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

Public Deposits: Deposits accepted from public directly by the companies are called public deposits. These deposits generally carry a rate of interest higher than the deposits in commercial banks.

Merits of Public Deposits

The procedure of obtaining deposits is simple and does not contain restrictive conditions. 

Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions. 

Public company usually does not create a charge on the assets of the company. 

As the depositors do not have voting rights, it does not dilute control in the company.

Demerits of Public Deposits

• It is difficult for a newly established company to be able to get funds from public deposits. 
• It is dependent on public response and can’t be relied on if financial needs are urgent. 
• It is difficult especially when size of deposits is large.

Retained Earnings: For any company, the amount of earnings retained within the business has a direct impact on the amount of dividends. Profit re-invested as retained earnings is profit that could have been paid as a dividend.

Merits of Retained Earnings:

• The management of many companies believes that retained earnings are funds which do not cost anything, although this is not true. However, it is true that the use of retained earnings as a source of funds does not lead to the payment of cash.
• The dividend policy of the company is in practice determined by the directors. From their standpoint, retained earnings are an attractive source of finance because investment projects can be undertaken without involving either the shareholders or any outsiders
• The use of retained earnings as opposed to new shares or debentures avoids issue costs.
• The use of retained earnings avoids the possibility of a change in control resulting from an issue of new shares.
• Another factor that may be of importance is the financial and taxation position of the company’s shareholders. For example, because of taxation considerations, they would rather make a capital profit (which will only be taxed when shares are sold) than receive current income, then finance through retained earnings would be preferred to other methods.

Demerits of Retained Earnings:

• A company must restrict its self-financing through retained profits because shareholders should be paid a reasonable dividend, in line with realistic expectations, even if the directors would rather keep the funds for re-investing.
• At the same time, a company that is looking for extra funds will not be expected by investors (such as banks) to pay generous dividends, nor over-generous salaries to owner-directors.
• Scope of retained earnings is limited by amount of profits. A loss incurring firm has no source called retained earnings.

Public Deposits The deposits that are raised by organizations directly from the public are known as public deposits. Rates of interest offered on public deposits are usually higher than that offered on bank deposits. The amount raised from public deposits is generally used by the company for meeting the requirement of working capital. It can take care of both medium and short term financial requirements.

Merits of Public Deposits

1. The procedure of obtaining deposits is simple and does not contain restrictive conditions as in case of a loan agreement. 

2. Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions. 

3. Public deposits do not usually create any charge on the assets of the company and hence the assets can be used as security for raising loans from other sources. 

4. The control of the company is not diluted as the depositors do not have voting . rights.

Limitations of Public Deposits.

1. New companies generally find it difficult to raise fund;; through public deposits due to lack of goodwill. 

2. It is an unreliable source of finance as the public may not respond when the company needs money. 

3. Collection of public deposits may prove difficult, particularly when the size of deposits required is large.

Retained Earnings The portion of the net earnings which is not distributed amongst the shareholders as dividends and is retained in the business for use in the future is known as retained earnings. It is a source of internal financing and is also termed as accumulated earning.

Merits of Retained Earnings

1. etained earnings is a permanent source of funds available to an organization. 

2. It does not involve any explicit cost in the form of interest, or floatation cost. 

3. There is a greater degree of operational freedom and flexibility as the funds are generated internally. 

4. It enhances the capacity of the business to absorb unexpected losses. 

5. It may lead to increase in the market price of the equity shares of a company.

Limitations of Retained Earnings

1. High retention ratio may cause dissatisfaction amongst the shareholders as they would get lower dividends. 

2. It is an uncertain source of funds as the profits of business keep fluctuating. 

3. If the opportunity cost associated with these funds is high it may lead to sub¬’ optimal use of the funds.

Merits of public Deposits: 

1. These deposits take care of short-term and medium-term financial requirements. 

2. These deposits do not involve the creation of any charge on any asset of the borrower.

Demerits of public Deposits:

1. Collection of deposits form a large number of depositors is somewhat difficult. 

2. New companies generally find it difficult to borrow funds through public deposits.

Merits of retained earnings:

1. Retained profits reduce the dependence of company on external borrowings. 

2. The Society stand to benefit from the stability accorded to industrial sector by retained earnings.

Demerits of retained earnings:

1. Ploughing-back of profits is possible only when there is stability in earnings. 

2. Retained earings may lead to over-capitalisation, which is not good for a concern.