Finance 1 Modules 3-6

MABINI COLLEGES, INC.
Daet, Camarines Norte
COLLEGE OF BUSINESS ADMINISTRATION

And ACCOUNTANCY
1st Sem., S.Y.2021-2022
Finance 1 – Business Finance

MODULE 3
Title: Fundamental Concepts and Tools of Business Finance
Name of Student:
Course/ year:
Class Schedule:
Date Submitted:
In Module 3, you will read about the fundamental concepts and some terms related to business
finance. The topic aims to understand the goals of business finance; the financial statements; the
significance of financial statements and budgets and the annual report.
After completing this module, students must have:

● Know the goals of business finance
● Learn the details of the financial statements as well as budgets
● Able to identify the significance of financial statements and budgets
Fundamental Concepts and Tools of Business Finance
A. BASIC CONCEPTS
Terms, unless they are clearly defined, are sometimes confusing. As some of them related, it is
important so define them and discuss their relationships with other relevant terms.
Finance
Finance may be defined as the study of the acquisition and investment of cash for the purpose of
enhancing value and wealth.
Categories of Finance. Finance, in general, is divided into categories according to the type of
entity or organization served. They are the following:
1. public finance
2. private finance
Public Finance. Public finance is that the category of general finance, which deals with the
revenue and expenditure patterns of the government and their various effects on the economy.
Private Finance. This category deals with the area of general finance not classified under public
finance. It is subdivided into the following:
1. personal finance;
2. the finance of non-profit organization; and
3. business finance.
Personal finance is concerned with the fundamental of managing one’s own personal money
affairs. The finance of non-profit organizations includes private undertakings such as charity, religion, and
some private educational institutions.
B. DEFINITION OF BUSINESS FINANCE

The term business finance refers to the provision of money for commercial use. Business
finance, however, is more than just provision of money. It is also concerned with the effective use of
funds. As such, it covers the financial management of private profit- seeking concerns in the business of
service, trade, manufacturing, mining, public utilities, and financing. With the foregoing requirements,
business finance may be defined as the procurement and administration of funds with the view of
achieving the objectives of the business.
Specifically, however, business finance may be concerned with three aspects:
1. small business finance;
2. corporation finance; and
3. multinational business finance.
It must be made clear that there are similarities and differences between the three aspects of
business finance.
FINANCE
Public Finance Private Finance
Personal Business Finance of

Finance Finance Non- profit Organization
Small Business Corporation Multinational

Finance Finance Business
C. THE GOALS OF BUSINESS FINANCE

Private business is established primarily for profit. This end however, can be achieved by the
effective management of the various business functions. One of these is the finance function. Like the
other functions, it has its own goals. The goals of business finance are variously expressed as follows:
1. maximizing profit;
2. maximizing profitability;
3. maximizing profit subject to cash constraint;
4. maximizing net present worth; and
5. seeking an optimum position along a risk- return frontier
1. Maximizing Profit
Maximizing profit means realizing the highest possible peso or dollar income. A firm, for
instance, may seek to double its peso or dollar income for the current year. This framework, however, is
not very useful in making sound financial decisions. The amount of profit earned by the firm is not
adequate to evaluate its performance. For instance, the net income earned by XYZ Company for a
certain year in the amount of P480 million does not provide much useful information for the investor or
financial manager. This is true even if the same amount represents an increase from previous year’s
profit of the firm.
2. Maximizing Profitability
When a firm decides on obtaining a higher rate of return on its own investment, it is said to be
maximizing profitability. The following data show an improvement in the company’s performance.
MIKAELA COMPANY
(2006)
2005 2006
Net Worth P100,000,000 P200,000,000
Net Profit 1,000,000 5,000,000
Return on Investment 10% 25%
3. Maximizing Profit Subject to Cash Constraint

In the quest for profit maximization, undue emphasis is sometimes placed on cash balances.
Maintaining too large a cash balance reduces the chance of a favorable rate of return, while running out
of cash when needed is disastrous. The ideal set- up is to maximize profits, while at the same time
maintaining a cash balance that can take care of cash requirements anytime. This condition is especially
critical in the operation of banks.
4. Maximizing Net Present Worth

Under the net present worth concept, the objective of the firm is to maximize the current value
of the company to its owners. The net present worth of the firm is equal to the value now of the firm
plus values arising in the future. The present worth of values arising in the future are computed and
added to the present worth of the other values of the firm. Present values may be better understood by
the way of knowing the concept of the time value of money.
Time Value of Money. This concept indicates that money increases in value with the passing of
time. A peso today could be deposited in a bank and made to earn interest. This capacity to earn makes
the peso today worth more than the peso that would be received in the future. Thus, to be able to find
out the present worth of a peso that would be received in the future, the corresponding interest (or
discount) should be deducted from that future peso.
Calculation of Present Worth. The present worth of a value to be received in the future is
illustrated as follows:
Question: What is the value today of P100,000 to be received next year assuming that the
prevailing rate of interest is ten percent (10%) per annum?
Solution:
Value today amount P100,000

Of next year’s = = = P 90,909.09
P100,000 1 + rate of 1.10
Interest
5. Seeking an Optimum Position Along a Risk- Return Frontier

A firm can set a goal of achieving the best possible combination of risk and return. A little more
risk may be accepted, for instance, for an expected additional rate of return.
Definition of Return on Investment or Net worth. The net income generated by the use of
investments or the net worth of a firm is referred to as return on investment. When it is expressed in
percentage, it is called the rate of return.
Definition of Risk. Uncertainly as to loss is called risk. When used in finance, the term applies to
the potential incurrence of loss of money or its equivalent. Risk is discussed at length in a succeeding of
money or its equivalent. Risk is discussed at length in a succeeding chapter.
Calculation of Expected Value Using Risk and Return Factors.
The optimum position of risk and return may be determined by calculating the expected value of
alternative decisions. The expected value of a return on investment is equal to the return times the
percentage of probability that it will happen (called the risk factor). An illustration is provided as follows:
Alternative Return on Probability Expected Value
Net Worth
(A) (B) (AxB)
1 P100 million 60% P60 million
(optimum position)
D. THE FINANCIAL STATEMENT

Financial statements are those that present financial information to various interested parties. Inasmuch
as the finance manager is responsible for managing the financial activities of the firm, he is naturally one
of the most concerned about getting relevant information through the use of financial statements. There
are various types of financial statements, but only two of them are important from the point of view of
business finance. These are: (1) the balance sheet; and (2) the profit and loss statement.
The Balance Sheet

The balance sheet is the statement produced periodically, normally at the end of a financial year,
showing an organization’s assets, liabilities, and the interest of the owners.
Assets. The assets section of the balance sheet shows everything that the firm owns and which
has monetary value. Assets are classified into four items and are presented in the balance sheet in the
order of how quick they can be converted into cash. The classifications are as follows:
1. Current Assets. These are composed of cash, bank deposits, and other items readily
convertible into cash like accounts receivable, stocks and work-in-process, and marketable securities;
2. Trade Investments. These are composed of investments in subsidiary or associated
companies;
3. Fixed Assets. These items show the firm’s ownership of property like land, buildings, plant and
machinery, equipment, vehicles, furniture and fixtures, all valued at cost less depreciation written off;
and
4. Intangible Assets. These items present goodwill, patents, copyright which are attributed to
the firm.
Liabilities. The liabilities section of the balance sheet shows the profile of the debts of the
company. They are classified into several items and are presented first and referred to as current
liabilities. Long- term liabilities are those which are payable after one year. The following are common
liability items:
1. Accounts Payable. These are usually composed of debts payable within a few days, weeks, or
months, like those incurred in the purchase of raw materials and stocks.
2. Loans and Notes Payable. These are debts evidenced by promissory notes and oftentimes
backed up by collaterals. Creditors of this type of liability are composed of banks, suppliers, financing
companies, and the public.
3. Advances from Customers. Sometimes, customers are required to make down payments
before orders are processed. Inasmuch as this is not yet earned by the company, they are considered
liabilities.
4. Accrued Expenses. These represent obligations, which have been incurred but not yet paid.
5. Mortgage Payable. This comprises borrowings and other sources of funds. This item also
represents long-term debts and is usually secured by land, buildings, or equipment.
6. Bonds Payable. When a large amount of long-term debt is sought by the firm from a large
number of creditors, bonds are usually issued. The amount borrowed is divided in denominations like
P500, P1,000, P5,000, and individual bond certificates are issued in these amounts. Each creditor holds
the bond, or the promise to pay, for his share of the company’s debt.
Net Worth. The net worth section of the balance sheet shows the interest of the owner or
owners in the company.
In a single proprietorship, the owner’s interest usually appears as a single account, for instance,
“Isabelo Musingi, Capital.” This represents sums invested by the owner, which is increased by profits and
decreased by losses and withdrawals.
In a partnership, the interests of the partners are presented separately like the following:
Francisco Taguinod, Capital P10,000,000
Clarita Navarro, Capital 20,000,000
Angelita Ballesteros, Capital 30,000,000
Total Net Worth P60,000,000
The Net Worth section of a corporation’s balance sheet will appear as follows:
1. when the shares of stock have par value
Capital Stock P50,000,000
2. when the shares of stock have no par value (but with an arbitrary stated value):
Capital stock (stated value at P20,000,000
P10 per share)
Paid- in surplus 30,000,000
Total Net Worth P50,000,000
Exhibit 1
A SAMPLE BALANCE SHEET
ANDRES NICOLAS CORPORATION
BALANCE SHEET
DECEMBER 31,2006
ASSETS
Cash P 38,
130, 000
Accounts Receivable 97,
943, 000
Inventory 161,
351, 000
Total Current Assets P 297,
424, 000
Fixed Assets 131,
067, 000
Prepaid Expenses 9,
239, 000
Cash Value, Life Insurance 22,
431, 000
Total Assets P 460,
161, 000
LIABILITIES
Due Banks P 45,
000, 000
Notes Payable 24,
000, 000
Accounts Payable 40,
203, 000
Accruals 15,
332, 000
Taxes 5,
906, 000
Undistributed Earnings 2,
109, 000
Total Current Liabilities P 132,
604, 000
OWNERS’S EQUITY
Common Stock P
104, 500, 000
Capital Surplus
0
Earned Surplus
223, 057, 000
Total Liabilities and Net worth P 460,
161, 000
3. when there is a special class of ownership:

Capital Stock
Preferred (P500 par, 8% 100,000 shares) P 50, 000, 000
Common (P500 par, 200, 000 shares) 100, 000, 000
Total Net Worth P 150, 000,000
The Income Statement

The income statement represents the revenues realized from the sale of commodities and
services produced by the company, as well as the costs and expenses incurred in connection with the
realization of said revenues. The income statement is also referred to as profit and loss statement, as
two possibilities are presented, i.e., net profit or net loss. Unlike the balance sheet which shows the
financial condition of the firm on a given date, the income statement presents a summary of the
transactions for a given period.
The income statement is characterized by four distinct items: (1) revenues; (2) expenses; (3)
other income; and (4) net profit or loss.
Revenues. This term refers to the gross income from the production and sale of a firm’s product
or service. Revenues include cash collections and receivables or unpaid sale. This item does not include
trade discounts allowed to distributors of other middleman. To obtain net income or net sales, returns
and allowances are deducted from the gross revenues.
Expenses. This refers to the monetary values of the goods and services used in the production
and delivery process in order to obtain revenues. Expenses consist of three items; (1) the cost of goods
manufactured and sold; (2) operating expenses; and (3) other expenses.
1. Cost of Goods Manufactured and Sold. This item presents a summary of the cost of raw
materials, labor, and various overhead costs directly involved in the manufacturing process and which
represent the manufacturing cost of goods sold during the period under consideration. Overhead costs
include expenditures like salaries of supervisors, depreciation, light and water, supplies, and factory rent.
The cost of direct materials is computed by deducting the raw materials inventory at the end of
the period from the total raw materials available for use. In turn, the raw materials available for use are
computed by getting the sum of raw materials inventory at the beginning of the period and purchase
during the period. The formula for determining the cost of raw materials used is as follows:
Raw Materials Inventory, Beginning of the Period

+ Purchases during the period
= Raw Materials Available for Use
- Raw Materials Inventory, End of the Period
= Cost of Raw Materials Used
The cost of good manufactured is computed by deducing the work- in- process, end of the
period, from the cost of goods processed. In turn, the cost of goods processed is the sum of the cost of
raw materials used, the direct labor, overhead, and if applicable, the work-in-process at the beginning, of
the period. When the cost of goods manufactured is determined, the formula will appear as follows:
Cost of Raw Materials
+ Direct Labor
+ Overhead
+ Work-in-Process, beginning
= Cost of Goods, Processed
- Work-in-process, end
= Cost of Goods Manufactured
As some of the goods manufactured may have been added to inventory, the cost of goods sold
may be computed by deducting the finished goods inventory (end) from the total amount of goods
available for sale. The cost of goods manufactured and the finished goods inventory (beginning)
comprises the total amount of goods available for sale. Thus, the following formula is used in
determining the cost of goods manufactured and sold:
Cost of Goods Manufactured
+ Finished Goods, Beginning
= Total Goods Available for Sale
- Finished Goods, End
= Cost of Goods Manufactured and Sold
Exhibit 2
A SAMPLE INCOME STATEMENT
VIRGILIO ILAGAN COMPANY
Income Statement
12 Months to December 31, 2006
Sales P 150, 817,

000
Less: Royalties 8, 853,
000
Net
P 141, 964, 000
Cost of Goods Sold:
Beginning Inventory
17, 161, 000
Purchases
79, 600, 000
Freight
1, 179, 000
Labor
12, 970, 000
Indirect Manufacturing Expenses
4, 847, 000
P 115, 757, 000
53, 400, 000

Less: Ending Inventory
P 62, 357, 000
Gross Profit
P 79, 607, 000
Operating Expenses:
Salaries- administrative
P 27, 090 , 000
Salaries- secretarial
5, 625, 000
General Office
2, 120, 000
Travel and Entertainment
7,650, 000
Auto Expenses
4, 374, 000
Depreciation and Amortization
1, 016, 000
Legal and Accounting
4, 366, 000
Payroll Taxes
4, 753, 000
Business Taxes
1, 749, 000
Telephone
1, 749, 000
Insurance
1, 515, 000
Management Fee
9, 895, 000
Research and Development
2, 996, 000
Miscellaneous
4, 990, 000
Contributions
2, 508, 000
Advertising
509,000
Literature
808, 000
Interest
2, 447, 000
Bad Debts
2, 580, 000
Commission
-
P 88, 740, 000

Net Loss
- P 9,133, 000
2. Operating Expenses. These represent marketing, general, and administrative expenses. Examples are
advertising, salaries, and wages.
3. Other Expenses. These include interest expense and sale discounts.
Other Income. This item refers to non-operating income such as interest income and purchase discounts.
Net Profit or Net Loss. Net profit or net income refers to the difference between revenues less period
expenses and product costs. When expenses and costs are greater than the revenues, the result is a net
loss.
E. THE BUDGET
Concerning the finance function of the manager, one of the useful tools he could use is the
budget.
The budget is defined as an estimate of income and expenditures for a future period. The budget
is contrasted with the income statement, which is a summary of the performance of the firm for a past
period, and with the balance sheet which presents the financial condition of the firm at a given date,
past or present. The budget completes the financial picture by referring to the future.
Budgets are essential elements in the planning and control of the financial affairs of the
business. Large corporations place so much emphasis in the annual budget which is normally broken
down into monthly and weekly periods, and which may take several months to prepare.
In preparing the budget, an estimate of sales and income for the period is made, followed by
estimates of expenditures in purchasing, administration, production, distribution, and research. Detailed
budgets of cash flow and capital expenditures are also included.
The Sales Budget

The sales budget is the starting point of company budgets. It shows an estimate of sales in units and
dollars or pesos for each major subdivision of sales.
The Materials and Purchases Budget

This portion of the company budget refers to the estimate of the materials required by the firm,
specified in quantities, costs, timing of purchase, the required delivery dates, and other requirements.
The Production Budget
The production budget is an estimate of the quantity of the products that should be produced in
accordance with the sales budget. It also shows the monthly breakdown of quantities to be produced for
each product depending upon the firm’s seasonal sales index. The total units to be produced could be
derived using the following equation:
Budget Sales
- Starting Finished Goods Inventory (Expected)
+ Ending Finished Goods Inventory (Planned)
= Total Units to be Produced
F. SIGNIFICANCE OF FINANCIAL STATEMENTS AND BUDGETS
There are five distinct groups interested in knowing the financial standing of the firm. These are:
(1) the owners, (2) the management, (3) the creditors, (4) the government, and (5) prospective investors.
In some cases, customers and employees require financial data about the firm. Financial statements and
budgets provide most of information required by interested parties.
The owners are primarily concerned with receiving information on the anticipated financial
benefits that will be generated by the firm. They also need to know whether it is wise or not to continue
their relationship with the firm as owners. These information requirements are provided by the financial
statements.
The management is concerned with effective planning and control of the activities of the firm.
As various financial information is provided by the financial statements and budgets, they are particularly
useful to management.
The creditors will be interested to know if the firm is credit worthy. The use of the firm’s financial
statements will help them find out the answer.
Financial statements are required by the government for tax and regulatory purposes. Examples of
the areas of concern are income tax assessment and the regulation of the issuance of securities like
stocks and bonds.
Financial statements are also especially important to prospective investors. They are mainly
interested in the protection of their investments and the earnings they require over a period of years.
The balance sheet and the income statement will be very useful in this regard.
Budgets are especially important to management because they are able to do the following:
1. anticipate asset needs;
2. plan for necessary financing; and
3. establish standard by which to test current operating performance.
Customers who would want to establish long-term relationship with the firm would be
particularly interested to know how stable the firm is. Financial statements could provide them with
initial information.
Employees who would want to consider long-term employment with the firm would also want to
know the long-term prospects of the firm. Financial statements would be useful in this regard.
G. THE ANNUAL REPORT

The report sent out each year by the company to its stockholders or members is called the annual
report. It normally contains the following:
1. the balance sheet;

2. the profit and loss statement;
3. the auditor’s report; and
4. the chairman’s report.
In case the firm is part of the group, the report must also contain a consolidated balance sheet
and a consolidated profit and loss statement.
Discuss your answers on the following questions briefly:

(If means of learning and teaching is done online, the following questions will be asked to students during
video conference or be posted by the teacher in the Google Class Stream/ Wall as a discussion point.)
1. Distinguish private finance from public finance.

2. Define the term business finance.
3. A prospective investor has three investment choices. In investment proposal A, he is 50% sure to
make a P100,000 profit. In proposal B, an P80,000 profit is 55% certain, while in proposal C, a
P120,000 profit is 45% certain. In terms of expected value, which is the best choice?
4. What are presented in the balance sheet? In the profit and loss statement?
5. What does net worth represent?
Compile balance sheets of three companies representing three different industries. Point out
and provide reasons for the differences in the information provided by the balance sheets.
(In Google Classroom, this will be posted as a written task. There will be a deadline to be set for the
submission of answers)
True or False. Write I like to if the statement is True and Move it if the statement is False.
_____________ 1. The budget is sent out each year by the company to its stockholders or members.
_____________ 2. Financial statements and budgets of the firm are the concern of the owners, the
management, the creditors, the government, and prospective investors.
_____________ 3. Public finance may be subdivided into: (1) personal finance; (2) the finance of
non-profit organizations; and (3) business finance.
_____________ 4. Business finance refers to the provision of money for commercial use, as well as the
effective use of funds.
_____________ 5. The various goals of business finance are; (1) maximizing profits; (2) maximizing
profitability; (3) maximizing profit subject to cash constraint; (4) maximizing net present worth; and (5)
seeking an optimum position along a risk- return frontier.
_____________ 6. In the performance of the finance function of the manager, the budget, which is an
estimate of income and expenditures for a future period, is a useful tool.
_____________ 7. Finance refers to the study of acquisition and investment of cash for the purpose of
enhancing value and wealth. It may be categorized as either public finance or private finance.
_____________ 8. The production budget is an estimate of the quantity of the products that should be
produced in accordance with the sales budget.
_____________ 9. Revenues refer to the gross income from the production and sale of a firm’s product
or service.
_____________ 10. Net profit or net income refers to the difference between revenues less period
expenses and product costs.


And ACCOUNTANCY
st
1 Sem., S.Y.2021-2022

MODULE 4
Title: FINANCIAL MARKETS
Name of Student:
Course/ year:
Class Schedule:
Date Submitted:
In Module 4, you will learn about the Financial Markets. Awareness of the environment where
the business operates provides a better perspective to the one making decisions relating to the finance
function. An important concern refers to financial markets which perform a vital role in the operation
of the overall financial system including business finance.
● Know what are financial markets and its benefits
● Learn why firms invest and borrow
● Determine the methods by which financial market transfer funds
● Know the classification of financial markets
FINANCIAL MARKETS
A. WHAT ARE FINANCIAL MARKETS
There are lots of individual and firms with surplus funds. This actually means that their current
expenditures are smaller than their current incomes. To many of them, the surplus funds needs to be
invested.
At the same time, there are people and firm whose needs for funds are greater than their
current incomes. They need a reliable source of loanable funds.
Individuals and firms who want to borrow money are brought together with those who want to
lend in the financial markets. These markets provide a permanent venue for savers and borrowers, and
which render financial services whenever required by their customers. These services are made possible
by the financial markets through expediting the creation and trading of financial instruments.
Figure 4 shows an illustration of how funds and financial instruments are channeled to and from
the surplus spending units (SSUs) and the deficit spending units (DSUs) in the financial markets .
B. BENEFITS OF FINANCIAL MARKETS
The operation of financial markets offer advantages which covers the following:
1. funds are directed to DSUs which can use them most efficiently; and 2. liquidity is provided to savers.
DIRECT FINANCING
Private placements
Direct Credit Market Brokers
Dealers
Investment bankers Primary Securities
Funds
Funds
SURPLUS SPENDING Primary Securities DEFICIT SPENDING

UNITS UNITS
Households Households
Business Firms Secondary Securities Business Firms
Funds INDIRECT FINANCING BY

FINANCIAL INTERMEDIARIES Primary Securities
Commercial banks Funds
Savings and loans Associations
Mutual saving
Credit unions
Insurance companies
Pension funds
Finance companies
Mutual funds
Money market funds
Intermediation Market Direct Credit Market
Figure 4. Channels for Funds and Financial

Instruments in the Financial Market
Financial markets, just like any market, operate under the influence of the demand and supply
of funds. DSUs that can use borrowed funds in the most productive manner can afford to pay higher
interest rates. Because of this, they have an edge in the bidding for loanable funds. As such, business
firms, big and small, compete for the use of the funds made available by the financial market. The
competition will push interest rates higher and this will motivate savers to save more so they will have
more funds for lending.
An additional benefit provided by financial markets is liquidity. Without the intervention of

financial markets, savers will directly lend to borrowers. This arrangement forces the lender to wait for
the maturity date of the loan before he gets his money back. The lender will be at a great disadvantage if
he finds out later that he needs the loaned amount before maturity. This problem is eliminated when
financial markets are tapped. This happens because financial instruments are issued to lenders, which in
turn, can be converted to cash even before maturity, by endorsement or sale.
C. WHY FIRMS INVEST AND BORROW
Firms, at one time or another, are confronted by capital deficiency. This happens when
opportunities for investment come by. Additional investment may bring additional income or economies
in operation. An electronics-retailing firm, for instance, may expand by opening branches in various
places. The immediate advantages that may be derived are as follows:
1. quantity discounts for bulk purchases granted by suppliers; and
2. additional revenues from sales
When the owners of the firm cannot provide additional capital, they will resort to borrowing.
This situation happens not only to small firms but to big firms as well.
A system must be able to address that particular economic need. The answer lies in the
operation and maintenance of a financial system, which includes financial markets.
D. METHODS BY WHICH FINANCIAL MARKETS TRANSFER FUNDS
When firms need funds, the financial markets provide two methods by which funds could be
transferred to them. The methods consist of direct and indirect finance.
1. Direct Finance
Direct finance refers to lending by ultimate borrowers with no intermediary. Under this method, the
SSU gives money to the DSU in exchange for financial claims on the DSU. The claims issued by the DSU
are called direct claims and are typically sold in direct credit markets such as money or capital markets.
Direct financing provides SSUs with a venue for savings with expected returns. The DSUs as a
result, are provided with a source of funds for consumption or investment. This arrangement increases
the efficiency of the financial market.
Direct financing however, has some disadvantages. These are as follows:
1. There are few DSUs which can transact in the direct market because the denominations of
securities sold are very large (usually millions of pesos).
2. It is difficult to match the requirements of SSUs and DSUs in terms of denomination, maturity,
and other factors.
Methods of Direct Financing. There are various means used in direct financing. These are as follows:
1. private placements;
2. brokers and dealers; and
3. investment brokers.
Private placement refers to the selling of securities by private negotiation directly to insurance
companies, commercial banks, pension funds, large-scale corporate investors, and wealthy individual
investors.
A broker is one who acts as an intermediary between buyers and sellers but does not take title
to the securities traded.
INDIRECT FINANCE
FINANCIAL INTERMEDIARIES
Funds Funds Funds
Lenders-savers Borrowers- Spenders
1. Households 1. Business Firms
2. Business Firms FINANCIAL 2. Government
3. Government MARKETS 3. Households
4. Foreigners Funds Funds 4. Foreigners
DIRECT FINANCE
Figure 5. Transfer of Funds From Lenders to Borrowers
A dealer is one who is in the security business acting as a principal rather than an agent. The
dealer buys for his account and sells to costumers from inventory. He makes profits by selling his
inventory of securities at a price higher than acquisition cost.
The investment banker is a person who provides financial advice and who underwrites and
distributes new investment securities.
2. Indirect Finance
Indirect finance (also called financial intermediation) refers to lending by an ultimate lender to a
financial intermediary that then relends to ultimate borrowers. Financial intermediaries include
commercial banks, mutual savings banks, credit unions, life insurance companies, and pension funds.
The beneficiaries of direct financing brought to the fore the services of financial intermediaries.
Direct claims with one set of characteristics are purchased from borrowers, then transformed into
indirect claims with a different set of characteristics and then sold to lenders.
E. CLASSIFICATION OF FINANCIAL MARKETS
Financial markets may be classified as follows:
1. primary market
2. secondary market
3. money market
4. capital market
5. bond market
6. stock market
7. mortgage market
8. consumer credit market
9. auction market
10. negotiation market
11. organized market
12. over-the-counter market
13. spot market
14. futures market
15. options market
16. foreign exchange market
1. Primary Market. A financial market in which newly issued primary and secondary securities are
traded for the first time is called primary market. Investors who buy these new issues are supplying
funds to DSUs which issue the securities.
Large corporations needing large amount of funds usually tap the primary market through bond
issuance.
2. Secondary Market. A secondary market is that financial market through which existing financial
securities are traded. SSUs which bought new securities from the primary market may sell the same to
the secondary market anytime they wish to change their portfolios before maturity dates. As such, the
secondary market provides liquidity to the SSUs with securities held.
When banks buy Treasury bills (T-bills) from the Bangko Sentral, they do so in consideration of
their clients who buy the T-bills from them and which forms a solid secondary market. Figure 6 shows
the flow of funds and securities in the primary and secondary markets.
3. Money Market. The money market is that financial market on which debt securities with an original
maturity of one year or less are traded. Long- term securities may also be traded in the money market if
they have six months or less left to maturity.
Banks like the Land Bank of the Philippines perform money market functions.
PRIMARY MARKET: New Issues
Investment Bankers and
Money Invested Private Placement New Funds
New Common Stock New Stock
and Bond Certificates and Bond Certificates
Household Business
Sector Money Sector
Common Stock and
Bond Certificates
Common Stock and
Bond Certificates
Stock Exchanges and
Money Over-the-counter
Market
SECONDARY MARKETS: Seasoned or Existing Issues
Figure 6: The Flow of Funds and Securities in

Primary and Secondary Markets
4. Capital Market. The capital market is that portion of the financial market where trading is
undertaken for securities with maturity of more than one year. Banks that bid for two-year Treasury
bonds are considered part of the capital market.
The capital market is subdivided into three parts:
1. the bond market;
2. the stock market; and
3. the mortgage market.
5. Bond Market. The market for debt instruments of any kind is called the bond market. It operates
through a system of dealers using a telecommunications network, rather than in a single physical
location for trading. Dealers include giant banking firms located around the world.
6. Stock Market. The stock market is that financial market where the common and preferred stocks
issued by corporations are traded. It has two components: (1) the organized exchanges; and (2) the less
formal over-the-counter markets.
There are many organized exchanges throughout the world like the New York and the London
Stock Exchanges. In the Philippines, stocks are openly traded in the Philippines Stock Exchange. The
companies whose stocks are traded in the Philippine Stock Exchange are classified into the following
categories:
1. banks
2. financial service
3. communication
4. power and energy
5. transportation services
6. construction and other related products
7. food, beverages, and tobacco
8. holding firms
9. manufacturing, distribution and trading
10. hotel, recreation, and other services
11. bonds, preferred stocks, and warrants
12. others
7. Mortgage Market. The mortgage market is that portion of the financial market which deals with
loans on residential, commercial, and industrial real estate, and on farmland.
Various financial institutions comprise the mortgage market. This may be derived from a review
of advertisements in newspapers where financial institutions are inviting interested parties to buy
foreclosed properties. Aside from banks, the National Home Mortgage Finance Corporation (NHMFC),
the Government Service Insurance System (GSIS), and the Social Security System (SSS) grant mortgage
loans, secured by house and lot as collaterals.
8. Consumer Credit Market. The market involved in loans on autos, appliances, education, travel is
referred to as the consumer credit market. As there are millions of consumers tapping the credit market,
it is expected that there will be a number of financing institutions extending auto, salary and various
personal loans to consumers.
9. Auction Market. The auction market is one where trading is conducted by an independent third
party according to a matching of prices on orders received to buy and sell a particular security. Stocks are
sold to the highest bidder on the trading floors.
At the Philippine Stock Exchange, buyers of securities make their bids and prospective sellers
make their offer. Bids and offers stipulate both price and volume and are handled by the trader, an agent
of the auction market.
Offers are ranked from the lowest price up; bids from the highest price down. Bids and offers are
matched with one another. If there is a match, trade is consummated. Buyers and sellers do not directly
trade with one another, but through the trader.
The Philippine Stock Exchange is an example of an auction market.
10. Negotiation Market. When buyers and sellers of securities negotiate with each other regarding price
and volume, either directly or through a broker or dealer, they are engaged in the financial market called
negotiation market.
Securities that are not frequently traded and which are in large volumes may not be readily
accommodated in the auction market for lack of time to receive sufficient orders. This situation is
remedied by the negotiation market where the buyers and sellers are given sufficient time to locate one
another and to revise either price or volume in order to clear the market.
Once in a while, the Philippine government negotiates with institutions like the World Bank for
loans intended for various projects.
11. Organized Market. The organized market is that financial market with fixed trading rules. It is
situated in central location in the financial district in which trading is generally conducted by auction.
Another name for organized markets are exchanges like the Philippine Stock Exchange and the Australian
Stock Exchange. Common and preferred stocks, bonds, and warrants are sold at the Philippine Stock
Exchange.
Stock exchanges have specifically designated members, and have an elected governing body –
the board. Members have seats in the exchange, which are bought and sold. The seat gives the holder
the right to trade on exchange. The board of governors of the Philippine Stock Exchange is composed of
15 members.
12. Over-the-counter Market. The over-the-counter market is that market consisting of large collection
of brokers and dealers, connected electronically by telephones and computers that provide for trading in
unlisted securities. All securities not traded in the stock exchange, for one reason or another, are traded
over the counter.
The over-the-counter market consists of facilities, namely;
1. relatively few dealers who hold inventories or over-the-counter securities and act as a
securities market;
2. the many brokers who act as agents in bringing these dealers together with investors; and
3. the computers, terminals, and electronic networks that provide a communications link
between dealers and brokers.
13. Spot Market. When securities are traded for immediate delivery and payment, the market type
referred to is the spot market. The spot price is the feature of the spot market and which is actually the
price paid for a security that will be delivered on the spot immediately. The term immediately may
actually mean one or two days to one week depending on the facilities used or the tradition in the area.
The spot market is an alternative to the futures market.

14. Futures Market. The futures market is that markets where contracts are originated and traded that
give the holder the right to buy something in the future at a price specified by the contract.
For some time in the past, there was a futures market operating in the Philippines, but it was
dissolved because of some difficulties. As its importance cannot be discounted, the Bankers Association
of the Philippines has recommended key reforms in government regulations that will pave the way for
the resumption of futures trading in the country.
15. Options Market. The options market is one where stock options are traded. A stock option is a
contract giving the owner the right to either buy or sell a fixed number of shares of a stock (usually 100)
at any time before the expiration date at a price specified in the option.
Option contracts may cover items like gold and Treasury bonds. Options are traded in organized
securities exchanges like the Philippine Stock Exchange.
One purpose of the options market is to make possible for investors who wish to reduce the risk
of losing money due to price changes in the future. For instance, an importer purchasing goods to be
paid in foreign currency may avoid the risk of a sharp rise in the foreign exchange rate by buying an
options contract.
16. Foreign Exchange Market. The foreign exchange market is the market where people buy and sell
foreign currencies. This market is composed of the following:
1. banks located throughout the world buying and selling foreign monies, in the form of foreign
currencies and deposits in foreign banks;
2. foreign exchange dealers; and
3. currency exchanges catering mostly to tourists and are found in the downtown areas, airports, and
railroad stations in major tourist centers.

1. Why is knowledge of financial markets an important requirement in business finance?

2. What methods do financial markets use to transfer funds?
3. What is traded in the money market?
4. How does funds and securities flow in primary and secondary markets?
5. What situation is remedied by the negotiation market?
Prepare a list of financial intermediaries in your area providing indirect financing.
_____________ 1. Financial markets transfer funds directly or indirectly.

_____________ 2. Financial markets are useful in two aspects: (1) funds are directed to DSUs which
can use them most efficiently; and (2) liquidity is provided to savers.
_____________ 3. The options market is that financial market with fixed trading rules.
_____________ 4. The mortgage market is that portion of the financial market which deals with loans
on residential, commercial, and industrial real estate, and on farmland.
_____________ 5. Direct finance refers to lending by an ultimate lender to a financial intermediary that
then relends to ultimate borrowers.
_____________ 6. Direct finance refers to lending by ultimate borrowers with no intermediary.
_____________ 7. The foreign exchange market is the market where people buy and sell foreign
currencies.
_____________ 8. The options market is that market consisting of large collection of brokers and
dealers, connected electronically by telephones and computers that provide for trading in unlisted
securities.
_____________ 9. When buyers and sellers of securities negotiate with each other regarding price and
volume, either directly or through a broker or dealer, they are engaged in the financial market called
negotiation market.
_____________ 10. The market for debt instruments of any kind is called the stock market.


And ACCOUNTANCY
1st Sem., S.Y.2021-2022

MODULE 5
Title: CAPITAL BUDGETING
Name of Student:
Course/ year:
Class Schedule:
Date Submitted:
In Module 5, you will learn about the Capital Budgeting. The topic aims to present capital
budgeting as an important segment of business finance. Among those included are the relevant concepts
pertaining to investment, valuation, risk, and uncertainty.

● Know the basic terms and objectives of capital budgeting
● Understand the Capital Budgeting System
● Learn the evaluation of Proposed Capital Expenditures
● Know the Methods of Economic Valuation
● Understand risk, uncertainty and sensitivity
CAPITAL BUDGETING
A. BASIC TERMS IN CAPITAL BUDGETING
For a better understanding of capital budgeting concepts, the following terms are defined and
explained: capital expenditures, capital budgeting, valuation, and investments.
1. Capital Expenditures
The term capital expenditure refers to substantial outlay of funds the purpose of which is to lower
costs and increase net income for several years in the future. It includes expenditures that tie up capital
inflexibility for long periods. It covers not only outlays for fixed assets but also expenditures for major
research on new products and methods and for advertising that has cumulative effects.
Classes of Capital Expenditures. Capital expenditures may be classified into the following:
1. replacement investments – this refers to investments on replacement of worn-out or obsolete

facilities;
2. expansion investments – this type of expenditure will provide additional facilities to increase the
production and/ or distribution capabilities of the firm;
3. product-line or new market investments – this refers to expenditures on new products or new
markets, and on improvement of old products with the combined features of replacement and
expansion investments.
4. investments in safety and/or environmental projects – these are expenditures necessary to comply
with government orders, labor agreements, or insurance policy terms. These are sometimes called
mandatory investments or non-revenue producing projects.
5. strategic investments – these are investments designed to accomplish the overall objectives of the
firm.
6. other investments – this catch-all term includes office buildings, parking lots, executive aircraft.
2. Capital Budgeting
The planning and control of capital expenditures is referred to as capital budgeting. This activity
is essential because it provides a systematic evaluation of the firm’s alternative. It helps management in
choosing an alternative that will provide the best yield for the company.
3. Valuation
Management is, at times, confronted with the problem of evaluating a proposal. When the
proposal’s real worth to the firm is determined, the process is called valuation.
4. Investment
An investment is made when a firm spends some of its funds for the establishment of a project.
By doing so, the opportunity to use the same funds in other possible projects is lost.
Investments take two forms: (1) initial; and (2) later. Initial investment refers to the amount
that has been devoted to a project until it generates cash inflows from operations. Expenditures made
after the first cash inflow is called later investments.
B. OBJECTIVES OF CAPITAL BUDGETING
The objectives of capital budgeting are the following:
1. establishing priorities;
2. cash planning;
3. construction planning;
4. eliminating duplication; and
5. revising plans.
1. Establishing Priorities
The resources of the firm is said to be limited. The total number of opportunities available for
investment cannot all be accommodated by the firm. Capital budgeting will help to solve this difficulty.
This is possible because investment priorities are established in capital budgeting.
2. Cash Planning
The objectives of the cash planning activities of the firm is to ensure the availability of funds that
will be sufficient to meet its cash requirements, including those concerning the acquisition of capital
assets. A periodic cash expenditures estimate included in the capital budget helps to attain such
objective.
3. Construction Planning
The objective of construction planning is to minimize the period expended for the construction
or acquisition of a capital asset. The construction plan, a requirement for capital budgeting, will be
presented before the capital budget is prepared. This requirement ensures the preparation of such plans.
4. Eliminating Duplication
A centralized capital budgeting activity will help identify efforts undertaken at various levels in a
decentralized organization. The duplication of efforts, as a result, will be minimized if not totally
eliminated.
5. Revising Plans
Changes in the environmental factors may require appropriate revisions in the authorization of
investments projects which include expected profitability, construction cost, and the timing of start-up ,
where coordination with related activities is essential. Such requirements will be made obvious by a
good capital budgeting system. A timely response to such problems, then becomes a possibility.
C. THE CAPITAL BUDGETING SYSTEM
The capital budgeting system is composed of the following:
1. preparation and submission of budget requests;
2. approval of budget;
3. request of appropriation;
4. submission of progress reports; and
5. post approval reviews.
1. Budget Requests
Budget requests are those made to include in the corporate budget capital projects which are
felt to be desirable by those in the lower organization levels.
The budget request contains the following:
1. project title;
2. cost; including estimates on:
a. fixed capital
b. working capital
c. non-operating outlays
d. others, including opportunity costs;
3. priority rating of the project;
4. profitability of the project;
5. timing or the ability to adhere to a construction schedule;
6. financing method;
7. project classification; and
8. project narrative.
2. Approval of the Budget
The approval of the budget is a process which requires the following steps;
1. budget request are forwarded to top management;
2. top management decides which projects to recommend to the board of directors;
3. top management sends recommendations to the board of directors;
4. the board of directors approves or disapproves the recommendations; and
5. top management informs projects sponsors of the action taken on their projects.
3. Request for Appropriation
After the approval of the budget, the next step undertaken is getting an appropriations request
approved. The officers and managers of a corporation are usually given the authority to approve
appropriations requests up to certain established limits.
The appropriations request usually contains the following:
1. the request and authority section – this serves to identify the originator and the project;
2. the narrative section – this details the requesting entity’s justification for undertaking the
proposal. This section normally includes the following:
a. proposal;
b. objectives;
c. conceptual framework;
d. alternatives; and
e. sensitivity and risk.
3. supporting documentation section – this contains cost estimates and the results of market
studies and financial analysis.
4. Submission of Progress Reports
Progress reports are submitted at regular intervals for the following purposes:
1. to review the accuracy of the expenditures forecasts;
2. to provide updated expenditures forecasts; and
3. to verify the assumptions and economics underlying the acceptance of individual projects.
5. Post Approval Reviews
Post approval reviews are required to satisfy the following objectives:
1. to provide management with a standard method of evaluating the abilities and judgment of
project sponsors;
2. to identify errors or patterns of error in judgment which can be avoided in future similar
situations; and
3. to help ensure that the quality and accuracy of information attains the highest feasible
standards.
D. EVALUATION OF PROPOSED CAPITAL EXPENDITURES
Proposed capital expenditures should be scrutinized since they involve large outlays of funds. A
number of primary factors should be considered by management. These are the following:
1. Urgency. Decisions should be made as quickly as possible for requirements that are urgent.
2. Repairs. Management should consider the availability of spare parts and maintenance
experts. When these are critical and they are not available, the concerned proposal should be ruled out.
3. Credit. This factor should be considered in the sense that some credit terms may be highly
favorable to the company.
4. Non-Economic Factors. These refer to social considerations, and other non-economic
persuasions and preferences.
5. Investment Worth. This refers to the economic evaluation of a certain proposal.
6. Risk Involved. This refers to the uncertainty of an expected return.
E. METHODS OF ECONOMIC EVALUATION
Since the primary objective of the firm is to make profits, every business activity should be
directed towards achieving this end. Capital investments are not exempted from this requirement. It is,
therefore, a requirement that investment proposals should be analyzed and a determination of their
economic value to the firm should be made.
There are three basic methods of evaluating proposals. These are composed of the following: (1)
the payback method; (2) the average of return methods; and (3) the discounted cash flow methods.
These methods will be discussed using data indicated in Exhibit 3.
Exhibit 3
A SAMPLE INVESTMENT PROPOSAL

FOR THE PURCHASE OF A MACHINE
Acquisition Cost P 10,000,000
Economic Life 10
years
Salvage Value P
100,000
Earnings and Costs per
Income
5,000,000
Expenses -
2,000,000
Net Income before fax ond depreciation
3,000,000
Less: Depreciation (Straight line)

1,000,000
Net Income Before Tax

2,000,000
Less: Income Tax
620,000
Average Net Annual Earnings 1,
380,000
Cash Inflows Per Year = Net Earnings + Depreciation = P2,380,000
1. The Payback Method
The payback method determines the number of years required to recover the cash investment
made on a project. The recovery of cash comes from the cash inflows generated from the project. The
formula used is as follows:
Payback period = Cost

Annual Cash Inflow
Substituting data from Exhibit 3, the payback period is presented as:
Poybock period = P 10,000,000

= 4.2 years
P 2,380,000
The cost of the machinery is expected to be recovered in full after 4.2 years. The payback
method is simple and easy to understand. When the firm does not favor exposure of its own
investments for longer periods, the proposal is rejected. This decision can be made quickly with the use
of the payback method.
The payback method, however, has some disadvantages. These are the following:
1. it does not consider the time value of money;
2. the accept-reject criterion is stated in terms of years rather than at a discount rate;
3. the firm's attention is focused on cash flow rather than on rate of return;
4. careful projection of the timing of the investment outlays and the year-by-year projection of
cash inflows over the entire life of the proposal are not encouraged; and
5. the salvage value of the proposal is not considered.
2. The Average Rate of Return Methods
The average rate of return methods consists of the following: (1) the average return on
investment; and (2) the average return on average investment.
a) Average Return on Investment. This method is simple and is easy to compute. It shows the
ratio of the average cash inflow to the investment. The formula is as follows:
Average return on investment = Annual cash Inflows
Investment Outlay
Substituting data from Exhibit 3, we have
Average return on investment = P 2,380,000
= 24%
P10,000,000
The advantage of this method is that it is very easy to compute and the available accounting data may be
readily used. Its main a disadvantage, however, is that it does not take into account the time value of
money.
b) Average Return on Average Investment. This method is similar to the average return on
investment method except that the effect of the depreciation charge on the investment is taken into
consideration. The formula is as follows:
Average return = Annual Cash Inflow

On Average Investment Investment/2
Substituting data from Exhibit 3, the computation is shown as follows:
Average Return P 2, 380, 000

on Average = = 48%
Investment P 10, 000, 000
Under this method, the initial investment outlay is divided by two to derive the average balance
of the investment as it is decreased periodically by the depreciation charge. This method is also simple
and easy to compute. The true rate of return is, however, overstated Moreover, it does not also consider
the time value of money.
3. Discounted Cash Flow Methods
The time value of money is recognized under the discounted cash flow methods. There are two
approaches available: (1) the net present value method; and (2) the internal rate of return method.
Under these approaches, all future values of a proposal are discounted and compared to the values of
other proposals. The discounting factor makes these two methods preferred by users in evaluating
capital expenditure proposals.
a) Net Present Value Method. Under this method, a desired rate of return is used tor discounting
purposes. The term discounting is synonymous to the calculation of the present worth of a future value
as presented in Module 3. The present value concept is applied to the cash flows of a proposal and are
discounted at the desired rate of return for the periods involved. The sum of the present values of the
outflows (i.e, the cost of the machine in Exhibit 3) is compared with the sum of the present values of the
inflows (i.e. net income plus depreciation).
If the discounted cash inflows are larger than the discounted cash outflows, the project will earn more
than the desired rate of return. The proposal is accepted.
Conversely, if the discounted cash outflows are larger than the discounted cash inflows, the project will
not be able to generate the desired minimum rate of return. The proposal is, then, rejected. To illustrate,
the following formula and computation are presented as follows:
NPV = PVCI -PVCO
where NPV = net present value (also the net value derived after deducting the discounted cash outflow
from the discounted cash inflow)
PVCI = discounted value of the anticipated cash inflows

PVCO = discounted value of the anticipated cash outflows
The formula for finding the present value of an expected cash inflow is as follows:
PV = A
(1 + R)n
where: A = expected cash inflow
R= desired rate of return
n = number of years the cash inflow is expected
If the desired rate of return in Exhibit 3 is 25%%, the cash inflows for the ten-year period may be
computed to determine the present value for each year. For example, the present value of the cash
inflow for the second year is computed as follows:
PV of cash inflow, P2, 380, 000 P2, 380, 000

Year 2 = =
(1 + .25)2 (1.25)2

= P 1,523, 200
Applying the present value formula, the present values of the cash flows indicated in Exhibit 3 will
appear as follows:
Cash Flow Future Value Present Value
Outflows - P10, 000, 000
Inflows
1st year P 2, 380, 000 P 1, 904, 000

2nd year 2, 380, 000 1, 523, 000
3rd year 2, 380, 000 1, 218,
560
4th year 2, 380, 000 972,
840
5th year 2, 380, 000 779,
870
6th year 2, 380, 000 623,
900
7th year 2, 380, 000 499,
120
8th year 2, 380, 000 399,
290
9th year 2, 380, 000 319,
430
10th year 2, 380, 000 255,
550
10th year (salvage value) 100, 000 10,
730
TOTAL P 23, 900, 000 P 8, 508,

490
To find out the net present value of the proposal presented in Exhibit 3, the formula earlier
stated is applied as follows:
NPV = PVCI – PVCO

= P8, 508, 490 - P 10,000, 000
= - (P1,491, 510)
The computation shows a negative net present value indicating that the sum of the discounted cash
outflow is greater than the sum of the discounted cash flows. On this basis, the proposal is rejected.
b. Internal Rate of Return Method. This method and the net present value method use the discount
rate as a factor. The difference, however, is that under the internal rate of return method, the
discount rate is not given. Rather, it becomes the object of computation. The discount rate which will
yield a net present value of zero or one approximating zero is the correct discount rate. This
means that the present value of the cash inflows is equal to the present value of the cash outflows. The
correct discount rate may be determined by trial and error.
The acceptability of the proposal will depend on the prevailing interest rates as compared with
the computed correct discount rate. If the prevailing rate is higher, the proposal is rejected, and
conversely, if it is lower, the proposal is accepted.
In our computation of the preceding method, a negative net present value of P1, 491, 510 was
shown. Since the discount rate of 25% was used, an attempt to find the correct discount rate will be
made using one which is lower than 25%. Computations using various discount rates applicable to the
example shown in the preceding method are shown below.
Computations at Various Discount Rates
Cash Flow Future Flow Present Value
Outflow (at 22%)

(21%) (at 20%)
Inflow P10, 000, 000 P10,
000, 000 P10, 000, 000
1st year P 2, 380, 000 P 1, 950, 000 P
1,966, 694 P 1, 983, 330
2nd year 2, 380, 000 1, 599, 030 1,
625, 570 1, 652, 570
rd
3 year 2, 380, 000 1, 310, 680 1,
343, 440 1, 377, 310
4th year 2, 380, 000 1, 074, 320 1,
110, 280 1, 147, 760
5th year 2, 380, 000 885, 090
917, 590 956, 460
6th year 2, 380, 000 721, 780
758, 340 797, 050
th
7 year 2, 380, 000 591, 640
626, 720 664, 210
8th year 2, 380, 000 484, 950
517, 950 553, 510
9th year 2, 380, 000 397, 500
428, 060 461, 250
10th year 2, 380, 000 325, 820
353, 770 384, 380
Salvage Value 100, 000 13, 680
14, 860 16, 150
Total Inflows P 9, 350, 800 P9,
663, 520 P9, 994, 180
The net present values at different discount rates may now be computed as follows:
a. NPV at 22% discount rate = PVCI – PVCO

= P 9, 350, 800 – P 10, 000, 000
= - (P649, 200)
b. NPV at 21% discount rate = PVCI – PVCO

= P 9,603, 520 – P 10,000, 000
= - (P 396, 480)
c. NPV at 20% discount rate = PVCI – PVCO

= P9, 994, 080 – P10, 000, 000
= - (P5,920)
The results of the computation show net present values a different discount rates. Obviously, the
discount rate which yield the net present value nearest to zero is 20%. If the standard interest rate is
below 20%, the proposal is acceptable.
F. RISK, UNCERTAINTY, AND SENSITIVITY
Among the primary factors considered in the evaluation of proposed capital expenditures, the
uncertainty of expected returns pose a challenge to one who manages the firm's finances. In the
preceding discussion of the methods of economic evaluation, it is assumed that the returns are certain.
This is misleading because one can never be fully certain about the results that will be obtained from an
investment.
Meaning of Risk, Uncertainty, and Sensitivity
Risk is defined in Module 3 as the uncertainty concerning loss. Uncertainty, as a term is

synonymous to risk, and as such, they will be used interchangeably in the discussions that will follow. At
this point, however, it is worth mentioning their similarity and difference. Uncertainty and risk both refer
to variations of actual values from average or expected values. They differ, however, in the cause of the
variations. The variations referred to in risks is caused by chance, while the variations referred to in
uncertainty is caused by errors in estimating.
Sensitivity refers to the effect on investment of changes in some factors, which were not
previously determined with certainty.
Factors Affecting Risk
There are four (4) primary factors involved in the evaluation of risks pertaining to capital
expenditures. These are the following: (1) possible inaccuracy of the figures used in the evaluation; (2)
type of business involved; 3) type of physical plant and equipment involved; and (4)
the length of time that must pass before all the conditions of the evaluation become fulfilled.
Estimates could be wrong or inaccurate at times. Accuracy however, depends on how the
figures were obtained. Estimates can be made either by scientific methods or by plain guesswork. A
certain degree of reliability can be assigned to the former and none to the latter method.
Every type of business has its own degree of risk that is peculiar to itself. One line may be more
stable in terms of demand than the others. The demand for food, for instance, is more stable than the
demand to specialized consumer items like hair dyes. Also, more risk is involved in the operations of a
new venture than a business with a successful record of past performance.
Physical plants and equipment are also subject to risks. Some may become obsolete before
their economic life expires. The demand for special equipment, like that tor DVD players, may diminish
without warning
Finally, estimates involving longer periods are usually more prone to inaccuracies than those
involving shorter periods. This is true because, most often, changes in the environment happen sooner
than expected.
Sensitivity Analysis
The expected returns on investment may change as changes in some relevant factors happen.
Capacity utilization at various levels, for instance, may yield various rates of return on investment. As
capacity utilization depends mostly on some relevant factors like the availability of raw materials, it is
important that an analysis of the expected returns be made on various utilization levels. This is actually
finding the sensitivity of an investment to various changes.
Sensitivity analysis is applicable to capital expenditures useful involving the purchase or

construction of a plant. It is useful for management to know the expected returns that will be
generated by the various capacity utilization in the operation of the plant. Consider the following
example:
Effect of Various Capacity Operation

on Rate of Return Pertaining to a Plant
Capacity Operation
100% 75% 50%
Annual Revenue P10, 000,000 P 7, 500, 000

P5, 000, 000
Annual Expenses 7, 000, 000 5, 500, 000
4, 000,000
Net Income 3, 000, 000 2, 000, 000
1, 000, 000
Rate of Return 43% 36%
25%
The example cited above indicates that by using the plant at full capacity, the return will be at
its highest level, which is 43%. However, if because of some factors, this is not possible, the expected
return will still be 36% at 75%o capacity operation, and 25% at 50% capacity operation. If the prevailing
interest rate is below 25%, the proposal should be accepted.

1. What is capital budgeting? Explain the reasons why this activity cannot be disregarded by
management.
2. Cite examples of the different classes of capital expenditures.
3. Cite specific examples applicable to each of the six primary factors that must be considered by
management in the evaluation of proposed capital expenditures.
4. Why must risk, uncertainty, and sensitivity be included as factors in the evaluation of proposed
capital expenditures?
5. Discuss the importance of obsolescence as a risk factor.
A firm is considering the purchase of a forty-year old building. The following pertinent data were
provided:
Acquisition Cost P12,000,000
Economic Life (remaining) 10 years
Salvage value P200,000
Annual Rental Income P5,000,000

Annual Expenses P3,000,000
Net Income before Tax and Depreciation P2,000,000
Depreciation (straight line method) P1,000,000
Net Income before Tax P1,000,000
Income Tax (withheld by lessors) P50,000
Average net Annual Earnings P950,000
Required: Evaluate the proposal using the three basic methods.
_____________ 1. Capital budgeting is an important segment of business finance. It includes relevant

aspects of investment, valuation, risk, and uncertainty.
_____________ 2. The substantial outlay of funds for the purpose of lowering costs and increasing net
income for several years in the future is called capital expenditure.
_____________ 3. The planning and control of capital expenditure is called valuation.
____________ 4. When the real worth to the firm of any proposal for capital expenditure is
determined, the process is called valuation.
_____________ 5. Sensitivity refers to the effect on investment of changes in some factors, which were
not previously determined with certainty.
_____________ 6. Under the discounted cash flow method, a desired rate of return is used tor
discounting purposes.
_____________ 7. Credit as a factor should be considered in the sense that some credit terms may be
highly favorable to the company.
_____________ 8. The payback method determines the number of years required to recover the cash
investment made on a project.
_____________ 9. This Average Return on Average Investment method is similar to the average return
on investment method except that the effect of the depreciation charge on the investment is taken into
consideration.
_____________ 10. Risk is defined as the uncertainty concerning loss.


And ACCOUNTANCY
1st Sem., S.Y.2021-2022

MODULE 6
Title: WORKING CAPITAL
Name of Student:
Course/ year:
Class Schedule:
Date Submitted:
In Module 6, you will learn about Working Capital. The topic aims to understand the meaning
and composition of working capital; the need for working capital; management of working capital;
liquidity management; cash management; accounts receivable management; and inventory
management.

● Know the meaning, composition and need for working capital
● Learn the management of working capital
● Understand liquidity management, cash management, accounts receivable management and
inventory management
WORKING CAPITAL
A. MEANING AND COMPOSITION OF WORKING CAPITAL
Working capital refers to that part of the capital of the company which is continually circulating.
It is circulating in the sense that the initial cash funds of the firm are converted into inventories, which in
turn are converted into cash or accounts receivable and ultimately into cash again.
Working capital may be described in two ways: (1) gross working capital which is the total
amount of the firm's current assets; and (2) working capital, which is the total amount of current assets
minus current liabilities.
The gross working capital of the firm is usually composed of the following:
1. cash in the firm's safe;

2. checks to be cashed;
3. balances in the bank accounts;
4. marketable securities (not including stocks in subsidiaries);
5. notes and accounts receivable;
6. supplies;
7. inventories;
8. prepaid expenses; and
9. deferred items.
B. THE NEED FOR WORKING CAPITAL
Working capital is required for the following purposes;
1. Replenishment of Inventory. A sufficient stock of inventory is required to support the sales target of
the firm. This requirement, however, will depend on the availability of resources. An unserved portion of
demand may mean lost revenues for the firm.
2. Provision for Operating Expenses. To maintain the operations of the firm on a day-to-day basis, a
working capital is required. This will be needed to take care of salaries and wages, advertising, taxes and
licenses, insurance premium, and interest payments.
3.Support for Credit Sales. At times, conditions require that credit sales be extended to the firm's clients.
This will need sufficient working capital to enable the firm to maintain its operations until receivables are
converted into cash.
4. Provision of a Safety Margin. The firm should have sufficient amount of capital to provide for
unexpected expenditures, delays in the expected inflow of cash, and
possible decline in revenue.
Cash Requirements
The firm needs cash to pay for expenditures that arise from time to time. Even if the anticipated
cash receipts is equal to the anticipated cash expenditures, it is still necessary to maintain a
sufficient cash fund for the firm to meet its cash commitments. This is needed because of the difficulty in
synchronizing cash receipts with cash disbursements. It is, therefore, required that a positive cash
balance be maintained so that the firm's obligations are settled as they become due.
The amount of cash needed depends upon the following:
1. the amount of the firm's purchases and cash sales;
2. the time period for which the firm receives and grants credit;
3. the time period from the dates of purchase of raw materials and payment of wages to the dates of
cash receipts from sales;
4. the amount of cash to be used for investment in inventories; and
5. the amount of cash needed for other purposes such as cash dividends.
Accounts Receivable Requirements

Since liquidity is a primary concern of sound business finance firms prefer cash sales over credit
sales. Many companies, however, cannot avoid the extension of credit to customers for various reasons.
Credit is used to sustain and to promote production, distribution, and consumption of goods and
services.
The unpaid portion of credit sales is represented by accounts receivable in the firm's records.
The collection of accounts receivable from customers contribute to cash inflow requirements of the firm.
Credit terms vary according to the degree of competition within individual industries, the
availability of bank credit, and pressures for increased sales in periods of increasing plant capacities.
Inventory Requirements
The production of large stocks of inventory generate savings as a result of lower production cost.
It will also provide the firm with large quantity of stocks to meet increasing or unusually large orders
from customers. The maintenance of large stocks of inventory, however, may unnecessarily tie up funds
which could have been made available for other uses. Outside financing may even be required. In
addition, storage and warehousing costs may also increase.
The ideal set-up is for the firm to make sales as soon as finished products come out of the
production line, or to acquire raw materials and supplies as soon as they are needed. Since these are not
possible, economists have devised a method of knowing the inventory level that will optimize
results considering both of the above-mentioned requirements.
C. MANAGEMENT OF WORKING CAPITAL
Working capital must always be able to cover fund requirements of the company as they are
needed. There are times when unusual pressures on working capital makes the job of the finance
manager very difficult. To overcome this, a system should be adapted considering the following
objectives:
1. Working capital must be adequate to cover all current financial requirements. It must be allocated
among various needs in sufficient amounts. The quantity of inventory Stock to be carried and the
maximum allowable amount of receivables must be decided in advance.
2. The working capital structure must be liquid enough to meet current obligations as they fall due.
Salaries and Wages must be paid on time. Raw materials and supplies must be acquired on days they are
needed.
3. Working capital must be conserved through proper allocation and economical use. It must be
protected against losses arising out of natural calamities, malversation, or, pilferage.
4. Working capital must be used in the attainment of the profit objectives of the firm. Measures to
contribute to increased profits through avoidance of loss must be instituted.

D. LIQUIDITY MANAGEMENT
Liquidity refers to the ability of the firm to pay its bills on time or otherwise its current
obligations. Activities geared towards achieving the liquidity objectives of the firm is called liquidity
management.
The objective of management is to acquire sufficient amounts of funds to cover the cash
requirements of the firm. The cash requirements of the firm come from various sources which are briefly
described as follows:
1. Cash Sales. The percentages of cash derived from sales vary from company to company and from
industry to industry.
2. Collection of Accounts Receivables. The credit policies and the pattern of company sales determine
the frequency and volume of collections from receivables.
3. Loans. Loans from banks and other creditors may be availed of by management mostly on its own
initiative. The timing and amount of cash receipts derived from loans
depend largely on the borrowing firm.
4. Sale of Assets. Assets are sometimes sold by the company for various reasons. Obsolescence is one of
those.
5. Ownership Contribution. Additional contributions from the owners are sometimes tapped to improve
the liquidity posture of the firm.
6. Advances from Customers. Manufacturers, at times, require cash advances from customers as soon as
an order is made and before production is started. This is not unusual especially if the objects of sale are
capital goods like airplanes and ships. The number of years required in the manufacturing process
justifies whatever cash advances are required from customers.
Cash Management
Idle cash earns nothing and even if it is kept in a bank, the interest it earns is minimal. If
sufficient amounts of profits must be attained, cash should be invested. Sufficient cash must be
maintained, however, to cover the firm's cash expenditures. The activity involved in achieving these two
opposite goals is called cash management.
To effectively manage cash, five major approaches are suggested. These are as follows:
1. Exploit techniques of money mobilization to reduce operating requirements for cash;
2. Expend major efforts to increase the precision and reliability of cash flow forecasting;
3. Use maximum efforts to define and quantify the liquidity reserve needs of the firm;
4. Develop explicit alternative sources of liquidity; and
5. Search aggressively for more productive uses of surplus money assets.
Money Mobilization. Some companies maintain branches and agencies in distant places. Those that
serve customers directly may find that they are also serving customers from far-flung areas. These two
conditions are characterized by remittances which take several days before they are converted into
usable cash balances. Check payments, for instance, are sent through the mail. When these checks
are received, they are deposited in the bank. These checks will only be cleared for the company's use
after several days. Checked issued by customers from distant areas require longer clearing period. This
time lag stated briefly, consists of two identifiable periods: (1) the mail traveling time of the check
payment; and (2) the check clearing time
Various solutions are offered to improve the set-up. To shorten the time lag some companies
open accounts with banks located in the far-flung areas where the company's branches are located.
These banks serve as the collecting arm of the companies. In most cases this improvement reduces to
half the number of days spent between actual payment made by the client and the availability of such
payment for use by the firm.
Improved Cash Flow Forecasting. A cash flow forecast with a high degree of precision and reliability
provides the firm with realistic approaches to planning and budgeting. The disadvantages of cash excess
and cash shortages are eliminated if not minimized. The advantages brought by an improved cash flow
forecast are the following:
1. Surplus funds are more fully invested;

2. Alternative methods of meeting the outflows can be
explored; and
3. The creation of special reserves for major future outlays
will be minimized.
Defining and Quantifying the Liquidity Reserve Needs of the Firm. Firms are faced with a number of
uncertainties and contingencies which may require cash reserves. To be protected
against the worst possibilities, a very large reserve of cash will be needed. The idea is to avoid
unnecessary losses or expenditures brought about by liquidity problems. The holding of cash reserves,
however, entails cost. The management is left with striking a reasonable balance between the two
requirements. several steps are necessary to accomplish this objective. These are the following:
1. Identification of contingencies requiring protection;

2. Assessment of the probabilities of the contingencies
occurring.
3. Assessment of the probabilities of the contingencies occurring at the same time; and
4. Assessment of the probable amount of cash required if each of the contingencies happens.
lf reserves for certain contingencies will not be provided, amount of possible losses must be
ascertained. If reserves will be provided, the cost of carrying the reserves must also be determined.
The expected value of the losses and cost must be computed. This may be arrived at by multiplying the
losses or cost with probability estimates of occurrence.
To illustrate, assume that a labor strike happening in the premises or the company will paralyze
operations. Borrowing funds to cover the necessary expenditures of the firm will penalize the firm with
interest charges amounting to one million pesos. It has also been ascertained that if a reserve fund has
to be carried for the contingency, the firm will be penalized with eight thousand pesos
in the form of lost income which could have been otherwise earned by the idle cash reserve.
If the probability of the strike happening is placed at 50%, the expected values of the options
may be computed as follows:
Option Penalty Probability Expected
No reserve P1,000,000 50% P500, 000

With cash reserve P 800, 000 50% P400, 000
Carrying a cash reserve in this case is more economical to the firm because it carries a lower
penalty expected value.
Development of Alternative Sources of Liquidity. Once the liquidity reserve needs of the firm
have been defined and quantified, alternative sources of meeting these needs should be identified and
evaluated.
One possible alternative is the exploitation of the unused borrowing capacity of the firm.
Borrowings, oftentimes, provide the funds necessary for liquidity. Not all companies, however may avail
is option. During recession, when small companies are unable to
from lending institutions, inter business financing may borrow money from lending institutions, inter
business financing May provided the answer to liquidity problems. Inter business financing refers to
credit flowing from a large business to small business.
Search for More Productive Uses of Cash Surplus. Cash Surplus may be utilized by the firm to
earn higher returns. A gap may exist, however, between the time when cash starts coming in the time it
is actually made more productive. As various investment opportunities may be available, it is important
that sufficient eff-ort is expended in the determination or the best alternative. Planning activities must
also be geared towards eliminating the unproductive or less productive gap.
Inasmuch as new investment opportunities may be made available from time to time, a continuous
search and evaluation activity must be done.
Accounts Receivable Management

As sales on account cannot be avoided most of the time, management must face the difficulty
squarely and make it work to the advantage of the firm. This is important because when accounts
receivables are not properly managed, the financial viability of the firm may be impaired.
Objectives. One of the goals of business finance is to maximize profitability. In this regard, all
activities of the firm must contribute towards the attainment of this objective.
The purpose of credit extension to clients is to maximize sales. Thus, if more sales is required
by the firm, more credit is extended. Increased sales, however, 1s not an end in itself. Any advantage
gained in extending credit to customers may be offset or even surpassed by problems brought about by
bad-debt losses and the consequent tie-up of funds in receivables.
The objective of accounts receivable management is to determine the cost and profitability of
credit sales. There is no point in extending credit to customers if this will cause a lowering of the firm's
return on investment.
The second objective of accounts receivable management is the projection of cash flows from
receivables. This will provide an essential input in the preparation of the firm's financial plan. The third
objective relates to the direction and control of activities involved 1n the extension of credit to
customers.
Elements of the Cost of Credit. The cost of credit is composed of three elements: (1) bad
debts cost; (2) cost of invested funds; and (3) administrative costs.
Bad debts cost refers to accounts receivable uncollected and subsequently written off. The cost
of invested funds refers to the rate at which the firm could borrow funds to finance credit sales. These
include form letters, individually written letters, telephone charges clerical and administrative time spent
on an account, and credit and investigation expenses.
Functions of the Credit Department. The credit department performs the following functions:
1. gathering and organizing of information necessary for decisions on the granting of credit to particular
customers;
2. assuring that efforts are made to collect receivables when they become due; and
3. determining and carrying out appropriate efforts to collect accounts of customers who cannot or do
not intend to pay.
Sources of Credit Information. A variety of sources may be used to obtain credit information concerning
customers. The sources most commonly used are the following:
1. personal interviews;
2. references;
3. credit bureaus;
4 credit-reporting agencies; and
5. Banks
.
Personal interviews provide basic information concerning an applicant for credit. The applicant is usually
required to fill up a credit application blank. The credit application contains the following items:
1. the name of the applicant;

2. residence and former address;
3. Occupation or business
4. business address,
5. bank where the applicant maintains an account; and
6. Property owned.
More information is usually required if the credit applicant is company. References also provide
a valuable source of information. The credit applicant is usually required to furnish names of at least
three credit references. These references, in turn, may provide valuable insights into the character and
ability of the applicant.
Credit bureaus are institutions organized for the exchange of ledger information among associated
creditors. Among the services rendered by credit bureaus are the following:
1. reports;
2. bulletins;
3. credit guides; and
4. special services.
Credit reporting agencies consist of more specialized forms of credit bureaus. Banks constitute a
valuable source of credit information. This is largely due to their involvement in lending activities.
Evaluation of Credit Risk. Before credit is granted, the risk involved is evaluated. This is done after
information regarding the credit risk has been gathered. In the evaluation of a credit risk, the basic
criteria used refer to the following:
1. Capital;
2. Capacity;
3. Character; and
4. Conditions.
Capital refers to the financial resources of the credit applicant. The balance sheet is a very useful
tool in determining the resources of the applicant. Capacity refers to the ability of the applicant to
operate successfully. This is indicated in the profit and loss statement of the applicant. Character refers
to the reputation for honesty and fair dealing of the applicant or the owners of the firm applying for
credit. Conditions refer to the environment required for the extension of credit.
Inventory Management
Inventory management refers to the activity that keeps track of how many of the procured items
needed to create a product of service are on hand, where each item is, and who has responsibility
for each item.
Inventory management consists of two aspects: liquidity, and profitability. The liquidity aspects
is usually measured in terms of inventory turnover. The profitability aspect is measured in terms of
inventory level at a given level of sales and profit.
A successful inventory management program's main objective is to strike a balance among

three key elements as follows:
1. Customer service;
2. Inventory investment (in terms of pesos or dollars); and
3. Profit.
Customer Service. The period between when the order is made and the date of delivery is very
important to the customer Shorter periods are preferred. If the customers have to wait too long to get
the products, they will get them elsewhere. The company with the shortest lead time, ie., the number of
days the customers have to wait, has a better chance of improving its sales.
Inventory Investment. Funds tied up in inventory should ideally be kept to a minimum without
sacrificing customer service. Investments in inventory eat away company profits. These usually
take the form of interests, insurance, taxes, obsolescence, and storage.
Profit. The level of inventory caried by the company most often affects the profitability of the company.
The task of management is to determine the level which would bring the highest return on equity.
Functions of Inventory. Inventories perform certain functions. These are the following:
1. They serve to offset errors contained in the forecast of the demand for the company's products;
2. They often permit more economical utilization of equipment buildings, and manpower when the
nature of the business is such that fluctuations in demand exists; and
3. It permits the company to purchase or manufacture in economic lot sizes.
Forms of Inventory, Inventories are composed of three major forms which are as follows:
1. raw materials;
2. work-in-process; and
3. finished goods.
LIQUIDITY MANAGEMENT
Cash Management Accounts Receivable Inventory
Management Management
Money Determine Cost Customer
Mobilization And Profitability of service
Credit Sales
Effective Inventory
Cash Flow Investment
Forecasting Projection of
Cash Flows from
Liquidity Receivables
Reserve Definition Profit
And Quantification Direction and Aspects
Control of Credit
Productive Use of Extension
Surplus Assets
Figure 7. Components of Liquidity Management
Raw materials consist of all parts, sub-assemblies, and components purchased from other firms
but not yet put into the manufacturer’s own production processes. When raw materials and labor is
added into the basic raw material inputs, they are combined and transformed into work-in-process
inventories. They become finished goods when they are completed and stocked.
Methods of Achieving Inventory Goals. Inventory goals may be achieved by using any of the
several devices available. These devices are the following:
1. the ABC method;

2. the economic order quantity method;
3. the safety stock; and
4. the anticipation stock.
The ABC method classifies inventory into three categories: A, B and C tor management and control
purposes. Category A may be classified as those comprising a large proportion of the inventory value,
and in which tight control is applied. Category B comprises those accounting for a substantial part of the
total inventory value, requiring less tight control. Category C items are those that account only tor a
small proportion of the total inventory value and as a consequence is the least controlled.
The economic order quantity (EOQ) method is used to determine what quantity to order so
as to minimize total inventory costs. The EOQ method involves two major costs:
1. carrying costs (warehouse storage costs); and
2. ordering costs (filling in purchase requisitions).
These two costs tend to offset each other. One reason is that ordering in large quantities allows volume
discounts, but it also involves higher storage costs. To balance these two factors, an economic order
quantity should be determined. The EOQ formula is as follows:
E0Q = the square root of 2 US/CI
Where: EOQ = economic order quantity
U = annual usage
S = restocking or ordering cost
C = cost per unit
I = annual carrying cost (expressed as percentage of inventory value)
Thus, if annual usage is 1,000 units, restocking cost is PL000, cost per unit is Ps0,000, and
annual carrying cost is 10'%, E0Q1s:
EOQ = the square root of 2 x1,000 x P,00/P50,000 x 10%
= 20
When conditions are uncertain, safety stocks are needed. Safety stocks are that part of
inventory used to absorb random fluctuations in purchases, production, and sales.
Anticipated stock refers to that portion of the inventory used for expected seasonal,
cyclical, and secular changes in inventory.

1. What is meant by working capital? Gross working capital? Net working capital?
2. What factors determine the need for cash in the firm’s operations?
3. Why are accounts receivables inevitable? What advantages do selling on account offer?
4. What is the function of inventories?
5. What basic criteria are commonly used in evaluating credit risk?
Identify a retailing firm in your area. Find out the device used in the achievement of its
inventory goals. State the reason why such device is used.
_____________ 1. Working capital is needed tor the following purposes: (1) replenishment of
inventory; (2) provision tor operating expenses; (3) support for credit sales; and (4) provision of a safety
margin.
_____________ 2. That portion of the total capital of the firm which finance the day-to-day activities is
called gross working capital, and it is continually circulating.
_____________ 3. The net working capital is the total amount of current assets minus current liabilities.
_____________4. The gross working capital refers to the firm's total current assets.
_____________5. Inventory management refers to the activity that keeps track of how many of the
procured items needed to create a product of service are on hand, where each item is, and who has
responsibility for each item.
_____________ 6. The economic order quantity (EOQ) method is used to determine what quantity to
order so as to minimize total inventory costs.
_____________ 7. Capacity refers to the reputation for honesty and fair dealing of the applicant or the
owners of the firm applying for credit.
_____________ 8. Inter business financing refers to credit flowing from a large business to small
business.
_____________ 9. Liquidity management refers to the ability of the firm to pay its bills on time or
otherwise its current obligations.
_____________ 10. The firm should have sufficient amount of capital to provide for unexpected
expenditures, delays in the expected inflow of cash, and possible decline in revenue.

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MABINI COLLEGES, INC.

Daet, Camarines Norte

COLLEGE OF BUSINESS ADMINISTRATION

Finance 1 – Business Finance

After completing this module, students must have:

Fundamental Concepts and Tools of Business Finance

B. DEFINITION OF BUSINESS FINANCE

Public Finance Private Finance

Personal Business Finance of

Small Business Corporation Multinational

C. THE GOALS OF BUSINESS FINANCE

3. Maximizing Profit Subject to Cash Constraint

4. Maximizing Net Present Worth

Value today amount P100,000

5. Seeking an Optimum Position Along a Risk- Return Frontier

D. THE FINANCIAL STATEMENT

The Balance Sheet

3. when there is a special class of ownership:

The Income Statement

Raw Materials Inventory, Beginning of the Period

Sales P 150, 817,

P 115, 757, 000

53, 400, 000

P 88, 740, 000

3. Other Expenses. These include interest expense and sale discounts.

The Sales Budget

The Materials and Purchases Budget

F. SIGNIFICANCE OF FINANCIAL STATEMENTS AND BUDGETS

G. THE ANNUAL REPORT

1. the balance sheet;

Discuss your answers on the following questions briefly:

1. Distinguish private finance from public finance.

MABINI COLLEGES, INC.

COLLEGE OF BUSINESS ADMINISTRATION

Finance 1 – Business Finance

A. WHAT ARE FINANCIAL MARKETS

B. BENEFITS OF FINANCIAL MARKETS

SURPLUS SPENDING Primary Securities DEFICIT SPENDING

Business Firms Secondary Securities Business Firms

Funds INDIRECT FINANCING BY

Intermediation Market Direct Credit Market

Figure 4. Channels for Funds and Financial

An additional benefit provided by financial markets is liquidity. Without the intervention of

C. WHY FIRMS INVEST AND BORROW

2. additional revenues from sales

D. METHODS BY WHICH FINANCIAL MARKETS TRANSFER FUNDS

Direct financing however, has some disadvantages. These are as follows:

2. brokers and dealers; and

Lenders-savers Borrowers- Spenders

1. Households 1. Business Firms

2. Business Firms FINANCIAL 2. Government

3. Government MARKETS 3. Households

4. Foreigners Funds Funds 4. Foreigners

Figure 5. Transfer of Funds From Lenders to Borrowers

E. CLASSIFICATION OF FINANCIAL MARKETS

Financial markets may be classified as follows:

10. negotiation market

11. organized market

12. over-the-counter market

13. spot market

14. futures market

15. options market

16. foreign exchange market