Sources of Raising Capital Notes for ICSE Class 10 Commercial Studies Chapter 13

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Last Updated on December 2, 2024 by sanjjeett

Hello students, we are providing notes for ICSE class 10 commercial studies. The resources for ICSE Commercial Studies are very less. So, to help icse board students we have created chapterwise notes for class 10 commercial studies. In this article, you will find notes for ICSE Class 10 Commercial Studies Chapter 12 Capital Market. It is a part of Notes for ICSE Class 10 Commercial Studies series.

Chapter	Sources of Raising Capital
Type of Material	Notes
Board	ICSE
Class	10
Subject	Commercial Studies
Unit	Unit 3 Finance and Accounting
Useful for	Class 10 Studying Students
Notes provided	Yes
Important Link	ICSE Class 10 Commercial Studies Chapterwise Notes

Notes on Sources of Raising Capital for ICSE Class 10 Commercial Studies

Source of raising capital

1. Long term
2. Short term

Long term

1. Preference shares
2. Equity shares
3. Debenture

Short term

1. Loan from commercial bank
2. Cash credit
3. Overdraft
4. Discounting of bills

Long-term

Long-term sources of finance refer to funding that a company obtains for periods typically exceeding one year. These sources are used to finance the purchase of fixed assets, expansion projects, or other long-term investments. Examples include bank loans, bonds, equity financing, and retained earnings. They provide stability and support fo the company’s growth and development over an extended period.

Shares

Shares, also known as stocks, represent ownership in a company. When you own shares of a company, you are essentially a part owner of that company. Shares are typically bought and sold on stock exchanges, and their value can fluctuate based on various factors such as company performance, market conditions, and investor sentiment. Shareholders are entitled to a portion of the company’s profits, usually paid out as dividends, and they may also have voting rights in certain company matters depending on the type of shares they hold.

Two type of shares

1. Equity shares
2. Preference shares

Equity Shares

Equity shares, also known as common shares or ordinary shares, represent ownership in a company. Equity shareholders are part owners of the company and have a claim on its assets and earnings after all debts and preferred stock obligations have been paid off.

Here’s an example to illustrate equity shares:

Let’s say Company XYZ decides to raise capital by issuing equity shares. They offer 1,000,000 shares at $10 per share, giving the company a total equity capital of $10,000,000.
Investors who purchase these shares become equity shareholders of Company XYZ. Each shareholder now owns a portion of the company proportional to the number of shares they hold.
If Company XYZ generates profits, they may choose to distribute a portion of those profits to shareholders in the form of dividends. For example, if the company earns $2,000,000 in profits and decides to distribute $1,000,000 as dividends, each shareholder would receive a dividend payment based on the number of shares they own.

Equity

Equity shareholders also have voting rights, which allows them to participate in major company decisions such as the election of the board of directors or approving significant corporate actions.
However, equity shareholders bear the risk of the company’s performance. If the company performs poorly, the value of the shares may decrease, resulting in a loss for the shareholders. On the other hand, if the company performs well, the value of the shares may increase, providing capital appreciation for the shareholders.

Preference shares

Preference shares, also known as preferred stock, are a type of share that combines features of both equity and debt. Preference shareholders have priority over common shareholders in terms of dividend payments and assets in the event of liquidation, but they typically do not have voting rights.

Here’s an example to illustrate preference shares:

Let’s consider a fictional company called Renewable Energy Corp. It decides to issue preference shares to raise capital for a new solar energy project. The company offers 100,000 preference shares at $50 per share, aiming to raise $5,000,000 in total.

Preference shares of Renewable Energy Corp. come with the following features:

1. Fixed dividends: Preference shareholders are entitled to receive a fixed dividend payment before any dividends can be paid to common shareholders. For example, Renewable Energy Corp. may offer a dividend rate of 5% on its preference shares, which means shareholders would receive $2.50 per share annually ($50 x 5%).
2. Priority in liquidation: In the event of liquidation or bankruptcy, preference shareholders have priority over common shareholders in receiving assets. This means they would be paid out their investment amount before common shareholders receive anything.
3. No voting rights: Unlike common shareholders, preference shareholders typically do not have voting rights in corporate matters such as the election of the board of directors or major company decisions.
   Preference shares offer investors a steady income stream through fixed dividends and greater security in terms of asset priority in the event of company liquidation. However, they do not participate in the company’s growth to the same extent as common shareholders, as they do not benefit from increases in the company’s share price.

Difference between Equity and Preference share

1. Dividend Priority:

• Equity shares: Dividends on equity shares are paid out of the company’s profits after all obligations, including preference dividends, are met. They are not fixed and can vary based on the company’s performance.
• Preference shares: Preference shareholders have a fixed rate of dividend, which must be paid before any dividends can be distributed to equity shareholders. They have priority over equity shareholders in receiving dividends.

2. Voting Rights:

• Equity shares: Equity shareholders typically have voting rights in the company, allowing them to participate in decisions such as the election of the board of directors and major corporate actions.
• Preference shares: Preference shareholders usually do not have voting rights. They do not participate in corporate decision-making to the same extent as equity shareholders.

3. Risk and Return:

• Equity shares: Equity shareholders bear higher risk compared to preference shareholders. They have the potential for higher returns through capital appreciation and increased dividends if the company performs well.
• Preference shares: Preference shareholders have lower risk compared to equity shareholders. They receive fixed dividends and have priority in receiving assets in the event of liquidation, providing more security.

4. Convertible Option:

• Equity shares: Equity shares are not convertible into any other form of security.
• Preference shares: Preference shares may have the option to be converted into equity shares after a specified period or under certain conditions. This allows preference shareholders to participate in the company’s growth if desired.

5. Redemption Feature:

• Equity shares: Equity shares typically do not have a redemption feature. They represent permanent ownership in the company.
• Preference shares: Preference shares may be redeemable or have a maturity date, allowing the company to buy back the shares at a predetermined price after a specified period. This provides flexibility for the company and may offer an exit option for preference shareholders.

Debentures

Debentures are debt instruments issued by companies or governments to raise funds from investors. Essentially, when an investor purchases a debenture, they are lending money to the issuer in exchange for a promise to repay the principal amount at maturity, along with periodic interest payments.

Here’s an example to illustrate debentures:

Imagine a fictional company called GreenTech Inc. that wants to expand its operations but needs additional funds. Instead of obtaining a bank loan, GreenTech decides to issue debentures to raise capital.

GreenTech offers debentures with a face value of $1,000 each and an interest rate of 5% per annum. Investors who purchase these debentures lend $1,000 to GreenTech and receive interest payments of $50 per year ($1,000 x 5%) until the debentures mature.
The debentures issued by GreenTech are backed by the company’s assets, but they are not secured by any specific collateral. This means that if GreenTech defaults on its payments, debenture holders may have to rely solely on the company’s ability to repay the debt.

At maturity, GreenTech repays the principal amount of $1,000 to the debenture holders, completing the debt obligation.
Debentures can vary in terms of their features, such as interest rate, maturity date, and redemption provisions. They offer investors a fixed income stream through interest payments and are considered relatively safe investments compared to equity shares, as they are typically backed by the issuer’s assets. However, they still carry some level of risk, especially if the issuer faces financial difficulties.

Difference between share and debentures

1. Ownership vs. Debt:

• Shares: Shares represent ownership in a company. When an investor purchases shares, they become a part-owner of the company and have a claim on its assets and earnings.
• Debentures: Debentures are debt instruments. When an investor purchases debentures, they are lending money to the issuer (company or government) and become creditors of the issuer. The issuer promises to repay the principal amount at maturity, along with periodic interest payments.

2. Income Stream:

• Shares: Shareholders may receive dividends, which are a portion of the company’s profits distributed to shareholders. Dividends are not guaranteed and can vary based on the company’s performance.
• Debentures: Debenture holders receive fixed interest payments at regular intervals until the debentures mature. These payments are contractual obligations of the issuer and are generally guaranteed.

3. Risk and Return:

• Shares: Shareholders bear the risk of the company’s performance. They have the potential for higher returns through capital appreciation and increased dividends if the company performs well.
• Debentures: Debenture holders have a lower risk compared to shareholders. They receive fixed interest payments and have priority in receiving payments in the event of issuer default. However, their returns are typically lower compared to equity investments.

4. Voting Rights:

• Shares: Shareholders typically have voting rights in the company, allowing them to participate in corporate decision-making.
• Debentures: Debenture holders generally do not have voting rights. They do not participate in company decisions and rely solely on the issuer’s ability to fulfill its debt obligations.

5. Priority in Liquidation:

• Shares: In the event of company liquidation, shareholders are the last to receive payments after all other obligations, including debentures and creditors, are met.
• Debentures: Debenture holders have priority over shareholders in receiving payments in the event of issuer liquidation. They are considered creditors and have a higher claim on the issuer’s assets.

Short term source of raising capital

Short-term sources of raising capital refer to methods used by businesses to obtain funds for a period typically less than one year. These sources are often utilized to finance short-term operational needs, manage cash flow fluctuations, or take advantage of immediate investment opportunities.

Loan from commercial banks

Loans from commercial banks refer to funds borrowed by individuals, businesses, or governments from banks for various purposes, such as financing operations, purchasing assets, or meeting short-term financial needs.

Cash credit

Cash credit is a type of short-term loan facility provided by banks to businesses to meet their working capital needs. It allows businesses to borrow funds up to a specified limit, typically based on their creditworthiness and collateral, and repay the borrowed amount as per the terms agreed upon with the bank.

Here’s how cash credit works with an example:

Imagine a manufacturing company called Tech Components Inc. that needs funds to purchase raw materials for its production process. Instead of taking out a traditional term loan, Tech Components applies for a cash credit facility from a commercial bank.

After evaluating Tech Components’ financial health, creditworthiness, and collateral, the bank approves a cash credit limit of $500,000. This means that Tech Components can borrow up to $500,000 from the bank as needed to finance its working capital requirements.

Throughout the year, Tech Components draws funds from the cash credit facility to purchase raw materials, pay wages, and cover other operational expenses. As Tech Components utilizes the funds, it incurs interest charges on the amount borrowed.

For example, if Tech Components borrows $200,000 from the cash credit facility for two months, it would pay interest only on the amount borrowed for the duration it was utilized. The interest rate charged by the bank is typically based on prevailing market rates and the credit risk associated with Tech Components.

Tech Components is required to repay the borrowed amount within the agreed-upon timeframe, usually on a short-term basis. As Tech Components repays the borrowed funds, the available credit limit under the cash credit facility is replenished, allowing the company to borrow additional funds if needed.

Overall, cash credit provides Tech Components with flexibility in managing its working capital needs, as it can borrow funds on an as-needed basis and repay them as per its cash flow cycle. However, it’s essential for Tech Components to use the cash credit facility responsibly and manage its finances effectively to avoid overborrowing and potential financial strain.

Overdraft

An overdraft is a financial arrangement provided by banks that allows an account holder to withdraw more money from their bank account than what is available in the account. Essentially, an overdraft allows individuals or businesses to borrow funds from the bank temporarily, up to a predetermined limit, to cover short-term cash flow shortages or unexpected expenses.

Here’s how an overdraft works with an example:

Imagine a small business called Bright Retailers Inc. that maintains a checking account with a commercial bank. Due to a delay in receiving payments from customers, Bright Retailers faces a temporary cash flow shortfall and needs to pay its suppliers to restock inventory.

Instead of bouncing checks or facing declined transactions, Bright Retailers decides to utilize the overdraft facility offered by its bank. The bank has approved an overdraft limit of $10,000 for Bright Retailers’ checking account.

When Bright Retailers issues checks to pay its suppliers, causing its account balance to dip below zero, the bank automatically covers the shortfall using the overdraft facility. For example, if Bright Retailers’ account balance is $2,000, and it issues checks totaling $12,000, the bank will honor the checks and create an overdraft of $10,000.

Bright Retailers now owes the bank $10,000, plus any applicable fees or interest charges associated with the overdraft. The overdraft facility provides Bright Retailers with immediate access to funds to meet its payment obligations and maintain its operations smoothly.

As Bright Retailers’ cash flow improves and customer payments are received, it deposits funds into its checking account to reduce the overdraft balance. Bright Retailers is responsible for repaying the overdraft amount within the agreed-upon timeframe, usually subject to interest charges.

Overall, an overdraft provides businesses like Bright Retailers with flexibility in managing short- term cash flow needs, ensuring that they can meet their financial obligations without disruptions. However, it’s essential for businesses to use overdrafts responsibly and understand the associated costs and terms set by the bank.

Discounting of bill

Discounting of bills, also known as bill discounting or invoice discounting, is a financing arrangement where a business sells its accounts receivable (unpaid invoices or bills) to a financial institution (such as a bank) at a discount in exchange for immediate cash. It provides businesses with access to funds before their customers’ payments are due, helping improve cash flow and working capital management.

Here’s how discounting of bills works with an example:

Imagine a wholesale distributor called Global Electronics Ltd. that supplies electronic goods to retailers on credit terms. Global Electronics sells $50,000 worth of products to a retailer, issuing an invoice with payment terms of 60 days.

However, Global Electronics needs immediate funds to pay its suppliers and cover operating expenses. Instead of waiting 60 days for the retailer to make the payment, Global Electronics decides to discount the invoice with a bank.

1. Invoice Discounting Agreement: Global Electronics approaches a bank and enters into an agreement to discount the invoice. The bank agrees to purchase the invoice at a discount, providing Global Electronics with immediate cash.
2. Discounting Process: The bank evaluates the creditworthiness of the retailer and the quality of the invoice. Assuming the invoice meets the bank’s criteria, it offers to discount the invoice at a discount rate of 3%.
3. Calculation of Discount: The bank calculates the discount amount by multiplying the invoice value ($50,000) by the discount rate (3%). The discount amount is $1,500 ($50,000 3%).
4. Payment to Global Electronics: The bank pays Global Electronics $48,500 ($50,000 – $1,500) upfront, deducting the discount amount. This provides Global Electronics with immediate cash to meet its financial obligations.
5. Payment from Retailer: After 60 days, the retailer makes the full payment of $50,000 to the bank as per the original invoice terms.
6. Settlement with Bank: The bank receives the payment from the retailer and deducts the discounted amount ($1,500) as its fee. The remaining amount ($48,500) is paid to Global Electronics as the final settlement.

By discounting the invoice, Global Electronics was able to convert its accounts receivable into cash immediately, improving its liquidity and enabling it to meet its financial needs without waiting for customer payments. The bank earns a fee for providing the discounting service, while Global Electronics benefits from improved cash flow and working capital management.

Also check

• Sources of Raising Capital Notes for ICSE Class 10 Commercial Studies Chapter 13
• Capital Market Notes for ICSE Class 10 Commercial Studies Chapter 12
• Budgeting Notes for ICSE Class 10 Commercial Studies Chapter 11
• Costs Notes for ICSE Class 10 Commercial Studies Chapter 10
• Final accounts of Sole Proprietorship Notes for ICSE Class 10 Commercial Studies Chapter 9
• Capital and Revenue Notes for ICSE Class 10 Commercial Studies Chapter 8
• E-commerce Notes for ICSE Class 10 Commercial Studies Chapter 7
• Consumer Protection Notes for ICSE Class 10 Commercial Studies Chapter 6
• Advertising and Sales promotion Notes for ICSE Class 10 Commercial Studies Chapter 5
• Pricing Notes for ICSE Class 10 Commercial Studies Chapter 4
• ICSE Class 10 Commercial Studies Notes
• Product and Service Notes for ICSE Class 10 Commercial Studies Chapter 3
• Marketing Notes for ICSE Class 10 Commercial Studies Chapter 2
• Stakeholders in Commercial Organisations Notes for ICSE Class 10 Commercial Studies Chapter 1

Topics covered in ICSE Class 10 Commercial Studies Chapter 13 Sources of Raising Capital

13.1	Long term: Meaning of shares (Types; preference and equity) and debentures, differences between the two.
13.2	Short term: loans from commercial banks (cash credit, overdraft, discounting of bills– meaning only)

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