Equity and Preference Shares, Debentures, Retained Profits, Deposits and Loans (ISC Class 12)
Updated 17 October 2026 · Fact-checked
Owned funds come from the owners: equity shares, preference shares and retained profits. Borrowed funds must be repaid: debentures and bonds, public deposits and loans. Equity holders are owners who get a variable dividend, preference holders get a fixed dividend with priority, debenture holders are creditors who get fixed interest, and retained profits are the profits kept in the business.
Owned funds come from owners and need no repayment; borrowed funds must be repaid with interest.
Illustration drawn for QuestionBuddy.
Understand Equity and Preference Shares, Debentures, Retained Profits, Deposits and Loans
The syllabus asks for a *basic understanding* of each source. Group them as owned funds (no repayment, owners' money) and borrowed funds (repayable, with interest).
A. Owned funds
1. Equity shares
Equity shares represent ownership in a company. Holders get voting rights and a dividend that varies with profits, which is paid only after the preference dividend. On winding up they are paid last and receive the residual assets. They carry the highest risk and the highest possible return.
*For the company*: permanent capital; no fixed burden (dividend is not compulsory); assets are not charged. *Limitations*: dilutes control as more shareholders vote; costlier to issue; dividends are not tax-deductible.
2. Preference shares
They carry two preferences over equity shares: (a) a fixed rate of dividend, paid before any dividend to equity holders, and (b) repayment of capital before equity holders on winding up. They normally have no voting rights (except on matters that affect them). Types include cumulative and non-cumulative, participating and non-participating, convertible and non-convertible, and redeemable. They suit cautious investors who want a steady dividend.
*For the company*: no dilution of control; fixed dividend, no repayment burden during life. *Limitations*: a fixed commitment; dividends are not tax-deductible; the cost is higher than debentures.
3. Retained profits (ploughing back of profits)
The part of net profit kept in the business instead of being paid out as dividend. It is an internal source of owned funds.
*Merits*: no cost of issue; no interest; no dilution of control; strengthens financial position and supports growth.
*Limitations*: shareholders may be unhappy with smaller dividends; available only to profitable firms; the amount is uncertain; over-retention may lead to over-capitalisation.
B. Borrowed funds
4. Debentures and bonds
A debenture is an instrument acknowledging a debt taken by a company from the public. Debenture holders are creditors, not owners. They receive interest at a fixed rate whatever the profit (not 'dividend'), are generally secured by a charge on assets, and are repaid after a fixed period. Bonds are similar debt instruments, a term used especially for those issued by governments and public bodies.
*Merits*: control is not diluted; interest is a tax-deductible expense; suits firms with stable earnings. *Limitations*: a fixed interest burden even in loss; assets are charged; risky when profits fall.
5. Public deposits
Deposits raised by a company directly from the public (including shareholders and employees), usually for 6 months to 3 years, at an interest rate higher than that of bank deposits, within the limits of the Companies Act rules.
*Merits*: simple; cheaper than bank loans; no charge on assets. *Limitations*: short-term; available mainly to well-known firms; can be withdrawn at a time of difficulty.
6. Loans
Money borrowed from banks and financial institutions for a fixed period at an agreed rate of interest, usually against security (collateral) and repaid in instalments. *Term loans* finance fixed assets; *cash credit and overdraft* finance working capital. In answers on loans, refer to business loans, not personal housing or car loans.
C. Owned versus borrowed funds
| Basis | Owned funds | Borrowed funds |
|---|---|---|
| Source | Owners (shares, retained profits) | Outsiders (debentures, deposits, loans) |
| Repayment | None during the life of the business | Must be repaid |
| Return | Dividend (variable or fixed) | Interest at a fixed rate |
| Control | Voting shareholders share control | Lenders do not share control |
| Risk to the firm | Low (no compulsory payment) | High (interest due even in loss) |
D. Equity versus preference shares
| Basis | Equity shares | Preference shares |
|---|---|---|
| Dividend | Variable, paid after preference | Fixed rate, paid first |
| Repayment on winding up | After preference | Before equity |
| Voting rights | Yes | Normally no |
| Risk and return | High risk, high return | Lower risk, steady return |
E. Debenture holders versus shareholders. A shareholder is an owner and gets a dividend; a debenture holder is a creditor and gets interest. Writing 'dividend' for debentures is a common error.
F. Case skill. Match the need to the source: permanent funds with no repayment burden (equity); steady returns for a cautious investor (preference); cheap internal finance (retained profits); fixed-term borrowing without giving up control (debentures or loans).
Equity and Preference Shares, Debentures, Retained Profits, Deposits and Loans: key facts
- Owned funds
- Equity shares
- Preference shares
- Retained profits
- No repayment.
- Borrowed funds
- Debentures and bonds
- Public deposits
- Loans
- Repayable with interest.
- Returns
Equity variable dividend Preference fixed dividend Debentures fixed interest - Dividend for owners; interest for creditors.
How to answer Equity and Preference Shares, Debentures, Retained Profits, Deposits and Loans questions
Questions identify a source from a description, ask for merits and limitations, or distinguish between equity and preference shares or between owned and borrowed funds.
- 1Ask who the investor is: owner (shares, retained profits) or creditor (debentures, deposits, loans).
- 2Use 'dividend' for shareholders and 'interest' for debenture holders and lenders.
- 3Give merits and limitations from the company's point of view unless the investor's is asked.
- 4In a case, name the source and justify with the need: control, risk, cost and repayment.
Equity and Preference Shares, Debentures, Retained Profits, Deposits and Loans 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.
Retained profits
Suppose a profitable furniture company earns ₹50 lakh profit, pays out ₹30 lakh as dividend and keeps the remaining ₹20 lakh in the business to buy a new machine.
Which source of finance is this? State two merits.
Try it first, then show the solutionSolution
- Part of the profit is kept back in the business.
- It is therefore retained profit, an internal source.
Answer: Retained profits (ploughing back); merits: no cost of issue or interest, and no dilution of control.
Memory hook: Keep some profit at home.
Preference shares
Imagine a retired teacher who wants a safe, steady income from a company without wanting to vote or to take large risks.
Which kind of share suits her and why?
Try it first, then show the solutionSolution
- She wants a fixed dividend and priority in repayment.
- She is not interested in voting.
Answer: Preference shares: they give a fixed dividend with priority over equity shares.
Memory hook: Preference = preference in payment.
Tricks to remember Equity and Preference Shares, Debentures, Retained Profits, Deposits and Loans
Short memory aids. Say each one aloud once, then use it on a question the same day.
DIV vs INT
Shareholders get DIVidend; debenture holders get INTerest.
Use it when: Return on securities.
E-P-R and D-P-L
Owned: Equity, Preference, Retained. Borrowed: Debentures, Public deposits, Loans.
Use it when: Two groups.
Two preferences
Preference shares: paid first (dividend) and repaid first (capital).
Use it when: Meaning.
Equity and Preference Shares, Debentures, Retained Profits, Deposits and Loans: solved examples
Ordered from board level to HOTS. Try each one before you open the solution.
Example 1: Identify the source · 1 mark · Very short answerBoard level
A company issues instruments that carry a fixed rate of interest and are secured on its assets, and the holders are its creditors. Name the source of finance.
Try it first, then show the solutionSolution
- Creditors with fixed-rate interest and security are debenture holders.
Answer: Debentures.
Example 2: Right word · 1 mark · MCQBoard level
The return paid to debenture holders is called:
(a) dividend
(b) interest
(c) profit share
(d) bonus
Try it first, then show the solutionSolution
- Debenture holders are creditors who receive interest.
Answer: (b)
Example 3: Equity versus preference shares · 4 marks · Short answerHarder board level
A friend with savings is torn between buying equity shares and preference shares of the same company. Distinguish between the two on four bases, in complete sentences, to help her.
Try it first, then show the solutionSolution
- Dividend: equity shareholders receive a variable dividend; preference shareholders receive a fixed rate.
- Priority: preference dividend is paid before equity dividend, and preference capital is repaid before equity capital on winding up.
- Voting: equity shareholders have voting rights; preference shareholders normally do not.
- Risk and return: equity carries higher risk and higher potential return; preference gives a steadier return.
Answer: Four differences: dividend, priority, voting rights, and risk and return.
Example 4: Merits and limitations of retained profits · 4 marks · Short answerHarder board level
A company plans to finance its expansion wholly by retained profits. Explain three merits and two limitations of this source.
Try it first, then show the solutionSolution
- Merit: no cost of issue and no interest.
- Merit: no dilution of control.
- Merit: strengthens financial position and supports growth.
- Limitation: shareholders may be unhappy with lower dividends.
- Limitation: available only to profitable firms, and the amount is uncertain.
Answer: Three merits (no cost, no dilution, growth) and two limitations (lower dividends; only for profitable firms).
Example 5: Choose the sources · 8 marks · Long answerHOTS / competency
Suppose a profitable textile company wants ₹60 crore for a new plant. It does not want to dilute the control of its promoters, does not mind a fixed charge as its earnings are stable, and also wants a small amount of cheap short-term funds from the public. Recommend suitable sources, naming at least three, with a reason for each and one limitation, and state which would be unsuitable and why.
Try it first, then show the solutionSolution
- Debentures: no dilution of control, interest is tax-deductible, suits stable earnings; limitation: fixed interest and charge on assets.
- Loans from banks or institutions: term loan for the plant; limitation: collateral and instalments.
- Retained profits: cheap internal money; limitation: limited amount and lower dividends.
- Public deposits for short-term funds: simple and cheaper than bank loans; limitation: short period.
- Unsuitable: a large new equity issue, because it would dilute the promoters' control.
- A mix reduces dependence on one source.
Answer: Debentures, term loans, retained profits and public deposits; a big equity issue is unsuitable because it dilutes control.
Where students lose marks in Equity and Preference Shares, Debentures, Retained Profits, Deposits and Loans
The slips examiners see most often, and what to write instead.
Mistake: Writing dividend for debentures
CISCE examiners' comments, 2024, note that candidates said dividend, instead of interest, is paid to debenture holders.
Wrong working
Debenture holders get a dividend.
Right working
Debenture holders are creditors and get interest at a fixed rate.
Do this: Dividend for owners; interest for lenders.
Usually costs: 1 mark.
Mistake: Writing 'equity' or 'preferential' for preference shares
CISCE examiners' comments, 2025, note that candidates wrote equity or 'preferential' instead of preference for shares suited to cautious investors seeking steady dividends.
Wrong working
Cautious investor: preferential shares / equity shares.
Right working
Cautious investor seeking a steady dividend: preference shares.
Do this: Fixed dividend, priority: preference.
Usually costs: 1 mark.
Mistake: Describing personal loans when business loans are asked
CISCE examiners' comments, 2025, note that candidates described housing and car loans rather than business loans.
Wrong working
Loans: money to buy a house or a car.
Right working
Business loans: funds from banks and institutions for a fixed period, with interest and security, for fixed assets or working capital.
Do this: Keep to the business context.
Usually costs: 1-2 marks.
Mistake: Confusing owned and borrowed funds
Preference shares have fixed dividend like interest.
Wrong working
Preference shares are borrowed funds as they carry a fixed return.
Right working
Preference shares are part of owned funds (share capital), though they carry a fixed dividend.
Do this: Shares = owned, even if the dividend is fixed.
Usually costs: 1 mark.
Exam tips
- The syllabus asks only for a basic understanding of each source, so give a clear meaning, a feature and a merit or limitation.
- CISCE's examiners' comments for 2024 note the use of 'dividend' for debentures; and for 2025 the use of 'equity' or 'preferential' for preference shares.
- CISCE's examiners' comments for 2025 note that candidates described housing and car loans for loans; stay with business loans.
- Always say whose point of view you are taking: the company's or the investor's.
Practice questions on Equity and Preference Shares, Debentures, Retained Profits, Deposits and Loans
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 · Very short answerBoard level
A pensioner invests in a company's shares only because they promise a fixed annual dividend, paid before any equity dividend. Name these shares.
Hint
Preferred.
Answer
Preference shares.
Q2 · 1 mark · Very short answerBoard level
State one limitation of debentures as a source of finance.
Hint
Fixed payment.
Answer
Interest must be paid at a fixed rate even in a loss, and assets are charged.
Q3 · 4 marks · Short answerHarder board level
A company wants to keep its control with a few promoters but needs ₹10 crore for ten years. Explain two sources it may prefer, and one reason why it would avoid raising the entire amount through equity shares.
Hint
No voting rights.
Answer
It may prefer debentures (creditors have no voting rights, and interest is tax-deductible) and a bank term loan (no share in control, repaid in instalments). It would avoid equity because equity shareholders have voting rights, so a large issue dilutes the promoters' control.
Q4 · 4 marks · Short answerHarder board level
Explain public deposits and loans as sources of business finance, with one advantage of each.
Hint
Direct from the public; from banks.
Answer
Public deposits are funds raised by a company directly from the public, usually for six months to three years, at an interest higher than banks pay; advantage: simple to raise and cheaper than bank loans. Loans are funds borrowed from banks or financial institutions for a fixed period at an agreed rate against security and repaid in instalments; advantage: a firm gets large funds without sharing control.
Q5 · 8 marks · Long answerHOTS / competency
Suppose a young company decides to finance everything by debentures and loans because 'interest is tax-deductible and nobody shares control'. Evaluate the decision for a company whose profits are uncertain, and suggest a better capital mix.
Hint
Fixed burden when profits fall.
Answer
Debentures and loans do preserve control and interest is a tax-deductible expense. But interest is a fixed burden that must be paid whatever the profit, and assets are charged as security; with uncertain profits, the company could fail to pay and lose assets or even face closure. A better mix would use owned funds, such as equity shares and retained profits, for a base that carries no compulsory payment, and use borrowed funds only to the level that the earnings can comfortably service. Preference shares could add a fixed-dividend option that carries no voting rights, which helps to protect control while the dividend commitment is lighter than a loan's interest and security.
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.What do we call the part of profit kept in the business instead of being distributed?Show answer
Retained profits.
2.Do debenture holders have voting rights?Show answer
No, they are creditors.
3.Which shares normally have no voting rights?Show answer
Preference shares.
4.Which source carries the highest risk for the investor?Show answer
Equity shares.
5.What is a term loan used for?Show answer
Financing fixed assets, repaid in instalments.
Equity and Preference Shares, Debentures, Retained Profits, Deposits and Loans: frequently asked questions
Is a bond the same as a debenture?
They are similar debt instruments; 'bond' is used especially for those issued by governments and public bodies.
Are retained profits owned funds?
Yes. They belong to the owners and are an internal source.
Why is interest on debentures preferred by companies for tax reasons?
Interest is a deductible expense, whereas dividend is paid out of profits after tax.