LEARNING OUTCOME/COMPETENCIES

The learners…
 Know the advantages and disadvantages of using debt and equity financing.
 Distinguish the different sources and uses of funds available in the Philippines and their applicability in
different situations

MODULE 9: Sources & Uses of Short-Term & Long-term Funds Pt. 1

I. Instruction on the Proper use of this module:

1. Follow closely the instruction in every activity.
2. Be honest in answering and checking your exercises.
3. Answer the pre-test before going over the materials. This is to find out what you already know.
4. Answer the exercises encountered at the end of every lesson.
5. Review the lesson that you think you failed to understand.
6. Seek assistance from your teacher if you need help.

II. Introduction
Equity financing also has costs that may be more expensive than the cost of debt. Why?
Because there is no guaranty on the returns. Even if the cost of equity is more expensive, companies
still utilize equity due to its benefits such as no maturity, and other advantages which will be further
discussed.
1. Definitions
•Debt Financing - borrowing money from lenders and not giving up ownership.
•Equity Financing - the method of raising capital by selling company stock to investors (stockholders)
in exchange of ownership interests in the company.

Table 1: Comparison of Advantages and Disadvantages of Debt Financing vs. Equity Financing

2. Differentiate long-term and short-term financing.

Short term financing is debt scheduled to be paid within a year while long-term financing is debt
to be paid in more than a year.

3. Recap on liquidity risks and liquidity ratios.

 Liquidity risk typically refers to the inability of an investor to buy or sell an asset to avoid financial
loss. It can also refer to the inability to meet obligations since assets are tied up with investments or
inventory.
Ratios such as the current ratio and quick ratio measure the institution’s liquidity. There should be
a balance between liquid funds and investments.

4. Sources and uses of short-term funds

• Suppliers Credit – refers to the extension of payment due date by suppliers.

• Advances from stockholders or other owners – personal funds advanced by a stockholder to a

company that usually requires interest. These usually require little to no interest on advances,
especially if the owner is advancing funds to assist the company in sudden liquidity crisis. This
source, however, is depended on the availability of funds of an individual.

• Credit cooperatives – provided lending services to its members. Members usually pay
contributions to the cooperative.

• Banks – provides several loan products catering to different types of needs.

• Credit Cards – just take note of the high interest rates on this source of funds.

• Lending Companies – companies that are dedicated to lending. They usually charge higher
interest than banks but their credit requirements are more lenient compared to banks.

• Pawnshops – provides funds in exchange for collateral, usually jewelry, or other items of value.

• Informal lending sources (5/6)

• Describe the actual interest paid for this type of lending
• Interest is usually paid per month, and monthly interest is (6-5)/5 or 20%. Annual
interest is actually 20%*12 or 240%.

5. Factors considered in selecting the source of short-term financing

a. Cost (Interest)
- Informal lending sources like 5/6 may be the most expensive.
b. Availability of short-term funds
- Informal lending sources like 5/6 is most available because there are no formal
requirements to avail of the facility.
c. Risk
- Whatever the source of fund is, if the company defaults, the lenders may foreclose some of
the company’s properties or even the entire business itself to settle the loan.
d. Flexibility
- This pertains to the ability of the company to access funds.
- for example, a bank loan may be cheaper but the bank may reject the loan application of the
borrower because he/she did not pass the credit evaluation process of the bank.
- This financial flexibility can be influenced by:
• Nature of the Company’s business
• Leverage ratio
• Stability of operating cash flows
e. Restrictions (Debt covenants)
• Some lenders like banks may require a minimum deposit balance with their branch for as
long as the loans remain outstanding.
• The bank’s approval may also be secured before cash dividends can be declared.
1. Sources and uses of long-term funds
• Equity investors – these are the individuals/corporations which are issued common stock. They
share in the ownership of the company. There are also equity investors who do not have voting rights
in the company but have a share in dividends, usually a fixed percentage. These investors are issued
preferred stock. Holders of preferred shares are first to receive dividends than common stock holders.
• Internally generated funds – not all profits are distributed to stockholders. Most of the profits are
re-invested and used by companies to finance their needs.
• Banks – they provide long-term loans, depending on the nature of the need. For example, a 5-year
to 10-year loan may be granted if the purpose of the loan is construction of an office building.
• Bonds – these are debt investments where an investor loans money to an entity which borrows the
funds.
• Lending companies – they can also provide long-term loans.

III. WHAT CAN I DO?

Direction: Write your answers on a separate sheet

1. Identify whether the following need/activity below are short-term or long-term sources of financing.
2. Provide scenarios and let them decide whether long-term or short-term financing is needed. Write it in
a piece of paper.

.
3. Why is it important to distinguish between long-term or short term financing?’

B. ESSAY
1. What are the advantages and disadvantages of long term debt financing? Give at least 3. Explain.
2. What are the advantages and disadvantages of equity financing? Give at least 3. Explain.
3. Identify the different sources of short-term funds and long-term funds. Give at least 3 and define.
4. Discuss when to use short-term funds in business.
5. Discuss when to use long-term funds in business.

BIBLIOGRAPHY

Business Finance TG pdf

edoc.site.com
LEARNING OUTCOME/COMPETENCIES
The learners…
 Know the advantages and disadvantages of using debt and equity financing.
 Distinguish the different sources and uses of funds available in the Philippines and their applicability in
different situations

MODULE 10: Sources & Uses of Short-Term & Long-term Funds Pt. 2
I. Instruction on the Proper use of this module:
1. Follow closely the instruction in every activity.
2. Be honest in answering and checking your exercises.
3. Answer the pre-test before going over the materials. This is to find out what you already know.
4. Answer the exercises encountered at the end of every lesson.
5. Review the lesson that you think you failed to understand.
6. Seek assistance from your teacher if you need help.

II. Introduction
Equity financing also has costs that may be more expensive than the cost of debt. Why?
Because there is no guaranty on the returns. Even if the cost of equity is more expensive, companies
still utilize equity due to its benefits such as no maturity, and other advantages which will be further
discussed.

1. The usual loan products from banks that people encounter are.
• Sample Responses
• Auto-Loan
• Housing Loan
• Credit Card loan
• Working Capital Loan, etc.
2. Importance of Know-Your-Customer (KYC) initiatives. Banks are required to verify the identity of
their customers to ensure that the funds will not be used for illegal activities such as, but not limited
to, money laundering and terrorist financing.
2. Explain the 5C’s of Credit - the institution’s primary consideration in approving loan applications.

• Character –the willingness of the borrower to repay the loan

• Capacity – a customer’s ability to generate cash flows
• Collateral – security pledged for payment of the loan
• Capital – a customer’s financial resources
• Condition – current economic or business conditions
(Show some examples/case)

3. Duties of the Borrower to Creditors.

a. Pay the creditors based on the payment schedule agreed upon. If you cannot pay on time, notify
the creditors ahead of time. But as much as possible, pay on time.
b. Provide the collaterals as agreed upon in the loan negotiation with proper documentation, if
necessary and if applicable (e.g. annotation of the TCT or CCT). Ensure that these collaterals are
in the physical condition perceived by the creditors in determining the loanable value of the
loans.
c. Comply with the provisions of loan covenant such as maintaining certain liquidity and leverage
ratios. These conditions are supposed to benefit the borrower so that his company will not be
over-exposed to borrowing or he will monitor the liquidity position on a more regular basis.
 d. Notify the creditor if the company is acquiring another company or the company is now the
subject of acquisition. The interest of creditors may be jeopardized if new owners take over the
company or if the company is going to acquire another company.
e. Do not default on the loans as much as possible. Aside from the creditors, there may be other
parties such as the guarantors of the loan who will be put at a disadvantage if the borrower
defaults.

III. WHAT CAN I DO?

Direction: Write your answers on a separate sheet

1. Mr. Joe Salazar applied for a PHP1.5 million loan in behalf of his business, “Joe’s
Restaurant”, for additional capital in 2015. He is the Chairman of the Board of Joe’s Restaurant. In their
meeting, the Board decided to open an additional branch for the restaurant. Joe’s Restaurant currently
has 3 branches in Metro Manila and would like to open up a small branch in Quezon City. Joe’s
Restaurant has been in the business for 12 fruitful years and has been a previous borrower of the bank.
The company had previous late payments before but the reasons are usually justifiable, and the balance
of the loan, along with any penalties, if any, is paid. The three branches earn a net income of
PHP900,000/ year. The lot where the main restaurant is located is pledged as collateral to the bank.
This property is valued at PHP2 million. Shown below is an excerpt from Joe’s Restaurant’s 2014
consolidated audited financial statements.

Identify the information to be used in analyzing the 5C’s of Credit

a. Character: ___________________________
b. Capacity: ____________________________
c. Collateral: ___________________________
d. Capital: _____________________________
e. Condition: ___________________________
LEARNING OUTCOME/COMPETENCIES
The learners…
 Know the advantages and disadvantages of using debt and equity financing.
 Distinguish the different sources and uses of funds available in the Philippines and their applicability in
different situations

MODULE 11: Basic Long-term Financial Concepts

I. Class Activity
Direction: Kindly write your answer on a separate paper. Kindly put your Name, year and block, Subject,
Module # and Date.

a. Share one or two of your experiences in investing your money.

b. One day, the Master was going on a trip and decided to entrust his wealth to three of his most
trusted servants. The wealth shall be given to each servant based on the Master’s assessment
of their talents. To his first servant, he entrusted PHP500,000. To his second servant,
believing that he can make wise choices as well, he also gave an amount of PHP500,000.
Finally, he called on his third servant and gave him PHP500,000. The Master then went on his
journey and told the servants he will not be back for a long time. Since the first servant was a
very smart person, he decided to invest the PHP500,000 given to him. He was very pleased
that he was quoted a long-term investment for 5 years at 8% per annum compounded
annually, and decided to invest the money in that institution. The second servant saw what
the first servant did and also decided to invest the money. However, when given the choice by
the investment firm, he did not understand simple and compound interest. In the end, he
accepted the quote at 8% per annum simple interest. The third servant saw them and thought
that they were being too much of a risk-taker and decided just to keep the money locked in a
vault in his home. The Master returned after 5 years. He then called on the servants and
asked them what has become of the wealth he had entrusted them. The first servant
presented his PHP500,000 plus the interest he earned worth PHP500,000 x (1.08)5 – 500,000
= 234,664.04 . The second servant presented his PHP500,000 along with the interest earned
at 500,000 x .08 x 5 = 200,000 Lastly the third servant returned his PHP500,000.

Which servant will make the Master most pleased?

II. Instruction on the Proper use of this module:
1. Follow closely the instruction in every activity.
2. Be honest in answering and checking your exercises.
3. Answer the pre-test before going over the materials. This is to find out what you already know.
4. Answer the exercises encountered at the end of every lesson.
5. Review the lesson that you think you failed to understand.
6. Seek assistance from your teacher if you need help.

III. Introduction
Equity financing also has costs that may be more expensive than the cost of debt. Why?
Because there is no guaranty on the returns. Even if the cost of equity is more expensive, companies
 still utilize equity due to its benefits such as no maturity, and other advantages which will be further
discussed.

1. Differentiate simple and compounded interest.

• Simple Interest – the charging interest rate r based on a principal P over T number of years.

Interest = P x r x T

In the story above,

Principal = PHP500,000
Rate = 8% Time = 5 years

Thus,

Interest = 500,000 x .08 x 5 = PHP200,000

• Compound Interest - the interest in the first compounding period is added on the principal, which
will then be the basis for the interest to be computed for the next period. So in our earlier example,
the interest to be earned on the first year is equal to 500,000 x .08 = 40,000. The 40,000 interest will
be added to the 500,000 principal which will then be the basis for interest computation for the
second year; 540,000 x .08 = 43,200, and so on. The formula below shows the summary of the
effects of adding on the interest, where m is the compounding frequency.

In the story above,

Principal = PHP500,000
Rate = 8% Time = 5 years
Compounding frequency = annually

Thus,

Interest = 500,000 x (1 + (0.08/1))(5x1) – 500,000 = PHP234,664.04

2. Use of compounding frequency.

• Compounding Frequency - the number of times interest is computed on a certain principal in one
year.
• If the investment pays annually, the interest is the same as computed above since m=1.
• If the investment pays semi-annually, the total interest will be equal to:

Interest = 500,000 x (1+(0.08/2))(5x2) – 500,000 = PHP240,122.14

ACTIVITY #2

a. compute the interest earned over the 5-year term with PHP500,000 as principal using the
following compounding periods. (FOLLOW THE FORMULA ABOVE) Quarterly (m=4), Monthly (m
= 12), Semi-monthly (m= 24), Daily (m=365)
• Quarterly:
• Monthly:
• Semi-monthly:
• Daily (365 days):
2. Introduce the Effective Annual Rate (EAR).
- Both businesses and investors need to make an objective comparison of loan costs or investment
returns over different compounding periods. The effective annual rate allows this comparison
because it is the actual interest actually paid or earned. It should be distinguished from the
nominal rate, or the stated contractual rate which is the interest charged by a lender or promised
by a borrower. It does not reflect the effect of compounding frequency.

The formula for computing the EAR is as follows:

- This is very similar to the formula for computing for interest earned using compounded interest.
The only difference is that EAR only takes into consideration the actual interest for one year.

ACTIVITY # 3
Mr. Lopez wishes to find the effective annual rate for his loan in BOD bank with a 5% nominal
annual rate when interest is compounded (1) annually, (2) semi-annually, and (3) quarterly.
• For annual compounding: _____________
• For semiannual compounding: ______________
• For quarterly compounding: _____________

compute the EAR for the following:

• For monthly compounding: ___________
• For daily compounding: ____________

The effective annual rate increases with increasing compounding frequency, up to a limit that occurs
with continuous compounding, which is almost equivalent to daily compounding.

3. Differentiate future value and present value.

• Future Value - the amount to which an investment will grow after earning interest. In our previous
examples, it is the principal plus total interest earned over a stated period. So the future value of an
investment of PHP500,000.00 yielding an interest of 8% for a 5-year period compounded annually is
PHP734,664.04.
• Present Value - the amount you have to invest today if you want to have a certain amount of cash flow
in the future.

4. Differentiate the basic patterns of cash flow.

• Single Amount (Lump Sum) - a single cash outflow is made and the total receipts will be at a single
future date.

• Annuity - periodic stream of equal cash flow at equal time intervals (annually, monthly, etc.). For
example, payment for a certain item shall be for 12 equal monthly instalments of PHP1,000.
• Mixed Stream - unequal periodic cash flows that reflect no particular pattern.

5. Computation for present value and future value of annuity payments

• An annuity is a stream of equal periodic cash flows over a specified period. First, you have to
distinguish between ordinary annuity and annuity due. Ordinary annuity payments are made at the
end of each period (usually annually), while for annuity due, the cash flow occurs at the beginning of
each period. We shall first illustrate ordinary annuities.

•(Future Value of an Ordinary Annuity) The formula for computing the future value of an ordinary
annuity is as follows:

•(Present of an Ordinary Annuity) The formula for computing the present value of an ordinary
annuity is as follows:

IV. WHAT CAN I DO?

1. You deposited PHP1,500 in a bank with an interest rate of 5% for 1 year. What is the future value of
your deposit?
2. You need to save up for P1,500 in 1 year. How much should you save now if the bank offers a rate of
5% (Find the present value)
3. FNB pays 6% interest compounded semi-annually. SNB pays 6% compounded monthly. Which bank
offers the higher effective rate?

BIBLIOGRAPHY

Business Finance TG pdf

edoc.site.com