Chapter 1 Intro To Financial MNGT

1.
1 AN
INTRODUCTION
TO FINANCIAL
MANAGEMENT
Business Finance
Mr. Christopher B. Cauan
Learning Objectives -----------------------------
.
. .
. This chapter aims to achieve the following: .
.
. .
. introduce financial management to the .
. students through the discussion of the .
role of financial institutions and .
. .
. financial instruments; .
. .
cover all aspects of finance and financial .
. management; and .
. .
. develop the student’s interest to a whole .
. new world of business and finance. .
.
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Business Finance
Political System
Economic System
Financial System
Technological
system
Socio-cultural
Legal System System
The Business
The Societal Environment of the Business
Business Finance
Financial System
Societal environment or regional level is
principally responsible for the flow of money or
funds from the lender to the borrower
This controls, regulates, and facilitates the

saving, borrowing, lending, and investing
activities happening among the different
players in the system.
There is no standard structure of a financial system

that operates in the world – varies among countries
and business organizations.
Business Finance
What is FINANCE?
is the study of how individuals or business
evaluate investment opportunities, business
FINANCE proposals, and business projects, and raise
capital to fund them.
Means the efficient and effective

management of funds through
FINANCIAL MANAGEMENT better understanding and applying
financial management tools,
concepts and theories.
Funds are important to any business for starting,

sustaining, or expanding operations, it helps to
understand how funds are raised.
Thus, you have to understand banks, nonbanks, other
financing companies, and their vital role in raising funds.
Business Finance
ACTIVITY #1
TELL ME WHAT TO DO
Rubric
Comm. Skill 10
Accuracy 10
Illustration 10
Total 30
Business Finance
Financial Institutions and the Key Individuals who play Vital Roles
Financial Institution
Evaluation of investment
Financial Institution
Lends funds 2
1 Business
Depositor Borrower Project
4 3
Financial Institution Financial Institution

Pays interest Return of investment
The role of financial institutions in the money flow
Business Finance
The main role of Financial Institution is to act as financial
intermediary. It means to be in middle, to be go-between or
link between the depositors who have the money and the
borrowers who need the money.
Financial Management is the handling of all financial matters,
including analyzing financial statements, evaluating
investment opportunities which happens before one actually
starts investing, and raising capital or funds from different
sources.
The Key Individual Roles

The Depositor who has the funds
The depositor is the person who has the money and deposits
it in a saving account with a bank that pools this together
with the savings from other depositors.
Business Finance
The Borrower who needs the funds
The borrower is the party at other end. He is the small business

owner. He is the one who needs the funds and borrows the funds
through a bank.
a start-up (new business) venture;

an expansion, i.e., a purchase of equipments
equity in an on-going business concern; and
investing in financial instrument (such as money market

placements, treasury notes, corporate notes, corporate
bonds, government bonds, local stocks, and foreign stocks).
Business Finance
1.2 FINANCIAL
INSTRUMENTS
and
FINANCIAL
MARKETS
Business Finance
Financial Institutions include banks and non-banks. These are
your commercial banks, universal banks, investment banks,
investment companies, life and nonlife insurance companies,
mutual fund companies, and private equity firms.
Financial Instruments are the tools that help a business’ daily

operations, and eventually make it grow. These tools help the
finance manager handle his cash, his short term operating
requirements and his short-term business requirements.
These are assets or even packages of capital that can be traded.
These assets can be cash, a contractual right to deliver or
receive cash or another type of financial instrument, or
evidence of one’s ownership.
FI can be real or virtual documents representing a legal

agreement involving any kind of monetary value. Equity-based
financial instruments and debt-based financial instrument.
Business Finance
Money market instruments are an inexpensive ways for
government and financial institutions to raise funds. Funds are
usually available for short term period of time; therefore, their
rates are generally lower than funds which are available for use
over longer periods of time.
The short-term debts and securities sold in on the money

markets – which are known as money market instruments –
have maturities.
including treasury bills, commercial paper, deposits, and

certificates of deposit.
Business Finance
Financial Instrument Basic Characteristics
Money market debt:
• issued by the treasury/government
Treasury bills • matures w/ one year
• is generally default-free as government will exert all
effort to pay
Commercial paper • issued by financially sound businesses to fund
investments in inventories and receivables
• maturity is about 9 mos.
• generally low default risk as businesses have good credit
standing
Money market funds • issued by banks or mutual fund companies
• no specific maturity date
•the degree of default risk is very low
• these funds are usually invested in money market
instruments, treasuries and commercial papers.
Consumer credit, • issued by banks, credit unions, finance companies
credit card debt • maturity date varies
• default risk varies
Different money markets instruments and their characteristics
Business Finance
Long term debts are also available to the borrower for his business
needs. The interest rate is higher than money market instruments
and usually locked in over the entire life of the debt.
Bond is 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 is a security that has no longer term than a money

market instrument, but shorter term than a bond.
In the Philippines, notes are long-term debt securities,

while in the United States, they are medium term debt
securities.
To the investor, long-term fixed income securities can generate

recurring income that he can depend on. Returns on these types
of securities tend to be higher than your money market
instruments.
Business Finance
Financial Instrument Basic Characteristics
Long-term debt:
• issued by the government
Treasury notes and • notes mature in two, five, or ten years
bonds • bonds mature longer (ten years or 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 markets rise
Federal agency debt • US type of long-term debt and not applicable in the
Philippine setting
• issued by federal agencies and is similar to treasuries
• has long-term maturity (30 years)
• has low default risk
Municipal bonds, local • issued by the local governments
government bonds • matures longer (30 years)
• more risky than government securities
Corporate bonds • issued by corporations
• matures in 40 years, some bonds like Walt Disney and
Coca-Cola have issued 100-year bonds.
• more risky than government securities and rely on the
financial soundness of the company.
Financial instruments and their characteristics
Business Finance
Stock is a type of security that signifies ownership in a corporation
and represents a claim on the part of the corporation’s assets and
earnings.
Preferred and common stocks are financial instruments businesses
can use to raise funds for their long-term requirements. Should
your business expand, you can issue preferred and common stock
to potential investors.
Financial instruments Basic Characteristics

Preferred stock • issued by corporations in exchange for
units of ownership
• has no maturity date
• 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”
Business Finance
Financial instruments Basic Characteristics
Common stock • units of ownership in a public corporation
• pays dividends when declared
• owners are entitled to vote on the selection
of directors and other important matters
• in the event if a corporate liquidation,
claims of preferred stock holders take
precedence over common stockholders
• for the most part, common stockholders
enjoy potential profits from the capital
appreciation of their stock.
Business Finance
1.3 FINANCIAL
INSTITUTIONS
and
FINANCIAL
SERVICES
Business Finance
Financial Institutions support nation building
Different types of financial institutions

Financial institutions help in funding important government
projects and extend advisory services to help the nation
building. A financial institution can be a bank or nonbank.
Depository Institutions are financial institutions that accept

deposits (savings, current, and time deposits) from individuals and
corporate entities, extend loans to borrowers, transfer funds, and
manage funds for investment purposes.
Banks. These are institutions authorized to operate and regulated

by BSP under the General Banking Law of 2000. They accept
deposits and bill payment, provide loans, and facilitate the transfer
of funds domestically or abroad.
Business Finance
Under BSP Circular No. 271, the major classifications of banks
operating in the Philippines are as follows:
1. Thrift banks
Thrift banks are deposit-taking financial institutions that also

extend credit to the consumer market. Thrift banks usually cater
to the countryside or rural areas as compared to commercial
banks which focus mainly on the top companies located in the
major cities.
i.e Allied Savings Bank, Asiatrust Development Bank, BPI Family

Savings Bank, Express Savings Bank, Inc, LBC Development Bank,
Farmers Savings and Loan Bank, Inc, Pacific Ace Savings Bank,
Philippine Postal Savings Bank, Philippine Savings Bank.
Business Finance
2. Commercial banks
Commercial banks are mainly deposit-taking financial institutions
that extend credit to the retail and consumer market. They deal
with “mom and pop stores” and their transactions are usually
many but small, denominated in the local currency.
Commercial banks also lend the money of the savers/depositors
to small medium enterprise that will pay them an interest regularly
in exchange for the use of their funds. The spread between the
rates paid to the depositors and the rate received by the bank
from the borrower will be paid to banking costs which will include
employee, salaries, office rent, electricity, and other business
costs.
i.e Bank of the Philippine Island, Citibank Philippines, Land Bank
of the Philippines, Standard Chartered, Philippine National Bank,
Philippine Commercial International Bank, Unionbank of the
Philippines, United Coconut Planters Bank, Urban Bank,
Metropolitan Bank and Trust Company.
Business Finance
3. Universal banks
Universal banks lends to multinational companies or companies

with global presence. Their transactions are larger than
commercial banking transactions and are denominated in
multicurrency and not just limited to the local currency.
Universal banks are like commercial banks except that their

clientele are mostly the larger corporations. They are usually
multinationals, unlike the retail clientele of the commercial
banks.
Universal banks offer an expanded line of financial services due
to an expanded license to engage with clients.
i.e BDO Unibank, Inc, Metropolitan Bank and Trust Company,
Bank of the Philippine Island, PNB, Development Bank of the
Philippines, China Banking Corporation, Rizal Commercial
Banking Corporation, Union Bank of the Philippines, Security
Bank Corporation, UCPB, SHBC, East West Banking Corporation,
Standard Chartered Bank, Asia United Bank Corporation.
Business Finance
4. Investment banks
Investment banks are known to successfully raise funds for
big corporations and governments. They deal with the “ big
ticket items” and are able to raise funds from the “investing
public” through bond issuances and initial public offerings.
Investment banks also lend or provide funding to businesses

but in a somewhat more creative manner and more specialized
than the commercial banks. They will raise funds from what is
called the investing public or the man on the street – you and
me.
a. Identify the business who needs the financing.
b. They will talk and negotiate with the business on the
following:
amount that needs to be raised;
in what denominations to use;
How much investment rate to pay the investing public?;
How much fee to charge for putting all the funding raising and
lending together?
Business Finance
c. Once in agreement, they will execute the fund raising.
d. Monitor the financial soundness and viability of the issuer.
e. Monitor payments to investors.
i.e Allied Bank Corporation, China Banking Corporation,
Chinatrust Commercial Bank, East West Bank, Australia and
New Zealand Banking Group, Banco de Oro Universal Bank,
Bank of China, Hongkong and Shanghai Banking Corporation,
Metropolitan Bank and Trust Company, Philtrust Bank,
Philippine National Bank.
5. Rural Bank and Cooperative Bank
Rural and cooperative banks are organized and operating in
rural areas. They are intended to promote and expand the rural
economy by providing the people with basic financial services.
Their primary targets markets are farmers who need financial

help in the production and marketing of agricultural products.
They are also engaged in micro financing to assist small
individual entrepreneurs.
Business Finance
Rural banks are privately owned and managed while
cooperative banks are organized and owned by cooperatives or
a federation of cooperatives.
6. Islamic Bank
This has been created and organized under R.A No.6848, aims
to promote and accelerate the socio-economic development of
Autonomous Region of Muslim Mindanao by performing
banking, financing, and investment operations and to establish
and participate in agricultural, commercial, and industrial
ventures based on the Islamic concept of banking.
The nonbanks that lend or raise funds for businesses are the
following:
1. Leasing Companies
Leasing companies are not banks and are not governed by
the central banks. Yet leasing companies also extend credit
or financing to companies that need it for their projects.
Business Finance
i.e South Asialink Credit Corporation (MBL-SAU), Avis Rent a Car,
Rizal Commercial Banking Corporation, Asialink Finance
Corporation, BERTHAPHIL, Inc., Megaworld Corporation,
Philippine National Construction Corporation.
2. Investment Companies
Investment companies are regulated by the Securities and
Exchange Commission (SEC) and perform similar functions as
banks in the sense that they can provide funding to companies
or raise funds through bond issuances or initial public offerings.
i.e MSU II TNational Multi Purpose Cooperative, OSG Global

Consulting, Inc., Caritas Financial Plans, Inc., RE/MAX Asyenda
Realty.
Business Finance
3. Mutual Funds
Mutual Funds are collective investments or funds of small
investors pooled together and managed to be able to reach
maximum returns. Mutual Funds, though small individually, are
big collectively. In the US, mutual funds amount to billions of
dollars in value put together.
A type of investment in which the money of many people is used

to buy stock from many different companies.
An open-end investment company that invests money of its

shareholders in a usually diversified group of securities of other
corporations.
Business Finance
4. Insurance Companies
Insurance companies sell insurance coverage to provide
guarantee of compensation of specified death, illness, accident,
loss, or damage of property in return for payment of a premium.
Insurance companies sell life and nonlife insurance products.
This nonbank financial institution’s role is to offer security and
stability during times of death of a loved one, loss of property,
other business risks, or uncertainty.
5. Private equity funds
Private equity funds are not regulated by government or any
regulatory body. They are funds managed by private fund
managers and private investors and hence, the owners are able
to invest more aggressively in the financial markets.
Private equity funds finance businesses and projects. In UK, there
are lot of private equity funds to invest in because the
investment market is more mature than in the Philippines.
i.e. Eastgate Capital Partners, Inc; First Metro Investment
Corporation; Investment & Capital Corporation of the Philippines
Business Finance
1.4 FINANCIAL
INSTRUMENTS
COMPARED
and
CONTRASTED
Business Finance
Commercial Paper
Commercial Papers are mainly borrowings of corporations
usually with good credit standing.
Fund raised through commercial paper borrowing are used to
finance inventories and receivables.
Means that while inventories are not yet sold or not yet
converted into cash, corporations resort to financing by
issuing commercial papers.
Also, while not yet receiving payments in cash, companies
survive through commercial paper financing.
Commercial papers mature in about 9 months and, hence, are
short-term compared to notes and bonds.
Their credit risk or the chance of them not paying is also
lower as these are borrowings of companies with sound
financial statements, and moreover, because maturity is
shorter.
Business Finance
Treasury notes
Notes are borrowings of governments.

When governments embark on long-term infrastructure
projects, for example, to ensure the viability of businesses,
building new roads and bridges, they borrow by issuing notes.
Notes have very long-term maturity, which means that
governments have more time to before they pay back the
financial institution.
The maturity of notes may extend up to ten years.
Their credit risk is low because governments have better
resources than corporations given their more predictable
revenues through taxes.
Governments usually exhaust all avenues before defaulting on
an obligation.
Business Finance
Government and Corporate Bonds
Bonds are borrowing of government or corporations.

Like notes, bonds are issued to finance very long-term
projects of governments or corporations.
For corporations, these projects may be capital intensive
projects like building a new factory or financing a new
manufacturing plant.
Bonds have a longer maturity compared to notes; some may
even take up to 30 or 40 years to mature.
Bonds’ prices are inversely related to the prevailing interest
rate in the market.
When market rates move up, they become more attractive
investments than notes, hence investors sell their bonds to
move to the market. This behavior of selling bonds causes
bond prices to go down.
Business Finance
Stocks
Stocks are shares issued by businesses.

They raise funds by selling part of their companies to potential
stock investors.
Stock investors become part owners of corporations.
Stock investors are part owners.
Because stock investors are part owners of business, they have
a say on who will be the leaders of their business by voting for
their Board of Directors.
Also, through voting, they will have a say on other important
matters that shape the business.
Business Finance
Stock investors benefit from growth potential.
Stock investors also benefit from investing in businesses that

have growth potential.
As businesses grow in sales, revenues and profits grow as well
over the years.
Their intrinsic value increases.
The value of the shares of the businesses also increases in
value.
The stockholder benefits from this increase in the value of the
shares of the company.
His investment in the shares of stock increase in value, he
experiences capital appreciation.
Business Finance
Stock investors receive cash
When businesses are successful, they share their wealth to
their stockholders for supporting them throughout the years.
They do this by either declaring stock dividend or cash
dividends.
Stock investors receive cash from cash dividends, or additional
shares in business through stock dividends which they
eventually can liquidate or encash.
Mutual Funds/Investment Funds
Financial markets are platform where financial instruments are

offered, bought, and sold.
In simple terms, it is where you can find the financial
instruments like money market instruments, notes, and bonds
that you need to manage your business daily, and the financial
instruments you need to grow your business exponentially.
Business Finance
Mutual funds or investment funds are pooled investments.
They are investments of small investors pooled together and
managed collectively to afford investment outlets in the bigger
global landscape.
Mutual funds are invested in money market instruments, notes,
bonds and stocks.
They finance important projects of large corporations and
governments.
They move global financial markets and though are small
individually, they are very important collectively.
In the US, mutual funds amount to trillions of dollars in value.
They are measured on a net asset value per unit. As each unit
increases in value, so does the value of the ownership of
mutual fund owner.
Business Finance
1.5 THE FLOW OF
MONEY and the
ROLE OF THE
FINANCIAL
MANAGER
Business Finance
The goal of finance is to maximize profit.
The financial manager invests the borrowed money in projects
that are worthwhile.
The borrower invest it in a new business venture, or a new
manufacturing plant.
He can invest it to expand his already thriving business
because he has dreams of a bigger enterprise.
He invests this money to train his people to continue servicing
his customers and to continue performing an excellent job.
Business Finance
Goals of this endeavor:
Aims to make money work for him, to make money grow, and
to make his business earn profits so that,
He can pay his employees and in turn, his employees can feed
their families and send their children to school;
He can pay the rent or amortization of his office property;
He can pay his creditors the interest from the borrowed
money; and
He can reinvest some of the profits to the business, thereby,
sustaining all who depend on it.
Business Finance
What is a worthwhile business?
Worthwhile business is a business worth giving your time and

attention because it achieves the goal of financial soundness,
liquidity, profitability, and nation building.
The role of financial manager is to ensure that the entire flow

of money happens and is completed up to the payments of
interest on the borrowed loan after money is invested in a
worthwhile business.
Business Finance
Before credit is extended, there is an evaluation of the business done
to ensure that the money borrowed is paid back on time.
EVALUATION OF THE BUSINESS

Measuring Liquidity
Will the business/project/investment be liquid?
Are regular cash flows expected?
Will debts be paid on time?
Identifying Capital Structure
How was the business funded: 50% financed through debts and
50% financed through owners’ capital?
Asset Management Efficiency

Is the business efficient? Does it use all assets (inventory, plant,
and equipment) efficiently to generate sales and revenues?
Measuring Profitability
Is the business profitable?
Are revenues growing faster than costs?
Business Finance
End
of
Chapter 1

Chapter 1 Intro To Financial MNGT

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Chapter 1 Intro To Financial MNGT

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1.

The Societal Environment of the Business

This controls, regulates, and facilitates the

There is no standard structure of a financial system

Means the efficient and effective

Funds are important to any business for starting,

Financial Institution Financial Institution

The role of financial institutions in the money flow

The Key Individual Roles

The borrower is the party at other end. He is the small business

a start-up (new business) venture;

equity in an on-going business concern; and

investing in financial instrument (such as money market

Financial Instruments are the tools that help a business’ daily

FI can be real or virtual documents representing a legal

The short-term debts and securities sold in on the money

including treasury bills, commercial paper, deposits, and

Different money markets instruments and their characteristics

Bond is a security that represents the debt of a

Note is a security that has no longer term than a money

In the Philippines, notes are long-term debt securities,

To the investor, long-term fixed income securities can generate

Financial instruments Basic Characteristics

Different types of financial institutions

Depository Institutions are financial institutions that accept

Banks. These are institutions authorized to operate and regulated

Thrift banks are deposit-taking financial institutions that also

i.e Allied Savings Bank, Asiatrust Development Bank, BPI Family

Universal banks lends to multinational companies or companies

Universal banks are like commercial banks except that their

Investment banks also lend or provide funding to businesses

Their primary targets markets are farmers who need financial

i.e MSU II TNational Multi Purpose Cooperative, OSG Global

A type of investment in which the money of many people is used

An open-end investment company that invests money of its

Notes are borrowings of governments.

Bonds are borrowing of government or corporations.

Stocks are shares issued by businesses.

Stock investors also benefit from investing in businesses that

Financial markets are platform where financial instruments are

Worthwhile business is a business worth giving your time and

The role of financial manager is to ensure that the entire flow

EVALUATION OF THE BUSINESS

Asset Management Efficiency

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