Question

Mr. Anoop has been running a restaurant for last two years with his own savings. The excellent quality of food has made the restaurant popular in no time. Motivated by the success of his business, Mr. Anoop is now contemplating the idea of expanding his business. However, the money available with him from his personal sources is not sufficient to meet the expansion requirements of his business. His father suggested that he can organise the business as a company form of organisation and consider issuing of debentures which will provide him a host of benefits. He also advised him to take a bank loan to fulfil his financial requirements. He is worried and confused and has no idea, how and from where he should obtain additional funds. He also discussed the problem with his friend Swapnil, who suggested him some other sources like Equity shares, Preference shares and Debentures, which are available only to company form of organisation. He further cautions him that each method has its own advantages and limitations and his final decision should be taken with extreme rationality.

1. ‘Mr. Anoop has been running a restaurant for last two years with his own savings’. With reference to the given text, identify the source of fund employed by Mr. Anoop. Also, state its any two disadvantages. (2)
2. Out of the sources of funds suggested by Swapnil, what may be the possible reasons for not raising funds through issue of debentures?  (3)
3. Identify which type of source of funds were suggested by Mr. Anoop’s friend on the basis of duration? (1)
4. Explain the advantages of raising capital through equity shares. (2)

Answer 1

1. Source of Funds Employed by Mr. Anoop and its Disadvantages:
   
   • The source of funds employed by Mr. Anoop is Owner’s Capital/Own Savings (also called Owner’s Fund).
   • Two Disadvantages:
     1. Limited Financial Resources: Owner’s capital may not be sufficient for large-scale expansion.
     2. Risk of Personal Loss: If the business fails, the entire amount invested is at risk, potentially leading to personal financial loss.
2. Mr. Anoop may not prefer raising funds through debentures because:
   • Debentures involve fixed interest payments, even if the business is not making profits, increasing the financial burden.
   • Debentures are a form of debt, and excessive borrowing can lead to higher financial risk (risk of insolvency).
   • Debenture holders do not contribute to ownership but expect repayment of principal, which can strain cash flows.
3. The sources suggested by Swapnil (Equity Shares, Preference Shares, Debentures) are long-term sources of finance.
4. Advantages of Raising Capital Through Equity Shares:
   
   1. Permanent Capital: Equity shares provide long-term capital that does not require repayment.
   2. No Fixed Financial Obligation: The company is not bound to pay a fixed dividend; dividends are paid only when there are sufficient profits.