FINANCE

•Finance can be defined as the science and art of

managing money. (Gitman & Zutter, 2012)

•Financial Decision
➢most of the activities we do involving decisions on
where to use our finances
 BUDGETING

• Budgeting is the act of estimating revenue (in the form of

their allowance) and expenses over a period of time (in this
case, on a daily basis).
• In finance, it a process to create a plan or estimate of the
expected incomes and expenditures in the upcoming financial
year.
 INVESTMENTS

•Investments come in many forms that will

generate income or appreciate in the future.
•An investment is an asset or item acquired with
the goal of generating income or appreciation.
 SOURCES OF FUNDS

• When faced with financial difficulties (in this case, the lack
of funds to meet the current expenses) we look for
people or institutions that will give us the money we need.
• Is the origin of funds or assets used in specific business
transaction between a client and financial institution.
 FORMS OF BUSINESS ORGANIZATIONS

• Sole Proprietorship - A business owned by one person and

operated for his or her own profit.
• Partnership - A business owned by two or more people and
operated for profit.
• Corporation – An entity created by law owned by
shareholders.
 TYPES OF A CORPORATION

• Privately-owned
➢- Privately owned corporations are often owned by family members
whose stocks may not be offered to outsiders unless consent by the family
members is secured.

• Publicly-owned
➢Companies which are publicly listed are owned by unrelated investors and
are traded in organized exchanges like the Philippine Stock Exchange.
• While there are many stockholders, there is generally a group of
investors or a family which controls each listed company. For
example, in the case of BPI, the biggest stockholder is Ayala
Corporation and in the case of Banco De Oro, it is SM
Investment Corporation. Prices of stocks of listed corporations
are driven by several factors such as the earnings of the
companies, the prospects of the industry where these companies
operate, the general market sentiment, and the economic
prospects of the country, among others.
WEALTH MAXIMIZATION

• Wealth maximization is the concept of increasing a

firm’s worth to increase the value of stockholders’
shares.
• The objective of a shareholder should be wealth
maximization
• Example:
Assume that Alma bought 10 shares of Globe Telecom at
PHP2,510 each on September 9, 2010. This brings her
investments to PHP25,100. What happens to the value of
her investment if the price goes up to PHP2,600 per share
or it goes down to PHP2,300 per share?
• An increase of the share price to PHP2,600 per share means that people
are willing to buy the shares for that amount. If the learners were to sell
their shares at this point, it will result to a profit of PHP90 per share or
PHP900 on their whole investment. Hence, the value of their investment
increased from PHP25,100 to PHP26,000. Therefore, there is an increase in
shareholder’s wealth.
• On the other hand, a decrease in the share price to PHP2,300 per share
means that people are only willing to buy shares for PHP2,300. If the
learners were to sell their investment at this point, they will receive
PHP23,000 which would result to a loss of PHP2,100. The decrease in value
of their investment leads to a decrease in shareholder’s wealth.
• Note: The shareholders’ wealth is measured based
on the current market price of the corporation’s
stocks. The market price changes across different
periods. Hence, the value of your investment changes
in different points on time based on the market value
at that time.
FACTORS THAT INFLUENCE MARKET PRICE

• Group the factors into two: Factors that the

Management can control and external factors
that cannot be controlled by management.
1. PROFITABILITY

• Profit is a measure of the financial performance

of a company for a period of time.
• Although it is a major driver for increasing the
value of stock, an investor should not rely on
profits alone. It is possible that the company has
profits, but its cash flow is negative.
EXAMPLE:
• Company A is profitable but generated negative cash flows which resulted
from the uncollected accounts receivable of PHP100,000. Without adequate
cash inflows to meet its obligations, the company will face liquidity problems,
regardless of its level of profits.
• Company B on the other hand has a positive cash flow but is unprofitable.
This is a result of the company’s delay in payment of its costs. Accordingly, the
Company will soon have to pay the remaining PHP100,000 liability and its
cash will no longer be sufficient. Again, without adequate cash inflows to meet
its obligations, the company will face liquidity problems.
• Company C is profitable and has a positive cash flow. Based on the
information provided, Company C seems to be the best.
2. GOOD LIQUIDITY AND REASONABLE
LEVERAGE POSITION.

• Liquidity and leverage refers to the company’s

management of the type and amount of assets
and liabilities that it will hold in the course of its
operations.
 3. DIVIDENDS

• Holders of shares receive dividends from a corporation as returns on their

investments in form of cash or other properties. Companies which have better
dividend policies are generally more attractive than companies who do not pay
out dividends.
• Note that there may be times that companies do not pay out dividends
because of future expansions. Same with the other factors affecting share
price, dividend policies should go hand in hand with other factors in
determining market price.
4. COMPETENT MANAGEMENT

•Competent managers may have any of the

following attributes: 1) visionary 2) decisive
3) people-oriented, 4) inspiring, 5)
innovative, 6) respected and 7)
experienced/seasoned manager.
5. CORPORATE PLANS THAT IMPROVE THE
BUSINESS PROSPECTS
Example:
• Company A which is in the business of selling Halo-halo in the
Dapitan area (or any other area) for 5 years. Company A is
consistently earning profits and has a positive cash flow. When asked
how Company A sees itself after 5 more years, Company A
answered that it would continue to sell Halo-halo in Dapitan (or any
other area).
• On the other hand, Company B sells Buko Juice in Katipunan area
(or any other area different from Company A’s area) for 5 years.
Company B is consistently earning profits and has a positive cash
flow. When asked how Company B sees itself after 5 more years,
Company B answered that it has generated enough cash to expand
its business to Cubao area (or any other area) to take advantage of
the growing demand of Buko Juice in Cubao.
•Between Company A and Company B,
Company B would be a better investment.
Since it has more concrete future prospects
allowing investors to hope for better
revenues and net income.
 EXTERNAL FACTORS

- These factors influences the general reaction of investors in making

an investment decision.
- Its effect is not only to a specific company but on all companies or a
group of companies under similar circumstances.
- Such factors are a result of the environment a company operates in
rather than the decisions of the company’s management.
INTRODUCTION TO
FINANCIAL
MANAGEMENT
FINANCIAL MANAGEMENT

Financial Management deals with

decisions that are supposed to maximize
the value of shareholder’s wealth.
FINANCIAL MANAGER

A Financial Manager is part of a

management team whose ultimate goal is to
maximize shareholders wealth.
THE CORPORATE ORGANIZATION
STRUCTURE
• From the diagram presented, emphasize that
each line is working for the interest of the person
on the line above them. Since the managers of the
company are making decisions for the interest of
the board of directors and the board of directors
does the same for the interest of the shareholders,
it follows that the goal of each individual in a
corporate organization should have an objective of
shareholders’ wealth maximization.
 SHAREHOLDERS
The shareholders elect the Board of Directors
(BOD). Each share held is equal to one voting right.
Since the BOD is elected by the shareholders,
their responsibility is to carry out the objectives of
the shareholders otherwise, they would not have
been elected in that position.
 BOARD OF DIRECTORS
The board of directors is the highest policy
making body in a corporation. The board’s primary
responsibility is to ensure that the corporation is
operating to serve the best interest of the
stockholders. The following are among the
responsibilities of the board of directors:
- Setting policies on investments, capital structure
and dividend policies.
- Approving company’s strategies, goals and budgets.
- Appointing and removing members of the top
management including the president.
- Determining top management’s compensation.
- Approving the information and other disclosures
reported in the financial statements
PRESIDENT (CHIEF EXECUTIVE
OFFICER)
The roles of a president in a
corporation may vary from one company
to another. Among the responsibilities of
a president are the following:
-Overseeing the operations of a company and
ensuring that the strategies as approved by the
board are implemented as planned.
- Performing all areas of management: planning,
organizing, staffing, directing and controlling.
-Representing the company in professional,
social, and civic activities.
 VP FOR MARKETING
• The following are among the responsibilities of VP for Marketing
✓Formulating marketing strategies and plans.
✓Directing and coordinating company sales.
✓Performing market and competitor analysis.
✓Analyzing and evaluating the effectiveness and cost of marketing methods
applied.
✓Conducting or directing research that will allow the company identify new
marketing opportunities, e.g. variants of the existing products/services already
offered in the market.
✓Promoting good relationships with customers and distributors.
 VP FOR PRODUCTION
• The following are among the responsibilities of VP for
Production:
✓Ensuring production meets customer demands.
✓Identifying production technology/process that minimizes
production cost and make the company cost competitive.
✓Coming up with a production plan that maximizes the
utilization of the company’s production facilities.
✓Identifying adequate and cheap raw material suppliers.
 VP FOR ADMINISTRATION
• The following are among the responsibilities of VP for Administration:
✓Coordinating the functions of administration, finance, and marketing
departments.
✓Assisting other departments in hiring employees.
✓Providing assistance in payroll preparation, payment of vendors, and collection
of receivables.
✓Determining the location and the maximum amount of office space needed
by the company.
✓Identifying means, processes, or systems that will minimize the operating
costs of the company.
 QUOTES FROM THE CHIEF FINANCIAL OFFICERS
(CFOS) OF THE RESPECTIVE CORPORATIONS:

Unilever: “Finance plays a critical role across every aspect of

our business. We enable the business to turn our ambition and
strategy into sustainable, consistent and superior performance”
- Jean-Marc Huët (Unilever) –
Jollibee: “It’s very exciting because you are not just thinking
of today but what the company will need in the future” -
Ysmael V. Baysa (Morales, 2013)
Globe Telecom: “Yesterday’s solutions are never
adequate for the future” - Albert De Larrazabal
(Klobucher, 2015)
SM Corporation: “Now, we don’t go out because
we need funds.We go out because it’s an opportunity.”
– Jose T. Sio (Montealegre, 2015)
THE FOUR FUNCTIONS OF A VP FOR FINANCE
(CFO) AS FOLLOWS:

➢Financing
➢Investing
➢Operating
➢Dividend Policies
FINANCING
Financing is to determine the
appropriate capital structure of the
company and to raise funds from debt
and equity.
FINANCING DECISIONS

Financing decisions include making decisions

on how to fund long term investments (such as
company expansions) and working capital which deals
with the day-to-day operations of the company (i.e.,
purchase of inventory, payment of operating expenses,
etc.).
 The role of the VP for Finance of the
Financial Manager is to determine the
appropriate capital structure of the company.
Capital structure refers to how much of your
total assets is financed by debt and how
much is financed by equity.
 To be able to acquire assets, our funds must
have come somewhere. If it was bought using cash
from our pockets, it is financed by equity.
On the other hand, if we used money from our
borrowings, the asset bought is financed by debt.
In the figure above, the total assets is financed
by 60% debt and 40% equity. Accordingly, the capital
structure is 60% debt and 40% equity.
INVESTING
Investing is the process of buying
the assets that increase in value over
time and provide returns in the form
of income payments or capital gains.
SHORT TERM INVESTMENT

- decisions are needed when the

company is in an excess cash position
•To plan for this, the Financial Manager should
be able to make use of Financial Planning tools
such as budgeting and forecasting.
•Moreover, the company should choose which
type of investment it should invest in that
would provide an most optimal risk and return
trade off.
LONG TERM INVESTMENTS

- should be supported by a capital

budgeting analysis which is among the
responsibilities of a finance manager.
• Capital budgeting analysis is a tool to assess whether
the investment will be profitable in the long run. This
is a crucial function of management especially if this
investment would be financed by debt.
• The lenders should have the confidence that the
investments that management will push through with
will be profitable or else they would not lend the
company any money.
OPERATING DECISIONS
Operating decisions deal with the daily operations
of the company. The role of the VP for finance is
determining how to finance working capital accounts such
as accounts receivable and inventories. The company has a
choice on whether to finance working capital needs by
long term or short term sources.
▪Short Term sources are those that will be payable
in at most 12 months. This includes short-term
loans with banks and suppliers’ credit. For short-
term bank loans, the interest rate is generally
lower as compared to that of long-term loans.
Hence, this would lead to a lower financing cost.
▪Suppliers’ credit are the amounts owed to suppliers
for the inventories they delivered or services they
provided. While suppliers’ credit is generally free of
interest charges, the obligations with them have to
be paid on time to maintain good supplier
relationship. Such relationships should be nurtured
to ensure timely delivery of inventories.
▪Short term sources pose a trade-off between
profitability and liquidity risk. Because this source
matures in a short period, there is a possibility that
the company may not be able to obtain enough
cash to pay their obligation (i.e., liquidity risk).
▪Long term sources, on the other hand, mature in longer
periods. Since this will be paid much later, the lenders
expect more risk and place a higher interest rate which
makes the cost of long-term sources higher than short
term sources. However, since long term sources have a
longer time to mature, it gives the company more time
to accumulate cash to pay off the obligation in the
future.
▪Hence, the choice between short- and long-
term sources depends on the risk and
return trade off that management is willing
to take.
 DIVIDEND POLICIES
Cash dividends are paid by corporations to existing
shareholders based on their shareholdings in the
company as a return on their investment. Some investors
buy stocks because of the dividends they expect to
receive from the company. Non-declaration of dividends
may disappoint these investors. Hence, it is the role of a
financial manager to determine when the company
should declare cash dividends.
Before a company may be able to declare
cash dividends, two conditions must exist:
1. The company must have enough retained
earnings (accumulated profits) to support
cash dividend declaration.
2. The company must have cash.
• One of the functions of a finance manager is investing
and its available cash may be used to invest in long term
investments that would increase the profitability of the
company. Some small enterprises which are undergoing
expansion may have limited access to long term
financing (both long term debt and equity). This results
to these small companies reinvesting their earnings into
their business rather than paying them out as dividends.
• On the other hand, a company which has access to long
term sources of funds may be able to declare dividends
even if they are faced with investment opportunities.
However, these investment opportunities are generally
financed by both debt and equity.
➢ The management usually appropriates a portion of
retained earnings for investment undertakings and this
may limit the amount of retained earnings available for
dividend declaration.
• Creditors are not willing to finance entirely the cost
of a company’s long-term investment. Hence, the
need for equity financing (e.g., internally generated
funds or issuance of new shares).
• Examples of these companies are publicly listed
companies such as PLDT, Globe Telecom, and Petron.
PLDT and Globe are two of the Philippine listed
companies which have generously distributed cash
dividends for the last five years
•For companies which have limited access to
capital and have target capital structure, they
may end up with a residual dividend policy. This
means that when companies are faced with
investment opportunities, internally generated
funds will be used first to finance these
investments and dividends can only be declared if
there are excess funds.
FINANCIAL SYSTEM
FINANCIAL SYSTEM

•A set of institutions, such as banks,

insurance companies, and stock exchanges,
that permit the exchange of funds.
PRIVATE PLACEMENTS

•The sale of a new security directly to an

investor or group of investors.
FINANCIAL MARKET

•Organized forums in which the suppliers

and users of various types of funds can
make transactions directly
FINANCIAL INSTITUTIONS

•Intermediaries that channels the savings of

individuals, businesses, and governments into
loans or investments.
NOTE THAT ON THE DIAGRAM PRESENTED, THE SOLID LINES REPRESENT THE FLOW OF CASH/FUNDS,
WHILE THE BROKEN LINES REPRESENT THE FLOW OF FINANCIAL INSTRUMENTS WHICH REPRESENT
OBLIGATIONS TO TRANSFER CASH OR OTHER ASSETS IN THE FUTURE.
FINANCIAL INSTRUMENTS
FINANCIAL INSTRUMENTS

• is a real or a virtual document representing a legal

agreement involving some sort-of monetary value
• the transfers of funds from one party to another
are made through Financial Instruments.
FINANCIAL INSTRUMENTS

• When a financial instrument is issued, it gives rise

to a financial asset on one hand and a 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.
• A contractual right to exchange instruments with another entity under
conditions that are potentially favorable.
Examples: Notes Receivable, Loans Receivable, Investment in Stocks,
Investment in Bonds
 A FINANCIAL LIABILITY IS ANY LIABILITY
THAT IS A CONTRACTUAL OBLIGATION:

• To deliver cash or other financial instrument to another

entity.
• To exchange financial instruments with another entity under
conditions that are potentially unfavorable.
Examples: Notes Payable, Loans Payable, Bonds Payable
EQUITY INSTRUMENT

An Equity Instrument is any contract that evidences a

residual interest in the assets of an entity after deducting
all liabilities.
Examples: Ordinary Share Capital, Preference Share
Capital
• When companies are in need of funding, they either sell debt
securities (or bonds) or issue equity instruments. The
proceeds from the sale of the debt securities and issuance of
bonds will be used to finance the company’s plans. On the
other hand, investors buy debt securities of equity instruments
in hopes of receiving returns through interest, dividend
income or appreciation in the financial asset’s price.
DEBT INSTRUMENTS

• Debt Instruments generally have fixed returns

due to fixed interest rates. Examples of debt
instruments are as follows:
TREASURY BONDS AND TREASURY BILLS

• are issued by the Philippine government. These

bonds and bills have usually low interest rates
and have very low risk of default since the
government assures that these will be paid.
 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 INSTRUMENTS

• Equity Instruments generally have varied

returns based on the performance of the issuing
company. Returns from equity instruments come
from either dividends or stock price appreciation.
The following are types of equity instruments:
 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.
 COMMON STOCK

• 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.
FINANCIAL MARKETS
 PRIMARY MARKET VS SECONDARY
MARKET

• Primary Market - Financial market in which securities

are initially issued; the only market in which the issuer is
directly involved in the transaction.
• Secondary Market - Financial market in which
preowned securities (those that are not new issues) are
traded.
• 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(either bonds or stocks) 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.
• The Philippine Stock Exchange (PSE) is
both a primary and secondary market.
MONEY MARKETS VS. CAPITAL MARKETS

• Money market - A financial relationship created

between suppliers and users of short-term funds.
• Capital market - A market that enables suppliers
and users of long-term funds to make transactions.
• 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.
At the same time, other individuals, businesses,
governments, and financial institutions find themselves in
need of seasonal or temporary financing.
• 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).
FINANCIAL INSTITUTIONS
 COMMERCIAL BANKS

• 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

• Insurance Companies - Individuals purchase insurance (life,

property and casualty, and health) protection with insurance
premiums. The insurance companies pool these payments and invest
the proceeds in various securities until the funds are needed to pay
off claims by policyholders. Because they often own large blocks of a
firm’s stocks or bonds, they frequently attempt to influence the
management of the firm to improve the firm’s performance, and
ultimately, the performance of the securities they own.
 MUTUAL FUNDS

• 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

•Pension Funds - Financial institutions that

receive payments from employees and invest
the proceeds on their behalf.
OTHER FINANCIAL INSTITUTIONS

• 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.