BUSINESS FINANCE
- Increase its own value (growth
REVIEWER 1ST QUARTER
Chapter 1: Introduction to Financial
Management
Finance – Derived from the Latin word
‘finer’ meaning ‘to end’ or ‘to pay’
According to Webster
Noun: management of money
Verb: provide capital for a person
According to Cabrera: the art and
science of managing financial resources
of a business.
According to Saldana: efficient
allocation of scarce resources.
According to Medina: acquisition and
investment of cash to enhance value
and wealth
In simplest of terms, Finance
managing your money wisely
Business owners may fund their
business thru the following:
- Personal savings
- Earnings from other investment
- Loans from relatives, friends
- Loans from banks and other
financial institution
Funds, money, and cash are considered
as the lifeblood of the business.
3 General type of business
1. Service business
2. Merchandising business
3. Manufacturing business
Primary goal:
- Earn profit
and stability)
- Improve the quality of life in the
community (social responsibility)
Who manages the finances of a
business?
Sole Proprietor- the owner
Company or Corporation -
Finance Manager
Finance manager makes the important
decisions on how to effectively manage
the funds of the company. Responsible
for Financial Management.
Financial Management
- Efficient and effective allocation,
acquisition, and utilization of
funds.
Primary Activity of Finance Manager
1. Financial Planning and analysis
is
– forecasting of income,
budgeting of expenses, and
analyzing financial condition of a
business.
2. Managing the assets of the
company- assuring that assets
are being used and maximized.
3. Managing the company’s
liabilities and owner’s equity
-making sure that there are
sufficient funds to pay maturing
debts and obligations and capital
are efficiently used.
Goal of a Finance Manager
- Make significant decisions that
will maximize the wealth of the
business or a company.
Kinds of Corporation c. Savings and loans
association
- Private Corporation
d. Microfinance Thrift banks
- Public Corporation
e. Credit Unions
- Government Owned and
3. Rural Banks
controlled corporation

Managers B. Non-depository Institutions

1. Insurance Companies
Competent managers may have any
a. Life Insurance
of the following attributes:
b. Property Insurance
1. Visionary 2. Fund Managers
2. Decisive 3. Investment
3. People-oriented Banks/Houses/Companies
4. Inspiring 4. Finance Companies
5. Innovative 5. Securities dealers and brokers
6. Respected 6. Pawnshops
7. Experienced manager 7. Trust Companies and
Departments
Flow of Funds in a Financial System 8. Lending Investors
Financial Institutions Financial Markets
Savers of fund Users of - Institutions and systems that
Funds facilitates transactions in all
Private Placement types of claims

Financial Markets 1. As to term or maturity

a. Money Market
- Cover markets for short term
Financial Institutions – bridge the gap debt instruments
between investors, lenders, and b. Capital Market
borrowers - For long term securities; more
than 1 year
A. Depository Institutions
- Debt and equity securities are
1. Commercial Banks
traded in the capital market
a. Ordinary commercial
- Greater default and risk but carry
banks
higher yield
b. Universal banks or
- Traded in the PSE
expanded commercial
2. Thrift Banks
2. As to type of issue
a. Savings and Mortgage
a. Primary Market
Banks
- Also known as new issues market.
b. Private Development
Consist of issuers, underwriters,
Banks
and instruments
 b. Secondary Market 1. Understanding the information
- Markets for currently outstanding provided in the financial
securities. statement
2. Drawing logical conclusion based
Operating Fund Cycle
on the data presented
● Collection Activity (conversion 3. Making the appropriate decisions
cash) on the course of action to take
● Purchasing Activity
Standards in Financial Statement
● Production Activity
Analysis
● Selling Activity
● Ratio analysis- describes the
Cash Flows
situation that exists
● Operating ● Accounting ratios are important
● Investing to people outside the firm
● Financing
Financial Ratios
FINANCIAL ANALYSIS, TOOLS, AND
● Used in expressing financial
TECHNIQUES.
data, so it can be compared, and
Financial Analysis – refers to trends identified and thus
examination of financial data of an questions can be raised
entity to determine its: ● Build up and to summarize the
evidence available and to create
● Profitability- the ability to
a picture from which not
generate revenues
conclusions but better questions
● Growth- ability to increase its
can be drawn
value
● Solvency- ability to meet its Financial Ratio Analysis
long-term obligation
● Helps to determine the financial
● Stability- ability to meet
status and performance of a
economic downturns
company
● Effectiveness of management-
● Determines the key relationships
how effective is the management
and characteristics of the
in utilizing assets and
company in comparison with its
investments
competitors in the industry
Financing Decisions
Commonly Used Financial Ratios
- Decisions that involve funding
● Profitability Ratios – operating
investments and operations over
efficiency and overall returns on
the long run
asset and capital
Steps in Analyzing the Financial a. Gross Profit Margin
Statements Gross profit/sales x 100=
b. Return on Equity
 Net Income/stockholders
Equity x 100=
c. Return on Assets
Operating Income/total
assets x 100
● Leverage Ratios – long-term
solvency ratios reflect
company’s dependence
borrowings; the ability to meet
debt-service requirements
A. Debt to Equity
Total Liabilities/ total
stockholder’s Equity
● Liquidity Ratios – reveal the
capacity of the company to meet
its short-term obligation
a. Current Ratio
Current assets/ current
liability
b. Quick-asset Ratio
Current assets
inventory/current liability
● Efficiency Ratios – indicate how
well assets are being used to
generate revenues
a. Asset Turnover Ratio
Sales/ total assets
b. Fixed asset turnover ratio
Sales/ fixed assets
c. Accounts receivable turnover
ratio
Sales/ accounts receivable
d. Days Receivable
360/ AR turnover ratio
e. Inventory Turnover Ratio
COGS/ inventory
f. Days Inventory
360/ ITR
g. Accounts Payable Turnover
ratio
COGS/ accounts payable
h. Days Payable
360/ APTR
Operating Cycle – covers the period
from the time the merchandise is
a
bought to the time the proceeds from
on
the sale are collected
Operating Cycle=
Days Inventory + Days Receivable
Cash Cycle – how long it takes for the
company to collect receivables from the
time the merchandise sold was actually
paid and payment to suppliers are
made.
Cash Cycle=
Operating Cycle – Days payable
Limitations of Financial Statement
Analysis
– 1. Financial Analysis deals only with
quantitative data.
2. Management can take short-run
actions to influence ratios.
3. Different companies may use
different accounting policies
though they came from the same
industry
4. Different formulas can be used in
computing financial ratios
5. The amounts found in the
financial statements are already
part of historical data
6. A financial ratio alone is useless.
Introduction of Financial Planning
Planning – important aspect of the
firm’s operations. It provides road maps
for guiding, coordinating, and Sales Budget – is a financial plan that
controlling the firm’s action to achieve estimates a company’s total revenue in
its objectives a specific period. It focuses on (1)
number of products sold and (2) price at
Management planning- setting the
which they are sold. It is to predict how
goals of the organization and
the company will perform.
identifying ways on how to achieve
them Used of Sales Budget

Two phases of financial planning - Allows companies to manage

resources and profits based on
Long Term Plans & Short-Term Plans
expected sales.
Strategic (long term) Tactical (short
Importance of a Sales Budget
term)
- To achieve growth, even if it’s a
In charge of Planning
simple 1-percent increase in sales
Upper management – Long term goals, productivity
products, markets, business organizing.
Factors
Jobs like CEO etc.
- External and Internal
Middle Management – interprets plans
and sets actions, Jobs like, regional/ - Production Budget
plant managers - Provides information regarding
the number of units that should
be produced based on expected
Lower-Level Management – Implements sales and targeted level of
plans. Jobs like team leader, etc. ending inventories.

Long-term financial plans – integrated Operations Budget

strategy that considers various
- Variable and fixed costs needed
departments such as sales, production,
to run the operations of the
marketing, and operations for the
company but are not directly
purpose of guiding these departments
attributable to the generation of
towards strategic goals.
sales. Ex. Rent Payments
Short-term financial plans- include the
Fixed Cost
setting the sales forecast and other
forms of operating financial data. This - Items of cost which remain
would then translate inti operating constant in total.
budgets, the cash budget, and pro
Variable Cost
forma financial statements.
- Items of cost which vary directly,
in total, in relation to volume of
Budget Preparation production.
 Cash Budget Preparation
Cash Budget/ Cash Forecast
- statement of the firm’s planned inflows
and outflows of cash. It is used to
estimate its short-term cash
requirement, with particular attention
being paid to planning for surplus and
for cash shortages. -the cash
budget is a control tool to monitor the
way the company handles cash.
Inflows of Cash (sources)
● Cash sales
● Collection of accounts receivable
(decrease)
● Increase or infusion of capital
● Loans from creditors/lenders
● Sale of fixed assets
Outflows of Cash (uses)
● Payment of accounts payable
(decrease)
● Increase of accounts receivable
● Payment of Loans and interest
from creditors/lenders
● Payment of expenses
● Purchases or acquisition of fixed
assets
Sources and Uses of Short-Term Funds or
Short-Term Financing and Long-Term
Funds or Financing
Short Term Funds or Financing
● funds used for working capital
● financing used to meet seasonal
and temporary fluctuations in
fund position
● term is less than a year
Types of Short-Term Funds or Financing
Secured – Unsecured or clean
financing –financing or loans
that are secured without collateral
by a collateral
What Is Collateral?
Collateral in the financial world is a
valuable asset that a borrower pledge as
security for a loan. The collateral document
is Real Estate Mortgage or REM.
OTHER COLLATERAL
For vehicles, trucks, equipment the
collateral document is referred to as
Chattel Mortgage (CHM).
Sources of Short-Term Funds
Spontaneous sources of short-term funds
● deferred payment of salaries,
taxes and other obligations
arising from current operations
or accruals.
● trade credit
Deliberate sources-refers to sources that
can be made use of by the deliberate act,
on the borrower, of negotiating for the
availment of the funding/financing.
● bank loans
● commercial papers
Short-Term Financing big firms of unquestionable
credit standing and reputation.
Advantages
● regulated by the SEC. SEC
➔ easier to arrange evaluates the credit standing of
➔ less expensive the issuing company and issues a
➔ provides the credit rating.
➔ borrower more ● interest rate to be assigned to
➔ flexibility the issue will
Disadvantages ● depend on the credit rating
➔ interest rates fluctuates more Credit Rating – evaluation of the
capacity to pay obligations.
often
➔ refinancing is frequently needed Asset Backed Security-An asset-backed
➔ credit standing of the borrower security (ABS) is a financial security
may easily be adversely affected
collateralized by a pool of assets such
Factors to be Considered in Choosing
as loans, leases, credit card debt,
Short-Term Financing
royalties or receivables.
A. Cost => interest
Mortgage Backed Security
B. restrictions (terms and
agreements) e.g. payment ● long term loans secured by real
C. Flexibility estate
D. reliability (availability of funds ● amortizations are required either
when needed) monthly or quarterly
Trade Credits Bank Loans

● sales to customers on account ● loan products granted by Banks

● acquisition of merchandise or
raw materials or service on
account without any formal note
signed to evidence the liability.
● granted by suppliers
Credit terms-number of days granted to
the borrower when the obligation is to
be
Settled.
for:
consumer use such as housing loan,
car loan or salary loan
● working capital requirements
examples are: Credit Line, Promissory Note
Line, Discounting Line (either postdated
checks or receivables), Invoice Financing,
LC/TR Line etc.

●Example: 30 days, 60 days, end of capital expenditures-examples are

long-term loans
the month, etc. collateral
Commercial Papers Interest-Interest is the cost of money
borrowed. Banks charge interest for the
● unsecured promissory notes
funds borrowed from them since they also
maturing within a year issued by
need to pay interest to depositors for the -it is a debt instrument used in financing
money deposited in banks. purchases of merchandise.

Interest Rates charged by banks to Commercial Finance Companies

borrowers vary. The rate will depend on the
-lending institutions granting secured
quality of the loan and the credit worthiness
loans which
of the borrower.
may be short term or long term in nature.
Interest Rates
-unlike banks, interest rates charged are
The different interest rates are:
higher
Prime Rate of Interest – lowest rate
compared to the rates charged by banks.
charged by banks to their most valued
client/borrower. Rates also vary or
fluctuate depending on the rate currently
Loans by Commercial Finance
offered in the market. Subject to supply
Companies
and demand.
Receivables Financing-receivables from
Fixed Interest Rate – interest rate is fixed
customers are sold or discounted by the
for a given period. Typically charged to
company (borrower) to the financing
long-term loans
company.
Floating Interest Rate – this rate is
-most common forms of receivables
subject to adjustments on the changes in
financing.
the prime interest rates
Pledging of accounts receivable - used
Effective Interest Rate – rate of interest
as a support for bank loans obtained.
that is actually charged to the borrower
factoring of accounts receivable – sale
-it is computed by dividing the amount of
of receivables without recourse.
interest by the amount received by the
borrower assignment of accounts receivable – refers
to conditional sale of receivables. The
-when interest is payable at maturity date,
lender (or
the effective interest rate is the same as
the nominal rate assignee) can collect from the borrower (or
assignor) in case collections are
-When interest is deducted in advance (or
insufficient to cover the
the loan is discounted, the effective
interest rate is higher than the nominal amount advanced to the latter.
rate or the stated interest rate.
discounting of notes receivable – refers
Banker’s Acceptance to endorsing a promissory note in favor of
another party,
-is a draft, drawn by the seller (or
exporter) and accepted by the buyers usually a financial institution. Endorsement
bank, ordering payment to the seller’s is effected by the payee by signing his/her
bank at a later date. name on the
back of the instrument or PN. By doing so,
he/she transfers full legal title to the
instrument and
impliedly guarantees that the instrument
will be dully paid.
Common Terms in Receivable Financing
With Recourse-in case the financing
company can not collect from the
customers of the debtor/borrower, the
former will collect from the
borrower/debtor the funds borrowed or
advanced to the same
Without Recourse – the financing
company cannot collect anymore from the
borrower/debtor
Notification Basis – customers are
notified of the transfer of receivables so
they will have to pay the financing
company.
Non-notification – if customers are not
notified of the transfer of receivables so
they continue paying the borrower/debtor
company and the latter will
remit the payment to the financing
company
Contingent Liability – if a company sells
its receivables with recourse, then a
contingent liability may arise if the
customers with receivables will not pay.
Inventory Financing- inventories are
used as collateral or support for a loan if
accounts receivable financing are already
used up.
Sources of Long-Term Funds
-long term mortgage on land, plant and
other real estate properties
-long term chattel mortgage on
equipment
-issuance of long term commercial
papers
-issuance of corporate bonds
-issuances of shares of capital stocks,
common and preferred.
THE 5 C’s of Credit
WHAT ARE THE 5 Cs OF CREDIT?
- The 5 Cs of credit is a framework
used by financial institutions and
other non-bank lenders to
evaluate the creditworthiness of
a borrow, as well as strength of
an overall borrowing request.
- the 5 Cs of credit impact pricing,
structure, and the general terms
under which credit is advanced
to a borrower.
CHARACTER- Willingness to pay Track
record of borrower Standing in the
community For corporations, the track
record of the company, its top
management. Ranking in the industry,
brand recognition, etc
CAPACITY TO PAY- Capacity to pay
Results of operation and financial
condition Cashflow is the first way out
Financial ratios
CAPITAL Capital structure
Debt-to-equity ratio Guarantee from
owners
COLLATERAL Second way out Nature of
collateral: real estate or chattel Quality
of collateral Market value and loan
value of collateral Encumbrances or
liens
CONDITION Purpose of the loan Macro
and micro factors that affect the
business/industry Does the nature of
business belong to emerging/rising
industry (sunrise) or declining industry
(sunset)
Other Factor to Consider Credit risk is
the risk that some (or all) of the
repayments may
not be made, and that the creditor may
lose some (or all) of its
principal.
LOANS AND MORTGAGE
Loan- A loan is money, property or
other material goods that is given to
another party in exchange for future
repayment of the loan value amount
along with interest or other finance
charges.
Written or oral agreement for a
temporary transfer of a property
(usually cash) from its owner (the
lender) to a borrower who promises to
return it according to the terms of the
agreement, usually with interest for its
use.
CLASSIFICATIONS OF LOANS
● As to security
➢ Secure – loans that are
secured or backed by
collateral
➢ Unsecured – loans that
are not secured or backed
by collateral; no collateral;
also called clean loan
● As to term
➢ Short Term – loans that
are payable within a year
or less than a year
Medium Term – loans that are payable
more than a year or 3 years to 4 years;
also called installment loans since it has
to be repaid in equal monthly
installments
Long Term – loans whose terms are
extended over a long period of time,
five years or more; it normally requires
a collateral; loans used to buy a house,
a car or for capital expenditures e.g.
purchase of equipment, land or
construction of plant or building
COLLATERAL - Collateral is a property
or other asset that a borrower offers as
a way for a lender to secure the loan.
TYPES OF COLLATERAL
● Real Estate (land, land and
building, house and lot)
● Equipment
● Vehicles (cars, trucks)
MORTGAGE - A mortgage is a debt
instrument, secured by the collateral of
specified real estate property, that the
borrower is obliged to pay back with a
predetermined set of payments.
-A legal agreement that conveys the
conditional right of ownership on an
asset or property by its owner (the
mortgagor) to a lender (the mortgagee) Add-On Interest
as security for a loan. The lender
What Is Add-On Interest?
security interest is recorded in the
register of title documents to make it Add-on interest is a method of
public information, and is voided when calculating the interest to be paid on a
the loan is repaid in full. loan by combining the total principal
amount borrowed and the total interest
due into a single figure, then multiplying
MATURITY- Date when the loan needs that figure by the number of years to
to be repaid (principal and interest) repayment. The total is then divided by
the number of monthly payments to be
AMORTIZATION- Spreading of
made. The result is a loan that combines
payments on a long term loan over its
interest and principal into one amount
duration/term in equal monthly
due.
instalments or monthly payments on the
long term loan. This is substantially more expensive for
the borrower than the traditional simple
AMORTIZATION SCHEDULE- is a
interest calculation and is rarely used in
complete table of periodic loan
consumer loans . Add-on interest loans
payments, showing the amount of
may occasionally be used in short-term
principal and the amount of interest
installment loans and in loans to
that comprise each payment until the
subprime borrowers.
loan is paid off at the end of its term
[Important: Most loans are so-called
DOWN PAYMENT - initial payment
simple interest loans—that is, the
made by a buyer, normally a
interest charged is based on the
percentage of the price; also called
amount of principal that is owed after
buyer’s equity
each payment is made.]
FORMULAS:

I- Interest P-Principal MV-Maturity

Understanding Add-On Interest
Value LA- Loan Amount
TCP- Total Contract Price Most loans are so-called simple interest
DP- Down Payment loans—that is, the interest charged is
A- Amortization based on the amount of principal that is
owed after each payment is made. The
● I=Pxrxt
payments may be identical in size from
● Maturity Value (MV) = P + I
month to month, but that is because the
● Maturity Value (MV) = P + I
principal paid increases over time while
● LA = TCP – DP
the interest paid decreases.

If the consumer pays off a simple

interest loan early, the savings can be
substantial.
The number of interest payments that Number of months = term x 12
would have been attached to future
= 5 x 12
monthly
Number of months = 60 months
payments has been effectively erased.

But in an add-on interest loan, the

amount owed is calculated upfront as a To compute for the Monthly Interest:
total of the
MI = I / # of months
principal borrowed plus annual interest
= P100,000.00 / 60
at the stated rate, multiplied by the
number of years until the loan is fully MI = P1,666.67
repaid. That total owed is then divided
by the number of months of payments
due in order to arrive at a monthly To compute for the Monthly Principal:
payment figure.
MP = P / # of months
This means that the interest owed each
month remains constant throughout the = P250,000.00 / 60
life of the loan. The interest owed is MP = P4,166.67
much higher. And, even if the borrower
pays off the loan early, the interest
charged will be the same.
To compute for the Monthly Loan
Payment:

An Example of Add-On Interest MLP = MP + MI

Lou Tapas owns a bake shop. She wants = P4,166.67 + P1,666.67

to buy a new and complete set of
baking equipment costing P250,000.00.
She applied for a loan from a financing
company at an 8% add-on interest to be
repaid monthly over five years. How
much would be the total monthly loan
payment:
To compute for the add-on interest:
I=Pxrxt
I = P250,000.00 x 0.08 x 5
I = P100,000.00
To compute for the number of months:
MLP = P5,833.34
Using a simple interest loan payment
calculator, the same borrower with the
same 8% interest rate on a P250,000
loan over five years would have
required monthly payments of
P5,068.10. The total interest due would
be P54,155.25.***
The borrower would pay P45,844.75
more for the add-on interest loan
compared to the simple interest
loan—that is, if the borrower did not pay
off the loan early, reducing the total
interest even more. The reason for this
the diminishing principal balance over
the term of the loan as the monthly
amortization is paid.

Key Takeaways:

● Most loans are simple interest

loans—that is, the interest is
based on the amount owed after
each payment is made.
● The add-on interest loan
combines principal and interest
into one amount owed, to be paid
off in equal installments.
● The result is a substantially
higher cost to the consumer.

Note:

- In the Philippines, however, most

private financing companies use
the add-on interest for consumer
loans such as salary loans,
multi-purpose loans, and car
loans.
- Credit card companies and other
banks use the add-on interest for
cash advance and car loans,
respectively.
- Government institutions that
extend loans to members such as
SSS and Pag-IBIG use simple
loans for their
salary/multi-purpose loans and
housing loans.