According to Investopedia, financing is the process of funding business users of funds, meet and make transactions.

nsactions. Once Ancial and Mana have met in the Financial

activities, making purchases, or investments whereas investing is the act of Market, they can now agree to make a private placement. Financial market is defined as an
allocating resources, usually money, with the expectation of generating an organized forum in which the suppliers (investors) and users (creditors) of various types of funds
income or profit. Through this activities, company’s wealth is properly can make transactions directly.
utilized which paved the way to more income which leads to a higher market

price. Therefore, wealth is maximized. On the other hand, if Ancial and Mana do not want to make an effort to find a counterparty in the
financial markets, they may go to the financial institution. Financial institutions are intermediaries
Finance Manager
that channel the savings of individuals, businesses, and governments into loans or investments. A
financial institution will receive Ancial’s supply of funds (savings) and match with Mana’s demand
of funds. Unlike in the financial market where Ancial and Mana knows whom the fund went and
The Financial System from whom the funds came, financial institutions serves as intermediary to the suppliers and users
of funds.

Moreover, financial institutions actively participate in the financial markets as both suppliers

(investors) and users of funds (creditors).

Thus, the whole process is illustrated in the financial system diagram.

Financial Instruments

Due to the increased need for security for the performance of obligations arising from these
transactions and due to the growing size of the financial system, the transfers of funds from one
arty to another are made through financial instruments. According to Investopedia (2016),
financial instrument is a real or virtual document representing a legal agreement involving some
sort-of-money value. These can be debt securities like corporate bonds or equity like shares of
stocks. When a financial instrument is issued, it gives rise to a financial asset on one hand and
financial liability or equity instrument on the other.

A financial asset is any asset that is:

• Cash

• An equity instrument of another entity.

• A contractual right to receive cash or another financial asset from another entity equity.

• A contractual right to exchange instruments with another entity under conditions that
are potentially favorable. (IAS 32.11)
Example: Notes Receivable, Loans Receivable, Investment in Stock and Investments in Bonds
Using the same scenario, if Ancial knows that Mana is in need of funds, or if Mana knows that
Ancial
Financial Liability is any liability that is a contractual obligation.
is willing to invest funds, they may agree to make a private placement. Private placement is the sale
of a new security directly to an investor (saver/suppliers of funds) or group of investors. • To deliver cash or other financial instrument to another entity.

However, if these facts are known to them, Ancial and Mana can go to financial market which is an
• To exchange financial instruments with another entity under conditions that are
potentially unfavorable. (IAS 32.11)
organized forum that lets Ancial, along with other suppliers of funds, and Mana, along with other
 Example: Notes Payable, Loans Payable, Bonds Payable
Debt instruments generally have fixed returns due to fixed interest rates. Examples of debt
instruments are as follows:
i. Treasury Bonds and Treasury Bills are issued by the Philippine government.
These bonds and bills have usually low interest rates and have low risk of default
since the government assures that these will be paid.
ii. Corporate Bonds are issued by publicly listed companies. These bonds usually
have higher interest rates than Treasury bonds. However, these bonds are not
risk free. If the company which issued the bonds goes bankrupt, the holder of the
bonds will no longer receive any return from their investment and even their
principal investment can be wiped out.
Equity Instrument is any contract that evidences a residual interest in the assets of an entity after
deducting all liabilities.
• Ordinary shares (that cannot be put back to the issuer by the holder)
• Preference shares (that cannot be redeemed by the holder or provide
nondiscretionary dividends
• Warrants or written call options (that allow the holder to subscribe for—or purchase—a
fixed number of non-puttable ordinary shares in exchange for a fixed amount of cash or
another financial asset)
The following are types of equity instruments:
i. Preferred Stock has priority over a common stock in terms of claims over the assets of
a company. This means that if a company were to be liquidated and its assets have to be
distributed, no asset will be distributed to common stockholders unless all the claims of
the preferred stockholders have been given. Moreover, preferred stockholders have also
priority over common stockholders in cash dividend declaration. Dividends to preferred
stockholders are usually in a fixed rate. No cash dividends will be given to common
stockholders unless all the dividends due to preferred stockholders are paid first
ii. Holders of Common Stock on the other hand are the real owners of the company. If
the company’s growth is spurring, the common stockholders will benefit on the growth.
Moreover, during a profitable period for which a company may decide to declare higher
dividends, preferred stock will receive a fixed dividend rate while common stockholders
receive all the excess.
The suppliers of funds (investors) are the holders of financial assets whereas the makers of
financial liability and equity instruments are the users of funds (creditors).
Financial Markets
It can be classified into two: primary and secondary markets.
To raise money, users of funds will go to a primary market to issue new securities (either debt or
equity) through a public offering or a private placement. The sale of new securities to the general
public is referred to as a public offering and the first offering of stock is called an initial public
offering. The sale of new securities to one investor or a group of investors (institutional investors) is
referred to as a private placement. However, suppliers of funds or the holders of the securities may
decide to sell the securities that have previously been purchased. The sale of previously owned
securities takes place in secondary markets. Secondary market is defined as a financial market in
which pre-owned securities (those that are not new issues) are traded. The Philippine Stock
Exchange (PSE) is both a primary and secondary market
Financial Market can also be classified into money market and capital market. Money markets are
a venue wherein securities with short-term maturities (1 year or less) are sold . They are created
because some individuals, businesses, governments, and financial institutions have temporarily
idle funds that they wish to invest in a relatively safe, interest-bearing asset. Money market is a
for
financial relationship created between suppliers (investors) and users of short-term funds.
On the other hand, securities with longer-term maturities are sold in Capital markets. The key
capital market securities are bonds (long-term debt) and both common stock and preferred stock
(equity, or ownership). Thus, capital market is a market that enables suppliers and users of long-
term funds to make transactions.
How Financial Institutions Provide
Financing for Firms
Financial Institutions
Earlier, we defined financial institutions as intermediaries that channel the savings of individuals,
businesses, and governments into loans or investments. The following are examples of financial
institutions:
• Commercial Banks - Individuals deposit funds at commercial banks, which use the
deposited funds to provide commercial loans to firms and personal loans to
individuals, and purchase debt securities issued by firms or government agencies.
• Insurance Companies - Individuals purchase insurance (life, property and casualty,
and health) protection with insurance premiums.
• Mutual Funds - Mutual funds are owned by investment companies which enable
small investors to enjoy the benefits of investing in a diversified portfolio of securities
purchased on their behalf by professional investment managers. When mutual funds
use money from investors to invest in newly issued debt or equity securities, they
 finance new investment by firms. Conversely, when they invest in debt or equity
securities already held by investors, they are transferring ownership of the securities
among investors.

• Pension Funds - Financial institutions that receive payments from employees and
invest the proceeds on their behalf.

• Other financial institutions include pension funds like Government Service Insurance
System (GSIS) and Social Security System (SSS), Unit Investment Trust fund (UITF),
investment banks, and credit unions, among others.