MODULE 3 LORISA K.

CENIZA
INTRODUCTION TO MANAGERIAL FINANCE JOAN MAE A. VILLEGAS
Finance consists of three interrelated areas. These are:

a. Managerial economics
b. Investment
c. Money and capital markets

Management is concerned with utilizing the scarce resources of the organization to maximize the attainment of the
organization’s goals and objectives. It has four basic components:

a. Achievement of goals and objectives

b. Working with and through people
c. Maximization of limited resources by achieving productivity through efficiency and effectiveness
d. Coping with a changing environment

The 8Ms of management are:

a. Men
b. Money
c. Materials
d. Methods
e. Machine
f. Market
g. Moment
h. Media

Productivity is the output-input ratio (output/input) within a time period taking into consideration quality. Productivity =
efficiency + effectiveness. Efficiency is the quality of attaining desired objectives with the least amount of resources.
Effectiveness is the attainment of goals on a continuing basis.

Tools of the Financial Manager Include:

a. Financial policy-making – selecting financial goals, developing financial policies, and designing the finance
organization
b. Financial planning and budgeting – preparing plans to attain set goals, preparing forecasts and budgets, and
comparing actual performance with budgets to determine variances and determine actions needed to correct
such variances
c. Financial analysis – evaluating results of operation and financial condition, investment options, and other
finance-related activities

FINANCE AND ACCOUNTING

Financial Accounting is the branch of accounting which deals with the recording of business transaction with the basic
purpose of preparing the financial statements.

Managerial Accounting is the branch of accounting which deals with providing internal users, primarily the managers, with
the financial information they need to be able to perform their duties efficiently and make the necessary decisions to improve
operation.

Financial Management is the branch of management entrusted with managing the financial resources of the firm to attain
organizational objectives.

Financial accounting, managerial accounting, and financial accounting and financial management are all interrelated and
interdependent helping those entrusted with governance in the effective discharge of their responsibilities.

UNDERSTANDING FINANCIAL STATEMENTS

Financial statements, the product of financial accounting, show the results of operation ( income statement), financial position
(balance sheet), changes in the owner’s equity, and the sources and uses of funds (cash flow statement).

Income statement (also known as statement of comprehensive income ) shows the results of operation. It details operating
revenues ( service income or any other appropriate income account for a service enterprise, sales for a trading/merchandising and
manufacturing firm) and operating expenses for trading firms), and other income and other expense ( non-operating ) like interest
income and interest expense. It shows the profitability of the firm.

The income statement of a service enterprise is a simple statement with operating expenses deducted from the main revenue
to arrive at the operating profit. Other income is added and other expenses are deducted to arrive at the net income/net profit.

The income statement of a trading/merchandising firm is a bit complicated. The computation of cost of goods sold is complex
with beginning inventory added to the net cost of purchases to arrive at the total goods available for sale. From the total goods
available for sale is deducted the ending inventory to arrive at the cost of goods sold/cost of sales, which is deducted net sales to arrive
at the gross profit. From gross profit, operating expenses are deducted to arrive at the operating profit. Other income is then added and
other expenses are deducted to arrive at net income.
For a manufacturing concern, the income statement is the most complicated. The basic components are:

a. Total manufacturing cost

b. Cost of goods manufactured
c. Cost of goods available for sale
d. Cost of goods sold

Cash flow statement, also known as statement of sources and uses of cash, details all sources or inflow of cash and expenditures or
outflows of cash to show the net increase or decrease in cash. A more complicated form of the statement lists three basic activities of
the firm:

a. Operating activities
b. Investing activities
c. Financing activities

FINANCIAL STATEMENTS: TOOLS FOR DECISION-MAKING

Financial Statements -Are indispensable tools in making financial decisions for everyone individuals, households, business
enterprises, non-profit organizations and even government. They highlight the connection, relation and importance of accounting to
financial management in particular and to finance in general.

Financial Analysis-Deals with the understanding of the relationship between financial concepts and daily decision-making. It is both
an analytical and a judgmental process used in a managerial context.

Operating Decisions-Deals with the day-to-day operations of the firm. They include decisions such as pricing, selecting markets,
choosing the appropriate process or technology, outsourcing payroll, among other.

Operating Leverage-Involves the determination of the profitable level and proportion of fixed costs of operation of operation versus
the amount and nature of variable costs incurred in any of manufacturing, trading and service operations.

Break-even Analysis-Determines the volume of business a company needs to reach where the income equals expenses; profits is zero.

Investment Decision-Refers to deciding on what assets to acquire or projects to pursue

Financing Decision-Refers to decisions that involve funding investments and operations over the long run. It is concerned with
capital structure, debt-equity mix, funding sources, dividend policies, costs, cost of capital, among others. Whether to lease or to buy
is a financing decision.

Horizontal Analysis-Refers to comparative analysis of the financial statements. Financial statements of the current period are
compared with the past period or periods. It reveals trends; hence, it is also called trend analysis.

Vertical Analysis-- Refers to comparing an item with another item, which may come from the income statement only or from
both the income statement and the balance sheet.

Common-size statements-Are a type of ratio analysis where an element of the financial statement is chosen as the base (basis of
comparison) like sales for the income statement and total assets for the balance sheet. In short, it analyzes the components or elements
of the financial statements.

THE FINANCIAL ENVIRONMENT

Financial Environment-Is composed of individuals and entities (financial system participants) who/which need financing in one form
or the other and the financial markets and financial instruments that paly a major role in the financial system of a country.
Financial Markets-Are institutions and systems that facilitate transactions in all types of financial claims. They act as the bridge
between those with excess funds (saving units) and those who need funds (borrowing units).

Marketable Securities or Trading Securities-Is another term used to indicate securities that are held for the short term to be sold as
the need for cash arises.

Philippine Stock Exchange (PSE)-Is the Philippines organized stock market where companies and traders buy and sell stocks. Stock
market monitors performance of stocks, reporting opening and closing prices of different stocks and high and lows, indicating lowest
and highest prices are the indices for selected stocks, monitored by investor and traders.Money market institutions include:

a.Cash management bills--Government issued securities with maturities of less than 91 days.
 b.Treasury bills (T-bills)--Government issued securities with maturities of 91, 182, and 364 days.

c.Commercial Papers (CPs)-- marketable securities issued by highly financially secure firms ranging from 30-270 days.

d.Banker’s Acceptance--- bank drafts issued by banks to help traders and other customers to raise funds to pay for current
expenditures using their (the bank’s) credit; they are short –term drafts or time drafts that mature on a certain date; most
banker’s acceptances are used in connection with letters of credit.

e. Negotiable certificates of deposits -- a negotiable time deposit with a definite maturity date up to one year, when the
investor receives the face amount together with the interest.

f. Repurchase agreement or repos (RPs)--agreements involving the sale of securities by one party to another with a
promise to repurchase the securities at a specified date and price.

g. Money market deposit accounts (MMDAs)--a type of savings account with check writing privileges offers by banks and
other financial institutions which pay interests that are equivalent to and competitive with money market mutual funds
(MMMFs).

h. Money market mutual funds (MMMFs)- investment pool that buy safe, short-term securities such as T-bills, CDs, and
CPs offered by investment companied; the yield is generally a little higher than those offered by MMDAs

i. Certificates of assignments- an agreement that transfers the right of the seller over a security in favor of the buyer, the
underlying security carries a promise to pay a certain sum of money on a fixed date just like in a promissory note; the
underlying security is like a collateral to the certificate

j. Certificate of participation- an instrument that gives the buyer a share in a security that promises to a pay a certain sum of
money on a fixed date just as in a certificate of assignment; the underlying security us of big amount and the certificate of
participation is only a portion; the owner of the certificate participates in the bigger amount underlying security.

Capital market instruments are divided into:

Non-negotiable or non-marketable
(1) Loans – result from one-to-one arrangement between a lender and a borrower/
(2) Leases – an arrangement where the owner of the property (lessor) leases/rents the property out to the user of the
property (lessee) for a fixed monthly lease payment. Usually, properties can be ultimately owned by the lessee if the
lease agreement is a lease-to-buy.
(3) Mortgage – involve using real properties as collateral for a loan.
(4) Letters of credit – letters of a bank guaranteeing payment of a transaction like purchase of merchandise or other
items either domestically or internationally
a. Negotiable or marketable
(1) Corporate stocks – evidences ownership in a corporation the benefit of which is in terms of dividends.
(2) Corporate Bonds – evidences obligations of the issuing corporation the benefit if which is in terms of interests paid
on such bonds.
(3) T-notes and T-bonds – securities issued by the treasury of the country.
(4) Municipal bonds – securities issued by municipalities
(5) Mortgage-backed bonds – bonds issued collateralized by mortgages

FINANCIAL INTERMEDIATION

Financial Intermediaries-Are financial institutions that act as the bridge between savings units (lenders) and deficit units (borrowers).
Other than market specialists who do not issue their own securities, financial intermediaries issue their own financial instruments,
which are considered as secondary securities.

Direct Finance-Involves a one-on-one relationship between a lender and a borrower.

Financial Intermediaries cab be divided into two groups

(a) The Depository Institutions

(b) The Non-Depository Institutions
Depository Institution-Refer to financial institutions that accept deposits from surplus or savings units. The assets of depository
institutions are the loans that they grant borrowers.

Depository institutions are classified as:

a) Commercial banks
(1) Ordinary commercial banks
(2) Expanded commercial or Universal banks

b) Thrift banks
(1) Savings and mortgage banks
(2) Private development banks
(3) Savings and loan associations
(4) Microfinance thrift banks
(5) Credit unions
(6) Rural banks

Ordinary Commercial Banks-Perform the more simple functions of accepting deposits and granting loans. Expanded commercial
banks or universal banks (also called unibanks) perform investment services. It is expanded because of its function as an investment
house and investing in stocks and bonds of non-allied businesses. In addition, they render financial services , payment processing,
securities transactions, underwriting, and financial analysis.

A Branch-Is an independent unit of the head office performing all the functions and offers the service facilities of the head office. An
extension office operates like a branch, but us under the supervision and administrative control of the nearest branch of the head office
or the head office, if the head office is the one nearest it.

Banks are government-regulated-Bank supervision deals with ensuring the soundness and safety of banks. Bank regulation consists
of the administration of laws in the form of rules and regulations that govern the conduct of banking and the structure of the banking
industry.

Thrift Banks-Are banks which encourage the habit of thrift and savings and provide loans at reasonable rates. They include savings
and mortgage banks, private development banks, savings and loana associations, and microfinance thrift banks.

Saving and Mortgage banks-Are bank specializing in granting mortgage loans other than the basic functions of accepting deposits

Private Development Banks-Cater to the needs of agriculture and industry providing them with reasonable rate loans for medium and
long term purposes.

Savings and loan association (SLAs, S&Ls)-Accumulate savings of their depositors/ stockholders (the depositors are the
stockholders) and use these accumulated savings, together with their capital for the loans that they grant and for investments in
government and private securities. These associations provide personal finance and long-term financing for home building and
improvement.

Microfinance Thrift Banks-Are small thrift banks that cater to small, micro and cottage industries, hence, the term “micro”. They
grant small loans to small, micro and cottage businesses.

Credit Unions-Although not belonging to banks, are cooperatives principally functioning to pool savings and grant loans like
depository institutions. Loans granted are multiples (two or three times) of the member’s savings with the unions.

Rural and Cooperative Banks-Are the banks in the rural communities which help in the development of the countryside by providing
them with loans and other basic financial services.

Non-depository institutions include:

Life insurance companies-Provide protection over a contracted period of time or over the life of the insured in exchange of premiums
paid. Life insurance policies have face values, the amount to be received if the insured dies. Life insurance policies also have loan
values, amount that can be borrowed against the policy. In addition they have cash surrender values, amount to be received if the
policy is cancelled or surrendered.

Property/casualty insurance companies-Provide protection against injury or property loan resulting from accidents, work-related
injuries, malpractice , and natural calamities.

Fund managers-Include pension fund companies and mutual fund companies. Pension fund companies sell contracts to provide
income to policyholders, upon retirement. Mutual fund companies accept investments in small amounts to be pooled together to buy
securities that will form the portfolio of investments.

Investment banks-Underwrite new issues of stocks and bonds. They are also called merchant banks.

Finance companies borrow and lend funds to households and businesses. They engage in borrowing and lending, but they are not
banks. They could be sales finance companies providing installment credit to purchasers of big items like cars and appliances,
consumer finance companies granting credit to consumers, or commercial finance companies granting credit to businesses,

Lending Investors-Are like finance companies, but usually smaller, that grant loans to households

Financial Intermediaries-Play an important role in the socio-economic development of countries by providing the financial services
that uplift the society and the economy.

Financial Intermediaries -Spread risks by pooling funds which is called diversification. Because small investments are used to buy
securities, any loss in these securities is spread to many owners rather than one investment bearing the loss.The nature of financial
intermediation has changed from the old, more regulated and specialized institutions to the newer, more diversified institutions we
now have.

INTEREST

Interest Rate-Is the cost of borrowing or lending money. As such, it can be said that it is the cost of credit. It is expressed as the ratio
of interest to amount borrowed or lent.

Transaction Demand-Refers to the demand for money to pay for current expenditures like water and electricity bills, tuition fees,
house rent, among others.

Precautionary Demand-Refers to demand for money for unforeseen additional unforeseen caused by unexpected events like sickness,
accident, natural calamities, among others.

Speculative Demand-Refers to demand for money with the intention of using it when an opportunity to earn more arises.

Rate of Return (ROR)-Is a yield term that considers not only interest earned but also gain or loss arising from change in value
(capital gain or loss) to determine the total net yield to investors. Any capital gain is added to the interest earned and any capital loss is
deducted from the interest earned to determine the ROR.While simple interest is paid at the maturity date, discount is interest deducted
in advance, meaning interest is paid on the date the loan is taken. Banks discount loans they grant such that borrowers receive
proceeds from the loan lesser than the face value of the loan.Compounding pays interest on interest, meaning for every compounding
period, the principal accumulates interest earned.

Effective Annual Rate (EAR)-Is the rate which would produce the same future value if annual compounding is used. Therefore, it is
higher than the nominal interest rate.

Effective Interest Rate (EIR)-Is measured based on the kind of credit and is term. This includes interest on trade credit or open
account granted by businesses and bank loans in the form of lines of credit.

Yield to Maturity (YM)-Is the interest rate which equates the present value of all cash flows from the debt instrument to the current
value. For a simple loan, YM is equal to the simple interest rate. For bond the yield is computed through interpolation to arrive at the
exact yield or for more simple computation, the current yield is used by simply dividing the yearly coupon payment by the price of the
security.

Real risk-free rate of interest (k*)-Is the interest rate that is adjusted for inflation.
The Loanable Funds Theory-Expounded on the classical theory by theorizing that borrowers create the demand for loanable funds
and the lenders, on the other side, seek to provide the loanable funds needed by borrowers. This interplay of supply and demand for
loanable funds determines the interest rate.

The Liquidity preference theory-Maintains that the interest rate is determined in the money markets by the money demand and the
money supply.

The Rational Expectations Theory-Is based on the premise that financial markets are highly efficient in digesting new information is
translated by investor into borrowing or investment decisions.

Interest rates are determined by several factors including:

a) Savings
b) Investment demand
c) Money supply
d) Money demand
e) Inflation expectations
f) Monetary policy
g) Business cycle
h) Government budget deficits

FINANCIAL ASSETS

Financial Assets-Are intangible assets representing claims to future cash in terms of earnings, and principal. They include cash,
receivables, and financial securities or instruments like bonds, stocks, commercial papers, among others.

Accounts Receivables-Are open accounts granted by buyers or customers and cab be used as a source of financing through pledge,
assignment (with recourse or without recourse), and factoring.

Notes Receivables-Are also a source of financing through discounting. When note are discounted with the bank, the bank pays the
owner of the notes the face value of the notes less discount fees and other service or finance charges.

Activity 3:

1. How does interest rate affect the investment decision of businesses?

2. How are financial accounting, managerial accounting, and financial management
interrelated?