Business Finance 1

CYVELL M. ADORA, LPT, CTT

Business Finance 2
CYVELL M. ADORA, LPT, CTT
 LESSON

A. What is Finance and Financial Management?

Finance is always of great importance, be it in a business or in one's everyday life. It is important to manage risks in business, it is
equally important to manage risks in life as well. Risk is nothing but an uncertain event that might damage your assets and when it is
financial risks, it creates loss of Finance. Some books define Finance as the science and art of managing money. (Gitman & Zutter,
2012)

Financial Management deals with those decisions that are supposed to maximize the value of shareholder’s wealth (Cayanan). These
decisions will ultimately affect the markets perception of the company and influence the share price. The goal of Financial Management
is to maximize the value of shares of stocks. Managers of a corporation are responsible for making the decisions for the company that
would lead towards shareholder’s wealth maximization.

Organizational structure of the company is important especially in the financial aspect of the business and the particular set of people,
each play a role in the decision making of the company. See diagram below.

From the diagram presented, emphasized 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 do the same for the
interest of the shareholders, it follows the goal of each individual in a corporate organization should have an objective of shareholders
wealth maximization.

The roles of each position identified.

1. Shareholders: The shareholders elect the Board of Directors (BOD). Each share held is equal to one voting right. Since the
shareholders elect the BOD, their responsibility is to carry out the objectives of the shareholders. Otherwise, they would not be
elected in that position. Ask the learners again, what objective of the shareholders is, just to refresh.
2. 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:
a) Setting policies on investments, capital structure and dividend policies.
b) Approving company’s strategies, goals and budgets.
c) Appointing and removing members of the top management including the president.
d) Determining top management’s compensation.
e) Approving the information and other disclosures reported in the financial statements (Cayanan, 2015)
3. 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:
a) Approving the information and other disclosures reported in the financial statements. Overseeing the operations of a
company and ensuring that the strategies as approved by the board are implemented as planned.
b) Performing all areas of management: planning, organizing, staffing, directing and controlling.
c) Representing the company in professional, social, and civic activities.
4. VP for Marketing: The following are among the responsibilities:
a. Formulating marketing strategies and plans. Directing and coordinating company sales.
b. Performing market and competitor analysis.
c. Analyzing and evaluating the effectiveness and cost of marketing methods applied.
d. 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.
e. Promoting good relationships with customers and distributors. (Cayanan, 2015)
5. VP for Production: The following are among the responsibilities:
a. Ensuring production meets customer demands.
b. Identifying production technology/process that minimizes production cost and make the company cost competitive.
c. Coming up with a production plan that maximizes the utilization of the company’s production facilities.
d. Identifying adequate and cheap raw material suppliers. (Cayanan, 2015)

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 6. VP for Administration: The following are among the responsibilities:
a. Coordinating the functions of administration, finance, and marketing departments.
b. Assisting other departments in hiring employees.
c. Providing assistance in payroll preparation, payment of vendors, and collection of receivables.
d. 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. (Cayanan, 2015)

The role of the VP for Finance/Financial Manager is to determine the appropriate capital structure of the company. Capital structure
refers to how much of your total assets financed by debt and how much is financed by equity.

To be able to acquire assets, our funds must have come somewhere. If it has bought using cash from our pockets, it has financed by
equity. On the other hand, if we used money from our borrowings, the asset bought has financed by debt.

B. What are the functions of Financial Managers?

1. Financing decisions – include making decisions as to how to finance long-term investments and working capital-which deals
with the day-to-day operations of the company.
2. Investing Decisions – To minimize the probability of failure, long-term investments have supported by a capital budgeting
analysis.
3. Operating Decisions – deal with the daily operations of the company especially on how to finance working capital accounts such
as accounts receivable and inventories.
4. Dividend Policies – Dividend is a part of profits that are available for distribution, to equity shareholders. The Finance manager
must decide whether the firm should distribute all the profits or retain them or distribute a portion and retain the balance.

The financial system links the savers and the users of funds. Savings can come from households, individuals, companies, government
agencies, or any other entity whose cash inflows are greater than their cash outflows. The financial system through financial
intermediaries provides a mechanism by which these savings can be channeled to users of funds, borrowers, and investors.

Some of the financial instruments issued by users of funds such as the shares of stocks and corporate bonds of publicly listed companies
and the debt securities issued by the National Government has traded.

C. Differentiate the Financial instruments, financial institutions and financial markets

1. Financial institutions are companies in the financial sector that provide a broad range of business and services including
banking, insurance, and investment management.

Identify examples of financial institutions/Intermediaries:

a. 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.
b. 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
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.
c. Mutual Funds - Mutual funds owned by investment companies that 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.
d. Pension Funds - Financial institutions that receive payments from employees and invest the proceeds on their behalf.

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.

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 2. Financial Instruments is a real or a virtual document representing a legal agreement involving some sort of monetary value.
These can be debt securities like corporate bonds or equity like shares of stock. When a financial instrument issued, it gives rise
to a financial asset on one hand and a financial liability or equity instrument on the other.

a. 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. (IAS
32.11)
Examples: Notes Receivable, Loans Receivable, Investment in Stocks, Investment in Bonds

b. 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. (IAS 32)
Examples: Notes Payable, Loans Payable, Bonds Payable

c. An Equity Instrument is any contract that evidences a residual interest in the assets of an entity after deducting all liabilities.
(IAS 32)
Examples: Ordinary Share Capital, Preference Share Capital

Identify common examples of Debt and Equity Instruments.

✓ Debt Instruments generally have fixed returns due to fixed interest rates. Examples of debt instruments are as follows:
Treasury Bonds and Treasury Bills 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 has been paid.
a. Issued by the government, usually the central or federal government (like the Philippine government or the
U.S. Treasury).
b. Very low risk because they are backed by the government, which is unlikely to default on payments.
c. Generally offer lower interest rates because of the lower risk.
d. Considered one of the safest investments since the government guarantees the repayment of the principal
and interest.
e. Governments issue Treasury Bonds to raise money for public spending and projects.

Corporate Bonds 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 issued the bonds goes bankrupt, the holder of the
bonds will no longer receive any return from their investment and even their principal investment has wiped out.
a. Issued by corporations (private or publicly traded companies).
b. Higher risk compared to Treasury Bonds because companies can go bankrupt or default on payments. The
risk level depends on the financial health of the issuing company.
c. Offer higher interest rates to compensate for the increased risk.
d. Not guaranteed; the repayment depends on the company's ability to generate profits and manage its debt.
e. Corporations issue bonds to raise funds for business expansion, new projects, or refinancing debt.

✓ 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 has liquidated and its assets have to be distributed, no asset be distributed to common stockholders
unless all the claims of the preferred stockholders has 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 given to common stockholders unless all the dividends due to preferred stockholders paid first.
(Cayanan, 2015)
Who they are:
a. Investors who hold preferred shares, which give them priority over common stockholders when it comes to
receiving dividends and assets if the company is liquidated or goes bankrupt.
b. They receive fixed dividends, usually on a regular basis, regardless of the company’s performance.
c. They are paid before common stockholders in the event of liquidation.
d. They usually do not have voting rights, meaning they don’t participate in key company decisions like electing
the board of directors.
e. Their potential for profit is limited to the fixed dividend, so they don’t benefit as much from the company’s
growth.

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 Holders of Common Stock on the other hand are the real owners of the company. If the company’s growth is
encouraging, 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.
Who they are:
a. These are the majority of investors who hold common shares. They are considered the true owners of the
company.
b. Common stockholders have voting rights, meaning they can vote on important company decisions, such as
electing the board of directors.
c. They can benefit from company growth through dividends (if declared) and stock price appreciation.
d. They have lower priority in receiving dividends and company assets compared to preferred stockholders.
In the event of liquidation, they only receive what’s left after all debts and obligations are paid.
e. Dividends are not guaranteed, and the amount can vary depending on the company’s performance.

3. Financial Market - refers to a marketplace, where creation and trading of financial assets, such as shares, debentures, bonds,
derivatives, currencies, etc. take place.

Classify Financial Markets into comparative groups:

a. Primary vs. Secondary Markets
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 to the public referred to as a public offering and the first offering of stock named 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 purchased. The
sale of previously owned securities takes place in secondary markets.
The Philippine Stock Exchange (PSE) is both a primary and secondary market.

b. Money Markets vs. Capital Markets

Money markets are a venue wherein securities with short-term maturities (1 year or less) are sold. They have 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 sold in Capital markets. The key capital market securities are
bonds (long-term debt) and both common stock and preferred stock (equity, or ownership). Used by companies or
governments to raise funds for long-term projects or expansion.

The role of Financial Managers: make financing decisions that require funding from investors in the financial markets.

D. How do we measure wealth maximization?

For example:
Assume that Mr. Y bought 10 shares of Globe Telecom at PHP2, 510 each on September 9, 2010. This brings his investments to PHP25,
100. What happens to the value of his investment if the price goes up to PHP2, 600 per share or it goes down to PHP2, 300 per share?

Explanation:
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.

END OF MODULE 1

Business Finance 6
CYVELL M. ADORA, LPT, CTT