Business Finance

Lesson One: Understanding Finance

Definition and Concept of Finance

FINANCE is usually related to money. The American Heritage Desk Dictionary defines FINANCE as the
management of money, banking, investments, and credit. It is the science of the management of money and other
assets.

FINANCE is both a science and an art of correct application of the economic and accounting concepts and
principles that define the system, structure and process of management, allocation, and utilization of financial
resources, investments and expenditures.

FINANCE is a science. It deals with and is strictly governed by financial facts and truths that support and provide
the basis for making financial decisions.

FINANCE is also considered an art. The different financial services continue to change and develop as the
operations of the business organization become more complicated. The financial practices do not remain static but
become adaptive to the changes in the business environment over time. As business practices change over time,
new financial theories are introduced by experts or specialists in the field of finance. These new developments and
trends are a clear manifestation that finance will continue to evolve in the future.

1. PRIVATE FINANCE is the management of financial

resources of private individuals, and non-governmental
organizations in accordance with the prescribed financial
policy and priority of the person or business organizations.
2. PUBLIC FINANCE is the allocation of government income
generated from either taxation or borrowings and the
government expenditure based on the approved national and
local budget.
3. PERSONAL FINANCE deals with the process of
optimizing finances by individuals such as people, families, and
single consumers.
4. BUSINESS FINANCE is an area of finance that focuses on
the handling and management of financial resources of a
business organization.
5. FINANCIAL MANAGEMENT focuses on capital
budgeting decisions or investment decisions on the acquisition
of assets and its corresponding financing scheme.
6. CAPITAL MARKET is an area of business finance that
studies the different financial institutions and their functions
that provide assistance to both private and public borrowers of
funds.
7. FINANCIAL INVESTMENTS include business decisions about the value and price of stocks and bonds,
portfolio analysis, market analysis, security analysis, and the behavior of the investors.
Finance in a Business Organization

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:

1. Setting policies on investments, capital structure, and dividend policies.

2. Approving the company’s strategies, goals and budgets.
3. Appointing and removing members of the top management including the president.
4. Determining top management’s compensation.
5. Approving the information and other disclosures reported in the financial statements (Cayanan, 2015)

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:
1. Overseeing the operations of a company and ensuring that the strategies as approved by the board are
implemented as planned.
2. Performing all areas of management: planning, organizing, staffing, directing, and controlling.
3. Representing the company in professional, social, and civic activities.
4. Carries out the decision-making for all functions

Functions of a Finance Officer

❖ The finance officer plays a crucial role in the whole business organization.
❖ He or She acts as the wary financial traffic officer to almost all business transactions with monetary
considerations.
❖ The finance officer is also expected to be the "shock absorber" of budgetary requests and requirements of
other functional units of the business.
❖ The finance officer is heavily engaged in making decisions for the business to attain its objectives at the
optimum level. His or Her decision-making function is broadly classified into three :

1. Operating Decisions
2. Investing Decisions
3. Financing Decisions
TYPES OF FINANCIAL DECISIONS EXECUTED BY CHIEF FINANCIAL OFFICERS

Operating Decisions

Deal with the daily operations of the company. The

role of the VP for Finance is to determine 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.

Investing Decisions

Deals with choosing small and large projects with

several investment opportunities.

The different projects are critically evaluated in terms

of return on investment and expected cash flows.

However, investment decisions are made only when

investment opportunities come.

Financing Decisions

Deal with raising or acquiring of funds from outside

sources and not from the ordinary results of the
business operation. In other words, financing
decisions are made when the business needs to borrow
money.

Funds that come from outside sources such as

investors, lenders, and company owners are a result of
the financing activities of the business.

It is the principal responsibility of the finance officer to

look for funds from outside sources to cover the
investing requirement of the business.
Lesson Two: Financial Institutions, Instruments and Markets

Financial management deals with decisions that are supposed to maximize the value of shareholders’
wealth, collect funds for the company at a low cost and use this collected fund for earning maximum profits
and plan and control the finance of the company to achieve the objectives of the company

The Business Environment

Refers to the sum total of all the external forces constituting individuals, and institutions that are totally
out of the business control but it does affect its performance.

Has Two Types:

Internal Environment

Refers to the environment that is in direct contact with a business organization and can directly
affect the daily activities of the business.

Elements in the Internal Environment and its Affects

Suppliers - They provide raw products and other commodities to the business to
manufacture products.
Competitors/Rival - They compete in the market with equivalent products or services.
Costumers/Consumers - They purchase products or services and referred to as the "king
of business".
The Firm itself - Is a combination of a number of elements like owners, shareholders or investors,
employees and the board of directors who are interested in profit and the stability of the business.

Factors that Affect Internal Environment

Value System consists of all those components that are a part of regulatory frameworks, such
as culture, climate, work processes, management practices and norms of the organization.

Vision, Mission, and Objectives The company’s vision describes its future position, mission
defines the company’s business and the reason for its existence, and objectives imply the
ultimate aim of the company and the ways to reach those ends.

Organizational Structure determines the way in which activities are directed in the
organization so as to reach the ultimate goal.

Corporate Culture or otherwise called organizational culture refers to the values, beliefs and
behaviour of the organization
 Human Resources s the most valuable asset of the organization, as the success or failure of an
organization highly depends on the human resources

Physical Resources and Technological Capabilities

Physical resources refers to the tangible assets of the organization that play an important role
in ascertaining the competitive capability of the company.

External Environment

Refers to the outside factors that influence the organizational performance, decision making and
strategy of all businesses.

One of the environmental layers of the macro environment is the societal environment. This
environment is made up of the following systems:
1. Political System
2. Economic System
3. Financial System
4. Socio-Cultural System
5. Technological System
6. Legal System

Financial System
 ❖ Is principally responsible for the flow of money or funds from the lender to the borrower.
❖ It controls, regulates, and facilitates the saving, borrowing, lending, and investing activities
happening among the different players in the system.

Indirect Finance is where borrowers borrow

funds from the financial market through
indirect means, such as through a financial
intermediary.

Direct finance is a method of financing

where borrowers borrow funds directly from
the financial market without using a
third-party service, such as a financial
intermediary.

Elements of Financial System

Financial Institutions are institutions or organizations that provide financial services

among others in the form of loans, credits, fund administration, financing, and safekeeping.

1. DEPOSITORY INSTITUTIONS are financial institutions that accept deposits (saving, current and time deposits) from

individuals and corporate entities, extend loans to borrowers, transfer funds, and manage funds for investment purposes.

DEPOSITORY INSTITUTIONS include the following :

A. Banks
B. Savings and Loan Association
C. Trust Companies
D. Credit Unions
 1. BANKS
are institutions authorized to operate and regulated by the Bangko Sentral ng Pilipinas (BSP) under the General Banking Law
of 2000. They accept deposits and bills payment, provide loans and facilitate the transfer of funds domestically or abroad.
Under BSP Circular No. 271, the major classifications of banks operating in the Philippines are as follows :
➢ Universal Bank

➢ Commercial Bank

➢ Thrift Bank

➢ Rural Bank

➢ Cooperative Bank

➢ Islamic Bank

I. Universal Bank

It is considered the biggest bank in terms of assets, loan portfolio, and revenue.

It has the widest scope of banking activities authorized by the BSP and usually has the most number of branches nationwide and abroad.

The minimum capital requirement of a universal bank with more than 100 branches is set by the BSP at Php 20 billion in compliance

with BASEL III requirements. The increase in the capital requirement may continue in the future as the BSP moves to strengthen the

Philippine financial system.

21 Universal Bank with Active Operation in the PH.

II. Commercial Bank

It is a type of bank that provides commercial loans and offers investment products in addition to the regular banking service of accepting deposits.

Compared to a universal bank, it has more limited banking services.

It is ranked next to universal banks in terms of assets, revenue, general loan portfolio, and the number of branches operating across the country.

The minimum capital requirement of a commercial bank is also lower compared to that of a universal bank.
III. Thrift Bank
as defined in Republic Act no. 7906. Include savings and mortgage banks, private development banks, stock and savings, loan

associations, and microfinance thrift banks that are organized under existing laws.

IV. Rural Bank and Cooperative Bank

They are intended to promote and expand the rural economy by providing the people with basic financial services.

The primary target markets of rural and cooperative banks are farmers who need financial help in the production and marketing

of agricultural products.

Rural and cooperative banks are also engaged in microfinancing to assist small individual entrepreneurs. Rural Banks and

Cooperative Banks differ from each other by ownership.

Rural Banks are privately owned and managed, while Cooperative Banks are organized and owned by cooperatives or a

federation of cooperatives.

V. Islamic Bank
Is created and organized under R.A. No. 6848 and aims to promote and accelerate the socio-economic development of the

Autonomous Region of Muslim Mindanao by performing banking, financing, and investment operations and to establish

and participate in agricultural, commercial and individual ventures based on the Islamic concept of banking.

All business dealings and activities of the Islamic Bank are subject to the basic principles and rulings of Islamic Sharia Law.
2. SAVINGS AND LOAN ASSOCIATION

Sometimes referred to as a financing and mortgage loan company, is a financial institution that is engaged in the business of

accumulating the savings of its members and stockholders, and using such accumulations for loans or investments in securities of

productive enterprises.

It is created and regulated under R.A. No. 3779 and R.A. No. 4378. The unique feature of the financing and mortgage loan is that

the depositors are also the member-borrowers of the association.

3. TRUST COMPANIES

Are a legal business entity, usually a major division of a universal or commercial bank, that acts as fiduciary agent or trustee on

behalf of an individual person or corporate entity for the purpose of management, administration, and final transfer of property to

the beneficiary.

4. CREDIT UNIONS

Is a financial depository institution that is mainly controlled and operated by its members.

They exist to help and extend financial assistance to members by pooling and accumulating funds from all the members.

The funds from the membership fee shall be made available for borrowing by the members who are in need.

FINANCIAL INTERMEDIARIES

Are type of financial institution that acts as the middle person between two parties – the investors and the

borrowers.

They raise and accumulate money from investors and offer the accumulated money to individuals or corporate entities

in need of financial assistance.

They do not have depository functions similar to banks and other institutions.

A. MUTUAL FUNDS accumulate money by selling shares of stocks or bonds of publicly listed

corporations to individuals or corporate investors. The funds accumulated from individuals or

corporate entities are used to buy stocks, bonds or other market instruments.

B. PENSION FUNDS is set up by a business for the purpose of paying the pension requirements of all

private sector employees who retire from the business organization upon reaching their retirement age.

It represents the compulsory contributions of the employer or the combined contributions of the

employer and the employees depending on the type of pension plan. This fund, under the

administration of the trustee, may be invested in financial securities like bonds, stocks, treasury shares,

or any high-yield investment. The employees who contribute to the pension fund receive return on their

investments in the form of dividends and securities appreciation.

 C. INSURANCE COMPANIES act as a financial intermediary by pooling together the proceeds of insurance

policies sold to the public and investing the accumulated funds in high-yield maturing securities from investment

houses.

INVESTMENT INSTITUTIONS

Are companies engaged in buying securities of other companies which are listed in the stock exchange for investment purposes only.

FINANCIAL MARKETS
MARKET refers to the place where the sellers and the buyers of goods or services meet.

FINANCIAL MARKET refers to the place where the selling-buying activity occurs to trade equity securities such as bonds

and stocks, currencies, derivative securities, notes, and mortgages. The selling-buying transaction happening in the

financial market is called trading activity.

The typical financial market, among others, includes the following:

➢ Capital Market
➢ Money Market
➢ Primary Market
➢ Secondary Market
➢ Public market

1. CAPITAL MARKET is a financial market where stocks and bonds are issued for medium and long-term

periods. In the Philippines, the capital market is the Philippine Stock Exchange (PSE).

2. MONEY MARKET is a financial market where the financial securities being traded have a period of less

than one year. PSE is both a capital market and money market.

3. PRIMARY MARKET is a financial market where a corporation can issue new shares of stock.

4. SECONDARY MARKET is a financial market where financial securities are traded between or among

investors. In the secondary market, there is no issuance of new shares from the corporation.
 5. PUBLIC MARKET is a market which the financial securities of publicly-listed corporation are traded

following a standardized contract agreement and procedures. A corporation is classified as publicly-listed when its

shares are available for sale in the public.

Financial instruments
Refer to contracts that give rise to the formation of financial assets of one entity and at the same time
the creation of a financial liability or an equity instrument in another entity.

➢ Cash
➢ Check
➢ Loan
➢ Bond
➢ Stock

1. CASH On the part of the holder, cash is a financial asset. However, on the part of the government such as
the Bangko Sentral ng Pilipinas, cash is a financial liability.
2. CHECK It is a financial asset of the payee, but is considered a financial liability of the drawer or issuer.
3. LOAN It is a financial asset of the lender or creditor and a financial liability of the borrower or the debtor.
4. BOND It is a financial asset of the holder or investor but is considered a financial liability of the issuing
company. A BOND is a financial instrument that represents a contractual debt of the party issuing the bond.

This type of financial instrument is evidenced by a certificate called bond indenture.

Usually, the issuer makes a promise under oath to pay the specified amount borrowed at a determinable future
time with a periodic interest payment at a stated rate until such time that the whole amount borrowed is fully
settled.

The holder of the bond, therefore, earns income through interest.

Most Common Types of Bond

a. TERM BOND – It is a bond that has a single maturity date.

For example, a corporation has been authorized to issue a Php 10 million term bond on October 1, 2020
which will mature on October 1, 2030. Investors who acquire the bond on different dates after October 1,
2020 will have the same payment date which is October 1, 2030.

b SERIAL BOND - It is a kind of bond that has a series of several maturity dates instead of a single
maturity date.
 For example, a 10-year serial bond issued on October 1, 2020 may have a series of maturity dates every two
years from the date of issuance. When the bond is serial, a portion of the total debt obligations is paid out or
settled every maturity date. The total bond obligations, therefore, are reduced gradually as time passes by.

c. SECURED BOND - It is a type of bond that is secured by the issuing company. The security is
issued in the form of real property which serves as collateral in the event of default on the part of the bond
issuer.

d. DEBENTURE BOND - A bond is considered a DEBENTURE BOND when it is not supported by

any collateral or se.

e. CONVERTIBLE BOND – It is a bond that can be converted into a share of stock at a later date.

f CALLABLE BOND – The bond is CALLABLE when the issuing company has the option to redeem
the bond prior to its maturity date.

5. STOCKS

Are a financial security that signifies the ownership of the assets of the corporation.
Only stock corporations are authorized by the Securities and Exchange Commission (SEC) to issue
stocks, hence, sole proprietorships and partnerships can never issue shares of stock.

The holders of the shares of stock as evidenced by the stock certificate are called stockholders or
shareholders.

The shareholder has a claim on the net assets of the business as owners of the corporation.

Two Kinds of Stocks

The COMMON STOCK or ordinary share is a financial instrument whose holders do not have
preference over each other.
The COMMON STOCKHOLDERS have the same rights and privileges in terms of dividend or asset
distribution as other stockholders.

A COMMON STOCK is a voting stock. One share of stock corresponds to one vote.
The rights of the common stockholders include the right to vote during the election of the board of
directors, and the right to subscribe for additional shares to be issued.

PREFERRED STOCK is a kind of stock that is

preferred over common stock. These preferences are in
terms of the following:

a) distribution of earnings or dividend distribution

b) net assets at the time of liquidation.

The preference on the distribution of profit means that preferred stockholders are paid first of the
dividends accruing to them. It indicates that ordinary shareholders can only share the dividends once
all the dividend claims of the preferred shareholders are fully settled.

LENDERS AND BORROWERS

Borrowers are any agents who have investment opportunities, but who lack the cash to get
those projects started.

Lenders on the other hand are people who have surplus cash and are looking for an
opportunity to earn interest. They are looking for an opportunity to earn a rate of return on
their money, but they don’t have projects that they would like to do themselves.