Sources of Finance (Part 1) – Long Answer Questions
Medium Level (Application & Explanation)
Q1. Explain the meaning of retained earnings. How can a business use it for growth?
Answer:
Retained earnings are the part of net profits kept back in the business.
The company does not distribute this part as dividends to shareholders.
It is an internal source of finance. No borrowing is needed.
It can be used for expansion, new equipment, or emergencies.
Example: A bakery saves profit and later buys a new oven.
This builds self-reliance and reduces dependence on loans.
Q2. What is trade credit? Explain how it supports day-to-day operations of a business.
Answer:
Trade credit means buying now and paying later.
It is a short-term source, often for 30, 60, or 90 days.
The buyer gets goods without immediate cash.
It helps maintain stock and smooth operations.
It builds trust between buyer and seller.
Example: A restaurant takes supplies and pays after one month.
Q3. Describe lease financing. Why might a firm prefer leasing over buying?
Answer:
In lease financing, the lessor owns the asset.
The lessee uses it by paying regular rentals.
It avoids large lump-sum payment at the start.
Useful for machinery, vehicles, or computers.
The lessee enjoys use, but ownership stays with the lessor.
It is good when cash is tight, or need is temporary.
Q4. What are public deposits? State their features and typical use by companies.
Answer:
Public deposits are funds collected from the public by a company.
They are taken for a fixed period at an agreed interest.
They are short to medium term in nature.
They help companies raise funds without banks.
Individuals and firms can deposit and earn interest.
Example: A company advertises deposits at 8% interest for 2 years.
Q5. What is Commercial Paper (CP)? Who can issue it and for what purpose?
Answer:
Commercial Paper (CP) is an unsecured, short-term promissory note.
It is used to meet short-term financial needs.
It does not need collateral, so risk is higher for investors.
Only reputed, high credit rating companies usually issue it.
It is quick to raise and helps manage working capital.
Example: A large firm issues CP to pay suppliers on time.
High Complexity (Analysis & Scenario-Based)
Q6. A small manufacturer has no cash today but must keep production running. Choose between trade credit and public deposits. Justify your choice.
Answer:
Choose trade credit for immediate raw materials without cash.
Payment can be made in 30–90 days, so work does not stop.
Public deposits take time to advertise, collect, and process.
Trade credit also builds trust with suppliers.
It matches the need: short-term and operational.
Later, the firm can plan public deposits for larger, medium-term needs.
Q7. A bakery wants new ovens but cannot pay a lump sum. It also saved some profit last year. Suggest a financing plan using two sources and explain why.
Answer:
Use retained earnings first to reduce the total cost.
Combine with lease financing for the remaining amount.
Leasing avoids a big upfront payment.
Monthly lease rentals are easier to manage.
This mix keeps debt low and cash flow steady.
The bakery upgrades now and stays financially safe.
Q8. An NBFC wants quick funds for lending but does not want bank loans. Compare public deposits and Commercial Paper for this need.
Answer:
Public deposits: raised from the public, pay interest, need time to collect.
CP: issued by reputed firms, is unsecured, and is faster to raise.
If the NBFC has a high rating, CP can be quick for short-term needs.
Public deposits can support short to medium term and build a wider base.
CP suits urgent working capital; deposits suit planned fund pools.
Choose based on speed, rating, and tenor needed.
Q9. A startup has low profits and no credit rating. It needs money for working capital. Which sources are realistic and why? Which are not suitable?
Answer:
Suitable: Trade credit from suppliers for inventory.
Suitable: Small use of retained earnings, if any, for urgent needs.
Not suitable: Commercial Paper, since it needs high rating.
Hard: Public deposits, as trust and compliance take time.
Leasing can work for equipment, since it avoids big cash outflow.
Mix trade credit and leasing to keep operations running.
Q10. Compare retained earnings, trade credit, and leasing on cost, control, and risk. Advise a growing firm on balancing them.
Answer:
Retained earnings: no interest, no dilution, low risk. But limited by profits.
Trade credit: short-term, may have implicit cost if delayed. Builds supplier ties.
Leasing: spreads cost via rentals, keeps ownership with lessor, reduces lump-sum need.
Control stays with the firm in all three, as there is no equity involved.
Risk is lowest in retained earnings, then leasing, then trade credit if payments slip.
A growing firm should blend all three: use retained earnings first, trade credit for supplies, and leasing for assets.
