BUSINESS FINANCE

Jay-Ar C. Dimaculangan
Chapter 1
FINANCIAL MANAGEMENT
 Learning Objectives
• Have an appreciation of what the overall objective of management
should be
• Present an overview of the financial system and discuss the different
functions of the financial intermediaries
• Distinguish a financial institution from a financial instrument and
financial markets
• Compare and contrast the different financial instruments
• Explain the major functions of key management positions in a typical
organization, highlighting the crucial role of the finance manager
“ Beware of little expenses.
A small leak will sink a great ship “

– Benjamin Franklin
 FINANCIAL MANAGEMET

• Financial management starts with a plan

• “ It is a must!”
• From the perspective of the corporation,
financial management deals with decisions
that supposed to maximize the value of
shareholders’ wealth
• This means maximizing the market value of
the shares of stocks
 FINANCIAL MANAGEMET

“ Every decision has a consequence”

 FINANCIAL MANAGEMET

• To illustrate:

Globe Telecom Inc. shares closed at 2,200 on April 25, 2016. As of

the date, Globe’s total shares outstanding was 132, 742, 402. The
market value is more than P292 billion

• This amount represents the value of the shareholder’s wealth.

• As the shares are actively traded in PSE, the price of the stock
and the total market value of the shares may change every
trading day
 FINANCIAL MANAGEMET
The changes in the price of a stock can be a confluence of many
factors:
• profitable operation
• nature of the business
• prospects of the business
• projected earnings and timeframe
• ability to meet maturing obligations
• Appropriate capital structure
• Dividend policies
• Investing decisions
• management and market sentiment
 FINANCIAL MANAGEMET

• While profits significantly affect the price of

a stock, finance literature states that
PROFIT MAXIMIZATION should not be the
overriding objective of company’s
management, but shareholders
maximization.
 Shareholders’ Wealth Maximization

• Maximizing shareholders’ wealth through

maximization of stock price should be the
overriding objective of management
• it covers the different facets of operating a
company and it considers the different
stakeholders in the organization
 Stakeholders of an organization

• Stockholders
• Management
• Employees
• Suppliers
• Customers
• Creditors
• Regulatory agencies
• Community

For a longer and more sustainable operations, the interest of these different
stakeholders has to be borne in mind.
 Reasons why PM should not be the overriding
objective of a company

• Company may need to borrow more just to increase

sales or augment production capacity. However, too
much borrowing may expose the business to risk
• Too much focus on profits may force management
to consider inferior materials for production
• Management may also defer important repairs and
maintenance just to show better profits in the
current accounting period
 Stakeholders of an organization

• Stockholders
– The stockholders have to be happy with their investments
in the company so that they will be encouraged to invest
more. More investments means more jobs can be created
 Stakeholders of an organization

• Top Management

– Maximizing shareholders’ wealth motivates members of the top management to

develop longer perspective for the company that they manage.
– With this objective in mind, management will try to make their customers happy
by providing good products and services at reasonable prices
– To achieve this, management may have to innovate, invest in technology, and be
more efficient in their production and operation
– Management may also need to consider setting aside a certain percentage of
income to research and development to further improve, and possibly, expand the
company’s existing product and service offerings
 Stakeholders of an organization

• Employees
– Happy employees means more productive employees
– If employees are happy in the workplace and they have a
sense of belonging in the company, they will protect the
interest of the company
– Unhappy employees can damage the reputation of the
company, or they may do something that will taint the image
of the company
 Stakeholders of an organization

• Suppliers and Creditors

– Paying suppliers and creditors on time is a good business
practice that will improve relationships with these parties
– it is important that management takes care of suppliers to
ensure good quality of materials at reasonable prices
– Good relationships with creditors enhance the probability of
getting credit facilities especially during times of
emergencies
 Stakeholders of an organization

• Regulatory Agencies
– Compliance ensures smoother operations.
– Non compliance may result in suspension of operations or
unnecessary penalties
– Disruption in operations as a result of non-compliance with
regulatory requirements may also taint the image of the
company which may have adverse effects not just on the
operations but also on the cost of financing as well
 Stakeholders of an organization

• Community
– Supporting the community where the company operates, in whatever
capacity it can, increases the company’s chances of continuous
operations in the area
– Hiring employees from the community promotes employees’ support
for the company
– CORPORATE SOCIAL RESPONSIBILITY FOR THE COMMUNITY
 Self Test Questions

1. What should be the most important goal of a

company? Why?
2. Why is profit maximization supposedly not the most
important goal of a company?
3. What are the different factors that can influence the
price of a stock? Explain each briefly.
 FINANCIAL SYSTEM
The financial system links the savers and the users of funds
Savers Financial Intermediaries
• Households • Banks
• Individuals • Insurance Companies
• Corporations/Companies • Stock Exchange
• Government Agencies • Stock Brokerage
• Mutual Funds
• Other Financial Institutions
Users of Funds
(Borrowers/Investors)
• Households
• Individuals
• Corporations/Companies
• Government Agencies
 Financial System

• Savings can come from households, individuals, companies,

government agencies, or any other entity whose cash inflows
are greater than their cash outflows

• Some of the financial instruments issued by users of funds such

as the shares of stocks and corporate bonds of publicly listed
companies and debt securities issued by the National
Government can be traded
 Financial System
• The FINANCIAL MARKET provides a system for the trading of these securities.
The Philippine Stock Exchange (PSE) offers facilities for the trading of shares
of publicly listed companies

• A company can become publicly listed through an initial public offering (IPO)
where shares will be offered to may investors. The offering of the shares will
be coursed through an investment bank which will underwrite the offering of
the shares

• Corporate bonds and government debt securities can be traded through the
Philippine Dealing and Exchange Corp (Pdex)
 BANKS
• Banks provide a mechanism where savers can put their excess funds through
deposits
• Banks give the depositors interest on the money deposited to them
• To cover the interest given to depositors, banks lend the money to borrowers
after performing a credit investigation
• Some of the deposits can also be invested in some financial instruments like
government securities and government bonds
• Banks can also serve as conduits of investors in buying and selling both
government securities and corporate bonds
• They are regulated by BSP because they take deposits, and there is public
interest involved
 INSURANCE COMPANIES
• Offer life insurance products and non-life insurance products
• Life insurance products protect the insured from loss of life
• Non-life insurance products protect the insured from the loss of or
damage of properties
• In exchange for the protection, the insured pays premiums to the
insurance companies.
• The premiums are used to fund claims
• Generally, the cash collected from the premiums may cover more than
claims for most periods. Hence the excess cash can be invested
• They are regulated by the INSURANCE COMMISSION
 STOCK EXCHANGE

• The PSE provides a system for the trading of equity securities of

publicly listed companies
• These equity securities are common stocks and preferred
stocks
• An individual who wants to invest and trade in the stock market
cannot go directly to PSE to buy and sell stocks
• He has to open an account with an accredited stock brokerage
firm where he can channel his buy and sell orders of equity
securities
 STOCK BROKERAGE FIRMS
• Investing in stock market has to be coursed through stock brokerage firms.
• There are online brokers and live brokers
• With online brokers, one can trade in the stock market through the internet
• COL financial and BPI Trade are two of the online brokers in the Philippines
• To trade online, one must have an account and deposit with the online broker
• With live brokers, one needs a telephone to call brokers and place orders
• Settlement of the transaction can be arranged with the broker.
• Liver brokers normally have their messengers who deliver confirmation receipts as
well as collect and deliver checks
• Confirmation receipts are forms of evidence regarding the executed buy or sell
transaction that a client placed with the broker
 MUTUAL FUNDS
• Mutual funds provide opportunities for big and small investors to invest in
financial instruments which they would not have considered on their own, or
they may have considered but do not have the time or the expertise to do it
• These include investments in the stock market, bonds, treasury notes, and the
other money market instruments like treasury bills
• With mutual funds, investments are pooled and the funds are invested by
professional fund managers for a fee. The fees are a small percentage of the
funds invested
• Mutual funds cater two investment objectives: limited only to stocks and
restricted to fixed income instruments like bonds and treasury notes
• Others provide a combination of both stocks and fixed income instruments
 MUTUAL FUNDS

• It must be noted that when one invests in a mutual fund, he

becomes a part owner of that fund.
• To invest in mutual funds, he has to buy shares of the mutual
funds and the buying price depends on the net asset value
(NAV) of that fund when the purchase is made
• Note that the NAV of a mutual fund changes everyday as the
value of the financial instruments where the funds are invested
also changes
 MUTUAL FUNDS

• As of January 31, 2016, the top mutual funds in the Philippines

are :

• Philam Strategic Growth Fund, Inc.

• ALM Growth Fund
• PAMI Equity Index Fund, Inc.
• Sun Life Prosperity Philippine Stock Index Fund, Inc.
• United Fund , Inc.
 MUTUAL FUNDS

• Because NAV changes, an investor in mutual fund can also lose

as the NAV can fall below the NAV when the investment was
made

• However, because the fund is managed by professionals,

positive returns are expected overtime.

• How much one gains from investing mutual funds may also
depend on the investment horizon of the investor
 OTHER FINANCIAL INSTITUTIONS

• Other financial institutions include pension funds like GSIS, SSS,

Investment Banks, Credit Unions, among others
 FINANCIAL INSTRUMENTS

• Financial Instruments are generally classified into two major

categories: EQUITY SECURITIES AND DEBT SECURITIES
• Equity securities include common stocks and preferred stocks
• Debt securities include treasury notes, bonds, commercial
papers, others
 Common Stocks Vs. Preferred Stocks
• Preferred stock has priority over a common stock in terms of claims
over the assets of the company
• This means that if a company is 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
• Preferred stockholders also have priority over common
stockholders in cash dividend declaration. No cash dividends will be
given to common stockholders unless all the dividends due to
preferred stockholders are paid first
 Common Stocks Vs. Preferred Stocks

• If the preferred stockholders have preference over common

stockholders in terms of claims over the assets of the company
and in cash dividend declaration, why would an investor be
willing to become a common stockholder???
 Common Stocks Vs. Preferred Stocks

• Common stockholders are the real owners of the company

• Being residual owners, the growth potential of their
investments is unlimited
• If an investor has identified a good common stock, its value can
multiply over time
 Common Stocks Vs. Preferred Stocks

Case:
At the height of the global financial crisis in 2008 and 2009,
many fundamentally sound stocks went down. One of the was
Universal Robina Corporation (URC) which went down to P5.00
after hitting the high of around P26.50 during that period. As of
August 26, 2014, URS closed at P 163.50. If one had bought the
stock in 2009 even at P10, the investment would have multiplied
16 times.
 Common Stocks Vs. Preferred Stocks

Case:
One could have bought Jollibee Food Corporation stock at
P40.00 on January 2009. As of August 16, 2015, the stock closed at
P192.50.
One could have bought PLDT at P2,100 in the first quarter of
2009. As of August 26, 2014, the stock closed at P3,390.
 Common Stocks Vs. Preferred Stocks
• Unlike preferred stocks, the dividend per share for common stocks is not
fixed
• A common stock investor can received more cash dividends during period of
unusual profitability
• But during periods of unprofitable operations, both preferred stockholders
and common stockholders may not received dividends
• The company is not obligated to pay dividends if it is not in a position to do
so
• For cumulative preferred stockholders, however, unpaid dividdns can
accumulate and no cash dividends wil lbe paid to common stockholders
unless all the dividends in arrears for preferred stockholders are paid
 Common Stocks Vs. Preferred Stocks

• Being the residual owners of the company, common

stockholders have voting rights, a privilege generally not
available to preferred stockholders.
• This means that if one has enough common shares in a
company, he can nominate a director in the board of directors.
• If this happens, then he can influence the major decisions
made by a company as such major decisions are approved by
the board
 DEBT SECURITIES
• The Treasury Bonds and Treasury Bills issued by the National
Treasury are forms of indebtedness of the National Government
• Treasury bills are in the tenors of 91 days, 182 days, and 360 days
are auctioned at the National Treasury every Monday to accredited
dealers
• Treasury bonds are long-term securities. Occasionally, the National
Treasury also issues retail Treasury bonds. A small investor can
participate in these retail treasury bonds. These are normally in
multiples of P5,000. Coupon interest on these is paid quarterly. For
treasury bonds, coupon interest is paid semi-annually.
 CORPORATE BONDS
• Some publicly listed companies have also started issuing corporate bonds. The
tenors are usually 5 years, 7 years, and 10 years. GT capita, the holding company
which is the biggest stockholder of Metrobank, has just finalized the interest rates
on its corporate bond issue which covers those three tenors.
• PLDT and Meralco are the other big publicly listed companies which issued
corporate bonds recently. Corporate bonds offer slightly higher interest rates than
government securities
• Interest on investment in debt securities is subject to 20% final tax. For bank
deposits with tenors of at least 5 years. Tax rate is zero percent
• In terms of claims over the assets of a company, bondholders have preference
over preferred stocks and common stocks. Also, interest due to them, just like
bank creditors, has to be paid first before dividends are given to preferred and
common stockholders.
 SELF-TEST QUESTIONS
1. Explain why the same company can be a saver and a user of funds
2. What is the role of financial intermediaries in the financial system?
3. What is the role or function of the PSE?
4. What are the differences between Philippine Stock Exchange and
the stock brokerage firms ?
5. Explain t he role of the banks in the financial system
6. Explain the differences among common stocks, preferred stocks,
and debt securities
7. Go to the PSE website (www.pse.com.ph) and look for the
historical prices of the following stocks for the last 30 trading days:
 SELF-TEST QUESTIONS
a.) PLDT (stock code is TEL)
b.) Globe Telecom (GLO)
c.) Jollibee ( JFC)
d.) San Miguel Corporation (SMC)
e. Aboitiz Power (AP)

Based on the data that you have gathered, make an observation of the price movements
of each stock. Which of the five stocks is more volatile in terms of price movements?

8. Given you have excess funds, where will you invest the funds? Why? Your choices are
time deposits, corporate bonds, and stocks. Consider risk return trade off in your
investment decision
 ORGANIZATIONAL CHART AND THE
ROLES OF THE VP FOR FINANCE
Board of Directors

President

VP for Sales and

VP for Finance VP for Production VP for Administration
Marketing
 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 members of the boars who are called the “directors”
are elected by the stockholders
• The ability to elect a director in the board is contingent on
the amount of shares owned and the number of directors in
the board
 Board of Directors

• If a stockholder owns 10% of the voting shares of the

company, then this stockholder can elect one director in the
board. This is the reason why some investors want to own
the majority shares of a company if they want control over
that company
• Owning majority of the shares of the company means
having the right to elect majority of the directors in the
board
 Responsibilities of the
Board of Directors
• Setting policies on investments, capital structure, and
dividends
• 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
• Overseeing the operations of a company and ensuring that
the strategies as approved by the board are implemented as
planned
• Performing all areas/functions of management: planning,
organizing, staffing, directing, and controlling
• Representing the company in professional, social, and civic
activities
 PRESIDENT

• The president cannot manage the company on his own,

especially when the corporation has become to big. To assist
him are the vice presidents of different functional areas:
finance, sales and marketing, production, administration.
 VP for Sales and
Marketing
• Formulating marketing strategies and plans
• Directing and coordinating marketing 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
to identify new marketing opportunities, for example, variants
of existing products/services already offered in the market
• Promoting good relationships with customers and distributors
 VP for Production
• Ensuring production meets customer demands
• Identifying production technology/process that minimizes
production cost and makes the company cost competitive
• Coming up with a production plan that maximizes the
utilization of the company’s production facilities
• Identifying adequate and competitively priced raw material
suppliers
 VP for Administration
• Coordinating the functions of administration, finance, and
sales and marketing departments
• Assisting other departments in hiring employees
• Providing assistance in payroll preparation
• 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
 VP for Finance

• Financing
• Investing
• Operating
• Dividend Policies
 Financing Decisions

• They include making decisions as to how to finance long

terms investments and working capital which deals with the
day to day operations of the company
• The VP for Finance is also responsible for determining the
appropriate capital structure of the company, that is, how
much of the total assets should be financed by debt and
equity
• It is crucial because the company can get bankrupt because
of too much debt
 Financing Decisions

• Capital structure decisions vary from one company to

another. It is affected by the stability of cash flows, extent of
fixed operating expenses, and variable expenses.
 Investing Decision
• To minimize the probability of failure, long-term
investments have to be supported by a capital budgeting
analysis which is among the responsibilities of a finance
manager
• Capital budgeting analysis is a technique used to determine
the financial viability of a long term investment. This
requires forecasting the cost of investment and the streams
of cash flows expected to be generated from the
investment.
 Investing Decision
• This function of a finance manager is crucial. Many
companies which suffered financial distress went through an
aggressive expansion heavily financed by debt.
 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. Should the company finance these two
accounts substantially by short term sources of financing or
through long term sources of financing
 Operating Decisions
• The decision regarding the financing of these working
capital accounts depends on the appetite of top
management for risk. If the company is more aggressive,
then these accounts receivable and inventories can be
substantially financed by short term sources.
• Basically, short term sources of funds are cheaper. Interest
on short term loans is generally lower than the interest on
long term loans. Hence, using short terms loans can boost
the profitability of a company
 Operating Decisions
• While financing through short term sources of financing
may minimize the financing cost of the company, this
however, has a trade off. Financing working capital accounts
mostly through short terms sources may expose the
company to a liquidity problem where obligations are
already due but the company does not have sufficient cash
to pay for the obligations
• A more conservative management will opt to finance
working capital accounts mostly through long term sources
 Dividend Policies
• Some investors buy stocks because of the dividends
they expect to receive from the company.
• Non declaration of dividends may disappoint them
• Two conditions must exist before a company can
declare cash dividends : 1.) the company must have
enough retained earnings to support cash dividend
declaration. ; 2.) The company must have cash
 Dividend Policies
• How much cash dividends a company declares is
within the purview of the VP for Finance. Some of the
factors considered in declaring cash dividends are:
– Availability of investment opportunities.
– Access to long term sources of funds
– Capital Structure
 Self Test Questions
1. Give at least 3 important reasons why the board of
directors is the highest policy making body in a
corporation. Explain.
2. How is a director elected in the board of directors?
3. Identify the four important roles of a finance
manager and explain each function briefly.