Business StudiesCBSE Class 11 · Sources of Business Finance

Borrowed Funds Class 11 Business Studies: Debentures, Trading on Equity, Loans, Deposits and Trade Credit

Updated 17 October 2026 · Fact-checked

Borrowed funds are repayable with fixed interest. A debenture acknowledges a debt: holders are creditors who get fixed interest whether or not there is a profit, have no voting rights, and the interest is tax-deductible. Trading on equity uses such fixed-cost funds to raise earnings per share when the return on investment is higher than the interest rate, but it raises risk in bad years. Other borrowed sources are bank and institutional loans, public deposits, trade credit and inter-corporate deposits.

When return on investment (20%) beats the interest rate (10%), borrowing lifts EPS from Rs 14 to Rs 21, but fixed interest adds risk in bad years.

Illustration drawn for QuestionBuddy.

Understand Borrowed Funds: Debentures, Trading on Equity, Loans, Public Deposits, Trade Credit and ICDs (CBSE 11)

Debentures and bonds. A debenture is an instrument acknowledging a debt of the company; holders are creditors who receive fixed interest at regular intervals whether or not there is a profit, and are repaid after a fixed period. Bonds are similar (the term is used especially for public sector and government borrowing).

*Types:* secured / unsecured (charge on assets or not); registered / bearer (names recorded or transferable by delivery); convertible / non-convertible (into equity); first / second (order of repayment on winding up).
*Merits:* fixed income at lower risk for investors; no dilution of control (no voting rights); interest is tax-deductible, so cheaper than equity; suits stable earnings; allows trading on equity.
*Limitations:* fixed obligation even in a loss; a charge on assets limits future borrowing; repayment burden at maturity; increases financial risk.

Trading on equity. Using fixed-cost funds (debentures) to raise the return to equity shareholders when the return on investment is higher than the interest rate.
EPS = profit after tax / number of equity shares; PAT = (EBIT - interest) x (1 - tax rate).

Other borrowed sources.

Loans from commercial banks: short and medium term (cash credit, overdraft, term loans), against security. Merits: timely funds, secrecy, easy, flexible. Limitations: short or medium term, security and investigation needed, restrictive terms.
Loans from financial institutions: long and medium-term finance and advice. Merits: long-term funds, advice, goodwill, funds even in depression. Limitations: rigid criteria and formalities, restrictions on dividends, may nominate directors.
Public deposits: raised directly from the public, usually for 1 to 3 years, at interest higher than bank deposits. Merits: simple, no charge on assets, no dilution of control. Limitations: difficult for new companies, unreliable for large amounts.
Trade credit: credit from suppliers (buy now, pay later). Merits: convenient, continuous, no formalities, no charge on assets. Limitations: may cause over-trading; only limited funds; costlier if cash discounts are lost.
Inter-corporate deposits (ICDs): unsecured short-term deposits by one company with another, usually up to a year. Merits: quick, few formalities. Limitations: unsecured, so risky for the lender; rates vary; regulations limit amounts.

Borrowed Funds: Debentures, Trading on Equity, Loans, Public Deposits, Trade Credit and ICDs (CBSE 11): key facts

Debenture holders: creditors not owners
fixed interest even in a loss
no voting rights
interest is tax-deductible; Cheaper than equity.
EPS: EPS = profit after tax / number of equity shares | PAT = (EBIT - interest) x (1 - tax rate); Interest is deducted before tax.
Trading on equity: works when return on investment is higher than the interest rate | risky when EBIT falls; Fixed interest is paid in bad years too.
Short-term borrowed funds: trade credit from suppliers
bank loans cash credit and overdraft
ICDs up to a year
public deposits 1 to 3 years; Fund working capital.

How to answer Borrowed Funds: Debentures, Trading on Equity, Loans, Public Deposits, Trade Credit and ICDs (CBSE 11) questions

To compare financing plans, compute EPS for each plan at the given EBIT.

1Write EBIT for each plan and subtract interest on debentures (rate x amount).
2Subtract tax on the profit before tax to get the profit after tax (assume no tax on a loss unless told).
3Divide the PAT by the number of equity shares in that plan.
4Compare the return on investment (EBIT / total capital) with the interest rate: if higher, debt helps equity holders.
5Test a low EBIT to see the risk of the fixed interest.

Borrowed Funds: Debentures, Trading on Equity, Loans, Public Deposits, Trade Credit and ICDs (CBSE 11) in real life

The idea, met in an everyday situation. Answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

A shop that buys on credit

Suppose a retailer buys stock worth 1,00,000 from a supplier with 30 days to pay, and sells most of it within 15 days.

Which source is this and what is one merit?

Try it first, then show the solutionSolution

Credit given by the supplier is trade credit.
Merit: it is convenient and continuous and needs no formalities or charge on assets.

Answer: Trade credit; easy to obtain with no charge on assets.

Memory hook: The supplier is the lender.

Tricks to remember Borrowed Funds: Debentures, Trading on Equity, Loans, Public Deposits, Trade Credit and ICDs (CBSE 11)

Short memory aids. Say each one aloud once, then use it on a question the same day.

Debenture: D for debt
Debenture holders are creditors; they are paid interest, not dividend.
Use it when: Debenture questions.
Interest before tax, dividend after
Interest is deducted before tax; dividend is paid out of profit after tax.
Use it when: Cost comparison and EPS.
Debt helps when ROI beats interest
Trading on equity pays when the return on investment exceeds the interest rate.
Use it when: Trading on equity.

Borrowed Funds: Debentures, Trading on Equity, Loans, Public Deposits, Trade Credit and ICDs (CBSE 11): solved examples

Ordered from board level to HOTS. Try each one before you open the solution.

Example 1: Who is a debenture holder · 1 mark · MCQBoard level

Debenture holders are
(a) owners of the company
(b) creditors of the company
(c) directors of the company
(d) employees of the company

Try it first, then show the solutionSolution

A debenture acknowledges a debt, so its holders are creditors who receive fixed interest.

Answer: (b) creditors of the company

Example 2: Merits of debentures · 3 marks · Short answerBoard level

State any three merits of raising funds through debentures. (3 marks)

Try it first, then show the solutionSolution

Investors who want a fixed income at lower risk prefer them.
No dilution of control, because debenture holders have no voting rights.
Interest is tax-deductible, so debentures are cheaper than equity (also suit stable earnings and allow trading on equity).

Answer: Fixed income, no loss of control, tax-deductible interest.

Example 3: Trading on equity · 5 marks · Short answerHarder board level

A company needs 20,00,000. Plan A: all equity with 2,00,000 shares of 10. Plan B: 10,00,000 of equity (1,00,000 shares) and 10,00,000 of 12% debentures. EBIT is 4,00,000 and the tax rate is 30%. Find the EPS under each plan and the return on investment. (5 marks)

Try it first, then show the solutionSolution

Plan A: interest 0; PBT 4,00,000; tax 1,20,000; PAT 2,80,000; EPS = 2,80,000 / 2,00,000 = 1.40.
Plan B: interest = 12% of 10,00,000 = 1,20,000; PBT 2,80,000; tax 84,000; PAT 1,96,000; EPS = 1,96,000 / 1,00,000 = 1.96.
Return on investment = 4,00,000 / 20,00,000 = 20%, which is higher than the 12% interest, so debt raises EPS.

Answer: EPS 1.40 (A) and 1.96 (B); ROI 20%

Example 4: Risk of debt · 5 marks · Case-basedHOTS / competency

Case: Plan A is all equity with 2,00,000 shares; Plan B has 1,00,000 shares and 10,00,000 of 12% debentures. EBIT falls to 80,000; the tax rate is 30% (assume no tax on a loss). (5 marks)
(i) Find the EPS under each plan. (2)
(ii) Which plan is riskier and why? (2)
(iii) State the EBIT at which both plans give the same EPS. (1)

Try it first, then show the solutionSolution

(i) Plan A: PBT 80,000; tax 24,000; PAT 56,000; EPS = 56,000 / 2,00,000 = 0.28. Plan B: interest 1,20,000, so PBT = 80,000 - 1,20,000 = -40,000; with no tax, PAT = -40,000; EPS = -40,000 / 1,00,000 = -0.40.
(ii) Plan B is riskier: the fixed interest must be paid even when earnings fall, turning a profit into a loss.
(iii) Equal EPS when 0.7 x EBIT / 2,00,000 = 0.7 x (EBIT - 1,20,000) / 1,00,000, which gives EBIT = 2,40,000 (check: EPS 0.84 under both).

Answer: (i) 0.28 and -0.40. (ii) Plan B, because interest is fixed. (iii) EBIT 2,40,000.

Example 5: Which loan source? · 4 marks · Short answerHarder board level

Name the source of funds in each case. (4 marks)
(a) A supplier lets a firm pay for goods after 30 days.
(b) One company makes an unsecured short-term deposit with another.
(c) A company accepts 3-year deposits from the public at interest above bank rates.
(d) A specialised institution gives a long-term loan with advice and may nominate a director.

Try it first, then show the solutionSolution

(a) Trade credit.
(b) Inter-corporate deposit (ICD).
(c) Public deposits.
(d) Loan from a financial institution.

Answer: (a) Trade credit (b) ICD (c) Public deposits (d) Financial institution loan

Where students lose marks in Borrowed Funds: Debentures, Trading on Equity, Loans, Public Deposits, Trade Credit and ICDs (CBSE 11)

The slips examiners see most often, and what to write instead.

Mistake: Deducting tax before interest
Applying the tax rate to EBIT.
Wrong working
Tax = 30% of 4,00,000 under Plan B
Right working
Interest is deducted first: tax = 30% of 2,80,000 = 84,000
Do this: Interest is a pre-tax expense.
Usually costs: 1 to 2 marks
Mistake: Calling debenture interest a dividend
Mixing creditors with owners.
Wrong working
Debenture holders receive dividend
Right working
They receive interest, paid even in a loss
Do this: Creditors get interest.
Usually costs: 1 mark
Mistake: Using the whole capital for shares in Plan B
Not splitting the capital.
Wrong working
Plan B shares = 2,00,000
Right working
Equity is only 10,00,000, so 1,00,000 shares of 10
Do this: Divide the equity portion by the face value.
Usually costs: 1 to 2 marks

Exam tips

Show the EPS table with EBIT, interest, PBT, tax, PAT, shares and EPS.
Always compare the return on investment with the interest rate.
Give a low-EBIT case to show the risk of debt.
State merits and limitations for each short-term source in a table.

Practice questions on Borrowed Funds: Debentures, Trading on Equity, Loans, Public Deposits, Trade Credit and ICDs (CBSE 11)

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

Q1 · 1 mark · MCQBoard level
Trading on equity is advisable when
(a) the return on investment is lower than the rate of interest
(b) the return on investment is higher than the rate of interest
(c) the company has no earnings
(d) the company issues only equity
Hint
Compare ROI and interest.
Answer
(b) the return on investment is higher than the rate of interest
Q2 · 1 mark · Assertion-reasonHarder board level
Assertion (A): Debentures are a cheaper source of funds than equity shares.
Reason (R): Interest on debentures is tax-deductible, whereas dividend on shares is not.
(a) Both A and R are true, and R is the correct explanation of A.
(b) Both A and R are true, but R is not the correct explanation of A.
(c) A is true, but R is false.
(d) A is false, but R is true.
Hint
Tax treatment.
Answer
(a) Both A and R are true, and R is the correct explanation of A.
Q3 · 4 marks · Short answerHarder board level
Explain the types of debentures: secured and unsecured, registered and bearer, convertible and non-convertible, first and second. (4 marks)
Hint
Pair each with its opposite.
Answer
Secured debentures are backed by a charge on assets; unsecured are not. Registered debentures have the holder's name recorded with the company and are transferred by registration; bearer debentures are transferable by delivery. Convertible debentures can be converted into equity; non-convertible cannot. First debentures are repaid before, and second debentures after, others on winding up.
Q4 · 4 marks · Short answerHarder board level
A company has capital of 10,00,000. Plan A is all equity (1,00,000 shares of 10). Plan B has 6,00,000 equity (60,000 shares) and 4,00,000 of 10% debentures. EBIT is 1,50,000 and the tax rate is 30%. Find the EPS under each plan and say whether debt helps the equity holders. (4 marks)
Hint
Return on investment is EBIT / capital.
Answer
Plan A: PBT 1,50,000; tax 45,000; PAT 1,05,000; EPS = 1,05,000 / 1,00,000 = 1.05. Plan B: interest = 40,000; PBT 1,10,000; tax 33,000; PAT 77,000; EPS = 77,000 / 60,000 = 1.28 (rounded). Return on investment = 1,50,000 / 10,00,000 = 15%, above the 10% interest, so debt raises EPS.
Q5 · 5 marks · Case-basedHOTS / competency
Case: A trader buys goods for 1,00,000 on terms: a 2% discount if paid within 10 days, otherwise the full amount within 30 days. His cash is short, so he is also considering an inter-corporate deposit and public deposits. (5 marks)
(i) If he pays on day 30 instead of day 10, what extra amount does he pay, and what is the cost of the 20 extra days as a percentage of the amount he effectively uses? (2)
(ii) Name one merit and one limitation of trade credit. (2)
(iii) State one limitation of inter-corporate deposits. (1)
Hint
Effective funds used are the discounted price.
Answer
(i) Price on day 10 = 98,000; on day 30 = 1,00,000; extra = 2,000. Cost for 20 days = 2,000/98,000 x 100 = 2.04%, which is about 37.2% a year (2.04% x 365/20). (ii) Merit: convenient and continuous with no charge on assets. Limitation: costlier if cash discounts are lost, and may cause over-trading. (iii) ICDs are unsecured, so risky for the lender; rates vary and regulations limit the amounts.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1.Who are debenture holders?Show answer
Creditors of the company.
2.What is trading on equity?Show answer
Using fixed-cost funds to raise equity returns when ROI exceeds interest.
3.What is EPS?Show answer
Profit after tax divided by the number of equity shares.
4.For how long are public deposits usually taken?Show answer
1 to 3 years.
5.What are ICDs?Show answer
Unsecured short-term deposits made by one company with another.

Borrowed Funds: Debentures, Trading on Equity, Loans, Public Deposits, Trade Credit and ICDs (CBSE 11): frequently asked questions

Do debenture holders vote?

No, they have no voting rights.

Why is debt risky in bad years?

Interest is fixed and must be paid even when there is a loss.

What are bonds?

Debt instruments like debentures, used especially for public sector and government borrowing.