BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

Chapter 1: Overview to Financial Management

What is Finance?

 Finance is a body of facts, principles, and theories relating to raising and

using money by individuals, businesses and governments.
 It involves the ways people and organizations raise and allocate capital,
use monetary resources, and account for the risks involved.
 It is also the study of how to value all sort of things such as valuation of a
business enterprise, the payments left on a mortgage of a property, the
purchase of an entire company or a personal decision to retire early.

Subfields of Finance
 Study of corporate finance or financial management
 Study of investments
 Study of financial institutions and markets.

o Study of Financial Management

The Financial Management process has three major functions, namely,

a. financial analysis and planning

b. utilization of funds, and
c. acquisition of funds from investors

Specifically, financial management involves decisions, among others, about;

 how to organize the firm in a manner that will attract capital

 how should capital be raised (i.e., debt or equity)
 which projects to fund
 how should the resources (long-term and short-term) be allocated and
managed
 how to minimize taxation

o Study of Investments

 This involves methods and techniques for making appropriate decisions about
what kind of securities to own, which firms’ securities to buy or how to pay that
investor back in the form that the investor wishes.

o Financial Institutions and Markets

 These institutions help facilitate the capital flows between investors and
companies. This sub-area involves the firms initially acquiring capital and then
investors’ ongoing securities trading.
 BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

FINANCIAL MANAGEMENT

 Financial Management, also referred to as managerial finance, corporate

finance and business finance, is a decision-making process concerned
with planning, acquiring, and utilizing funds in a manner that achieves the
firm’s desired goals.
 Financial Management is a part of a larger discipline called finance.
 While getting the needed funds in the most suitable way and on the best
terms possible is clearly a central part of the finance job, the finance
function is much broader than one of funds procurement or supply.
OBJECTIVE OF FINANCIAL MANAGEMENT

 The goal of financial management is to maximize the current value of

ownership in a business firm.
 The above-stated goal considers the fact that the residual owners in
a firm are entitled only to what is left after employees, suppliers,
creditors and anyone else with a legitimate claim are paid their
due.
SIGNIFICANCE OF FINANCIAL MANAGEMENT

o Applicability
o Chances of Failure
o Return on investment
SCOPE OF FINANCIAL MANAGEMENT

o Traditional Approach
 Procurement of short-term as well as long-term funds from financial
institutions.
 Mobilization of funds through financial instruments such as equity
shares, preference shares, debentures, and so forth.
 Compliance with legal and regulatory provisions relating to funds
procurement, use and distribution.
o Modern Approach
 The total funds requirements of the firm
 The assets or resources to be acquired and
 The best pattern of financing the assets.
 BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

Chapter 2: Role of the Finance Manager

Role of the Finance Manager

 In striving to maximize owners’ or shareholders’ wealth, the financial

manager makes decisions involving planning, acquiring, and
utilizing funds which involve a set of risk-return trade-offs. These
financial decisions affect the market value of the firm’s equity
shares which leads to wealth maximization.

Figure 2.1. Role of the Finance Manager

Financial Manager
makes decisions
involving

Analysis and
Acquisition of Funds Utilization of Funds
Planning

Impact on Risk and

Return

Affect the Market

Value of the Business
Firm

Lead to
Shareholder's
Wealth Maximization
 BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

THE FINANCE ORGANIZATION

Broadly considered, the finance function is much the same as its basic aspects
in all businesses. The ways in which business firms organize to carry out the
finance function may be different.

 In a small business, the head of the firm (President or General Manager)

often assumes direct responsibility for marketing, production, finance and
still other functions such as human resources management, security, etc.
 In medium-size business concerns, a separate department headed by an
officer with the title as Finance Manager may be assigned primary
responsibility for the narrower funds supply aspects of the finance
function.
 Still, in some business firms, responsibilities in the broad financial area are
divided between a treasurer and a controller.
 In very large concerns, both the treasurer and the controller report to a
chief financial officer who often ha the title, Vice-President – Finance.

RELATIONSHIP WITH OTHER KEY FUNCTIONAL MANAGERS IN THE ORGANIZATION

 Finance is one of the major functional areas of a business. For

example, the functional areas of business operations for a typical
manufacturing firm are manufacturing, marketing and finance.
Manufacturing deals with the design and production of a product.
Marketing involves the selling, promotion, and distribution of a
product. Manufacturing and marketing are critical for the survival of
a firm because these areas determine what will be produced and
how these products will be sold. Thus, finance is an integral part of
total management and cuts across functional boundaries.

TYPES OF FINANCIAL DECISIONS

The four (4) major types of decisions that the Finance Manager of a
modern business firm will be involved are:

1. Investment decisions
2. Financing decisions
3. Operating decisions
4. Return of capital decisions
BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

1. Investment decisions
 The investment decisions are those which determine how scarce or
limited resources in terms of funds of the business firms are
committed to projects.
 Because the firm has numerous alternative uses of funds, the
finance manager strives to allocate funds wisely within the firm. This
task requires both the mix and type of assets to hold. The asset mix
refers to the amount of money invested in current and fixed assets.
 The investment decisions should aim at investments in assets only
when they are expected to earn a return greater than a minimum
acceptable return which is also called as hurdle rate.

 The following areas are examples of investing decisions of a finance

manager:
a. Funds allocation and its rationing
b. Determination of the total amount of funds that a firm can commit for
investment
c. Evaluation and selection of capital investment proposal
d. Prioritization of investment alternatives
e. Determination of the levels of investments in working capital
f. Determination of fixed assets to be acquired
g. Asset replacement decisions
h. Purchase or lease decisions
i. Restructuring reorganization mergers and acquisition
j. Securities analysis and portfolio management

2. Financing decisions
 Financing decisions assert that the mix of debt and equity chosen to
finance investment should maximize the value of investments
made.
 These decisions should consider the cost of finance available in
different forms and the risks attached to it.
 Financing decisions call for good knowledge of costs of raising
funds, procedures in hedging risk, different financial instruments and
obligation attached to them.
BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

3. Operating decisions
 This third responsibility area of the finance manager concerns
working capital management. The term working capital refers to a
firm short-term asset (i.e., inventory, receivables, cash and short-
term investments) and its short-term liabilities (i.e., accounts
payable, short-term loans).
 This also involves a number of activities related to the firm’s receipts
and disbursements of cash.
 Some issues that may have to be resolved in relation to managing a firm’s
working capital are:
a. The level of cash, securities and inventory that should kept on hand.
b. The credit policy (i.e., should the firm sell on credit? If so, what terms
should be extended?)
c. Source of short-term financing (i.e., if the firm would borrow in the short-
term, how and where should it borrow?)
d. Financing purchases of goods (i.e., should the firm purchase its raw
materials or merchandise on credit or should it borrow in the short-term
and pay cash?)

4. Return of capital decisions

 The return of capital (or dividend distribution to corporate owners)
decision is concerned with the determination of quantum of profits
to be distributed to the owners, the frequency of such payments
and the amounts to be retained by the firm.

 To summarize, the basic objective of the investment, financing, operating

and return of capital is to maximize the firm’s wealth. If the firm enjoys the
stability and growth, its shares prices in the market will improve and will
lead to capital appreciation of shareholders’ investment and ultimately
maximize the shareholders’ wealth.
 BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

Chapter 3: Financial Environment, Part 1 (Legal Forms of Business Organization,

Financial Markets and institutions)

The Organization of the Business Firm

 The business firm is an entity designed to organize raw materials, labor,
and machines with the goal of producing goods and/or services. Firms,
- purchase productive resources from households and other firms
- transform them into a different commodity, and
- sell the transformed product or service to consumers.

Legal Forms of Business Organization

- Business firms can be organized in one of three ways: as a
proprietorship, a partnership, or a corporation.

A. Sole Proprietorship
 is a business owned by a single person who has complete control
over business decisions. This individual owns all the firm’s assets and
is responsible for all its liabilities.
 From a legal point of view, the owner of a proprietorship is not
separable from the business and is personally liable for all debts of
the business.
 From an accounting prospective, however, the business is an entity
separate from the owner (proprietor). Therefore, the financial
statements of the business present only those assets and liabilities
pertaining to the business.

 Among the advantages of a sole proprietorship are:

1. Ease of entry and exit- A sole proprietorship requires no formal charter

and is inexpensive to form and dissolve.
2. Full ownership and control- The owner has full control, reaps all profits
and bears all losses.
3. Tax savings- The entire income generated by the proprietorship passes
directly to the owner.
4. Few government regulations- A sole proprietorship has the greatest
freedom as compared with any form of business organization.
BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

 Major disadvantages of the proprietorship form include:

1. Unlimited liability- The owner is personally liable or responsible for any

and all business debts.
2. Limitations in raising capital- Resources may be limited to the assets of
the owner and growth may depend on his or her ability to borrow
money.
3. Lack of continuity- Upon death or retirement of the owner, the
proprietorship ceases to exist.

 The “Owner’s Capital” Section in the Statement of Financial Position of a

Sole Proprietorship is presented below

Owner’s Equity or Net Worth

Jose del Pilar, Capital Pxxxx

B. Partnership
 is a legal arrangement in which two or more persons agree to
contribute capital or services to the business and divide the profits
or losses that may derived therefrom.
 Partnership may operate under varying degrees of formality. For
example, a formal partnership may be established using a written
contract known as the partnership agreement which is filed with the
Securities and Exchange Commission.
 A general partnership is one in which each partner has unlimited
liability for the debts incurred by the business.
 A limited partnership is one containing one or more general
partners and one or more limited partners.

 Advantages of a partnership include among others the following:

1. Ease of formation- Forming a partnership may require relatively little

effort and low start-up costs.
2. Additional sources of capital- A partnership has the financial resources
of several individuals.
3. Management base- A partnership has a broader management base
or expertise than a sole proprietorship.
BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

4. Tax implication- A partnership like a proprietorship does not pay any

income taxes. The income or loss of the business is distributed among
the partners in accordance with the partnership and each partner
reports his or her portion whether distributed or not on personal income
tax return.

 Disadvantages of partnership are:

1. Unlimited Liability- General partners have unlimited liability for the

debts and litigations of the business.
2. Lack of Continuity- A partnership may dissolve upon the withdrawal or
death of a general partner, depending on the provisions of the
partnership.
3. Difficulty of transferring ownership- It is difficult for a partner to liquidate
or transfer ownership. It varies with the conditions set forth in the
partnership agreement.
4. Limitations in raising capital- a partnership may have problems raising
large amounts of capital because many sources of funds are available
only to corporations.

 The “Partner’s Capital” Section in the Statement of Financial Position of a

Partnership is presented below

Partner’s Equity or Net Worth

Jose del Pilar, Capital Pxxxx
Marcelo de Guzman, Capital Pxxxx

C. Corporation
 an artificial being created by law and is a legal entity separate and
distinct from its owners.
 This legal entity may own assets, borrow money and engage in
other business entities without directly involving the owners.
 In many corporations, owners who are also called shareholders do
not directly manage the firm. Instead, they select managers
designated as the Board of Directors to run the firm for them.
 The incorporation process is initiated by filing the articles of
incorporation and other requirements with the SEC.
BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

 Advantages of a corporation are:

1. Limited liability- Shareholders are liable only to the extent of their

investment in the corporation. Thus, shareholders can only lease what
they have invested in the firm’s shares, not any other personal assets.
2. Unlimited Life- Corporations continue to exist even after the death of
the owners.
3. Ease in transferring ownership- Shareholders can easily sell their
ownership interest in most corporations by selling their stock without
affecting the legal form of business organizations.
4. Ability to raise capital- Corporations can raise capital through the sale
of securities such as bonds to investors who are lending money to the
corporations and equity securities such as common stock to investors
who are the owners.

 Disadvantages of a corporation include:

1. Time and cost of formation- Registration of public companies with the

SEC may be time-consuming and costly.
2. Regulation- Corporations are subject to greater government
regulations than other forms of business organizations. Shareholders
cannot just withdraw assets from the business.
3. Taxes- Corporations pay taxes on income they have earned. The
complexity of the subject of taxation demands the advice of a
qualified tax accountant.

 The “Shareholder’s Equity” Section in the Corpirate Statement of Financial

Position of a Partnership is presented below

Shareholder’s Equity
Ordinary shares, P100 par value
Authorized, 10,000 shares
Subscribed and paid up, 5,000 shares Pxxx,xxx
Additional paid in capital xx,xxx
Retained earnings xx,xxx
Total Shareholder’s equity Pxxx,xxx
 BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

Financial Markets and Financial Institutions

Financial Markets

- are the meeting place for people, corporations and institutions that
either need money or have money to lend or invest.
- Participants in the financial markets also include national, state, and
local governments; their markets are referred to as public financial
markets.
- Large corporations raise funds in the corporate financial markets.

 Financial market functions as both primary and secondary market for

debt and equity securities.

 Primary Market
- refers to original sale of securities by governments and corporations. In
a primary market transaction, the corporation or the government is the
seller and the transaction raises money for the corporation or
government.
- Corporations engage in two types of primary market transactions,
public offerings and private placements.

 Secondary Market
- popularly known as Stock Market or Exchange.
Two broad segments of the stock markets:

1. The Organized Stock Exchange. The stock exchanges will have a

physical location where stocks buying and selling transactions take
place in the stock exchange floor.
2. The Over-the-Counter (OTC) Exchange. Where shares, bonds and
money market instruments are traded using a system of computer
screens and telephones.

Stock Exchange- is an entity (a corporation or mutual organization) which is in

the business of bringing buyers and sellers of stocks and securities together.

- The purpose of stock exchange is to facilitate the exchange of

securities between buyers and sellers, thus providing a market place,
virtual or real.
 BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

Structure and Functions of the Financial Markets

 Types of Markets

1. Physical asset markets versus financial asset markets.

- Physical asset markets (also called tangible or real asset markets) are
for products such as wheat, autos, real estate, computers and
machinery.
- Financial asset markets, on the other hand, deal with stocks, bonds,
notes and mortgages. It also deals with the derivative securities whose
values are derived from changes in the prices of other assets.

2. Spot markets versus future markets.

- Spot markets are markets in which assets are bought or sold for “on-
the-spot” delivery.
- Future markets are markets in which participants agree today to buy or
sell an asset at some future time.

3. Money markets versus capital markets.

- Money markets are financial markets in which funds are borrowed or
loaned for short periods (less than one year).
- Capital markets are financial markets for stocks and for intermediate or
long-term debt (one year longer).

4. Primary markets versus secondary markets.

- Primary markets are the markets in which corporations raise capital by
issuing new securities.
- Secondary markets are the markets in which securities and other
financial assets are traded among investors after they have been
issued by corporations.

5. Private markets versus public markets.

- Private markets are markets in which transactions are worked out
directly between two parties.
- Public markets are markets in which standardized contracts are traded
on organized exchange.
 BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

Financial Institutions

 Financial Institutions are very important and critical to the function of a

capital society.

 Categories of Financial Institutions

1. Investment Banks. Organizations that underwrite and distribute new

investment securities and help business obtain financing.
2. Commercial Banks. The traditional department store of finance serving a
variety of savers and borrowers.
3. Financial services corporation. A firm that offers a wide range of financial
services, including investment banking, brokerage operations, insurance and
commercial banking.
4. Credit Unions. Cooperative associations whose members are supposed to
have a common bond, such as being employees of the same firm.
5. Pension funds. Organizations that handle retirement plans funded by
corporations or government agencies.
6. Life insurance companies. Companies whose savings are in the form of
annual premiums invest these funds in stocks, bonds, real estate and
mortgages; and make payments to the beneficiaries of the insured parties.
7. Mutual funds. Organizations that pool investor funds to purchase financial
instruments and thus reduce risks through diversification.
8. Exchange trade funds (ETF). Similar to regular mutual funds and are often
operated by mutual fund companies.
9. Hedge funds. Similar to mutual funds because they accept money and use
the funds to buy various securities, but there are some important differences.
10. Private equity companies. Organizations that operate much like hedge funds,
but rather than purchasing some of the stock of firm, private equity players
buy and then manage entire firms.

Banking Market in the Philippines

 Commercial banks and universal banks are the largest single group of financial
institutions in the Philippines, accounting for almost 90% of the combined assets
of the banking system.
 As of February 2017, there are more than 25 universal banks and 25 commercial
banks serving in the Philippines.
 The remainder of the banking market is divided between thrift banks, rural banks,
and a few specialized government institutions. As of Feb. 2017, there are more
than 80 thrift banks and 650 rural banks serving the Philippines.
 BUSINESS FINANCE UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

Structure of the Philippine Financial System

Bangko Sentral ng Pilipinas

Banks Non-Banks
Private banking Institution Private non-bank institution
a. Universal banks a. Investment Houses
b. Commercial banks b. Financing Companies
c. Thrift banks c. Investment Companies
1. Savings and Mortgage Banks d. Pawnshops
2. Stock Savings and Loan Association e. Credit Unions
3. Private Development Banks f. Securities Dealer/broker
d. Rural Banks g. NSSLA
e. Cooperative Banks h. Trust Companies
i. Fund Managers
j. Insurance Companies
Government Banking Institution k. Building and Loan Associations
a. Development Bank of the Philippines
b. Land Bank of the Philippines
c. Al-Amanah Islamic Investment Bank of the Philippines
Government Non-Bank
a. GSIS
b. SSS
c. PAG-IBIG