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CISCEISC (Commerce) Class 12
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Syllabus

Overview of Sources of Finance for a Joint Stock Company

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CISCE: Class 12

Key Points: Long Term Sources of Finance

  • A joint stock company needs two types of finance: long-term and short-term.
  • Long-term finance is used to buy fixed assets like land, buildings, machinery, etc.
  • Sources of long-term finance include shares, debentures, retained earnings, and long-term loans.
  • Short-term finance is needed for day-to-day requirements like stock, cash and debtors.
  • Funds are classified as owned funds (shares, retained earnings) and borrowed funds (debentures, deposits, loans).
CISCE: Class 12

Key Points: Equity Share

  • Equity shares are ownership securities and form the ownership capital of a company.
  • They carry no preferential rights in payment of dividend or repayment of capital.
  • Dividend on equity shares is paid only out of profits and after preference shareholders.
  • Equity shareholders are repaid last at winding up, so they bear the maximum risk.
  • They enjoy voting rights and control and are entitled to the residual profits of the company.
CISCE: Class 12

Key Points: Advantages and Disadvantages of Equity Share

  • No fixed dividend obligation – dividend is paid only when profits are available, so there is no burden on the company.
  • Permanent source of capital – equity capital is repaid only at winding up, but this may cause over-capitalisation.
  • Full voting rights to shareholders – gives control to owners, but may lead to manipulation of control by a few.
  • High return and capital gains possible – shareholders can earn high dividends and capital appreciation, but face high risk.
  • Costly and risky source – issuing equity shares is expensive for companies and prices fluctuate for investors.
CISCE: Class 12

Key Points: Preference Shares

  • Priority in dividend and capital – Preference shareholders get a fixed dividend before equity shareholders and their capital is repaid first at winding up.
  • Limited voting rights – Generally, preference shareholders do not have voting rights, except when dividend remains unpaid for a specified period.
  • Hybrid security – Preference shares have features of equity (dividend paid only out of profits) and debentures (fixed rate of dividend).
  • Types based on dividend and benefits – They may be cumulative or non-cumulative and participating or non-participating.
  • Types based on conversion and redemption – Preference shares can be convertible or non-convertible and redeemable (maximum period 20 years).
CISCE: Class 12

Key Points: Advantages and Disadvantages of Preference Share

  • Fixed priority return – Preference shareholders get a fixed dividend before equity shareholders and priority in repayment of capital, so risk is lower than equity.
  • No control in management – Generally, preference shares do not carry voting rights, so promoters retain control, but investors have no say.
  • No charge on assets – Issue of preference shares does not create a mortgage on company assets, improving borrowing capacity.
  • Fixed burden for company – Dividend on preference shares is payable before equity dividend and is not tax-deductible, making it costlier than debentures.
  • Limited growth benefit – Preference shareholders usually do not enjoy capital appreciation or high profits, except in participating preference shares.
CISCE: Class 12

Key Points: Distinction between Equity Shares and Preference Shares

Basis Equity Shares Preference Shares
Risk & Return High risk, variable return Lower risk, fixed return
Dividend Paid after preference shares Paid before equity shares
Refund of Capital Repaid last at winding up Repaid before equity shares
Voting Rights Full voting rights Limited / no voting rights
Appeal Risk-taking investors Cautious investors
CISCE: Class 12

Key Points: Bonus Share or Bonus Issue

  • Meaning: Bonus shares are fully paid shares issued free of cost to existing shareholders in proportion to their holdings, instead of cash dividend.
  • Purpose: Bonus issue is used to capitalise undistributed profits of the company.
  • Authorisation: Issue of bonus shares must be authorised by Articles of Association and approved by shareholders in a general meeting.
  • Conditions: Bonus shares can be issued only if the company has no default in payment of interest, debts, statutory dues, and all partly paid shares are made fully paid.
  • Source & Rules: Bonus shares are issued only from free reserves or share premium, not from revaluation reserves, and cannot replace dividend.
CISCE: Class 12

Key Points: Right Shares or Right Issue

  • Meaning: Right shares are new shares offered to existing shareholders in proportion to their holdings, usually at a price lower than the market price.
  • Legal provision: Under Section 62 of the Companies Act, 2013, a company must first offer new shares to existing shareholders (Right of Pre-emption).
  • Offer procedure: A notice is issued specifying the number of shares, and shareholders are given at least 30 days to accept the offer.
  • Shareholder options: Shareholders may accept, reject, or renounce (transfer) their right shares to someone else.
  • Exceptions: Right shares need not be offered in special cases such as early-stage issues, special resolution approval, Central Government approval, or when all shareholders decline.
CISCE: Class 12

Key Points: Distinction between Rights Shares and Bonus Shares

Basis Rights Shares Bonus Shares
Meaning New shares offered to existing shareholders for cash Free fully paid shares issued from undistributed profits
Payment Shareholders have to pay for rights shares No payment required by shareholders
Fully paid-up May be partly paid-up Always fully paid-up
Cash inflow Brings cash into the company No cash inflow to the company
Purpose Issued to raise funds for growth and expansion Issued to capitalise reserves/profits
CISCE: Class 12

Key Points: Employee Stock Option Plans (ESOP)

  • Meaning: ESOP gives employees the right to buy company shares at a fixed price (usually below market price) after meeting eligibility conditions.
  • Motivation: It links employee reward with performance and encourages better work.
  • Retention: Helps in retaining efficient employees and reduces employee turnover.
  • Ownership feeling: Creates a sense of ownership, responsibility and team spirit among employees.
  • Limitations: Useful mainly for profit-making companies; falling share prices and lack of transparency can cause losses and dissatisfaction.
CISCE: Class 12

Key Points: Sweat Equity Share

  • Meaning: Sweat equity shares are issued to employees or directors at a discount, for non-cash consideration, or for providing know-how / intellectual property.
  • Legal provision: They are issued under Section 79A of the Companies Act and must follow SEBI guidelines.
  • Approval required: Issue must be authorised by a special resolution in the general meeting specifying number, value and eligible employees/directors.
  • Eligibility conditions: Company must have completed at least one year of business and shares must be of a class already issued.
  • Purpose & restriction: Issued to retain talent; these shares cannot be sold for 3 years, and employees may choose cash instead of shares.
CISCE: Class 12

Key Points: Retained Earnings

  • Meaning: Retained earnings mean keeping a part of net profit in the business for reinvestment instead of distributing it as dividend; it is also called self-financing.
  • Source & use: It is an internal source of finance, mainly used for expansion, modernisation, debt repayment and replacement of old assets.
  • Advantages to company: It is cheap and convenient, creates no charge on assets, improves financial strength and creditworthiness, and does not dilute control.
  • Benefits to shareholders & society: Shareholders get safety, regular dividends and higher profitability, while society benefits through capital formation, stability and better quality goods.
  • Limitations: Excessive retention may cause low dividends, shareholder dissatisfaction, over-capitalisation, misuse of funds and unbalanced growth.
CISCE: Class 12

Key Points: Debentures

  • Debentures = Loan capital of a company; holders are creditors.
  • Fixed interest is paid even if there is no profit; no voting rights.
  • Secured or Unsecured: May be issued with or without charge on assets.
  • Redeemable or Irredeemable: Repaid after a fixed time or at winding up.
  • Bearer or Registered: Transferable by delivery or through records.
  • Convertible or Non-convertible: May or may not convert into shares.
  • Priority: Repaid before shareholders and legal action is possible on default.
CISCE: Class 12

Key Points: Distinction between Shares and Debentures

Basis Shares Debentures
Status of holder Owners of the company Creditors of the company
Return Dividend – paid only out of profits Fixed interest – paid even without profits
Risk High risk, unsecured Low risk, generally secured
Voting rights Carry voting rights No voting rights
Repayment Repaid last, usually on winding up Repaid before shares, as per terms
CISCE: Class 12

Key Points: Advantages and Disadvantages of Debentures

  • Safe & fixed return: Debentures provide regular fixed interest and are usually secured on assets, so they suit cautious investors.
  • Economical for company: Cost of issuing debentures is lower than shares and interest is tax-deductible.
  • No loss of control: Debentureholders have no voting rights, so management control is not diluted.
  • Fixed burden: Interest must be paid even during losses, which can strain company finances.
  • Limited investor appeal: Debentures offer no voting rights or capital appreciation, so they are unattractive to risk-taking investors.
CISCE: Class 12

Key Points: Loans From Commercial Banks

  • Meaning: Commercial banks provide short-term loans and sometimes medium/long-term loans to SSMEs as term loans.
  • Lump-sum & security: A fixed amount is given for a fixed period, usually against security or personal guarantee.
  • Advantages: Funds are available for a fixed time, allow trading on equity, and interest is tax-deductible.
  • Repayment: Loan is repaid in instalments out of future earnings of the business.
  • Disadvantages: Requires mortgage of assets, involves formalities, and interest must be paid even in losses.
CISCE: Class 12

Key Points: Loans From Financial Institutions

  • Meaning: Special financial institutions provide medium- and long-term finance for new, expanding and modernising businesses.
  • Types of finance: They provide both equity and loan capital and also offer technical and managerial support.
  • Major institutions: IFCI, IDBI, ICICI, SIDBI, LIC, GIC and State Financial Corporations are important sources.
  • Advantages: Finance is available on easy terms, with expert guidance, foreign currency loans and repayment in instalments.
  • Disadvantages: Involves strict investigation, security requirements, and sometimes restrictions on management freedom.
CISCE: Class 12

Key Points: Sources of Short-Term Finance > Public Deposits

  • Meaning: Public deposits are loans taken by companies from the public, including shareholders and employees, for a short or medium period.
  • Economical & simple: They are cheaper than bank loans, involve low formalities, and interest paid is tax-deductible.
  • No control or charge: Public deposits do not dilute ownership, give no voting rights to depositors, and usually do not create a charge on assets.
  • Flexible source: Deposits can be repaid when not needed, help in trading on equity, and are available for a longer period than bank loans.
  • Limitations: They are uncertain and risky, not available to new firms, may encourage speculation, and can restrict capital market growth.
CISCE: Class 12

Key Points: Sources of Short-Term Finance > Commercial Banks

  • Meaning: Commercial banks are a major source of short-term finance for businesses, mainly to meet working capital needs.
  • Forms of bank credit: Banks provide finance through loans and advances, cash credit, overdrafts, and discounting of bills.
  • Interest & security: Interest is charged at a fixed rate; loans are usually secured, and interest is paid only on the amount actually used in cash credit and overdrafts.
  • Advantages: Bank credit is flexible, offers various financing options, ensures secrecy, and does not interfere in business management.
  • Limitations: It involves legal formalities, security requirements, high interest, and loans are short-term with uncertain renewal.
CISCE: Class 12

Key Points: Sources of Short-Term Finance > Trade Credit

  • Meaning: Trade credit is credit given by sellers to buyers for goods and services, allowing the buyer to purchase now and pay later.
  • Nature: It is a short-term, unsecured credit, usually for 15 days to 3 months, and does not provide cash.
  • Forms: Trade credit is given through open account or bills payable.
  • Advantages: It is simple, interest-free, flexible, and more economical than bank loans.
  • Limitations: Credit prices are higher, cash discounts are lost, and sellers bear the risk of bad debts.
CISCE: Class 12

Key Points: Sources of Short-Term Finance > Instalment Credit

  • Meaning: Instalment credit allows a business to buy machinery and durable goods on credit by paying in instalments.
  • Payment system: A part of the price is paid at delivery and the balance in fixed instalments.
  • Interest: Interest is charged on the outstanding balance and is included in each instalment.
  • Ownership: In hire purchase, ownership remains with the seller until all instalments are paid.
  • Merit & Limitation: It helps firms use assets immediately and pay from earnings, but involves high interest cost.
CISCE: Class 12

Key Points: Sources of Short-Term Finance > Factoring (Accounts Receivable Financing)

  • Meaning: It is a method of raising finance by selling or pledging book debts (debtors).
  • Source: Finance companies or factors provide funds against accounts receivable.
  • Amount financed: Usually up to about 60% of receivables is advanced.
  • Factoring: Outright sale of receivables is called factoring; the factor collects debts.
  • Merit & Limitation: It reduces collection work, but is costly due to heavy discount.
CISCE: Class 12

Key Points: Sources of Short-Term Finance > Customer Advances

  • Meaning: Advance payment taken from customers at the time of booking goods.
  • Nature: It forms part of the sale price of goods to be delivered later.
  • Usage: Common for durable goods with waiting period (e.g., cars, phone connections).
  • Benefit: Provides working capital to the business before delivery.
  • Limitation: Available only to firms with high demand or short supply products.
CISCE: Class 12

Key Points: Sources of Short-Term Finance > Inter-corporate Deposits

  • Meaning: Short-term loan (up to about 6 months) taken by one company from another company.
  • Nature: ICDs are generally unsecured and arranged through a financier.
  • Procedure: No legal formalities are involved and borrower’s identity is not disclosed publicly.
  • Cost: Interest rate is usually lower than bank and financial institution loans.
  • Availability: Given only to reputed companies and based on mutual trust and personal relations.
CISCE: Class 12

Definitions: Equity Shares

  • According to the Companies Act, "a share is a share in the share capital of a company, and includes stock except where a distinction between stock and shares is expressed or implied".
  • According to Justice Farewell, "A share is the interest of the shareholders in the company measured by a sum of money for the purpose of liability and of interest (dividend). It also consists of other rights given by the Articles of Association".
CISCE: Class 12

Definition: Debentures

  • According to Evelyn Thomas, "a debenture is a document under the company's seal, which provides for the payment of a principal sum and interest thereon at regular intervals, which is usually secured by a fixed or floating change on the company's property or undertaking and which acknowledges a loan to the company".
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