Funds and Classification – Long Answer Questions

Medium Level (Application & Explanation)

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Fixed capital is used to buy long-term assets like land, building, and machines.
These assets stay in the business for many years.
Working capital is used for daily expenses like wages, materials, and bills.
It keeps operations smooth every day.
A business needs fixed capital to set up and working capital to run.
Both together ensure capacity and continuity of the business.

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On period basis, funds are long-term, medium-term, or short-term.
Long-term (over 5 years) funds buy land, building, and big machines.
Medium-term (1–5 years) funds buy vehicles or do renovation.
Short-term (under 1 year) funds meet daily needs and seasonal demand.
Example: Issue shares for a new plant, take a bank loan for vans, use trade credit for raw materials.
Matching the time of need with the time of funds reduces risk.

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On ownership basis, funds are owner’s funds and borrowed funds.
Owner’s funds include share capital and retained earnings. Control stays with owners. No compulsory repayment.
But it may dilute ownership (in case of new shares). Returns depend on profits.
Borrowed funds include bank loans, debentures, and public deposits. No loss of control.
But they need interest and repayment on time. This adds financial risk.
A good mix lowers cost and keeps control.

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For the factory, use long-term funds like shares, debentures, or long-term bank loans. The asset is long-lasting.
For vans (3 years), use medium-term loans or hire purchase. Life matches the loan period.
For salaries and materials, use short-term funds like trade credit, overdraft, or working capital loan.
This follows the matching principle: match fund life with asset/use life.
It reduces liquidity risk and refinancing pressure.
It also keeps cost and control balanced.

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Short-term funds need quick repayment. Long-term assets do not give fast cash inflow.
This creates a mismatch and liquidity problems.
The firm may face rollover risk if lenders refuse to extend credit.
Interest rates may rise, increasing the cost suddenly.
The firm might be forced to sell assets or cut output.
In the worst case, it may lead to default and loss of reputation.

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Shares bring owner’s funds. No fixed interest. No compulsory repayment.
But issuing shares may dilute control. Dividends depend on profits and investor expectations.
A bank loan keeps ownership intact. Interest and repayment schedule are fixed.
But loans increase financial risk and require collateral.
If control is critical and profits are stable, choose a loan.
If risk must be lower and growth is high, choose shares. A mix can balance both.

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Forecast sales and decide the stock level for the rush.
Arrange short-term funds: trade credit from suppliers and a bank overdraft.
Build stock in phases to reduce storage cost and damage risk.
Offer quick cash discounts to speed up receivables.
Keep a small cash buffer for urgent buys.
After the season, repay short-term debt fast to avoid extra interest.

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Retained earnings are owner’s funds. No interest. No repayment.
They keep control and reduce financial risk. But they may be limited and slow growth.
Public deposits are borrowed funds. They bring quick money for fixed or working capital.
But they need interest and repayment on time. There are legal rules to follow.
If internal funds are enough, prefer retained earnings.
If not, use a measured amount of public deposits with clear repayment planning.

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Renovation needs medium-term funds (1–5 years), like a term loan.
The scooter also fits medium-term funding or hire purchase.
Monthly bills need short-term sources like overdraft and trade credit.
Use some owner’s funds or retained earnings to lower debt.
Use borrowed funds where returns are clear and steady.
This mix balances cost, control, and liquidity.