Q.State the merits and demerits of public deposits and retained earnings as methods of business finance.

Public deposits and retained earnings are two very different sources of finance — one raised from outsiders and one generated from within the business — and each carries its own merits and demerits. …

Public deposits — deposits raised by an organisation directly from the public, usually at a higher interest rate than banks offer; the company issues a deposit receipt, and acceptance is regulated by the RBI (generally for up to three years, meeting medium- and short-term needs).

• Merits:
  • Simple procedure — free of the restrictive conditions of a loan agreement.
  • Lower cost than borrowing from banks and financial institutions.
  • Usually no charge on the company's assets, leaving them free as security for other loans.
  • Depositors have no voting rights, so the control of the company is not diluted.
• Demerits (limitations):
  • New companies find it difficult to raise funds this way.
  • It is an unreliable source — the public may not respond when the company needs money.
  • Collection can be difficult, especially when a large amount is required.

Retained earnings — the portion of net profits kept back in the business instead of being paid out as dividend; a form of internal (self-)financing or the "ploughing back of profits." The amount available depends on the firm's net profits, dividend policy and age.

• Merits:
  • A permanent source of funds.
  • No explicit cost such as interest, dividend or floatation cost.
  • Greater operational freedom and flexibility (funds generated internally).
  • Strengthens the firm's capacity to absorb unexpected losses (a cushion). …