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BUSINESS FINANCE

CHAPTER 1 : FINANCIAL
MANAGEMENT
Finance – study how individuals or businesses
evaluate investment opportunities, business
proposals, and business projects, and raise
capital to fund them.

Financer – person who finance the business.

Financial Management – the efficient and


effective management of funds.
The Important Role of the Financial Institutions

Financial Institution
Evaluation of Investment
Financial Institution
Lends Funds

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BUSINESS
DEPOSITOR BORROWER
PROJECT
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Financial Institution
Financial Institution
Pays Interest
Return of Investment
The Key Individual Roles
The Depositor Who Has the Funds

Depositor – the person who has the money


and deposits it in a savings account

The Borrower Who Needs the Funds

Borrower – the party at the other end.


Financial Instruments and Financial Markets

Financial Institution – an establishment that


conducts financial transactions such as investments,
loan and deposits.

Financial Instruments – tools that help a business


daily operations, and eventually make it grow.
Financial Market – a market in which people
trade financial securities and derivatives such as
futures and options at low transaction costs.

What are these Financial Instruments?

Money Market Instruments – an inexpensive way


for government and financial institutions to raise funds.
FINANCIAL INSTRUMENTS BASIC CHARACTERISTICS
Money market debt:
• Issued by the
treasury/government
Treasury bills • Matures within one year
• Is generally default-free as
government will exert all effort to
pay
• Issued by financially sound
businesses to fund investments in
inventories and receivables
• Maturity is about nine months
Commercial papers • Generally low default risk as
businesses have good credit
standing
• Issued by banks or mutual fund
companies
• No specific maturity date
Money market funds • The degree of default risk is low
• These funds are usually invested
in money market instruments,
treasuries, and commercial
papers.
• Issued by banks, credit unions,
Consumer credit, finance companies
Credit card debt • Maturity date varies
• Default risk varies
Long-term debts - amount owed for a period
exceeding 12 months from the date of the balance
sheet.

Example of Long-term debt:

Bond – a security that represents the debt of a


government or business promising to pay a fixed
interest to the holder of the bond for a definite period
of time.
Note – a security that has longer term than money
market instrument, but shorter term than a bond.
FINANCIAL INSTRUMENT BASIC CHARACTERISTICS
Long-term debt:
• Issued by the government
• Notes mature in two, five, or ten
years
• Bonds mature longer (ten years or
Treasury notes and bonds more)
• No default risk as governments
exert all efforts to pay
• The price of bonds usually fall,
becoming less attractive as in
interest rates in the market rise
• This is a United States type of
long-term debt and not applicable
in the Philippine setting
Federal agency debt • Issued by federal agencies and is
similar to treasuries
• Has long-term maturity, up to
thirty years
• Has low default risk
Municipal bonds, • Issued by local governments
Local government bonds • Matures longer, up to thirty years
• More risky than government
securities
• Issued by corporations
• Matures in forty years, some
bonds like Walt Disney and Coca-
Corporate bonds Cola have issued 100-year bonds
• More risky than government
securities and rely on the financial
soundness of the company
Stock – a type of security that signifies ownership in a
corporation and represents a claim on the part of the
corporations assets and earnings.

Preferred and Common Stocks – are financial


instruments businesses can use to raise funds for their
long-term requirements.
FINANCIAL INSTRUMENTS BASIC CHARACTERISTICS
• Issued by corporations in
exchange for units of ownership
• Has no maturity date
Preferred stock • Pays dividends when declared
• More risky than corporate bonds
• Has no voting rights
• Has preference over common
stocks in asset liquidation hence
the term “preferred”
• Units of ownership in a public
corporation
• Pays dividends when declared
• Owners are entitled to vote on the
Common stock selection of directors and other
important matters
• In the event if a corporate
liquidation, claims of preferred
stock holders take precedence
over common stockholders
Financial Institutions Support Nation Building

The role of Financial Institution - help in funding


important government projects and extend advisory
services to help in nation building.
Kinds of Banks

1. Thrift Banks – are deposit-taking financial


institutions that also extend credit to the consumer
market.
2. Commercial Banks - are mainly deposit-
taking financial institutions that extend credit to
the retail and consumer market.
3. Universal Banks - are like commercial banks
except that their clientele are mostly the larger
corporations.

4. Investment Banks – are known to successfully


raise funds for big corporations and governments.
Non Banks

1. Leasing Companies – are not banks and are


not governed by the central banks.

2. Investment – are regulated by the Securities


and Exchange Commission (SEC) and perform
similar functions as banks.
3. Mutual Funds – are collective investments or
funds of small investors pooled together and
managed to be able to reach maximum returns.
4. Insurance Companies - sell insurance
coverage to provide guarantee of compensation for
specified death, illness, accident, loss, or damage
to property in return for payment of a premium.
5. Private equity funds- are not regulated by
government or any regulatory body.
Financial Instruments Compared and Contrasted

1. Commercial Papers - are mainly borrowings of


corporations usually with good credit standing.
2. Treasury Notes - are borrowings of governments.
3.Government or Corporate Bonds - are borrowings
of governments or corporations.
4. Stocks - are shares issued by businesses.
5. Mutual Funds/Investment Funds- are pooled
investments.
The Flow of Money and the Role of the
Financial Manager

What is a worthwhile business?

Worthwhile Business – a business worth giving


your time and attention.
EVALUATION OF THE BUSINESS

Will the business/project/investment be liquid?


Are regular cash flows expected?
Will debts be paid on time?

Measuring Liquidity

How was the business funded: fifty percent financed through


debts and fifty-percent financed through owner’s capital?

Identifying Capital Structure


Is the business efficient? Does it use all its assets (inventory, plant, and
equipment) efficiently to generate sales and revenues?

Asset Management Efficiency

Is the business profitable?


Are revenues growing faster than costs?

Measuring Profitability