BUSINESS STUDIES – CHAPTER -21 - ANSWERS
BUSINESS FINANCE – NEEDS AND SOURCES
Total Marks 30
I.
The table given below shows the expenditure incurred by a company during the
month of May 2019.
Purchase of Factory building
Payment to suppliers
Salary paid Electricity and water charges for the factory Purchase of Machinery Purchase of Vehicles Gym equipment Maintenance cost Fuel expenses Rent paid for storage facility Miscellaneous expenses Insurance and Taxes paid a. You are asked to classify the following expenditures into Revenue expenditure and
Capital expenditure.
(Marks 6)
REVENUE EXPENSES
CAPITAL EXPENSES
Payment to suppliers
Purchase of Factory building
Salary paid
Purchase of Machinery
Electricity and water charges
Purchase of Vehicles
Maintenance cost
Gym equipment
Fuel expenses
Rent paid for storage facility
Miscellaneous expenses
Insurance and Taxes paid
II.
The following is an extract from the financial records of Baton Inc.
Factory equipment - $ 55,000/Stock of goods - $ 50,000/Cash in hand and at bank - $ 15,000/Creditors (Accounts payable) - $ 25,000/Deferred expenses - $ 12,000/Prepaid Insurance - $ 2,000/Debtors (Accounts receivable) - $ 35,000/Short term loans/ overdrafts - $ 20,000/Long term loans - $ 80,000/a. From the extract given above calculate the working capital that is available in the
business?
(Marks 6)
Working Capital = Current assets – Current liabilities
Current assets =
Stock of goods - $ 50,000/Cash in hand and at bank - $ 15,000/Prepaid Insurance - $ 2,000/Debtors (Accounts receivable) - $ 35,000/Current assets = $ 102,000/Current liabilities =
Creditors (Accounts payable) - $ 25,000/Deferred expenses - $ 12,000/Short term loans/ overdrafts - $ 20,000/Current liabilities = $ 57,000/Therefore Working Capital = Current assets – Current liabilities
Working Capital = 102,000 – 57,000 = $ 45,000/-
III.
Arun and Ashok, together decided to start a partnership business. Arun is confident
that both of them together will be able to raise $ 150,000/-, which is good enough
for the purchase of machinery and other equipment required for the business. But
Ashok said this money will not be sufficient to run the business and he suggested
different ways to raise money for the smooth functioning of the business.
a. Do you think Ashok is right when he said the business needs more money? If yes,
please explain the reasons and what are the different ways of raising money that
would have been suggested by Ashok?
(Marks 4)
Yes, Ashok is right because the business needs more money as working capital for
meeting the day to day expenditure. The business expenses are of two types
Revenue expenditure and Capital expenditure. By raising $ 150,000/-, the business
could meet only its capital expenditure, so as Ashok told business needs more
money to meet its day to day revenue expenditures like rent, electricity and water
charges, salary, wages, cost of raw materials, transportation cost, etc.
The different ways of raising money to meet the working capital needs could be by
taking medium term bank loans, owners own funds, bringing in another partner,
Trade credits, etc. Since it is a new business the options of raising money will be
limited to the above mentioned ones.
IV.
INDAL, is a well-established, Profit making Private limited company, producing
kitchenware and utensils for the past 20 years. The Managing Director of the
company proposed an expansion plan for which the company needs to raise an
amount of $ 5 million.
a. You are asked to find out the various options that the MD can use to raise money
and which option do you think will be the ideal one for the business. Justify.
(Marks 6)
Since it is a well-established and profit making Private limited company, they have
many options to raise money for their expansion projects. More over the money
that they raise should be for a long term and the cost should be very minimum. This
money can be raised both internally and externally.
Internal source of raising money include Retained profits, sale of unwanted assets,
owners’ savings, running down on stock, etc.
External source of finance include Long term bank loan, Issue of Shares, selling of
debentures, Venture capital, leasing, etc.
The most ideal option for INDAL Company will be retained profit because neither
does not involve any cost nor it need to be paid back. The same is the case with
selling unwanted assets, running down on stock. Another advantage of these
options is that there is no threat to the ownership of the business.
The next best options will be Issue of shares as the money thus raised need not be
paid back as it is a permanent capital for the business but the owners might lose
control over the business.
If none of the above options work then the company can think of raising money
through Long term bank loans, Selling debentures, Venture capital, leasing etc. Here
the cost of money will be high as the company is bound to pay an interest for the
money which will raise the total cost and also the money thus raised need to be paid
back with in a stipulated time.
V.
TIMCO is a partnership firm doing trading business. Recently the business is facing a
working capital shortage and is finding it difficult to survive. Being the Accountant of
the firm, the partners have entrusted you with the task of raising finance to
overcome this working capital shortage.
a. What all are the different options that you could ideally find to overcome this
working capital shortage?
(Marks 4)
Working capital for a business is the life blood that sustains the business. A shortage
in working capital occurs because there is a cash flow crisis. This means that the cash
inflow is less than the cash out flow.
So to overcome this, the business will have to reduce the cash out flow by reducing
its expenditure through delaying of planned expenditures, deferred payments to
creditors, running down on stock, etc. All these options are ideal as it will not incur
further cost to the business. Also the business can think of collecting the money back
from the debtors at an early date but it might affect the sales volume in future.
Other options that the business can think of is raising money from owners’ own
savings, short term bank loans, overdrafts, factoring of debts, etc. In these options
except for owners’ savings, in all other cases the business will incur additional cost
as interest need to be paid.
VI.
The total equity of a company is $ 6,000,000/- and the total long term and short
term loans taken by the company as on date amounts to $ 2,500,000/-. Calculate the
gearing up ratio.
(Marks 4)
Total Loans = $2,500,000
Total equity = $6,000,000
Gearing ratio = (2,500,000 ÷ 6,000,000 ) 100 = 41.66%