Owned Funds MCQs Quiz | Class 10
This quiz focuses on ‘Owned Funds’ for Class X, part of the ‘Elements of Business (154)’ subject, Unit II: Sources of Business Finance. It covers key concepts like Equity capital and Retained earnings. Attempt all 10 multiple-choice questions, submit your answers, and then download your personalized PDF answer sheet for review.
Understanding Owned Funds: Equity Capital and Retained Earnings
Owned funds, also known as owner’s funds or internal sources of finance, represent capital contributed by the owners of a business and profits reinvested back into the business. They form the foundational capital of any enterprise, providing stability and long-term financial strength. The two primary components of owned funds are Equity Capital and Retained Earnings.
1. Equity Capital
Equity capital is the money invested by the owners (shareholders) of a company. These shareholders are the real owners and risk-bearers of the company. They contribute capital in exchange for shares, which represent a portion of ownership.
Characteristics of Equity Capital:
- Permanent Capital: Equity capital is generally not repayable during the lifetime of the company, making it a permanent source of finance.
- Voting Rights: Equity shareholders typically have voting rights, allowing them to participate in the management and decision-making processes of the company.
- Residual Claim: They have a residual claim on income and assets, meaning they receive dividends only after all other claims (like debenture interest and preference dividends) are met, and they are repaid last during liquidation.
- Highest Risk: Equity shareholders bear the highest risk, as their returns are not fixed and depend on the company’s profitability.
Types of Shares within Equity Capital:
While ‘equity capital’ broadly refers to owners’ funds, it’s often differentiated between two main types of shares:
- Equity Shares: Represent true ownership, carry voting rights, and have variable dividends. They are the ultimate risk-bearers.
- Preference Shares: Carry a preferential right over equity shareholders regarding dividend payment (fixed rate) and repayment of capital during liquidation. They generally do not have voting rights.
Comparison of Equity Shares and Preference Shares
| Feature | Equity Shares | Preference Shares |
|---|---|---|
| Ownership | Real owners of the company | Part owners, but not real owners |
| Voting Rights | Yes, typically have voting rights | No, generally do not have voting rights |
| Dividend | Variable, depends on profits | Fixed rate, paid before equity shareholders |
| Repayment | Only at liquidation, after all claims | Repaid before equity shareholders at liquidation |
| Risk | Higher risk, residual claim | Lower risk than equity, higher than debentures |
| Capital | Permanent capital for the company | Can be redeemable after a period |
2. Retained Earnings
Retained earnings refer to a portion of the company’s net profits that are not distributed to shareholders as dividends but are kept aside and reinvested in the business. This is also popularly known as ‘ploughing back of profits’.
Characteristics of Retained Earnings:
- Internal Source: It is an internal source of finance, generated from within the business itself.
- Cheapest Source: Generally considered the cheapest source of finance as it involves no flotation costs (like brokerage, underwriting commission) or interest payments.
- No Dilution of Control: Using retained earnings for expansion does not dilute the ownership or control of existing shareholders.
- Flexibility: Management has greater flexibility in utilizing these funds for various purposes like expansion, modernization, or meeting working capital needs.
Advantages of Retained Earnings:
- No fixed obligation for interest or dividend payments.
- Enhances the company’s capacity to raise debt capital in the future.
- Increases the financial strength and stability of the company.
- Simple and convenient, as no legal formalities are involved.
Disadvantages of Retained Earnings:
- May lead to dissatisfaction among shareholders who prefer higher dividends.
- Risk of overcapitalization if funds are not utilized efficiently.
- Opportunity cost for shareholders who could have invested dividends elsewhere.
Quick Revision Points:
- Owned funds are owner-contributed capital and reinvested profits.
- Equity capital comes from shareholders, grants ownership and voting rights, and bears the highest risk.
- Retained earnings are undistributed profits reinvested, an internal and often cheapest source of finance.
- Preference shareholders have fixed dividends and prior claim but usually no voting rights.
- Both equity capital and retained earnings provide permanent, stable finance for long-term growth.
Practice Questions:
- What is another term commonly used for retained earnings?
- Name two distinct characteristics of equity capital.
- Why do preference shareholders typically receive dividends before equity shareholders?
- List a major advantage of using retained earnings for business expansion.
- Who bears the ultimate risk of ownership and business performance in a company?
