BUSINESS FINANCE (WEEK 1)

INTRODUCTION TO FINANCIAL MANAGEMENT Functions of Business Finance

Business finance is both the art and science of
BUSINESS managing the financial resources of an
● A business is an entity in which the skills, organization. It is concerned with the functions of
energy, and enterprise of owners and allocating the financial resources of the company,
partners are linked with money, its procurement of funds needed, and the efficient and
sources, and investment, and its effective utilization of funds.
success is measured by the wealth, or
profit the business gets. To be successful in FINANCIAL MANAGEMENT
the business finance function, Ernest Jones ● The handling of all financial matters,
(1994) identified the following elements: including analysis of financial statements,
○ First, the business entity must the evaluation of prospects before
obtain money from the right sources investment is actually started and the
and invest it in the right places; raising of capital or funds from various
○ Second, it must continue to attain its sources.
purpose of gaining profit; ● Finance, as an academic discipline, has its
○ Third, cash must be available when roots in accounting and economics. The
it is needed, and its availability can finance course emphasizes the analysis of
be crucial in some decision-making financial statements and legal, managerial,
situations. and marketing topics.

FINANCE Financial Management VS Accounting

● Finance is needed to establish a business
Financial Accounting
to run it, to modernize it, to expand or Management
diversify. It is required for buying of
assets. It is helpful to managers and Manages assets and The art of recording
potential managers to make sensible liabilities of the firm and reporting past
investment and financing decisions. financial transactions

It helps to decide on It gives the financial

BUSINESS FINANCE future projects and position of the business
● Business finance involves the management manage the assets
of financial resources available to the
organization. To operate, a business needs Majorly management of Management,
the company and shareholders,
a variety of assets- tangible and intangible,
shareholders regulators, analysts,
including plant, equipment, motor vehicles, creditors
technical expertise, patents, trademarks,
and tradenames.
The Role of Financial Managers
A financial manager is a qualified person who
Areas of Business Finance
does have a lot of experience in handling all the
1. Corporate Finance - deals with the
important financial functions of an organization.
management of companies
He or she should maintain far sightedness in
2. Financial Institutions and Markets
order to ensure that the funds are utilized in the
3. Investments - deciding for the best portfolio
most efficient manner.
of assets

Main Functions of a Financial Manager

Major Financial Decisions for the Business
1. Raising of Funds
● Financing decisions involve generating
2. Allocation of Funds
funds internally or from external sources.
3. Profit Planning
Funds may be generated externally from
4. Understanding Capital Market
borrowing and by issuing debt or equity
securities.
Major Types Decisions made by Financial
● Investment decisions determine the real
Managers
assets that a business has. These assets
1. Investment Decisions
generate the cash flows that are needed to
● The investment decisions are those
meet operating expenses, pay interest to
which determine how scarce or
creditors, taxes to the government and
limited resources in terms of
dividends to stockholders.
 funds of the business firms are
committed to projects.
2. Financing Decisions
● Financing decisions assert that the
mix of debt and equity chosen to
finance investments should
maximize the value of investments
made. These decisions should
consider the cost of finance
available in different forms and the
risks attached to it.
Various Financial Institutions and their Services
3. Operating Decisions
The major categories of financial institutions include
● The third responsibility area of the
central banks, commercial banks, credit
finance manager concerns working
cooperatives, savings and loans associations,
capital management. The term
investment companies, brokerage firms, insurance
working capital refers to a firm
companies and mortgage companies.
short-term asset (i.e., inventory,
receivables, cash, and short-term
Central Bank
loans.) managing the firm’s working
● A central bank is the financial institution
capital is a day-to-day responsibility
responsible for the oversight and
that ensures that the firm has
management of all other banks. In the
sufficient resources to continue its
Philippines, the central bank is the Bangko
operations and avoids costly
Sentral Ng Pilipinas (BSP).
interruptions.
4. Returns of Capital Decisions
Commercial Banks
● The return of capital policies and
● Commercial banks work directly with
retention of profits will have ultimate
businesses. The majority of large banks
effect on the form’s wealth. The
offer deposit accounts, lending and financial
business firm should retain its profits
advice to any business in different
in the form of appropriations or
industries.
reserves for financing its future
growth and expansion schemes.
Credit Cooperatives
● Credit cooperatives are not-for-profit
FINANCIAL INSTITUTIONS
financial institutions that exist to serve its
● Financial institutions are the ones that
members. Credit cooperatives provide
facilitate the transfer of resources
products and services to people who share
among those investors who are involved
something in common, such as where they
in buying and selling of financial
work or live, or even their nationality
instruments.

Savings and Loan Associations

The Role of Financial Institution in the Money
● Savings and loan associations are financial
Flow
institutions that are mutually held and
For every growing economy, the position of a
provide no more than 20% of total
financial institution is always important. This begins
lending to businesses.
with the flow of money to the person who has
deposited in the bank. It begins with the flow of
Investment Banks and Companies
money with the individual who deposits it in the
● Investment banks help individuals,
bank.
businesses and governments by raising
capital through the issuance of securities
Key Individual Roles
instead of accepting deposits.
● Depositor (has the funds) is the person
who has the money and deposits it in a
Insurance Companies
savings account.
● Insurance companies are financial
● Borrower (who needs the funds) is the one
institutions that help individuals to
who needs the funds and borrows the funds
transfer risk of loss.
through a bank. He needs the fund to start a
business project or venture.
Mortgage Companies
 ● Mortgage companies are financial popular choice for investors who want to
institutions that provide funds through receive a steady income stream upon
loans subject to the availability of retirement.
property used as collaterals.
FINANCIAL MARKETS
Basic Types of Financial Instruments ● Financial markets are the mechanisms
1. Savings Accounts used to trade the financial instruments.
● Savings accounts are a safe haven to There are many different financial markets
store emergency funds. It provides easy in a developing economy.
access to extra money and is generally ● Financial Market functions as both primary
insured with Philippine Deposit Insurance and secondary markets for debt and
Company for a maximum amount of P500, equity securities.
000.00. a. Primary Market refers to the original
2. Money Market Funds sale of securities by governments
● Money market funds are relatively and corporations.
conservative and low-risk instruments b. Secondary Market After the
invested in highly marketable and securities are sold to the public
“near-cash”. (institutions and individuals) they can
3. Stocks be traded in the secondary market
● The stock market gives the opportunity to between investors.
buy shares of companies under normal
circumstances. Two broad segments of the stock markets
4. Bonds The Organized Stock Exchange
● A bond is a debt security wherein ● The stock exchanges will have a physical
someone is borrowing money and there’s location where stock buying and selling
another one lending it. As a security, it transactions take place in the stock
means the borrower is under a legal exchange floor.
obligation to pay the lender. The Over-the-Counter (OTC) Exchange
● In the Philippines, there are two basic types ● Where shares, bonds, and money market
of bonds: government bonds and instruments are traded using a system of
corporate bonds. computer screens and telephones.
a. Government bonds are also called
retail treasury bonds, treasury Stock Exchange
notes, T- bills, and many others. Stock exchange is an organized secondary
When investing in government market where securities like shares, debentures
bonds, it means that the investors of public companies, government securities and
are lending money to the bonds issued by municipalities, public corporations,
government. utility undertakings, port trusts and such other local
b. Corporate bonds are sometimes authorities are purchased and sold. In order to
called long-term commercial bring liquidity, the stocks are traded
papers. Investing in corporate systematically in a stock exchange.
bonds, it means that the investors
are lending money to a STRUCTURE AND FUNCTIONS OF THE
corporation. FINANCIAL MARKETS
5. Mutual Funds
Physical Asset Financial Asset
● A mutual fund is generally a pool of money Markets Market
from a group of investors entrusted to a
financial institution for investment purposes. Physical asset markets Financial asset
The fund is usually professionally (also called tangible or markets, on the other
managed by a mutual fund manager for real asset markets) hand, deal with stocks,
investments in securities, like, shares, of are for products such bonds, notes and
stock, bonds, and money market as wheat, autos, real mortgages.
instruments. estate, computers and
6. Annuities machinery.
● An annuity is an insurance product that
pays out income on a predetermined Spot Markets Future Markets
amount during the lifetime or upon its Spot markets are Future markets are
maturity. It is being used as part of a financial markets in markets in which
retirement strategy. Annuities are a which assets are both participants agree to
 business. If the corporate financial planning
and sold for buy or sell an asset at
“on-the-spot” some future date. process is done correctly, the plan will show
delivery. your liquid assets at any point in time. That
way, you will always know if your business
Money Markets Capital Markets is financially sound or if action is required.
● Think of the financial planning process as
Money markets are Capital markets are
financial markets in financial markets for an investment in the future. If you want your
which funds are stocks and for business to succeed in the long run, it will
borrowed or loaned intermediate or be one of your most important investments.
for short periods (less long-term debt (one Your corporate financial plan influences
than one year). year or longer). future decisions by shining a light on
performance. This enables continuously
Primary Markets Secondary Markets
compare target and actual status and
Primary markets are Secondary markets are adjust your plan if necessary.
the market in which the markets in which
corporations raise securities and other Goal of Corporate Corporate Financial Planning
capital by issuing financial assets are - The goal of corporate financial planning is to
new securities. traded among
use the available resources—primarily
investors after they
have been issued by financial resources—as strategically as
corporations. possible. With the help of a corporate
financial plan, you can determine cash
Private Markets Public Markets requirements, reduce financing expenses,
and make forward-looking decisions based
Private markets are Public markets are
markets in which markets in which on accurate plans.
transactions are standardized
worked out directly contracts are traded Importance of Financial Planning
between two parties. on organized - It also allows you to determine the cash
exchanges. requirements for the next days, weeks, and
months and balance with the resources
BUSINESS FINANCE (WEEK 2) available. If you compare planned and
FINANCIAL PLAN actual values, the plan can also serve as a
● A statement of what to be done in the future controlling tool. If there are deviations of
as far as financial goals are concerned. more than 5–10 percent, action must be
● A document that covers an individual’s taken to address the deviations. For
current financial situation, short-term and example, if you have higher costs than
long-term economic goals, and an in-depth originally planned, or if you have higher
strategy to achieve them. surpluses, you can think about opportunities
● A financial plan is a document that covers for investments.
an individual’s current financial situation, - The tasks of your corporate financial plan
short-term and long-term economic goals, are derived from your individual objectives.
and an in-depth strategy to achieve the You should know at any given point in time
goals. how much liquidity you need and how many
of them are already available. To do this,
CORPORATE FINANCIAL PLANNING you need a comprehensive overview of the
● Corporate financial planning is a amount and number of incoming and
foundational portion of corporate planning outgoing payments and due dates. A solid
and an important business management financial plan allows for transparency about
tool. It forms the basis for future financial the company’s performance and ensure
decisions. In the corporate financial accuracy for future planning.
planning process, all financial data of a - It also allows you to determine the cash
company is recorded and evaluated. It requirements for the next days, weeks, and
enables you to determine how efficiently months and balance with the resources
your company is operating. If the available. If you compare planned and
assessment is positive, the financial plan actual values, the plan can also serve as a
may be more convincing to investors to controlling tool. If there are deviations of
invest profitably in your business. more than 5–10 percent, action must be
● Company founders often consider financial taken to address the deviations. For
planning, but the financial plan also plays a example, if you have higher costs than
central role beyond the initial phase of a originally planned, or if you have higher
 surpluses, you can think about opportunities Working Capital (WC) Management
for investments. A. Cash management
● Cash management tools:
FINANCIAL PLANNING TOOLS AND CONCEPTS ○ Cash budget preparation
Financial Planning Process ○ Cash break-even computation
- Planning that begins with long-term, or ○ Cash management model
strategic, financial plans that in turn guide ○ Cash Conversion Cycle
the formulation of short-term, or operating,
plans and budgets. BUDGET PREPARATION
● Budgeting – is the process or act of
A. Long-term (strategic) Financial Plans preparing a financial budget.
● Plans that lay out a company’s planned ● Budget – refers to a plan which is
financial actions and the anticipated impact expressed in a quantitative monetary value.
of those actions over periods ranging from 2
to 10 years. Purpose of Budgeting
● Note: all planning activities of an entity ● Facilitate planning
always start with the Mission, Vision, and ● Establishing financial coordination
Objectives (VMO). ● Proper allocation of resources
● Improve employee morale
B. Short-term (strategic) Financial Plans ● Enhancing control mechanism
● Specify short-term financial actions and the
anticipated impact of those actions. Period Covered
● Short-term – anchored on one year
budgetary requirements
● Medium-term – sets the budgetary
requirements of an entity for the next three
or five years.
● Long-term – also called strategic budget
which is anchored on the VMO.

Types of Budget
1. Fixed budget – based only on one level of
production capacity.
2. Flexible budget – shows the projected cost
Steps in Financial Forecasting at different levels of production capacity.
1. Forecast sales 3. Continuous or rolling budget –
2. Production plan (project the assets needed continuously prepared every month by
to support sales) adding another month once the current
3. Estimate marketing and administrative month has passed.
expenses 4. Cash budget – reflects the expected cash
4. Project outside (additional) funds needed receipts from cash sales, collections,
5. Decide how to raise funds proceeds from sale of other assets and
6. Prepare projected Financial Statements borrowings, expected disbursements on
(Pro Forma SFP and Pro Forma SCI) payments of OPEX, interest, taxes and
7. Review and Evaluate (see effects of plan on loans.
ratios and stock price) 5. Sales budget – reflects expected number
of units to be sold based on forecasts made
Common Financial Forecasting Tools from performance of previous years and
● Account Analysis (detailed) other marketing variables.
● Probability (t-distribution, chi-square, 6. Production budget – shows the costs of
Bernoulli, etc.) producing the product which includes the
● Simulation technique direct materials, direct labor, and factory
● Sensitivity analysis (please see managerial overhead.
accounting) 7. Operating budget – reflects the sales and
● Linear Programming (Graphic, Algebraic, production budgets.
Simplex) 8. Financial budget – usually includes the
● PERT-CPM cash budget and budgeted balance sheet.
● Regression Analysis (least-squares
regression)
 9. Capital budget – a long range budget that
incorporates the major expenditures for
plant and machineries.
10. Master budget – the overall budget of the
business entity.

Note: Since budgeting is a very broad topic, we will

focus only on three major types of budget, the
Sales Budget, Production Budget, and Cash
Budget. Other budgets shall be discussed in higher
accounting subjects in college.

BUSINESS FINANCE (WEEK 3)

OPERATING CYCLE
- This cycle is composed of two periods.
Inventory Period (Age of Inventory) + Accounts
Receivable Period (Age of Receivables)

CASH CONVERSION CYCLE

- Also known as the Cash Cycle
Accounts Payable Period - Operating Cycle

Accounts Receivables
● Trade Credit
● Consumer Credit
● Open account
● Credit period
● Discount period
Example of credit terms are as follows:
● n/30
● 2/10, n/30

5 C’s of Credit
Character
● This refers to the borrower’s identity and
character and his willingness to pay his
loans.
Capacity
● This is establishing the income and debts
that the borrower has.
Capital
● This is establishing the borrower’s assets,
cash, property, personal possession and
investments.
Collateral
 ● This refers to the value of the assets that c. collateral trust bonds - secured by
the customer has and plans to use to securities invested in by the issuing
secure the loan. company
Conditions UNSECURED BONDS
● This refers to the global and domestic - Do not have any sort of guarantee. They do
macroeconomic conditions not provide any lien against any specific
property or security for the obligation, that
BONDS is, there is no collateral.
Indenture or Bond Indenture - This is the reason why debenture bonds are
- The written agreement on bond issues generally issued by companies with a
between the issuing party and the steady high credit rating. Companies such
bondholder as large mail-order houses and commercial
banks are some of these companies.
Bond issuer - the debtor company
Bondholder - the investor or creditor of the bond BONDS AS TO MATURITY OF PRINCIPAL
Yield - current yield or yield to maturity, or the
interest Straight bonds - when the entire principal matures
at one time only.
BONDS AS TO THE ISSUING PARTY
Government bond Serial bonds - when the principal matures in
● is issued by the national government to installments. Staggered payments is the effect of
finance its deficits and is denominated in the payment in series.
country’s own currency. These are issued in
denominations not lower than Php 100, 000.
● An innovation was introduced when treasury BONDS AS TO RETIREMENT
bonds of smaller denominations were a. Callable/ redeemable bonds - can be
issued in as Iow as amount as Php 5, 000 to called, redeemed or retired by the issuing
finance various projects of the government. company before maturity date.
● Bonds issued by the Bureau of the Treasury b. Non-callable/ non-redeemable bonds -
are called T-bonds. are not subject to calls or redemption before
● Currently, T-bonds are issued in five maturity date.
maturities: 2-year; 5-year; 7-year; 10-year; c. Convertible bonds - can be exchanged for
and 20-year. Bonds issued by national other securities of the company at the
governments in foreign currencies are option of the bondholder. The owner has the
normally referred to as sovereign bonds. option to exchange his bond for a specified
Corporate bond number of shares of common stock,
● is issued by private corporations with very preferred stock or other types of bonds. This
strong credit ratings which needs a feature attracts investors, but these
significant amount of cash. convertible bonds usually carry lower
● Most corporate bonds are coupon bonds, interest rates.
where interest payments are made regularly
as scheduled, between the original issue BONDS AS TO INTEREST RATE
date and the maturity date. The owner of
the bond at a specified time in the future Variable rate bonds - are bonds whose interest
receives the par value. rate fluctuates and changes when the market rate
change.
BONDS AS TO SECURITY
SECURED BONDS Fixed-rate bonds - have rates that are fixed as
- are bonds collateralized either by stated in the bond indenture.
mortgages or other assets.
a. mortgage bond - secured by a lien BONDS OTHER CLASSIFICATIONS
on specifically named property such a. Income Bonds
as land, buildings, and other fixed ● are bonds that pay interest only
assets specifically pledged as when the interest only when the
security interest is earned by the issuing
b. equipment trust bond - secured by company. If the issuing company
the company’s equipment incurs a loss, it is not required to pay
interest on the income bonds.
b. Municipal Bonds
 ● are certificates of long-term ● Compound Interest - interest added to the
indebtedness issued by towns, cities principal of a deposit or loan so that the
or provinces, and are secured by the added interest also earns interest then on.
taxing power of these entities.
Remember that state and local NOMINAL AND EFFECTIVE INTEREST RATES
governments and other authorized ● Nominal interest rate - commonly known
public authorities must finance their as “simple interest rate” and sometimes
own capital investment projects like called “annual percentage rate”. It is the
roads, bridges, schools, hospitals, interest rate paid or earned in one year
sewage plants and airports among without compounding.
others. ● Effective interest rate - also known as
Types of Municipal Bonds “effective annual rate”. It indicates the
1. General Obligation Bonds are those that compound interest rate paid or earned in
are backed by the “full faith and credit” of one year. This is the true amount of interest
the issuer because it is assumed that the you pay or earn in one year.
municipality can able to raise taxes as
needed
2. Revenue Bonds are those which are repaid
from the revenues generated by the project
they were sold to finance
3. Perpetual Bonds are those for which the
holder cannot redeem payment. This is
commonly used in public finance, where the
debtor (the government) may be assumed
to have permanent existence.

TIME VALUE OF MONEY

Time value of money is central to the concept of
finance. It recognizes that the value of money is
different at different periods of time.

OPPORTUNITY COST
- is anything given up after choosing an
option. In finance, it is the possible income
from one option or investment opportunity
given up.

GOOD MONEY MANAGEMENT

- a decision to invest either in the money
market, fixed-income securities, stocks,
bonds, real estate, or in small business
ventures. If you decide to spend the money
instead of investing it, you are foregoing the
opportunity to earn interest from investing
this money. If you decide to invest in
financial instruments- fixed-income
securities, bonds or stocks—you are saying
“NO” to investment in real estate and a
business venture. RISK
- is a chance or possibility of losing
INTEREST something or everything. It is the uncertainty
● Interest - is the cost of using money over of the expected outcome. It is the
time. It is the money that is charged or paid consequence or the stake of doing things.
based on the total cumulative amount of
loan. RISK - RETURN TRADEOFF
● Simple Interest - calculated based on flat - is the concept that explains that there is a
percentage rate of the principal and remain commensurate return for every risk a
constant for the duration of the investment. business owner or investor takes and that
 the return expected is usually greater for MARKET RISK
more risk taken. - affects the prices of securities due to the
rise or fall of the market during a bull or a
Examples of Tradeoff Situations bear market, respectively. As to the
1. A business can enhance its profitability by meaning, Bull Market happens when share
carrying less cash and marketable prices and market goes up. Bear Market
securities since these earn very low rates in happens when share prices and market is
the market; not doing well. As to the origin of terms, the
2. The funds, instead, are put into more risk, former comes from the animal “bull” as it is
such as higher investment in inventories swinging its head up denoting upward while
that can generate more sales for the the latter comes from the animal “bear” as it
company; attacks backward.
3. If the company is able to sell more from this
inventory, then it is able to generate more MANAGEMENT RISK
return for the risk it entered into; - happens when the decisions made by a
4. However, the tradeoff can be complex: if the firm’s management and board of directors
additional investment in inventory does not materially affect its business models or the
generate more sales, perhaps because of a risk faced by its investors.
slowdown in the economy or the quality of
the product being sold; or when the BUSINESS RISK
business has carried less stable cash and - is the uncertainty about the rate of return
marketable securities to pay for the caused by the nature of the business.
short-term loans it used to finance this Competition, changes in consumer lifestyle
additional inventory; and and population changes can greatly impact
5. The higher the risk the business takes, the an industry. Due to technology, other
higher the potential to earn, as well as the businesses can be considered obsolete
potential to lose which can lead to delayed such as video rental as films and series are
payments on short-term debts that financed already available online.
the inventories in the first place.
FINANCIAL RISK
TYPES OF RISK - is the inability of the firm to not being able to
SYSTEMATIC RISK pay off the debt it has taken from the bank
market risk or undiversifiable risk or a financial institution. The higher the
Systematic risk is the fluctuations in the returns on debt-equity ratio of a firm, the higher the
securities that occur due to macroeconomic factors. financial risk it faces. Wrong capital
It results from the general market and economic structure also contributes to financial risk.
conditions (inflation, recession) that cannot be
avoided, cannot be diversified away or cannot be LIQUIDITY RISK
reduced through diversification. Its includes market - exists when an asset is not readily
risk, inflation risk and interest rate risk. marketable or simply, when an asset may
not be sold on short notice for its market
UNSYSTEMATIC RISK value.
diversifiable risk, residual risk, or
company-specific risk POLITICAL RISK
These risk factors exist within the company and can - arises from new tax laws, changes in the
be avoided and can be reduced through government, lack of consistency in
diversification. These factors include the production government policies and corruption among
of undesirable products, labor strikes, managerial others. Political risks include war,
change or the outcome of unfavorable litigation. revolutions and government seizure of
Unsystematic risk includes business risks and property.
financial risks.
DIVERSIFICATION
INTEREST RATE RISK - is a risk-management technique that mixes
- It is the fluctuations in the value of an asset a wide variety of investments within a
as the level of interest rates change. An portfolio to minimize the impact that any one
increase in the interest rate would result to security will have on the overall
the decrease of the asset value of a debtor performance of the portfolio.
company (bond issuer) as it will be paying
more interest expense.
Note: Portfolio is defined as “an accumulation of provident fund, life insurance, fixed deposits in the
assets owned by the investor and designed to corporate sector and unit trust schemes.
transfer purchasing power.”

Diversification usually lowers the risk of your

portfolio.

Three main practices can help you ensure the best

diversification:
1. Spread your portfolio among multiple
investment instruments.
2. Vary the risk in your securities
3. Vary your securities by industry

INFLATION IS A SILENT THIEF

SAVING
● “the act of putting away money for future
use.”
INVESTMENT
● “the act of committing money or capital to
an endeavor with the expectation of
obtaining an additional income or profit.”
● “investing is saving but saving is not
investing.”

IMPORTANCE OF INVESTMENT
LIFE EXPECTANCY
People saving by themselves does not increase
wealth; so prior to retirement, saving must be
invested in such a way that the principal and
income will be adequate for a greater number or
retirement years.

INCREASING RATES OF TAXATION

When tax rate is increased, it will focus for
generating saving by the tax payer. The tax payer
then may invest part of his or her income to
provident fund or pension fund in institutions
supervised by the government.

INTEREST RATES
Differs from one investment to another. There may
be changes between the degree of risk and safe
investments. They may also vary due to different
benefits schemes offered by the institutions. A high
interest rate is a factor favoring the outlet for
investment.

INCOME
More incomes and more avenues of investment
have led to the ability and willingness of working
people to save and invest their funds.

INVESTMENT CHANNELS
The growth and development of the country leading
to greater economic prosperity has led to the
introduction of vast areas of investment outlets.
Investment channels means an investor is willing to
invest in several instruments like corporate stock,