Business StudiesCBSE Class 11 · Sources of Business Finance

Owners' Funds Class 11 Business Studies: Equity Shares, Preference Shares and Retained Earnings

Updated 17 October 2026 · Fact-checked

Business finance is classified by period (long, medium, short term), by ownership (owners' funds and borrowed funds) and by source of generation (internal and external). Owners' funds are equity shares (voting rights, residual claim, higher cost), preference shares (fixed dividend and priority, no voting rights) and retained earnings (profit ploughed back, no explicit cost, but uncertain).

Owners' funds are permanent capital with three sources: equity (voting rights), preference (fixed dividend) and retained earnings (reinvested profit).

Illustration drawn for QuestionBuddy.

Understand Classification of Funds and Owners' Funds: Equity Shares, Preference Shares and Retained Earnings (CBSE 11)

Need. Finance is the lifeblood of business: fixed capital for fixed assets, working capital for day-to-day expenses, and funds for modernisation, expansion and diversification.

Classification of sources.

By period: long-term (more than 5 years: equity, preference shares, retained earnings, debentures, loans from financial institutions); medium-term (1 to 5 years: bank loans, public deposits); short-term (up to 1 year: trade credit, bank loans such as cash credit and overdraft, inter-corporate deposits).
By ownership: owners' funds (equity, preference capital, retained earnings; permanent, no fixed repayment during the company's life) and borrowed funds (debentures, bank loans, public deposits, trade credit and ICDs; repayable with fixed interest, usually secured, lenders get no control).
By source of generation: internal (retained earnings, collection of receivables, disposal of surplus stock) and external (shares, debentures, loans, public deposits, trade credit).

Equity shares. The ownership capital: shareholders are the real owners with voting rights; dividend is not fixed and is paid only after preference dividend; on winding up they are paid last. Capital is permanent. *Merits:* suit risk-taking investors, no burden of fixed dividend, permanent capital, creditworthiness (a cushion for lenders), no charge on assets, democratic control. *Limitations:* not liked by investors seeking steady income; higher cost than debt (dividend is not tax-deductible); issue dilutes control; more formalities; possible over-capitalisation.

Preference shares. Two preferential rights: dividend at a fixed rate before equity dividend, and return of capital before equity on winding up; usually no voting rights. *Types:* cumulative (unpaid dividends accumulate) and non-cumulative; participating (share in surplus profits) and non-participating; convertible (into equity) and non-convertible; redeemable (repaid after a fixed period) and irredeemable (not allowed under the Companies Act, 2013). *Merits:* steady income; no dilution of control; fixed dividend allows trading on equity; no charge on assets. *Limitations:* not for investors seeking ownership and growth; dividend not tax-deductible; priority claim on profits; rate generally higher than debenture interest.

Retained earnings. The part of net profit kept in the business instead of being paid as dividend; an internal, long-term owners' fund. *Merits:* permanent; no explicit cost (no interest, dividend or flotation cost); no dilution of control; raises creditworthiness; absorbs unexpected losses. *Limitations:* uncertain because profits fluctuate; shareholders may be dissatisfied with low dividends; opportunity cost that management may ignore.

Classification of Funds and Owners' Funds: Equity Shares, Preference Shares and Retained Earnings (CBSE 11): key facts

By period: long-term more than 5 years
medium-term 1 to 5 years
short-term up to 1 year; Long-term funds finance fixed capital.
By ownership and source: owners' funds are equity, preference and retained earnings
borrowed funds are debentures, loans, deposits, trade credit
internal or external; Retained earnings are internal.
Dividend order: preference dividend first
then equity dividend
retained earnings = profit - dividends; Cumulative arrears are paid first.
Preference types: cumulative
participating
convertible
redeemable; And their opposites.

How to answer Classification of Funds and Owners' Funds: Equity Shares, Preference Shares and Retained Earnings (CBSE 11) questions

To choose or compute, start with the need and then the right class of funds.

1Decide whether the need is for fixed capital (long-term) or working capital (short-term).
2Check whether control must be kept: preference shares, debentures and retained earnings do not dilute it.
3For dividend numericals pay the preference dividend first, adding arrears for cumulative shares.
4Subtract dividends from the profit to find retained earnings.
5For control questions compute holding / total shares x 100 before and after the issue.

Classification of Funds and Owners' Funds: Equity Shares, Preference Shares and Retained Earnings (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 bakery that ploughs back profit

Suppose a bakery company earns a profit of 10 lakh and, instead of paying all of it out, keeps 6 lakh to buy a new oven.

Name the source of funds and one merit.

Try it first, then show the solutionSolution

Profit kept in the business is retained earnings, an internal long-term source.
Merit: no explicit cost, since no interest or dividend has to be paid on it.

Answer: Retained earnings; no explicit cost.

Memory hook: Own profit, own money, no cost to pay.

Tricks to remember Classification of Funds and Owners' Funds: Equity Shares, Preference Shares and Retained Earnings (CBSE 11)

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

Owners last, preference first
Preference gets dividend and capital first; equity is paid last.
Use it when: Priority.
Cumulative catches up
Cumulative preference holders collect missed dividends later.
Use it when: Types of preference shares.
Internal means inside
Retained earnings, receivables, surplus stock are generated inside the firm.
Use it when: Classification.

Classification of Funds and Owners' Funds: Equity Shares, Preference Shares and Retained Earnings (CBSE 11): solved examples

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

Example 1: Preference shares · 1 mark · MCQBoard level

Which right do preference shareholders usually NOT have?
(a) Fixed dividend
(b) Priority of capital repayment
(c) Voting rights in all matters
(d) Preference in dividend payment

Try it first, then show the solutionSolution

Preference shareholders usually have no voting rights, except on matters directly affecting their rights.

Answer: (c) Voting rights in all matters

Example 2: Equity and preference compared · 3 marks · Short answerBoard level

Distinguish between equity shares and preference shares on dividend, voting rights and repayment on winding up. (3 marks)

Try it first, then show the solutionSolution

Dividend: equity dividend is not fixed and is paid after preference dividend; preference dividend is at a fixed rate and paid first.
Voting rights: equity shareholders have voting rights; preference shareholders usually do not.
Repayment on winding up: preference capital is returned before equity; equity is paid last.

Answer: Fixed versus variable dividend; no voting versus voting; priority of repayment.

Example 3: Cumulative dividend · 4 marks · Short answerHarder board level

A company has 5,00,000 of 8% cumulative preference shares and 1,00,000 equity shares. Last year no dividend was paid, and this year the profit available for dividends is 12,40,000. The board declares 5 per equity share. Find the preference dividend due, the equity dividend and the retained earnings. (4 marks)

Try it first, then show the solutionSolution

Yearly preference dividend = 8% of 5,00,000 = 40,000.
Arrears of last year = 40,000, so the total due = 80,000.
Equity dividend = 5 x 1,00,000 = 5,00,000.
Retained earnings = 12,40,000 - 80,000 - 5,00,000 = 6,60,000.

Answer: Preference 80,000; equity dividend 5,00,000; retained 6,60,000

Example 4: Choosing the source · 5 marks · Case-basedHOTS / competency

Case: A company needs 40,00,000 for a new plant and 6,00,000 for monthly salaries. The promoters do not want to lose control, and some investors want a steady income. (5 marks)
(i) Classify the two needs. (1)
(ii) Suggest a suitable long-term source for the plant that keeps control, with a reason. (2)
(iii) Suggest a source for the salaries and a type of investor for preference shares. (2)

Try it first, then show the solutionSolution

(i) The plant needs fixed capital (long-term); the salaries are a working capital (short-term) need.
(ii) Preference shares or retained earnings: neither dilutes control, because preference shares carry no voting rights and retained earnings come from the firm's own profit.
(iii) Short-term sources such as trade credit or a bank loan (cash credit or overdraft) for salaries. Preference shares suit investors seeking a steady income with less risk.

Answer: (i) Fixed capital and working capital. (ii) Preference shares or retained earnings. (iii) Trade credit or a bank loan; steady-income investors.

Example 5: Control after an issue · 4 marks · Short answerHarder board level

Promoters hold 60,000 of 1,00,000 equity shares. The company issues 50,000 more equity shares, which the promoters do not buy. Find their percentage before and after. What would it be if 50,000 preference shares were issued instead? (4 marks)

Try it first, then show the solutionSolution

Before: 60,000/1,00,000 x 100 = 60%.
After new equity: total shares = 1,50,000, so 60,000/1,50,000 x 100 = 40%, and the promoters lose their majority.
With preference shares there are no voting rights, so equity voting power is unchanged at 60%.
This shows that equity issue dilutes control while preference shares do not.

Answer: 60% to 40% with equity; stays 60% with preference shares

Where students lose marks in Classification of Funds and Owners' Funds: Equity Shares, Preference Shares and Retained Earnings (CBSE 11)

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

Mistake: Forgetting arrears on cumulative shares
Paying only the current year's dividend.
Wrong working
Preference dividend = 40,000
Right working
40,000 + arrears 40,000 = 80,000
Do this: Add unpaid dividends first.
Usually costs: 1 to 2 marks
Mistake: Calling retained earnings an external source
Forgetting that they come from the firm's profit.
Wrong working
Retained earnings are an external source
Right working
Retained earnings are an internal source
Do this: Internal: generated inside.
Usually costs: 1 mark
Mistake: Giving preference shareholders voting rights
Treating them like equity.
Wrong working
Preference shareholders vote on all matters
Right working
They usually have no voting rights, except on matters directly affecting their rights
Do this: No dilution of control.
Usually costs: 1 mark

Exam tips

Classify any source on all three bases when asked.
Give two merits and two limitations of each source with reasons.
For dividends pay preference first, then equity, and compute retained earnings last.
State that irredeemable preference shares cannot be issued under the Companies Act, 2013.

Practice questions on Classification of Funds and Owners' Funds: Equity Shares, Preference Shares and Retained Earnings (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
Retained earnings are
(a) an external source of funds
(b) an internal source of funds
(c) borrowed funds
(d) a short-term source
Hint
Ploughing back of profit.
Answer
(b) an internal source of funds
Q2 · 1 mark · Assertion-reasonHarder board level
Assertion (A): Equity shareholders bear the greatest risk in a company.
Reason (R): They receive dividend only after the preference dividend and are paid last on winding up.
(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
Residual claim.
Answer
(a) Both A and R are true, and R is the correct explanation of A.
Q3 · 4 marks · Short answerHarder board level
Explain cumulative, participating, convertible and redeemable preference shares. (4 marks)
Hint
Pair each with its opposite.
Answer
Cumulative: unpaid dividends of a loss year accumulate and are paid later. Participating: holders share in the surplus profits after the equity dividend. Convertible: can be converted into equity shares after a period. Redeemable: repaid after a fixed period (irredeemable shares cannot be issued under the Companies Act, 2013).
Q4 · 4 marks · Short answerHarder board level
A company with 5,00,000 of 10% cumulative preference capital and 2,00,000 equity shares missed the preference dividend in the previous two years. This year it has 9,00,000 available for dividends. Find the total preference dividend due, and the maximum equity dividend per share possible if the whole balance is distributed. (4 marks)
Hint
Three years of dividends are due.
Answer
Yearly preference dividend = 10% of 5,00,000 = 50,000. Dividends due = 2 years of arrears + current year = 3 x 50,000 = 1,50,000. Balance = 9,00,000 - 1,50,000 = 7,50,000. Maximum equity dividend per share = 7,50,000 / 2,00,000 = 3.75.
Q5 · 5 marks · Case-basedHOTS / competency
Case: Zenith Ltd earns a profit of 10 crore with 1 crore equity shares and decides to retain 70% of it. Some shareholders protest. (5 marks)
(i) Find the dividend per share and the retained amount per share. (2)
(ii) State two merits of retained earnings for the company. (2)
(iii) State one limitation shown. (1)
Hint
Dividend is 30% of the profit.
Answer
(i) Retained = 70% of 10 crore = 7 crore; dividend = 3 crore; dividend per share = 3 crore / 1 crore shares = 3; retained per share = 7. (ii) No explicit cost (no interest, dividend or flotation cost), and no dilution of control (also permanent and raises creditworthiness). (iii) Shareholders may be dissatisfied with low dividends.

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.Name the owners' funds.Show answer
Equity shares, preference shares and retained earnings.
2.Which shares are paid last on winding up?Show answer
Equity shares.
3.What is ploughing back of profit?Show answer
Retaining a part of net profit in the business.
4.Do preference shareholders usually vote?Show answer
No.
5.What is long-term finance?Show answer
Funds for more than 5 years.

Classification of Funds and Owners' Funds: Equity Shares, Preference Shares and Retained Earnings (CBSE 11): frequently asked questions

Is equity capital repaid?

No, not during the life of the company; it is repaid last on winding up.

Why is equity costlier than debt?

Investors expect higher returns and dividend is not tax-deductible.

What is over-capitalisation?

Raising more equity than needed.