Q1: BUSINESS FINANCE
Sources of Finance
Introduction to Financial Management
internal source of finance does not increase the debts
According to Gitman and Zutter (2012), “Finance can be of the business-like profit, savings, and sale of unwanted
defined as the science and art of managing money. assets
At the personal level, finance is concerned with
External source of finance is provided by people or
individuals’ decisions about how much of their earnings
institutions outside the business that creates debt and
they spend, how much they save, and how they invest requires payment like loans.
their savings.
In a business context, finance involves the same types Corporate Organization Structure:
of decisions:
➔ how firms raise money from investors,
➔ how firms invest money in an attempt to earn a
profit
➔ how they decide whether to reinvest profits in
the business or distribute them back to
investors.
Finance is a process that includes raising money or
resources and allocating them effectively and efficiently
to achieve the firm’s goals or objectives. ● Shareholders - elect the Board of Directors
- They buy shares to earn a profit in the
It includes financial management, the study of form of a dividend.
investment, and the study of institutions and markets. ● Board of Directors - is the highest position in a
corporation.
Money is needed by the firm to continue its operations, - Some of their responsibilities are
expansion, replacement of new machinery and providing direction of the company
equipment, payments, acquisition of new investment, ● President - supervises the company’s
and internal growth. operations and ensures that the strategies are
well executed and planned.
According to Cayanan and Borja (2017), “Financial ● Vice President for Sales and Marketing are
management deals with decisions that are supposed to formulating business strategies and plans,
maximize the value of shareholders’ wealth.” directing and coordinating sales
● Vice President for Administration is
Financial management is a decision-making process that responsible for the coordination of the different
includes planning, analysis, utilization, and acquisition of departments, hiring, and payroll.
funds in order to achieve the desired goals of the ● Vice President for Production makes sure that
business. the production meets the demand, production
facilities, production issues.
The goal of financial management is to maximize the ● Vice President for Finance makes decisions
wealth of the shareholders. including planning, acquiring and utilization of
funds.
➢ The business should make the customers happy ➢ Investing decisions deals with
➢ Must treat their employees well to become more managing the assets of the firms.
productive and trustworthy ➢ Financing decisions includes making
➢ Should pay their financial obligations decisions on how to finance the long-
➢ Pay attention to government and environmental term investments
issues ➢ Operating decisions deals with
working capital management.
Its aim is to make money and add value to the investors
and to the firm.
➢ Declaration of dividends refers to the The financial institution’s role is to act as a financial
determination of how much dividends intermediary.
are to be distributed to the shareholders
Dividend is a portion of profit or A financial intermediary serve as a link between the
payment made by a corporation to its depositor who has the money and the lender who needs
shareholders. money.
1. The company must have
enough retained earnings Financial Institution includes:
2. They must have enough - Commercial Banks
cash. - Universal Banks
- Investment Banks
The Role of Finance Manager - Investment Companies
- Finance Companies
According to Cabrera (2017), “In striving to maximize - Life / Non-life insurance
owners’ or shareholders’ wealth, the financial manager - Mutual Fund
makes decisions involving planning, acquiring, and - Private Equity Firms
utilizing funds which involve a set of risk-return trade-
offs.” Financial management is managing financial
matters including analysis of statements,
Thus, it is the responsibility of the financial assessment, or investment opportunities, which
manager to make decisions in allocating the funds happens before one starts investing and
or resources properly, finding the best alternatives acquiring funds from different sources.
for funding the company, and creating a policy in
distributing the dividends of the investors in line with The Key Individual Roles:
the organization’s objectives.
1. The Depositor Who Has the Funds
The depositor is the person who has the money
and puts in a savings account with a bank that
pools this together with the savings from other
depositors.
2. The Borrower Who Needs the Funds
The borrower is the one who needs funds and
The Financial Institutions
borrows it from a bank.
Financial Instruments
Financial instruments are the tools that help a
business’ daily operations and help the finance
manager handles his/her cash, his/her short-term
operating requirements, and long-term business
requirements.
Money market instruments are funds available for
a short time (1 year or less than a year). They are
The flow of money begins with the depositor who opens available most of the time and do not provide very
a bank account and earns interest from the account. In high returns.
exchange, these funds are lent by the banks to
businesses.
- They are borrowers who want to start up a new
business, a new product, expand a business, or
find another investment opportunity.
Money Market Debts Financial Characteristics
Financial Characteristics Instruments
Instruments Treasury notes • issued by the government
Treasury • issued by the government and bonds • matures in two, five or ten
bills (T-bills) • maturity within a year years or more
• not risky, because • no default risk (The
government must make an government exert effort to
effort to pay pay.)
Commercial • issued by • bonds price usually fall
papers financially sound business to becoming less attractive as
fund investment in interest rates in the market
inventories and receivables. rise
• maturity is about • not applicable in the
nine months Philippine setting (a
• generally low United States’ type of long-
default risk as business has term debt.)
good credit standing
Federal agency • issued by federal agencies
Money • issued by banks or mutual
debt and it is similar to
market funds funds companies
• maturity date is not specific treasuries
• the degree of default risk is • long-term maturity (i.e. up
low to thirty years)
• usually invested • low default risk
in money Municipal • issued by local
market instruments, bonds, local government
commercial papers, government • long-term maturity (i.e. up
and treasuries bonds to thirty years)
Consumer • issued by banks, credits • more risky than
credit, credit unions and finance government securities
card debt companies
• the maturity date varies Corporate • issued by corporations
• default risk varies bonds • mature in forty years
• more risky than
government securities and
Bond is an example of long-term debt. It is a security
rely on the financial
reflecting the debts of a government’s or business’ debt soundness of the company
promising to pay a fixed interest to the bondholder for a
definite time.
Liquidation is a process of converting an asset into
cash
A note is another example of long-term debt that has a
longer term than a money market instrument.
Long-Term Debts
Stocks are types of security that represent Types of Financial Institutions:
ownership in a corporation and a claim on part of
the corporation’s assets and earnings. A financial institution can be a bank or nonbank.
Kinds of Banks:
Financial
Instruments Characteristics 1. Thrift Banks - are deposit-taking
• issued by corporation in financial institutions that extend credit to
exchange of ownership the consumer market that is in the
Preferred • has no maturity date pay
countryside or rural areas.
stock • dividends when declared
2. Commercial Banks - banks are mainly
(Preference • more risky than corporate
deposit-taking financial institutions that
share) bonds
extend credit to the retail and consumer
• has no voting rights market, and their transactions are
• has preference over usually many but small, using the local
common stocks in asset currency.
liquidation 3. Universal Banks - lend money to
• units of ownership in a multinational companies.
• public corporation pays 4. Investment Companies - provide loans
• dividend when declared to big corporations and governments and
owners are entitled to vote can raise funds through bond issuances
Common stock on the selection of and initial public offerings. Investment
(Ordinary directors and other banks also provide funds to businesses.
share) important matters
• common stockholders Nonbank institutions:
enjoy potential profits from
the capital appreciation of 1. Leasing Companies - extend financing
their stock. to companies that need funds for their
business. They are not banks and are
Financial Markets are the meeting places of suppliers not regulated by the central bank.
and users of various types of funds that can make 2. Investment Companies - perform
transactions directly. similar functions as banks in the manner
that they can provide financing to
1. Primary Market – refers to financial companies or raise funds through bonds
market in which buyers and sellers or Initial Public Offerings. They are
negotiate and transact business directly regulated by the Securities and
without an intermediary. Exchange Commission (SEC).
● Public offering is the sale of 3. Mutual Funds - types of investments or
new securities to the general funds of small investors pooled together
public and the first offering of and managed to be able to generate
stock is called IPO or Initial maximum returns.
Public Offering. 4. Insurance Companies - types of
● Private placement is the sale of investments or funds of small investors
a new security to a private or pooled together and managed to be able
specific buyer. to generate maximum returns.
2. Secondary Market – refers to financial 5. Private Equity Funds - are managed by
market where previously issued private fund managers or investors,
securities (such as bond, notes and allowing owners to invest more
shares) are bought and sold. aggressively in the financial markets.
3. Money markets are venues wherein
securities with short-term maturities (1 What is a worthwhile business?
year or less) are borrowed or loaned.
Capital markets are financial is a business that achieves the objective
markets for stocks for a long-term of financial soundness, sustainability,
period (one year or longer) competitiveness, and nation-building.
Working Capital Management
is the proper administration of current assets and Days of Receivable = 365 Days / Receivable Ratio
liabilities.
Receivable Turnover Ratio = Net credit Sales / Ave. A/R
Good working capital management:
- management enables the firm to pay its financial
obligation The cash conversion cycle (CCC) is a metric that
- establish good relationships with suppliers and expresses the time (measured in days) it takes for a
creditors company to convert its investments in inventory and
- and improve the earnings of the company other resources into cash flows from sales.
Nature of current asset: Cash Conversion Cycle = Operating Cycle - Days of
Payable
- Cash
- Accounts receivable
Days of inventory = 365 / Payables turnover
- Inventories
- Prepaid Expenses
Payables Turnover Ratio = Net Credit Sales / Ave. A/P
These are used in operations of the business called
working capital. The operating cycle - A shorter cycle is preferred
because it means business is more efficient and has
Net working capital is the difference between enough cash to meet financial obligations. The company
current assets and current liabilities. must find ways to decrease its operating cycle.
Net Working capital
= Current Assets – Current Liabilities Working Capital Financial Policies
Example: The total assets of Masipag Corporation 1. Maturity-matching working capital policy
amounts to
The permanent working capital requirements
Php 20,000,000.00 and its total current liabilities
should be financed by long-term sources while
amounts to Php 16,000,000.00.
temporary working capital requirements should
• The working capital of Masipag Corporation is Php be financed by short-term sources of financing.
20,000,000.00.
• The net working capital of Masipag Corporation is 2. Aggressive working capital financing policy
Php 4,000,000.00
(Php 20,000,000 – Php 16,000,000.00) Some of the permanent working capital
requirements are financed by short-term sources
of financing. Managers use this kind of policy
Operating Cycle and Cash Conversion Cycle
because long-term sources of funds have a
higher cost as compared to short-term sources
Operating Cycle = Days of Inventory + Days of of financing.
Receivable
3. Conservative working capital financial policy
Days of Inventory (Inventory Conversion Period) is the
average number of days to sell its inventory.
There are of the temporary working capital
requirements that are financed by long-term
Days of Inventory = 365 Days / Inventory Ratio sources of financing.
Inventory Turnover Ratio = Cost of GS / Ave. Inventory
Days of Receivable (Receivable Conversion Period) is
the time it takes to collect cash from the sale of the
inventory.
4. Speculative Motive - A company holds cash for
Financing Permanent Temporary other investment opportunities
Policies Working Capital Working Capital
Cash budget is used in determining the cash needs of
Maturity- Long-term Short-term the company. It shows the projected cash receipts and
matching sources sources cash disbursements for a particular period of time.
Aggressive Long-term Short-term
sources, short- sources Receivables Management
term sources Providing credits to a customer is one way of increasing
Conservative Long-term Short-term sales and gaining additional customers. Properly
sources sources, managing the accounts receivable lets the company
long term continue its operations. To minimize loss from accounts
sources receivable, the customer must be given credit terms and
credit evaluation must likewise be done.
Permanent or fixed working capital refers to the The following 5C’s of credit can be used in credit
evaluation.
minimum level of current assets required by a firm to
continue the operations of the business and to cover up
1. Character – is the borrower’s willingness to pay
all current liabilities.
the loan.
2. Capacity – is the borrower’s ability to pay the
Temporary working capital is the difference between loan.
net working capital and permanent working capital. It can 3. Capital – is the borrower’s financial resources.
help the business survive during the slack season 4. Collateral – is the borrower’s security pledge for
the loan payment.
Net working capital – permanent working capital 5. Condition – is the current economic or business
conditions.
Long-term sources of financing include long-term debt
like loans from a bank and equity such as common stock
and preferred stock. Short-term sources include short- Inventory Management
term loans from a bank.
Inventory is the stocks of the product the business is
Cash Management selling and the parts or raw materials that made up the
involves the maintenance of a cash and marketable product.
securities investment level which enables the company
to meet its cash requirements and at the same time, Inventory management is very important for
optimize the income of idle funds (Cabrera, 2015). manufacturing and merchandising companies especially
companies with perishable products. There should be a
The objectives of cash management are to meet the sufficient number of inventories to secure the smooth
financial obligation of the firm and to avoid losses in the operations of the business.
normal operation of the business.
List of internal controls:
Reasons for Holding Cash:
1. Separating the custodial functions from recording
1. Transaction Motive - Cash is needed for the
functions. The company should not allow the
day-to-day operations of the business
assignment of custodial functions from recording
functions to one person to avoid manipulation of
2. Contractual Motive - Some banks require a
records.
company to maintain a certain compensating
2. Aging of inventories. It allows the company to decide
balance for their deposit accounts and loans.
what to do with slow-moving items. For example, they
can use bundling or buy one take promo.
3. Precautionary Motive - Firms hold cash to be
ready in case of unwanted situations such as 3. ABC Analysis. This approach categorizes the
slowdown of accounts receivables that may inventories according to their values. A is considered
affect the fund for operations. the most important inventory or with the highest
values, B is considered the average item and C is the
least important or has lower value.
