BUSINESS FINANCE

MODULE

CHAPTER 2

INTRODUCTION TO BUSINESS FINANCE

Learning Objectives:
Remember the meaning of Business Finance
Understand the importance of Business Finance
Enumerate functions of Business Finance
Identify the Roles of Financial Manages
Enumerate the types of business organizations
Illustrate payment of dividends

A business is an entity where the skills, energy and enterprise of owners and

partners are linked with money, its sources and investment, and its success is measured by

wealth, or profit derived from the business.

Business finance involves the management of financial resources available to

the organization. It refers to money and credit employed in business. Finance

is the basic of business. It is required to purchase assets, goods, raw materials and for the

other flow of economic activities. Business finance can be defined as “The provision

of money at the time when it is needed by a business”.

ELEMENTS OF BUSINESS
 To be successful, a business, Ernest Jones (1994), must have the following elements:

First, the business entity must obtain money from the right sources and invest it in the

right places.

Second, it must continue to attain its purpose of gaining profit;

Third, cash must be available when it is needed, and its availability can be crucial in

some decision-making situations.

IMPORTANCE OF BUSINESS FINANCE

The role of finance in business is also to make sure there are enough funds to

operate and that you're spending and investing wisely. The importance of business

finance lies in its capacity to keep a business operating smoothly without running out of

cash while also securing funds for longer-term investments.

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Capital is obtained from owner’s resources, such as savings; or from intermediaries

like banks. In corporations, these sources of capital are called shared capital in corporations,

those invested by stockholders, and loan capital those provided by creditors or lenders.

When money is invested in a business it will go to: first, things that are not intended to

be sold- the fixed assets, or capital expenditure, and second, things specifically intended

to go into what is to be sold-revenue expenditure, or working capital. Third, the

investments may also used for outside areas of the business.

AREAS OF FINANCE

Finance as a discipline has three areas: financial institutions, investments and

business finance.

a. Financial institutions covers the creation of financial assets, the markets for

trading securities, and the regulations of financial markets. Financial assets

originate from investment bankers and financial intermediaries, including

commercial banks, savings and loan associations, and life insurance companies.

b. Investments is concerned with the analysis of individual assets and the

planning for well-diversified portfolios.

c. Corporate or business finance studies the role of financial manager, his

ability to meet obligations as they come due, identifying the best sources of funds,

allocating resources among available investment alternatives.

 Funds can be borrowed from financial

institutions, or contributed by investors.

Business finance’s broad areas are:

 Corporate finance deals with the management of companies.

 Financial institutions and markets; and

 Investments deciding for the best portfolio of assets.

In line with these areas of business finance, the manager has to make major financial

decisions for the business. These are financing decisions and investment decisions.

 Financing decision involve generating funds internally or from external sources.

 Investment decisions determine the real assets of a business. These assets generate

the cash flows needed to meet operating expenses, pay interest to creditors, pay taxes to

government and dividends to stockholders. Managers must also ensure that investments

are in current assets: including cash, inventories and accounts receivables.

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OTHER TERMS RELATED TO BUSINESS FINANCE

 Financial Accounting and Managerial Accounting - The primary function in

financial accounting is the preparation of financial statements, including the balance

sheet, income statement, and cash flow statements, whereas managerial accounting help

internal executives or managers in making decisions.

 Financial management is the efficient and effective management of money,

involving planning, organizing, directing and controlling activities, to attain the

objectives of the organization.

FUNCTIONS OF BUSINESS FINANCE

 Business finance is both an art and science. It is concerned with allocating the financial

resources of the company; procurement of funds needed; and the efficient and effective

utilization of these funds

 Business finance, also known as corporate finance in the business world, is responsible

for allocating resources, creating economic forecasts, reviewing opportunities for equity

and debt financing, and other functions within your organization. In general, some small

businesses may not have a large business finance department, but nonetheless will have

these functions operating throughout the company. Where the function does not exist in-

house, you might rely on advice from outside sources to make financial decisions about

your business.

Business finance functions are important in an organization. Whether the

organization operates on a daily basis, it is connected to three essential benefits: low costs,
business support and control the environment effectively. It is said that cash is king and money

is the lifeblood of an organization that wants to succeed.

When there are procedures and principles to follow in an organization the success

and growth of that organization is greatest. Business finance represents the backbone of an

organization. The entire operation may fail if information is untimely and inaccurate.

ROLES OF FINANCIAL MANAGERS

Financial managers have a major role in a company’s management. This role is

essentially the same in all companies that is, to acquire the necessary funds and to ensure that

they are used effectively. In some companies, the financial manager may not be an independent

employee, particularly for small companies where financial management may be done by the

secretary or accountant. In larger companies, this function may be done by executives described

as the financial managers. These are people directly involved in making financial decisions.
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Three decisions made by Financial Managers identified by Stephen Ross (p.4)

 Capital budgeting. This concerns the planning and managing of the firm’s long- term

investments.

 Capital structuring. This evaluates ways in which the firms obtain and manages the

long-term financing to support its long-term investments.

 Working capital management. This refers to the administration of the firm’s short-

term assets, including inventory, its short-term liabilities-such as money owed to

suppliers.

BUSINESS ORGANIZATIONS

When a business is being organized, one of the first decisions to be made concerns the

form of business ownership. The forms can be a sole proprietorship, partnership or corporation.

 Sole proprietorship is a business owned by one person, such as small service

businesses, retail stores, professional practices. This is the simplest type of entity to start

and is the latest regulated form of organization.

 Partnership is an association of two or more persons who operate a business as co-

owners by voluntary legal agreement.

a. A general partnership is where partners are liable for the

businesses’ debts. Partners share in gains or losses, and all have unlimited

liability for all partnership debts. How a partnership gains(and losses) are

divided are described in the partnership agreement or articles of partnership.

b. A limited partnership is composed of partners whose liability is limited

 to the amount of capital contributed, provided a partner plays no active role

in the business, or does not participate in its operation.

 Corporation is a legal entity whose assets and liabilities are separate from those of its

owners. Its personality is distinct from its owners. Forming a corporation involves

preparing articles of incorporation ad a set of by-laws. The board of directors or trustees

is the governing body of a corporation.

The articles of incorporation must contain a number of things, including the

corporation’s name, its intended life, its business purpose, the number of shares that can be

issued.

The by-laws are rules describing how the corporation regulates its existence; how

directors are selected, and what are the functions of each officer.

Organizing a Sole Proprietorship

 Register the business name with the Department of Trade and Industry (DTI).

 Pay the city of municipal licenses with the local government.

 Apply VAT or non-VAT number.

 Register with the Bureau of Internal Revenue (BIR) the books of accounts

(journals and ledgers), and the business forms to be used (official receipts,
 MODULE BUSINESS FINANCE

sales invoices).

Organizing a Partnership.

A provision of the Civil Code on partnership formation states that:

 Article 1771. A partnership may be constituted in any form except where immovable

property or real rights are contributed there to, in which case a public instrument shall

be necessary.

 Article 1772. Every contract of partnership having a capital of three thousand pesos or

more, in money or property, shall appear in a public instrument, which must be

recorded in the Office of the Securities and Exchange Commission.

 Article 1786. Every partner is a debtor of the partnership for whatever he may have

promised to contribute thereto.

 Article 1826. A person admitted as a partner into an existing partnership is liable for all

the obligations of the partnership arising before his admission as though he had been a

partner when such obligation were incurred, except that this liability shall be satisfied

only out of partnership property, unless there is a stipulation to the contrary.

Classification of Partnerships

A. Based on the objects of contribution or the subject matter:

 Universal partnership refers to the contribution by partner of all present

property or all profits. Universal partnership of all profits refer to all the
 profits that the partners may acquire by their industry or work during the

existence of the partnership.

 Particular partnership includes objects which are determinate things such as

their use, fruits, undertaking or the exercise of a profession or vocation.

B. Based on the liability of partners for obligations:

 A general partnership is where partners are liable for the businesses’ debts

extending to their personal property after all the partnerships assets have been

exhausted. Partners share in gains or losses, and all have unlimited liability for

all partnership debts. How a partnership gains(and losses) are divided are

described in the partnership agreement or articles of partnership.

 A limited partnership is composed of partners whose liability is limited to

the amount of capital contributed.

C. Based on their contributions:

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 Capital partner contributes money, property to the funds of the

partnership.

 Industrial partner shares work, labor or industry to the business.

 Capitalist-industrial partner contributes money or property as work or

industry as well to the capital of the partnership.

Classification of Corporation

A. Based on source of capital

 A stock corporation is an entity where capital in the form of capital stock

divided into shares. Corporate earnings may be distributed to shareholders as

dividends.

 A non-stock corporation is one where no part of its income is distributable

as dividends to members, trustees, or officers. Non- stock corporations may

be formed for charitable, religious, educational, cultural, social, civic or

similar purposes.

B. Based on the type of ownership

 A public corporation is formed or organized for the government or a

portion of the State.

 A private corporation is formed for private purpose or benefit.

C. Based on their relation to other corporation

  A parent corporation which owns controlling interest in another

corporation, by more than 50%. It has the power to directly or indirectly

elect the majority of the directors of the corporation.

 A subsidiary corporation is the investee corporation in which the parent

corporation has controlling interest.

D. Based on their country of origin

 A domestic corporation is created under the Philippine law.

 A foreign corporation is formed, organized under existing laws other

than Philippines.

E. Based on acceptable stockholders

 A close corporation is limited to selected persons members of a

family.

 A open corporation is open to any person who may intend to

become a stockholder or member of the corporation.

DIVIDENDS
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Dividends this is the amount of money or items of value received by stockholders from

his investment in a corporation. All assets and earnings of a corporation are owned by the

company and not by its stockholders which can be transferred upon declaration by the board of

directors for dividends distribution. Dividends may be classified as:

 Cash dividends paid to stockholders. Upon payment to stockholders, corporate

accounts’ retained earnings may decrease and the cash entry may also

decrease. If an entry is made upon declaration, the immediate effects would be a

decrease in retained earnings and an increase in the current liability for dividends

payable.

 Property dividend is in the form of non-cash assets of a corporation. For

example, Corporation Alpha, invested in stocks of Beta Corporation, in which Beta

Corporation distributed the stocks to its own stockholders as dividend.

 Stock dividend is in the form of stocks of the issuing corporation, such that a

corporation distributes 15% stock dividend from its 10,000 shares of capital stock

outstanding. In this case, 1,500 shares of its capital stock is the dividend, totaling to

11,500 outstanding shares.

 Scrip dividend is in the form of promissory notes indicating the kind of benefits

the stockholders shall be entitled to receive in the future.

 Bond dividend is in the form of bond issuance. (An official document in

which a government or company promises to pay back an amount of money that it

has borrowed and to pay interest for the borrowed money.)

 Liquidating dividend is declared upon dissolution of corporate operations of

return of capital to investors.

Other forms of Dividends

The cash dividend, most common type of dividend, is in the form of cash payment

made by a firm to its owners in normal course of business, usually made four times a year.

Sometimes a firm may pay an extra cash dividend, indicating that part may or may not be

repeated in the future. Special dividend, but the name usually indicates that this dividend is

viewed as a truly unusual or one-time event and won’t be repeated. Liquidating dividend is paid

when business is to be liquidated, or will be sold off. Cash dividend reduces cash and retaining

earning, except in case of liquidating dividend which may reduce paid-in capital.

Important characteristics of Dividends

1. Unless a dividend is declared by the board of directors of the company, it is not a

liability. A corporation cannot default on the undeclared dividend, bankruptcy cannot

be declared because of no dividends. Its amount and payment are decisions based on the

judgment of the board of directors.

2. The payment of dividends by the corporations is not business expense. Dividends are

not deductible for corporate tax purposes, since they are paid out of the company’s

income after taxes.

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Dividend Payment: Steps

a. Declaration date. Date on which the board of directors passes a resolution to pay a

dividends.

b. Ex-dividend date. A date (officially set at two business days before the date of

record) to establish those individuals entitled to a dividend. To make sure that checks

go to the right people, brokerage firms and stock exchange establish this date. If a

holder buys the stock before the declaration date, he is entitled to the dividend.

However, if a holder bought it on the declaration date or after, then the previous owner

will get the dividend.

c. Date of record. The date by which a holder must be on record in order to be

designated to receive a dividend.

d. Date of payment. The date that the dividend checks are mailed.

For further discussion, please refer to the link provided: Business finance
https://www.youtube.com/watch?v=vLPmjO4K3Vk
For further discussion, please refer to the link provided: Dividends
https://www.youtube.com/watch?v=wTCJfPtFvNM

Reference:

Basic Business Finance: Management Approach, 2nd ed., Ruby F. Alminar-Mutya, DBA