustan Machine Tools, Indian Telephone Industries, and so on)
 Promotional agencies (such as National Industrial Development Corporation, National Small
Industries Corporation, and so on) to prepare feasibility reports for promoters who want to set up
public or private companies.
 Agency to promote trade or commerce. For example, state trading corporation, Export Credit
 Guarantee Corporation and so such like.
 A company to take over the existing sick companies under private management (E.g. Hindustan Shipyard)
 A company established as a totally state enterprise to safeguard national interests such as Hindustan
Aeronautics Ltd. And so on.
 Mixed ownership company in collaboration with a private consult to obtain technical know how and
guidance for the management of its enterprises, e.g. Hindustan Cables)
Features
The following are the features of a government company:
1. Like any other registered company: It is incorporated as a registered company under the Indian
companies Act. 1956. Like any other company, the government company has separate legal existence.
Common seal, perpetual succession, limited liability, and so on. The provisions of the Indian
Companies Act apply for all matters relating to formation, administration and winding up. However,
the government has a right to exempt the application of any provisions of the government companies.
2. Shareholding: The majority of the share are held by the Government, Central or State, partly by the
Central and State Government(s), in the name of the President of India, It is also common that the
collaborators and allotted some shares for providing the transfer of technology.
3. Directors are nominated: As the government is the owner of the entire or majority of the share
capital of the company, it has freedom to nominate the directors to the Board. Government may
consider the requirements of the company in terms of necessary specialization and appoints the
directors accordingly.
4. Administrative autonomy and financial freedom: A government company functions independently
with full discretion and in the normal administration of affairs of the undertaking.
5. Subject to ministerial control: Concerned minister may act as the immediate boss. It is because it is
the government that nominates the directors, the minister issue directions for a company and he can
call for information related to the progress and affairs of the company any time.

Advantages
1. Formation is easy: There is no need for an Act in legislature or parliament to promote a government
company. A Government company can be promoted as per the provisions of the companies Act.
Which is relatively easier?
2. Separate legal entity: It retains the advantages of public corporation such as autonomy, legal entity.
3. Ability to compete: It is free from the rigid rules and regulations. It can smoothly function with all
the necessary initiative and drive necessary to complete with any other private organization. It retains
its independence in respect of large financial resources, recruitment of personnel, management of its
affairs, and so on.
4. Flexibility: A Government company is more flexible than a departmental undertaking or public
corporation. Necessary changes can be initiated, which the framework of the company law.
Government can, if necessary, change the provisions of the Companies Act. If found restricting the
freedom of the government company. The form of Government Company is so flexible that it can be
used for taking over sick units promoting strategic industries in the context of national security and
interest.
5. Quick decision and prompt actions: In view of the autonomy, the government company take
decision quickly and ensure that the actions and initiated promptly.
6. Private participation facilitated: Government company is the only from providing scope for private
participation in the ownership. The facilities to take the best, necessary to conduct the affairs of
 business, from the private sector and also from the public sector.
Disadvantages
1. Continued political and government interference: Government seldom leaves the government
company to function on its own. Government is the major shareholder and it dictates its decisions to
the Board. The Board of Directors gets these approved in the general body. There were a number of
cases where the operational polices were influenced by the whims and fancies of the civil servants and
the ministers.
2. Higher degree of government control: The degree of government control is so high that the
government company is reduced to mere adjuncts to the ministry and is, in majority of the cases, not
treated better than the subordinate organization or offices of the government.
3. Evades constitutional responsibility: A government company is creating by executive action of the
government without the specific approval of the parliament or Legislature.
4. Poor sense of attachment or commitment: The members of the Board of Management of
government companies and from the ministerial departments in their ex-officio capacity. The lack the
sense of attachment and do not reflect any degree of commitment to lead the company in a
competitive environment.
5. Divided loyalties: The employees are mostly drawn from the regular government departments for a
defined period. After this period, they go back to their government departments and hence their
divided loyalty dilutes their interest towards their job in the government company.
6. Flexibility on paper: The powers of the directors are to be approved by the concerned Ministry,
particularly the power relating to borrowing, increase in the capital, appointment of top officials,
entering into contracts for large orders and restrictions on capital expenditure. The government
companies are rarely allowed to exercise their flexibility and independence.
Sources of Finance
There are various sources of finance such as equity, debt, debentures, retained earnings, term loans, working capital
loans, letter of credit, euro issue, venture funding etc. These sources are useful in different situations. They are
classified based on time period, ownership and control, and their source of generation.
Sources of finance are the most explorable area especially for the entrepreneurs who are about to start a new business.
It is perhaps the toughest part of all the efforts. There are various sources of finance, we can classify on the basis of
time period, ownership and control, and source of generation of finance.

Having known that there are many alternatives of finance or capital, a company can choose from. Choosing right
source and the right mix of finance is a key challenge for every finance manager. The process of selecting right source
of finance involves in-depth analysis of each and every source of finance. For analyzing and comparing the sources of
finance, it needs understanding of all the characteristics of the financing sources. There are many characteristics on the
basis of which sources of finance are classified. On the basis of a time period, sources are classified into long term,
medium term, and short term. Ownership and control classify sources of finance into owned capital and borrowed
capital. Internal sources and external sources are the two sources of generation of capital. All the sources of capital
have different characteristics to suit different types of requirements. Let’s understand them in a little depth.
A business can raise funds from various sources. Each of the source has unique characteristics, which must be properly
understood so that the best available source of raising funds can be identified. There is not a single best source of funds
for all organisations. Depending on the situation, purpose, cost and associated risk, a choice may be made about the
source to be used. For example, if a business wants to raise funds for meeting fixed capital requirements, long term
funds may be required which can be raised in the form of owned funds or borrowed funds. Similarly, if the purpose is to
meet the day-to-day requirements of business, the short term sources may be tapped.
Sources of finance may be classified under various categories according to the following important heads:
1. Based on the Period
Sources of Finance may be classified under various categories based on the period. Long-term sources: Finance may
be mobilized by long-term or short-term. When the finance mobilized with large amount and the repayable over the
period will
be more than five years, it may be considered as long-term sources. Share capital,
issue of debenture, long-term loans from financial institutions and commercial banks come under this kind of source of
finance. Long-term source of finance needs to meet the capital expenditure of the firms such as purchase of fixed
assets, land and buildings, etc.
Long-term sources of finance include:
● Equity Shares
● Preference Shares
● Debenture
● Long-term Loans
● Fixed Deposits
Short-term sources: Apart from the long-term source of finance, firms can generate finance with the help of short-
term sources like loans and advances from commercial banks, moneylenders, etc. Short-term source of finance needs
to meet the operational expenditure of the business concern.
Short-term source of finance include:
● Bank Credit
● Customer Advances
● Trade Credit
● Factoring
● Public Deposits
● Money Market Instruments
2. Based on Ownership
Sources of Finance may be classified under various categories based on the period:
An ownership source of finance include
● Shares capital, earnings
● Retained earnings
● Surplus and Profits
Borrowed capital include
● Debenture
● Bonds
● Public deposits
● Loans from Bank and Financial Institutions.
3. Based on Sources of Generation
Sources of Finance may be classified into various categories based on the period.
Internal source of finance includes
● Retained earnings
● Depreciation funds
● Surplus
External sources of finance may be include
● Share capital
● Debenture
● Public deposits
● Loans from Banks and Financial institutions
4. Based in Mode of Finance Security finance may be include
● Shares capital
● Debenture
Retained earnings may include
● Retained earnings
● Depreciation funds
Loan finance may include
● Long-term loans from Financial Institutions
● Short-term loans from Commercial banks.

ACCORDING TO TIME-PERIOD:
Sources of financing a business are classified based on the time period for which the money is required. Time period is
commonly classified into following three:

LONG TERM SOURCES OF FINANCE

Long-term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years or maybe more
depending on other factors. Capital expenditures in fixed assets like plant and machinery, land and building etc of a
business are funded using long-term sources of finance. Part of working capital which permanently stays with the
business is also financed with long-term sources of finance. Long term financing sources can be in form of any of
them:

 Share Capital or Equity Shares

 Preference Capital or Preference Shares
 Retained Earnings or Internal Accruals
 Debenture / Bonds
 Term Loans from Financial Institutes, Government, and Commercial Banks
 Venture Funding
 Asset Securitization
 International Financing by way of Euro Issue, Foreign Currency Loans, ADR, GDR etc.
MEDIUM TERM SOURCES OF FINANCE
Medium term financing means financing for a period of 3 to 5 years and is used generally for two reasons. One, when
long-term capital is not available for the time being and second, when deferred revenue expenditures like
advertisements are made which are to be written off over a period of 3 to 5 years. Medium term financing sources can
in the form of one of them:

 Preference Capital or Preference Shares

 Debenture / Bonds
 Medium Term Loans from
 Financial Institutes
 Government, and
 Commercial Banks
 Lease Finance
 Hire Purchase Finance
SHORT TERM SOURCES OF FINANCE
Short term financing means financing for a period of less than 1 year. The need for short-term finance arises to finance
the current assets of a business like an inventory of raw material and finished goods, debtors, minimum cash and bank
balance etc. Short term financing is also named as working capital financing. Short term finances are available in the
form of:
 Trade Credit
 Short Term Loans like Working Capital Loans from Commercial Banks
 Fixed Deposits for a period of 1 year or less
 Advances received from customers
 Creditors
 Payables
 Factoring Services
 Bill Discounting etc.
ACCORDING TO OWNERSHIP AND CONTROL:
Sources of finances are classified based on ownership and control over the business. These two parameters are an
important consideration while selecting a source of finance for the business. Whenever we bring in capital, there are
two types of costs – one is the interest and another is sharing of ownership and control. Some entrepreneurs may not
like to dilute their ownership rights in the business and others may believe in sharing the risk.
OWNED CAPITAL
Owned capital also refers to equity capital. It is sourced from promoters of the company or from the general public by
issuing new equity shares. Promoters start the business by bringing in the required capital for a startup. Following are
the sources of Owned Capital:

 Equity Capital
 Preference Capital
 Retained Earnings
 Convertible Debentures
 Venture Fund or Private Equity
Further, when the business grows and internal accruals like profits of the company are not enough to satisfy
financing requirements, the promoters have a choice of selecting ownership capital or non-ownership capital. This
decision is up to the promoters. Still, to discuss, certain advantages of equity capital are as follows:

 It is a long term capital which means it stays permanently with the business.
 There is no burden of paying interest or installments like borrowed capital. So, the risk of bankruptcy also
reduces. Businesses in infancy stages prefer equity capital for this reason.
BORROWED CAPITAL
Borrowed capital is the capital arranged from outside sources. These include the following:

 Financial institutions,
 Commercial banks or
 The general public in case of debentures.
In this type of capital, the borrower has a charge on the assets of the business which means the company will pay the
borrower by selling the assets in case of liquidation. Another feature of borrowed capital is regular payment of fixed
interest and repayment of capital. Certain advantages of borrowing capital are as follows:
 There is no dilution in ownership and control of business.
 The cost of borrowed funds is low since it is a deductible expense for taxation purpose which ends up
saving on taxes for the company.
 It gives the business a leverage benefit.

ACCORDING TO SOURCE OF GENERATION:

INTERNAL SOURCES
Internal source of capital is the capital which is generated internally from the business. These are as follows:

 Retained profits
 Reduction or controlling of working capital
 Sale of assets etc.
The internal source has the same characteristics of owned capital. The best part of the internal sourcing of capital is
that the business grows by itself and does not depend on outside parties. Disadvantages of both equity capital and
debt capital are not present in this form of financing. Neither ownership dilutes nor fixed obligation / bankruptcy
risk arises.

EXTERNAL SOURCES
An external source of finance is the capital generated from outside the business. Apart from the internal sources
finance, all the sources are external sources of capital.

Deciding the right source of finance is a crucial business decision taken by top-level finance managers. The wrong
source of finance increases the cost of funds which in turn would have a direct impact on the feasibility of project
under concern. Improper match of the type of capital with business requirements may go against the smooth
functioning of the business. For instance, if fixed assets, which derive benefits after 2 years, are financed through
short-term finances will create cash flow mismatch after one year and the manager will again have to look for finances
and pay the fee for raising capital again.

Period Basis
On the basis of period, the different sources of funds can be categorised into three parts. These are long-term sources,
medium-term sources and short-term sources.
The long-term sources fulfil the financial requirements of an enterprise for a period exceeding 5 years and include
sources such as shares and debentures, long-term borrowings and loans from financial institutions. Such financing is
generally required for the acquisition of fixed assets such as equipment, plant, etc.
Where the funds are required for a period of more than one year but less than five years, medium-term sources of
finance are used. These sources include borrowings from commercial banks, public deposits, lease financing and loans
from financial institutions.
Short-term funds are those which are required for a period not exceeding one year. Trade credit, loans from
commercial banks and commercial papers are some of the examples of the sources that provide funds for short duration.
Short-term financing is most common for financing of current assets such as accounts receivable and
inventories. Seasonal businesses that must build inventories in anticipation of selling requirements often need short- term
financing for the interim period between seasons. Wholesalers and manufacturers with a major portion of their assets
tied up in inventories or receivables also require large amount of funds for a short period.
 Ownership Basis
On the basis of ownership, the sources can be classified into ‘owner’s funds’ and ‘borrowed funds’. Owner’s funds
means funds that are provided by the owners of an enterprise, which may be a sole trader or partners or
shareholders of a company. Apart from capital, it also includes profits reinvested in the business. The owner’s
capital remains invested in the business for a longer duration and is not required to be refunded during the life period of the
business. Such capital forms the basis on which owners acquire their right of control of management. Issue of
equity shares and retained earnings are the two important sources from where owner’s funds can be obtained.
‘Borrowed funds’ on the other hand, refer to the funds raised through loans or borrowings. The sources for raising
borrowed funds include loans from commercial banks, loans from financial institutions, issue of debentures,
public deposits and trade credit. Such sources provide funds for a specified period, on certain terms and conditions and
have to be repaid after the expiry of that period. A fixed rate of interest is paid by the borrowers on such funds. At
times it puts a lot of burden on the business as payment of interest is to be made even when the earnings are low or
when loss is incurred. Generally, borrowed funds are provided on the security of some fixed assets.
Source of Generation Basis
Another basis of categorising the sources of funds can be whether the funds are generated from within the organisation or from
external sources. Internal sources of funds are those that are generated from within the business. A business, for example, can
generate funds internally by accelerating collection of receivables, disposing of surplus inventories and ploughing back its
profit. The internal sources of funds can fulfill only limited needs of the business.
External sources of funds include those sources that lie outside an organisation, such as suppliers, lenders,
and investors. When large amount of money is required to be raised, it is generally done through the use of external
sources. External funds may be costly as compared to those raised through internal sources. In some cases, business is
required to mortgage its assets as security while obtaining funds from external sources. Issue of debentures, borrowing
from commercial banks and financial institutions and accepting public deposits are some of the examples of
external sources of funds commonly used by business organisations.

Retained Earnings
A company generally does not distribute all its earnings amongst the shareholders as dividends. A portion of the net
earnings may be retained in the business for use in the future. This is known as retained earnings. It is a source of internal
financing or self- financing or ‘ploughing back of profits’. The profit available for ploughing back in an organisation
depends on many factors like net profits, dividend policy and age of the organisation.

Merits
The merits of retained earning as a source of finance are as follows:
(i) Retained earnings is a permanent source of funds available to an organisation;
(ii) It does not involve any explicit cost in the form of interest, dividend or floatation cost;
(iii) As the funds are generated internally, there is a greater degree of operational freedom and flexibility;
(iv) It enhances the capacity of the business to absorb unexpected losses;
(v) It may lead to increase in the market price of the equity shares of a company.

Limitations
Retained earning as a source of funds has the following limitations:
(i) Excessive ploughing back may cause dissatisfaction amongstthe shareholders as they would get lower dividends;
(ii) It is an uncertain source of funds as the profits of business are fluctuating;
(iii) The opportunity cost associated with these funds is not recognised by many firms. This may lead to sub-optimal use of
the funds.
 Trade Credit
Trade credit is the credit extended by one trader to another for the purchase of goods and services. Trade credit
facilitates the purchase of supplies without immediate payment. Such credit appears in the records of the buyer of
goods as ‘sundry creditors’ or ‘accounts payable’. Trade credit is commonly used by business organisations as a
source of short-term financing. It is granted to those customers who have reasonable amount of financial standing and
goodwill. The volume and period of credit extended depends on factors such as reputation of the purchasing firm, financial
position of the seller, volume of purchases, past record of payment and degree of competition in the market. Terms of
trade credit may vary from one industry to another and from one person to another. A firm may also offer different credit
terms to different customers.

Merits
The important merits of trade credit are as follows:
(i) Trade credit is a convenient and continuous source of funds;
(ii) T rade credit may be readily available in case the credit worthiness of the customers is known to the seller;
(iii) Trade credit needs to promote the sales of an organisation;
(iv) If an organisation wants to increase its inventory level in order to meet expected rise in the sales volume in the near future, it
may use trade credit to, finance the same;
(v) It does not create any charge on the assets of the firm while providing funds.

Limitations
Trade credit as a source of funds has certain limitations, which are given as follows:
(i) Availability of easy and flexible trade credit facilities may induce a firm to indulge in overtrading, which may add to the
risks of the firm;
(ii) Only limited amount of funds can be generated through trade credit;
(iii) It is generally a costly source of funds as compared to most other sources of raising money.
Factoring
Factoring is a financial service under which the ‘factor’ renders various services which includes:
(a)Discounting of bills (with or without recourse) and collection of the client’s debts. Under this, the receivables on account of
sale of goods or services are sold to the factor at a certain discount. The factor becomes responsible for all credit
control and debt collection from the buyer and provides protection against any bad debt losses to the firm. There are two
methods of factoring — recourse and non-recourse. Under recourse factoring, the client is not protected against the
risk of bad debts. On the other hand, the factor assumes the entire credit risk under non-recourse factoring i.e., full amount
of invoice is paid to the client in the event of the debt becoming bad.
(b) Providing information about credit worthiness of prospective client’s etc., Factors hold large amounts
of information about the trading histories of the firms. This can be valuable to those who are using factoring
services and can thereby avoid doing business with customers having poor payment record. Factors may also offer relevant
consultancy services in the areas of finance, marketing, etc.
The factor charges fees for the services rendered. Factoring appeared on the Indian financial scene only in the
early nineties as a result of RBI initiatives. The organisations that provides such services include SBI Factors and
Commercial Services Ltd., Canbank Factors Ltd., Foremost Factors Ltd., State Bank of India, Canara Bank, Punjab
National Bank, Allahabad Bank. In addition, many non-banking finance companies and other agencies provide factoring
service.
Merits
The merits of factoring as a source of finance are as follows:
 (i) Obtaining funds through factoring is cheaper than financing through other means such as bank credit;
(ii) With cash flow accelerated by factoring, the client is able to meet his/her liabilities promptly as and when these arise;
(iii) Factoring as a source of funds is flexible and ensures a definite pattern of cash inflows from credit sales. It provides
security for a debt that a firm might otherwise be unable to obtain;
(iv) It does not create any charge on the assets of the firm;
(v) The client can concentrate on other functional areas of business as the responsibility of credit control is shouldered by the
factor.
Limitations
The limitations of factoring as a source of finance are as follows:
(i) This source is expensive when the invoices are numerous and smaller in amount;
(ii) The advance finance provided by the factor firm is generally available at a higher interest cost than the usual rate of interest;
(iii) The factor is a third party to the customer who may not feel comfortable while dealing with it.

Lease Financing
A lease is a contractual agreement whereby one party i.e., the owner of an asset grants the other party the right to use the
asset in return for a periodic payment. In other words it is a renting of an asset for some specified period. The owner of
the assets is called the ‘lessor’ while the party that uses the assets is known as the ‘lessee’ (see Box A). The lessee pays
a fixed periodic amount called lease rental to the lessor for the use of the asset. The terms and conditions regulating the
lease arrangements are given in the lease contract. At the end of the lease period, the asset goes back to the lessor. Lease
finance provides an important means of modernisation and diversification to the firm. Such type of financing is more
prevalent in the acquisition of such assets as computers and electronic equipment which become obsolete quicker
because of the fast changing technological developments. While making the leasing decision, the cost of leasing an
asset must be compared with the cost of owning the same.

Merits
The important merits of lease financing are as follows:
(i) It enables the lessee to acquire the asset with a lower investment;
(ii) Simple documentation makes it easier to finance assets;
(iii) Lease rentals paid by the lessee are deductible for computing taxable profits;
(iv) It provides finance without diluting the ownership or control of business;
(v) The lease agreement does not affect the debt raising capacity of an enterprise;
(vi) The risk of obsolescence is borne by the lesser. This allows greater flexibility to the lessee to replace the asset.

Limitations
The limitations of lease financing are given as below:
(i) A lease arrangement may impose certain restrictions on the use of assets. For example, it may not allow the lessee to
make any alteration or modification in the asset;
(ii) The normal business operations may be affected in case the lease is not renewed;
(iii) It may result in higher payout obligation in case the equipment is not found useful and the lessee opts for premature
termination of the lease agreement; and
(iv) The lessee never becomes the owner of the asset. It deprives him of the residual value of the asset.

Public Deposits
The deposits that are raised by organisations directly from the public are known as public deposits. Rates of interest
offered on public deposits are usually higher than that offered on bank deposits. Any person who is interested in
 depositing money in an organisation can do so by filling up a prescribed form. The organisation in return issues a
deposit receipt as acknowledgment of the debt. Public deposits can take care of both medium and short-term financial
requirements of a business. The deposits arebeneficial to both the depositor as well as to the organisation. While
the depositors get higher interest rate than that offered by banks, the cost of deposits to the company is less than the
cost of borrowings from banks. Companies generally invite public deposits for a period upto three years. The
acceptance of public deposits is regulated by the Reserve Bank of India.
Merits
The merits of public deposits are:
(i) The procedure of obtaining deposits is simple and does not contain restrictive conditions as are generally there in a loan
agreement;
(ii) Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions;
(iii) Public deposits do not usually create any charge on the assets of the company. The assets can be used as security for
raising loans from other sources;
(iv) As the depositors do not have voting rights, the control of the company is not diluted.

Limitations
The major limitation of public deposits are as follows:
(i) New companies generally find it difficult to raise funds through public deposits;
(ii) It is an unreliable source of finance as the public may not respond when the company needs money;
(iii) Collection of public deposits may prove difficult, particularly when the size of deposits required is large.

Commercial Paper (CP)

Commercial Paper emerged as a source of short term finance in our country in the early nineties. Commercial paper is an
unsecured promissory note issued by a firm to raise funds for a short period, varying from 90 days to 364 days. It is
issued by one firm to other business firms, insurance companies, pension funds and banks. The amount raised by CP is
generally very large. As the debt is totally unsecured, the firms having good credit rating can issue the CP. Its regulation
comes under the purview of the Reserve Bank of India.
The merits and limitations of a Commercial Paper are as follows:

Merits
(i) A commercial paper is sold on an unsecured basis and does not contain any restrictive conditions;
(ii) As it is a freely transferable instrument, it has high liquidity;
(iii) It provides more funds compared to other sources. Generally, the cost of CP to the issuing firm is lower than the cost of
commercial bank loans;
(iv) A commercial paper provides a continuous source of funds. This is because their maturity can be tailored to suit the
requirements of the issuing fir m. Further, maturing commercial paper can be repaid by selling new commercial
paper;
(v) Companies can park their excess funds in commercial paper thereby earning some good return on the same.

Limitations
(i) Only financially sound and highly rated firms can raise money through commercial papers. New and moderately rated
firms are not in a position to raise funds by this method;
(ii) The size of money that can be raised through commercial paper is limited to the excess liquidity available with the
suppliers of funds at a particular time;
Commercial paper is an impersonal method of financing. As such if a firm is not in a position to redeem its paper due to
 financial difficulties, extending the maturity of a CP is not possible.
Issue of Shares
The capital obtained by issue of shares is known as share capital. The capital of a company is divided into small units called
shares. Each share has its nominal value. For example, a company can issue 1,00,000 shares of Rs. 10 each for a
total value of Rs. 10,00,000. The person holding the share is known as shareholder. There are two types of shares
normally issued by a company. These are equity shares and preference shares. The money raised by issue of equity shares is
called equity share capital, while the money raised by issue of preference shares is called preference share capital.
(a) Equity Shares
Equity shares is the most important source of raising long term capital by a company. Equity shares represent the
ownership of a company and thus the capital raised by issue of such shares is known as ownership capital or owner’s
funds. Equity share capital is a prerequisite to the creation of a company. Equity shareholders do not get a fixed
dividend but are paid on the basis of earnings by the company. They are referred to as ‘residual owners’ since they receive
what is left after all other claims on the company’s income and assets have been settled. They enjoy the reward as well
as bear the risk of ownership. Their liability, however, is limited to the extent of capital contributed by them in the company.
Further, through their right to vote, these shareholders have a right to participate in the management of the company.
Merits
The important merits of raising funds through issuing equity shares are given as below:
(i) Equity shares are suitable for investors who are willing to assume risk for higher returns;
(ii) Payment of dividend to the equity shareholders is not compulsory. Therefore, there is no burden on the company in this
respect;
(iii) Equity capital serves as permanent capital as it is to be repaid only at the time of liquidation of a company. As it
stands last in the list of claims, it provides a cushion for creditors, in the event of winding up of a company;
(iv) Equity capital provides credit worthiness to the company and confidence to prospective loan providers;
(v) Funds can be raised through equity issue without creating
any charge on the assets of the company. The assets of a company are, therefore, free to be mortgaged for the purpose of
borrowings, if the need be;
(vi) Democratic control over management of the company is assured due to voting rights of equity shareholders.

Limitations
The major limitations of raising funds through issue of equity shares are as follows:
(i) Investors who want steady income may not prefer equity shares as equity shares get fluctuating returns;
(ii) The cost of equity shares is generally more as compared to the cost of raising funds through other sources;
(iii) Issue of additional equity shares dilutes the voting power, and earnings of existing equity shareholders;
(iv) More formalities and procedural delays are involved while raising funds through issue of equity share.
(b) Preference Shares
The capital raised by issue of preference shares is called preference share capital. The preference shareholders
enjoy a preferential position over equity shareholders in two ways:
(i) receiving a fixed rate of dividend, out of the net profits of the company, before any dividend is
declared for equity shareholders;and
(ii) (ii) receiving their capital after the claims of the company’s creditors have been settled, at the time
of liquidation. In other words, as compared to the equity shareholders, the preference shareholders have a
preferential claim over dividend and repayment of capital. Preference shares resemble debentures as they bear fixed rate
of return. Also as the dividend is payable only at the discretion of the directors and only out of profit after tax, to that extent,
these resemble equity shares. Thus, preference shares have some characteristics of both equity shares and debentures.
Preference shareholders generally do not enjoy any voting rights. A company can issue different types of preference
 shares (see Box B).

Box B
Types of Preference Shares
1. Cumulative and Non-Cumulative: The preference shares which enjoy the right to accumulate unpaid dividends in the future
years, in case the same is not paid during a year are known as cumulative preference shares. On the other hand, on non-
cumulative shares, dividend is not accumulated if it is not paid in a particular year.
2. Participating and Non-Participating: Preference shares which have a right to participate in the further surplus of a company
shares which after dividend at a certain rate has been paid on equity shares are called participating preference shares. The non-
participating preference are such which do not enjoy such rights of participation in the profits of the company.
3. Convertible and Non-Convertible: Preference shares that can be converted into equity shares within a specified period of time
are known as convertible preference shares. On the other hand, non-convertible shares are such that cannot be converted into
equity shares.

Merits
The merits of preference shares are given as follows:
(i) Preference shares provide reasonably steady income in the form of fixed rate of return and safety of investment;
(ii) Preference shares are useful for those investors who want fixed rate of return with comparatively low risk;
(iii) It does not affect the control of equity shareholders over the management as preference shareholders don’t have
voting rights;
(iv) Payment of fixed rate of dividend to preference shares may enable a company to declare higher rates of dividend for the
equity shareholders in good times;
(v) Preference shareholders have a preferential right of repayment over equity shareholders in the event of liquidation of a
company;
(vi) Preference capital does not create any sort of charge against the assets of a company.

Limitations
The major limitations of preference shares as source of business finance are as follows:
(i) Preference shares are not suitable for those investors who are willing to take risk and are interested in higher returns;
(ii) Preference capital dilutes the claims of equity shareholders over assets of the company;
(iii) The rate of dividend on preference shares is generally higher than the rate of interest on debentures;As the dividend on these
shares is to be paid only when the company earns profit, there is no assured return for the investors. Thus, these shares
may not be very attractive to the investors;
(iv) The dividend paid is not deductible from profits as expense. Thus, there is no tax saving as in the case of interest on
loans.

Debentures
Debentures are an important instrument for raising long term debt capital. A company can raise funds through issue
of debentures, which bear a fixed rate of interest. The debenture issued by a company is an acknowledgment that the
company has borrowed a certain amount of money, which it promises to repay at a future date. Debenture holders are,
therefore, termed as creditors of the company. Debenture holders are paid a fixed stated amount of interest at
specifiedintervals say six months or one year. Public issue of debentures requires that the issue be rated by a credit rating
agency like CRISIL (Credit Rating and Information Services of India Ltd.) on aspects like track record of the
company, its profitability, debt servicing capacity, credit worthiness and the perceived risk of lending. A company
can issue different types of debentures (see Box C and D). Issue of Zero Interest Debentures (ZID) which do not carry
any explicit rate of interest has also become popular in recent years. The difference between the face value of the
debenture and its purchase price is the return to the investor.
 Box C
Companies issuing different Debentures
Mahindra and Mahindra was the first company in India to issue convertible Zero Interest Debentures in January 1990. Recently, the
board of Titan Industries has approved the issue of partly convertible debentures on a rights basis to raise around Rs. 126.83 crore. The
issue will comprise 21 lakh partly convertible debentures of Rs. 600 each in the ratio of one partly convertible debenture for every 20
equity shares held in the company to the shareholders.

Box D
Types of Debentures
1. Secured and Unsecured: Secured debentures are such which create a charge on the assets of the company, thereby mortgaging the
assets of the company. Unsecured debentures on the other hand do not carry any charge or security on the assets of the company.
2. Registered and Bearer: Registered debentures are those which are duly recorded in the register of debenture holders maintained by
the company. These can be transferred only through a regular instrument of transfer. In contrast, the debentures which are transferable
by mere delivery are called bearer debentures.
3. Convertible and Non-Convertible: Convertible debentures are those debentures that can be converted into equity shares after
the expiry of a specified period. On the other hand, non-convertible debentures are those which cannot be converted into equity
shares.
4. First and Second: Debentures that are repaid before other debentures are repaid are known as first debentures. The second
debentures are those which are paid after the first debentures have been paid back.

Merits
The merits of raising funds through debentures are given as follows:
(i) It is preferred by investors who want fixed income at lesser risk;
(ii) Debentures are fixed charge funds and do not participate in profits of the company;
(iii) The issue of debentures is suitable in the situation when the sales and earnings are relatively stable;
(iv) As debentures do not carry voting rights, financing through debentures does not dilute control of equity
shareholders on management;Financing through debentures is less costly as compared to cost of preference or equity
capital as the interest payment on debentures is tax deductible.

Limitations
Debentures as source of funds has certain limitations. These are given as follows:
(i) As fixed charge instruments, debentures put a permanent burden on the earnings of a company. There is a
greater risk when earnings of the company fluctuate;
(ii) In case of redeemable debentures, the company has to make provisions for repayment on the specified date, even
during periods of financial difficulty;
(iii) Each company has certain borrowing capacity. With the issue of debentures, the capacity of a company to further
borrow funds reduces.

Commercial Banks
Commercial banks occupy a vital position as they provide funds for different purposes as well as for different time
periods. Banks extend loans tofirms of all sizes and in many ways, like, cash credits, overdrafts, term loans,
purchase/discounting of bills, and issue of letter of credit. The rate of interest charged by banks depends on various
factors such as the characteristics of the firm and the level of interest rates in the economy. The loan is repaid either in
lump sum or in installments.
Bank credit is not a permanent source of funds. Though banks have started extending loans for longer periods,
generally such loans are used for medium to short periods. The borrower is required to provide some security or create a
charge on the assets of the firm before a loan is sanctioned by a commercial bank.
 Merits
The merits of raising funds from a commercial bank are as follows: Banks provide timely assistance to business by
providing funds as and when needed by it.
(i) Secrecy of business can be maintained as the information supplied to the bank by the borrowers is kept
confidential;
(ii) Formalities such as issue of prospectus and underwriting are not required for raising loans from a bank. This, therefore,
is an easier source of funds;
(iii) Loan from a bank is a flexible source of finance as the loan amount can be increased according to business needs
and can be repaid in advance when funds are not needed.

Limitations
The major limitations of commercial banks as a source of finance are as follows:
(i) Funds are generally available for short periods and its extension or renewal is uncertain and difficult;
(ii) Banks make detailed investigation of the company’s affairs, financial structure etc., and may also ask for security of assets
and personal sureties. This makes the procedure of obtaining funds slightly difficult;
(iii) In some cases, difficult terms and conditions are imposed by banks. for the grant of loan. For example, restrictions may be
imposed on the sale of mortgaged goods, thus making normal business working difficult.

Financial Institutions
The government has established a number of financial institutions all over the country to provide finance to business
organisations (see Box E). These institutions are established by the central as well as state governments. They provide both
owned capital and loan capital for long and medium term requirements and supplement the traditional financial
agencies like commercial banks. As these institutions aim at promoting the industrial development of a country,
these are also called ‘development banks’. In addition to providing financial assistance, these institutions also
conduct market surveys and provide technical assistance and managerial services to people who run the enterprises.
This source of financing is considered suitable when large funds for longer duration are required for expansion,
reorganisation and modernisation of an enterprise.

Merits
The merits of raising funds through financial institutions are as follows:
(i) Financial institutions provide long- term finance, which are not provided by commercial banks;
(ii) Besides providing funds, many of these institutions provide financial, managerial and technical advice and consultancy to
business firms;
(iii) Obtaining loan from financial institutions increases the goodwill of the borrowing company in the capital market.
Consequently, such a company can raise funds easily from other sources as well;
(iv) As repayment of loan can be made in easy instalments, it does not prove to be much of a burden on the business;
(v) The funds are made available even during periods of depression, when other sources of finance are not available.

Limitations
The major limitations of raising funds from financial institutions are as given below:
(i) Financial institutions follow rigid criteria for grant of loans. Too many formalities make the procedure time consuming
and expensive;
(ii) Certain restrictions such as restriction on dividend payment are imposed on the powers of the borrowing company
by the financial institutions;
 Special Financial Institutions
1. Industrial Finance Corporation of India (IFCI): It was established in July 1948 as a statutory corporation under the
Industrial Finance Corporation Act, 1948. Its objectives include assistance towards balanced regional development
and encouraging new entrepreneurs to enter into the priority sectors of the economy. IFCI has also contributed to the
development of management education in the country.
2. State Financial Corporations (SFC): The State Financial Corporations Act, 1951 empowered the State
Governments to establish State Financial Corporations in their respective regions for providing medium and short
term finance to industries which are outside the scope of the IFCI. Its scope is wider than IFCI, since the former covers
not only public limited companies but also private limited companies, partnership firms and proprietary concerns.
3. Industrial Credit and Investment Corporation of India (ICICI): This was established in 1955 as a public limited
company under the Companies Act. ICICI assists the creation, expansion and modernisation of industrial
enterprises exclusively in the private sector. The corporation has also encouraged the participation of foreign
capital in the country.
4. Industrial Development Bank of India (IDBI): It was established in 1964 under the Industrial Development Bank of
India Act, 1964 with an objective to coordinate the activities of other financial institutions including commercial
banks. The bank performs three types of functions, namely, assistance to other financial institutions, direct assistance
to industrial concerns, and promotion and coordination of financial-technical services.
5. State Industrial Development Corporations (SIDC): Many state governments have set up State Industrial
Development Corporations for the purpose of promoting industrial development in their respective states. The
objectives of the SIDCs differ from one state to another.
6. Unit Trust of India (UTI): It was established by the Government of India in 1964 under the Unit Trust of India Act,
1963. The basic objective of UTI is to mobilise the community’s savings and channelise them into roductive
ventures. For this purpose, it sanctions direct assistance to industrial concerns, invests in their shares and
debentures, and participates with other financial institutions.
7. Industrial Investment Bank of India Ltd.: It was initially set up as a primary agency for rehabilitation of sick units
and was known as Industrial Reconstruction Corporation of India. It was reconstituted and renamed as the Industrial
Reconstruction Bank of India in 1985 and again in 1997 its name was changed to Industrial Investment Bank of India.
The Bank assists sick units in the reorganisation of their share capital, improvement in management system, and
provision of finance at liberal terms.
(iii) Life Insurance Corporation of India (LIC): LIC was set up in 1956 under the LIC Act, 1956 after nationalising 245
existing insurance companies. It mobilises the community’s savings in the form of insurance premia and makes it
available to industrial concerns, both public as well as private, in the form of direct loans and underwriting of and
subscription to shares and debentures.Financial institutions may have their nominees on the Board of Directors of
the borrowing company thereby restricting the powers of the company.

INTERNATIONAL FINANCING
In addition to the sources discussed above, there are various avenues for organisations to raise funds
internationally. With the opening up of an economy and the operations of the business organisations becoming global,
Indian companies have an access to funds in global capital market. Various international sources from where funds may
be generated include:
(i) Commercial Banks: Commercial banks all over the world extend foreign currency loans for business
purposes. They are an important source of financing non-trade international operations. The types of loans and
services provided by banks vary from country to country. For example, Standard Chartered emerged as a major
source of foreign currency loans to the Indian industry.
(ii) International Agencies and Development Banks: A number of international agencies
 and development banks have emerged over the years to finance international trade and business. These bodies provide
long and medium term loans and grants to promote the development of economically backward areas in the world.
These bodies were set up by the Governments of developed countries of the world at national, regional and international
levels for funding various projects. The more notable among them include International Finance Corporation (IFC),
EXIM Bank and Asian Development Bank.
(iii) International Capital Markets: Modern organisations including multinational companies depend upon
sizeable borrowings in rupees as well as in foreign currency. Prominent financial instruments used for this purpose
are:
(a) Global Depository Receipts (GDR’s): The local currency shares of a company are delivered to the depository
bank. The depository bank issues depository receipts against these shares. Such depository receipts denominated in
US dollars are known as Global Depository Receipts (GDR). GDR is a negotiable instrument and can be traded freely like
any other security. In the Indian context, a GDR is an instrument issued abroad by an Indian company to raise funds in
some foreign currency and is listed and traded on a foreign stock exchange. A holder of GDR can at any time convert it
into the number of shares it represents. The holders of GDRs do not carry any voting rights but only dividends and
capital appreciation. Many Indian companies such as Infosys, Reliance, Wipro and ICICI have raised money
through issue of GDRs (see Box F).
(b) American Depository Receipts (ADR’s): The depository receipts issued by a company in the USA are known as
American Depository Receipts. ADRs are bought and sold
in American markets like regular stocks. It is similar to a GDR except that it can be issued only to American citizens
and can be listed and traded on a stock exchange of USA.
(c) Foreign Currency Convertible Bonds (FCCB’s): Foreign currency convertible bonds are equity linked debt
securities that are to be converted into equity or depository receipts after a specific period. Thus, a holder of FCCB has
the option of either converting them into equity shares at a predetermined price or exchange rate, or retaining the
bonds. The FCCB’s are issued in a foreign currency and carry a fixed interest rate which is lower than the rate of any other
similar non- convertible debt instrument. FCCB’s are listed and traded in foreign stock exchanges. FCCB’s are very
similar to the convertible debentures issued in India.

FACTORS AFFECTING THE CHOICE OF THE SOURCE OF FUNDS

Financial needs of a business are of different types — long term, short term, fixed and fluctuating. Therefore, business
firms resort to different types of sources for raising funds. Short-term borrowings offer the benefit of reduced cost due to
reduction of idle capital, but long – term borrowings are considered a necessity on many grounds. Similarly equity capital
has a role to play in the scheme for raising funds in the corporate sector.
As no source of funds is devoid of limitations, it is advisable to use a combination of sources, instead of relying
only on a single source. A number of factors affect the choice of this combination, making it a very complex decision
for the business. The factors that affect the choice of source of finance are briefly discussed below:
(i) Cost: There are two types of cost viz., the cost of procurement of funds and cost of utilising the funds. Both these
costs should be taken into account while deciding about the source of funds that will be used by an organisation.
(ii) Financial strength and stability of operations: The financial strength of a business is also a key determinant. In
the choice of source of funds business should be in a sound financial position so as to be able to repay the principal
amount and interest on the borrowed amount. When the earnings of the organisation are not stable, fixed charged funds
like preference shares and debentures should be carefully selected as these add to the financial burden of the
organisation.
(iii) Form of organisation and legal status: The form of business organisation and status influences the choice
of a source for raising money. A partnership firm, for example, cannot raise money by issue of equity shares as these can
be issued only by a joint stock company.
(iv)Purpose and time period: Business should plan according to the time period for which the funds are required.
A short-term need for example can be met through borrowing funds at low rate of interest through trade credit,
commercial paper, etc. For long term finance, sources such as issue of shares and debentures are more appropriate.
Similarly, the purpose for which funds are required need to be considered so that the source is matched with the use.
For example, a long-term business expansion plan should not be financed by a bank overdraft which will be
required to be repaid in the short term.
(v) Risk profile: Business should evaluate each of the source of finance in terms of the risk involved. For
example, there is a least risk in equity as the share capital has to be repaid only at the time of winding up and dividends
need not be paid if no profits are available. A loan on the other hand, has a repayment schedule for both the principal and the
interest. The interest is required to be paid irrespective of the firm earning a profit or incurring a loss.
(vi) Control: A particular source of fund may affect the control and power of the owners on the management of a firm.
Issue of equity shares may mean dilution of the control. For example, as equity share holders enjoy voting rights,
financial institutions may take control of the assets or impose conditions as part of the loan agreement. Thus,
business firm should choose a source keeping in mind the extent to which they are willing to share their control over
business.
(vii) Effect on credit worthiness: The dependence of business on certain sources may affect its credit worthiness in the
market. For example, issue of secured debentures may affect the interest of unsecured creditors of the company and
may adversely affect their willingness to extend further loans as credit to the company.
(viii) Flexibility and ease: Another aspect affecting the choice of a source of finance is the flexibility and ease of
obtaining funds. Restrictive provisions, detailed investigation and documentation in case of borrowings from banks
and financial institutions for example may be the reason that a business organisations may not prefer it, if other options
are readily available.
(ix) Tax benefits: Various sources may also be weighed in terms of their tax benefits. For example, while the
dividend on preference shares is not tax deductible, interest paid on debentures and loan is tax deductible and may,
therefore, be preferred by organisations seeking tax advantage.