CHAPTER THREE:

FINANCIAL ENVIRONMENT

LEGAL FORMS OF BUSINESS ORGANIZATION,

FINANCIAL MARKETS AND FINANCIAL
INSTITUTIONS
 The organization of the busine
ss firm
The business firm is an e
ntity designed to organize r
aw materials, labor, and mac
hines with the goal of produ
cing goods and services.
LEGAL FORMS OF
BUSINESS ORGANI
ZATION
 A. SOLE PROPRIETORSHIP
• A sole proprietorship is a business owned by a single
person who has a complete control over business
decisions.
• From a legal Point of view, the owner of a
proprietorship is not separable from the business and is
personally liable for all debts of the business. From an
accounting perspective, however, the business is an
entity separate from the owner (proprietor).
• The business itself does not pay any income taxes. The
income or loss of the business is reported on the
owner’s personal income tax return on a supporting
schedule.
ADVANTAGES OF A SOLE PROPRIETO
RSHIP
1. Ease of entry and exit
2. Full ownership and control
3. Tax savings
4. Few government regulation

MAJOR DISADVANTAGES OF THE PROPRIETO

RSHIP:
5. Unlimited liability
6. Limitations in raising capital
7. Capital on continuity
 B. PARTNERSHIP
A partnership is a legal management in which two or more
persons agree to contribute capital or services of the
business and divide the profits or losses that may be
derived therefrom.

Partnership may be either general or limited.

• A general partnership is one in which each partner has
unlimited liability for the debts incurred by the business.
• A limited partnership is one containing one or more
general partners and one or more limited partners. The
personal liability of limited partners is limited to their
investment. Limited partners cannot be active in
management.
 ADVANTAGES OF A PARTNERSHIP:
1.Ease of formation
2.Additional sources of capital
3.Management Base
4.Tax implication

DISADVANTAGES OF A PARTNERSHIP:
5. Unlimited liability
6.Lack of continuity
7.Difficulty of transferring ownership
8.Limitations in raising capital
 C. CORPORATION
A Corporation is an artificial be
ing created by law and is a legal
entity separate and distinct from
its owners. This legal entity may
own assets, borrow money and enga
ge in other business.
The incorporation process is initiated by killing the ar
ticles of incorporation and other requirements with the S
ecurities and Exchange Commission (SEC). The artic
les of incorporation among others includes among other
s the following:

• Incorporators
• Name of the corporation
• Purpose of the corporation
• Capital stock/Ordinary Shares
• Authorized Shares
After the corporation is
legally formed, it will then
issue its capital stock or
ordinary equity. Ownership of
this stock is evidenced by a
stock certificate. The
corporate bylaws are the rules
that governs the internal
management of the company.
 ADVANTAGES OF A CORPORATION:
1. Limited Liability
2. Unlimited life
3. Ease in transferring ownership
4. Ability to raise capital

DISADVANTAGES OF A CORPORATION:
5. Time and cost of formation
6. Regulation
7. Taxes
FINANCIAL MARKE
TS
AND
FINANCIAL INSTITU
TIONS
 FINANCIAL MARKETS

Financial Market are the meeting pla

ce for people, corporation and insti
tutions that either need money or ha
ve money to lend or invest. Particip
ants in the financial markets also i
nclude national, states, and local g
overnment that are primarily borrowe
rs of funds for highways, education
welfare and other public activities;
their markets are referred to as pub
lic financial markets. Large corpora
tion raise funds in the corporate fi
nancial markets.
The following markets are the most interest to the financial man
ager.
Financial market functions as the both primary and secondary m
arkets for debts and equity securities.

• Primary Market
Primary market refers to original sale of securities by gove
rnments and corporations. Corporations engage in two typ
es of primary markets transactions, public offerings and
private placements. Private offering involves selling sec
urities to the general public whereas a private placement is
a negotiated sale involving a specific buyer.
• Secondary Market
After the securities are sold to the public (institutions a
nd individuals) they can be traded in the secondary ma
rket between investors. Secondary market is popularly
known as Stock Market or Exchange.

There are two broad segment of the stock market:

1. The Organized Stock Exchange.
The stock exchanges will have a physical location whe
re stocks buying and selling transactions take place in
the stock exchange floor (e.g. Philippine Stock Exchan
ge, Shanghai Components, etc.)
2. The Over-the-Counter (OTC) Exc
hange.
Where shares, bonds and money market i
nstruments are traded using a system o
f computer science and telephones.

Stock Exchange
Stock Exchange is an organized seconda
ry market where securities like shares
, debentures of public companies, gove
rnment securities and bonds issued by
municipalites, public corporation, uti
lity undertakings, port trust and such
other local authorities are purchased
and sold. In order to bring liquidity
Structure & Functions of the Financial Market
s

Types of Markets:
1.Physical Asset Markets versus Financial
Asset Markets
Physical asset markets (also called tangible and
real asset markets) are for products such as whe
at, autos, real state, computers, and machinery.
Financial asset markets also deal with derivativ
e securities whose values are derived from chang
es in the prices of the assets.
2.Spot Market versus Future Markets.
Spot markets are markets in which assets are bro
ught or sold for “on-the-spot” delivery. Future
markets are markets in which participants agree
today to buy or sell an asset at some future dat
e.
3. Money Markets versus Capital Mar
kets.
Money markets are financial markets in w
hich funds are borrowed or loaned for sh
ort periods (less than one year). Capita
l markets are financial markets for stoc
ks and for intermediate or long term deb
t (one year or longer).
4. Primary markets versus Secondary
markets.
Primary markets are the markets in which
corporations raise capital by issuing ne
w securities and other financial assets
are traded among investors after they ha
ve been issued by corporations.
5. Private markets versus
Public markets.
Private markets are markets
in which transactions are wo
rked out directly between tw
o parties. Public markets ar
e markets in standardized co
ntacts are traded on organiz
ed exchanges.
 FINANCIAL INSTITUTIONS
Financial Institutions are very
important critical to the function of
a capital society. Capitalism
requires the flow of capital from
those with excess funds to those with
good uses for it. Money is a scarce
resource and it must be able to flow
to the best ideas and projects in
order to maximize the benefit to the
economy and to society. Financial
institutions and markets make this
happen.
Categories of Financial Institutions:
1.Investment Banks. Organizations
2. Commercial Banks. The traditional dep
artment store of finance serving a variety
of savers and borrowers. (Example are BDO,
BPI, RCBC)
3. Financial Services Corporation. A firm
that offers a wide range of financial servi
ces, including investment banking, brokerag
e operators, insurance and commercial banki
ng.
4. Credit Unions. Cooperate associaties w
hose members are supposed to have a common
bond, such as being employees of the same f
irm. Credit unions are often the deepest so
urce of funds available to individuals borr
owers.
5. Pension Funds. Organization that hand
le retirement plans funded by corporation
or government agencies for their workers.
6. Life Insurance Companies. Companies
whose brings in the form of annual premium
s invest these funds in stocks, bonds, rea
l state and mortgage and make payments to
the beneficiaries of the insured parties.
7. Mutual Funds. Organizations that pool
investors to purchase financial instrument
s and thus reduce risk through diversifica
tion.
8. Exchange Trade Funds (ETF). ETF buy
portfolio of stocks of a certain type and
then sell their own shares to the public.
9. Hedge Funds. Similar to mutual funds
because they accept money and use funds t
o buy various securities.
10. Private Equity Companies. Organiza
tions that operate much like hedge funds,
but rather than purchasing some of the wo
rk of firm, private equity players buy an
d then manage their entire firms.