Business Finance Modules 1-4

St.
Louise de Marillac College of Sorsogon

Higher Education Department
Sorsogon City
1st Semester, S.Y 2021-2022
Program: Business Administration

Course Code & Title: Business Finance
Instructor: Ervas, Darwin F.
Name: _______________________________________________________________ Course/ Year Level: _____________________________
Module No.: 1-4

Topics: Introduction to Financial Management
Framework for Financial Decision Making
Objectives:
At the end of this module, the reader should be able to understand the following:
a. Discuss the concept, objective and significance of Financial Management
b. Identify the role of a finance manager in a business firm
c. Discuss the process of financial decision-making
Think about this!

• Who manages the household finances? Is it enough to maintain a comfortable lifestyle?
• As a student, how do you manage your own finances?
• Are you planning to start a business? Do you know how to manage its finances?
Business Finance is vitally important to the success of any business firm. Thus, everyone contemplating a career in business should be
familiar with the subject.
INTRODUCTION TO FINANCIAL MANAGEMENT
BUSINESS - an organization or enterprising entity engaged in commercial, industrial, or professional activities. Businesses can be for-profit entities
or they can be non-profit organizations that operate to fulfill a charitable mission or further a social cause. (Hayes A., July 2021,
https://www.investopedia.com/terms/b/business.asp)
St. Louise de Marillac College of Sorsogon
Sorsogon City
FINANCE - a body of facts, principles, and the theories relating to raising and using money by individuals, businesses, and governments. This
concerns both financial management of profit-oriented business organizations particularly the corporate form of business, as well as, concepts and
techniques that are applicable to individuals and to governments. Finance involves the ways people and organizations raise and allocate capital, use
monetary resources, and account for the risks involved. (Cabrera E. & Cabrera G.A., 2017, Business Finance Principles and Applications)
FINANCIAL MANAGEMENT – also referred to as managerial finance, corporate finance, and business finance, is a decision-making process
concerned with planning, acquiring and utilizing funds in a manner that achieves the firm’s desired goal.
Successfully applying finance theories helps money flow from individuals who want to improve their financial future to businesses that want to
expand the scale or scope of their operations. These exchanges lead to an expanding economy and more employment opportunities for people.
OBJECTIVE OF FINANCIAL MANAGEMENT
THE GOAL OF FINANCIAL MANAGEMENT IS TO MAXIMIZE THE CURRENT VALUE OF

OWNERSHIP IN A BUSINESS FIRM.
The above stated goal considers the fact that the residual owners in a firm are entitled only to what is left after expenses. If expenses aren’t
paid, the owners get nothing. So, if the owners are benefiting in the sense that the residual portion is growing, it must be true that everyone else is
being benefited too.
SIGNIFICANCE OF FINANCIAL MANAGEMENT
The importance of financial management is known for the following aspects:
Applicability
Any organization whether motivated with earning profit or not having cashflow requires to be viewed from the angle of financial discipline. The
principles of finance are applicable wherever there is a cash flow. Financial management is equally applicable to all forms of business like sole
traders, partnerships, and corporations. It is also applicable to nonprofit organizations like trust, societies, government organizations, public
sectors, and so forth.
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Chances of failure
A firm having latest technology, sophisticated machinery, high caliber marketing and technical experts, and so forth may still fail unless its finances
are managed on sound principles of financial management. The strength of the business lies in its financial discipline.
Return on investment
Anybody who invests his money will expect to earn a reasonable return on his investment. Financial management studies the risk-return perception
of the owners and the time value of money. The greater the time the risk associated with the expected cash flow, the greater is the rate of return.
“THE HIGHER THE RISK, THE HIGHER THE RETURN.”
ROLE OF THE FINANCE MANAGER
Financial Manager Makes Decisions

involving
Analysis and Planning Acquisition of Funds Utilization of Funds
Impact on Risk and Return
Affect the Market Value of the

Business Firm Figure 1 shows the financial
manager’s role in achieving the
Lead to Shareholder’s Wealth primary goal of the firm
Maximization
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In striving to maximize owner’s or shareholders’ wealth, the financial manager makes decisions involving planning, acquiring, and utilizing
funds which involve a set of risk-return trade-offs. These financial decisions affect the market value of the firm’s equity shares which lead to wealth
maximization.
LEGAL FORMS OF BUSINESS ORGANIZATION
Sole Proprietorship. A business owned by a single person who has complete control over business decisions. This individual owns all the firm’s
assets and is responsible for all its liabilities.
Advantages Disadvantages
Ease of entry and exit – requires no formal charter and is inexpensive Unlimited liability – the owner is liable to all business debts. Thus, the
to form or dissolve. owner’s personal assets can be claimed by the creditors.
Full ownership and control – the owner had full control, reaps all Limitations in raising capital – resources may be limited to the assets
profits and bears all losses. of the owner and growth may depend on the owner’s ability to borrow
money.
Tax savings – entire income passes directly to the owner. This may Lack of continuity – upon death or retirement of the owner, the
result in a tax advantage if the owner’s tax rate is less than the tax rate proprietorship ceases to exist
of a corporation.
Few government regulations – has the greatest freedom as compared
with any form of business organization.
Partnership. A legal arrangement in which two or more persons agree to contribute capital or services to the business and divide the profits or
losses that may be derived therefrom.
a. General Partnership – one in which each partner has unlimited liability for the debts incurred by the business.
b. Limited Partner – one containing one or more general partners and one or more limited partners.
Ease of formation – may require relatively little effort and low start-up Unlimited liability – general partners have unlimited liability for debts
costs. and litigation of the business
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Additional sources of capital – has the financial resources of several Lack of continuity – may dissolve upon the withdrawal or death of a
individuals general partner, depending on the provisions of the partnership.
Management base – has a broader management base or expertise than Difficulty of transferring ownership – it is difficult for a partner to
a sole proprietorship liquidate or transfer ownership. It varies with conditions det forth in the
partnership agreement.
Tax implication – a partnership like a proprietorship doesn’t pay any Limitations in raising capital – may have problems raising large
income taxes. The income or loss of the business is distributed among amounts of capitals because many sources of funds are available only
the partners in accordance with the partnership and each partner to corporations.
reports his or her portion whether distributed or not on personal
income tax return.
Corporation. An artificial being created by law and is a legal entity separate and distinct from its owners. This legal entity may own assets, borrow
money and engage in other business entities without directly involving the owners.
Limited liability – shareholders are liable only to the extent of their Time and cost of formation – registration of public companies with the
investment in the corporation SEC may be time-consuming and costly.
Unlimited life – continues to exist even after death of the owners Regulation – subject to greater government regulations than other
forms of business organizations
Ease in transferring ownership – shareholders can easily sell their Taxes – the complexity of the subject of taxation demands the advice
ownership interest in most corporations by selling their stock without of a qualified tax accountant.
affecting the legal form of business organizations.
Ability to raise capital – can raise capital through the sale of securities
such as bonds to investors who are lending money to the corporations
and equity securities such as common stock to investors who are the
owners.
FINANCIAL MARKET AND FINANCIAL INSTITUTIONS
A developed economies relies on financial markets and institutions for efficient transfer of funds from savers to borrowers.
Sorsogon City
FINANCIAL MARKETS
Financial markets are the meeting place for people, corporations and
institutions that either need money or have money to lend or invest. In a broad
context, the financial markets exist as a vast global network of individuals and
financial institutions that may be lenders, borrowers or owners of public companies
worldwide. Participants in the financial markets also include national, state and local
governments that are primarily borrowers of funds for highways, education, welfare
and other public activities; their markets are referred to as public financial markets.
Large corporations raise funds in the corporate financial markets.
Financial Market functions as both primary and secondary markets for debt and
equity securities.
• Primary Market – refers to original sale of securities by governments and

corporations. In a primary market transaction, the corporation or the government is
the seller and the transaction raises money for the corporation or the government.
• Secondary Market – after securities are sold to the public (institutions and individuals) they can be traded in the secondary market between
investors. Secondary market is popularly known as Stock Market or Exchange.
Stock Exchange
The stock exchange is an entity (a corporation or mutual organization) which is in the business of bringing buyers and sellers of stocks and
securities together. The purpose of stock exchange is to facilitate exchange between buyers and sellers, thus providing a market place, virtual or
real.
FINANCIAL INSTITUTIONS
Financial institutions are very important and critical to the function of a capital society. Capitalism requires the flow of capital from those with
excess funds to those with good uses for it. There are far more ideas on how to use money than there are sources of money. In other words, money
is a scarce resource and it must be able to flow to the best ideas and projects in order to maximize the benefit to the economy and to society.
Financial institutions and markets make this happen.
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Categories of Financial Institutions

1. Investment Banks. Organizations that underwrite and distribute new investment securities and help business obtain financing. They help
corporations design securities with the features that are attractive to investors. They can buy these securities from the corporation and then
resell them to savers and investors. (Examples are Goldman Sachs, Merrill Lynch)
2. Commercial banks. The traditional department store of finance serving a variety of savers and borrowers.
3. Financial services corporation. A firm that offers a wide range of financial services, including investment banking, brokerage operations,
insurance and commercial banking.
4. Credit Unions. Cooperative associations whose members are supposed to have a common bond, such as being employees of the same firm.
Credit unions often the cheapest source of funds available to individual borrowers.
5. Pension Funds. Organizations that handle retirement plans funded by corporations or government agencies for their workers. They are
administered primarily by the trust departments of commercial banks or by life insurance companies.
6. Life insurance companies. Companies whose savings in the form of annual premiums invest these funds in stocks, bonds, real estate and
mortgages; and make payments to the beneficiaries of the insured parties.
7. Mutual funds. Organizations that pool investors funds to purchase financial instruments and thus reduce risks through diversification. Money
market funds are mutual funds that invest in short-term, low-risk securities and allow investors to write checks against their accounts.
8. Exchange trade funds (ETF). Similar to regular mutual funds and are often operated by mutual fund companies. ETF buy a portfolio of stocks
of a certain type and then sell their own shares to the public.
9. Hedge funds. Similar to mutual funds because they accept money and use the funds to buy various securities, but there are some important
differences.
10. Private equity companies. Organizations that operate much like hedge funds, but rather than purchasing some of the stock of firm, private
equity players buy and then manage entire firms.
BANKING MARKET IN THE PHILIPPINES

Commercial banks and universal banks are the largest single group of financial institutions in the Philippines accounting for almost 90% of the
combined assets of the banking industry. Among their functions are:
1. Depository of funds and sources of credit
2. Accepting drafts
3. Issuing letters of credit
4. Discounting and negotiating promissory notes, drafts and bills of exchange and other evidences of debt
5. Accepting and/or creating demand deposits
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6. Receiving other types of deposits and deposit substitutes

7. Buying and selling foreign exchange
8. Accepting deposits and trust accounts from residents and non-residents
9. Maintaining deposits with foreign banks abroad, OBUs and FCDUs
10. Investing in debt and equity instruments denominated in foreign currency and other activities that may be necessary or incidental to carry
on the business of commercial banking.
Certain commercial banks, referred to as “universal banks” are also empowered to engage in the activities of an investment house (underwriting,
securities dealership and equity investment) and to invest in other industries other than those allied to the banking industry.
Other Banks
Thrift Banks – include savings and mortgage banks, private development banks, and stock savings and loan association. Savings banks serve
primarily as thrift institutions, drawing funds from household and individual savers.
Rural Banks – specialize in small loans for agricultural purposes as well as retail traders. Their main sources of funds are savings and time
deposits.
The following are government banks created for specialized purposes:

• The Development Bank of the Philippines (DBP) – established to finance development projects in such areas as agriculture, industry and
low-cost housing. It also undertakes investment banking functions.
• Landbank of the Philippines – established to assist the government in the acquisition of landed estates under the agrarian reform program.
• The Philippine Amanah Bank – established to provide financial assistance to the Muslim communities of Mindanao.
• The Opportunity Micro-Finance Bank – established to fund, monitor, service and screen Grameen-baking type development loans to
specified marginalized sectors of the Philippine society.
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FRAMEWORK FOR FINANCIAL DECISION MAKING
Corporate Governance and the Role of Directors
With larger companies, those who own the company (shareholders) are usually divorced from the day-to-day control of the business. The
shareholders employ the directors to manage the company for them. It may seem reasonable to assume that the best interests of shareholders will
guide the directors’ decisions. However, in practice this does not always occur. The directors may be more concerned with pursuing their own
interests and improving their job security and status. As a result, a conflict can occur between the interests of shareholders and the interests of
directors.
Where directors pursue their own interests at the expense of the shareholders, there is clearly a problem for the shareholders. However, it
may also be a problem for society as a whole. If shareholders feel that their funds are likely to be mismanaged, they will be reluctant to invest. Thus,
a lack of concern for shareholders can have a profound effect on the performance of individual companies and, with this, the health of the economy.
To avoid these problems, most competitive market economies have a framework of rules to help monitor and control the behaviour of directors.
These rules are usually based around three guiding principles:
a. Disclosure. Adequate and timely information about corporate performance enables investors to make informed buy-and-sell decisions
and thereby helps the market reflect the value of a corporation under present management. If the market determines that present
management is not performing, a decrease in stock [share] price will sanction management’s failure and open the way to management
change.
b. Accountability. This involves defining the roles and duties of the directors and establishing an adequate monitoring process.
c. Fairness. Directors should not be able to benefit from access to ‘inside’ information that is not available to shareholders.
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Steps in Financial Decision Making
•The decision maker should be clear what the outcome of the decision is intended to achieve. To do this, it is necessary to know
what the immediate objective is. If the decision maker does not know the desired destination, it is impossible to make a sensible
Define the
objectives
decision.
•Consideration should be given to any restrictions on freedom of action imposed by law or other forces not within the control of the
Identify possible decision maker. Good decision making requires that the horizon should constantly be surveyed for opportunities that will better
courses of enable the objectives to be achieved. This includes spotting new investment opportunities and the means to finance them.
action
•It is important to recognise what information is relevant to the decision and what is not. Often, gathering the information is time-
Assemble data consuming, and so restricting it to the relevant may well lead to considerable savings in the costs of making decision. Also, the
relevant to the presence of irrelevant information can confuse decision-makers, leading to sub-optimal decision.
decision
•This involves comparing the options by using the relevant data in such a way as to identify those courses of action that will best
Assess data & work towards the achievement of the objectives.
reach decision
•It is pointless taking time and trouble to make good decisions if no attempt is to be made to ensure that action follows the decision.
Implement the Steps should be taken to ensure, or try to ensure thay what was planned actually happens.
decision
•Good decision making requires that the effects of previous decisions are closely monitored. In practice most of the monitoring of
Monitor the financial decisions is through the accounting system, particularly the budgetary control routines.
effects of
decisions
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CONFLICT OF INTERESTS: SHAREHOLDERS VERSUS MANAGERS – THE AGENCY PROBLEM

The costs to the shareholders of managers making decisions that are not in the shareholders’ best interests, and/or of the shareholders
monitoring the managers, are known as agency costs. This is because managers act as agents of the shareholders in the management of the assets
of the business. Agency cost is a factor that arises in several areas of business finance.
There is, however, a strong sanction against managers who continually make suboptimal decisions, and that is the possibility of takeover. A
business whose share price reflects underutilization of assets is likely to become a prime target for a takeover, which might well leave the delinquent
managers without jobs. Buoyant share prices make businesses unattractive as takeover targets, so that managers have a vested interest in promoting
buoyancy, if not maximization, of share prices.
OVERVIEW
Business finance is a relatively new subject. Until the 1960s it consisted mostly of narrative accounts of decisions that had been made and
how, if identifiable, those decisions had been reached. More recently, theories of business finance have emerged and been tested so that the subject
now has a firmly based theoretical framework – a framework that stands up pretty well to testing with real-life events. In other words, the accepted
theories that attempt to explain and predict actual outcomes in business finance broadly succeed in their aim.
Business finance draws from many disciplines. Financing and investment decision making relates closely to certain aspects of economics, accounting,
law, quantitative methods and the behavioral sciences. Despite the fact that business finance draws what it finds most useful from other disciplines,
it is nonetheless a subject in its own right. Business finance is vital to the business.
Decisions on financing and investment go right to the heart of the business and its success or failure. This is because:
• such decisions often involve financial amounts that are very significant to the business concerned;
• once made, such decisions are not easy to reverse, so the business is typically committed in the long term to a particular type of finance or
to a particular investment.
Although modern business finance practice relies heavily on sound theory, we must be very clear that business finance is an intensely practical
subject, which is concerned with real-world decision making.
Assignment:
1. Review financial statement preparation, analysis and reporting.
2. Research about the published financial statements of banks posted on the BSP website.
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References:
• Eddie McLaney, Business Finance Theory and Practice 8th edition. 2009, Pearson Education Ltd.
• Cabrera, G.A & CABRERA E. (2017). Business Finance Principles and Applications 2017 Edition
• Market Business News. (August 2021). https://marketbusinessnews.com/financial-glossary/financial-market/

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St.

Louise de Marillac College of Sorsogon

Program: Business Administration

Name: _______________________________________________________________ Course/ Year Level: _____________________________

Module No.: 1-4

Think about this!

INTRODUCTION TO FINANCIAL MANAGEMENT

OBJECTIVE OF FINANCIAL MANAGEMENT

THE GOAL OF FINANCIAL MANAGEMENT IS TO MAXIMIZE THE CURRENT VALUE OF

SIGNIFICANCE OF FINANCIAL MANAGEMENT

The importance of financial management is known for the following aspects:

“THE HIGHER THE RISK, THE HIGHER THE RETURN.”

ROLE OF THE FINANCE MANAGER

Financial Manager Makes Decisions

Analysis and Planning Acquisition of Funds Utilization of Funds

Impact on Risk and Return

Affect the Market Value of the

LEGAL FORMS OF BUSINESS ORGANIZATION

FINANCIAL MARKET AND FINANCIAL INSTITUTIONS

• Primary Market – refers to original sale of securities by governments and

Categories of Financial Institutions

BANKING MARKET IN THE PHILIPPINES

6. Receiving other types of deposits and deposit substitutes

The following are government banks created for specialized purposes:

FRAMEWORK FOR FINANCIAL DECISION MAKING

Corporate Governance and the Role of Directors

Steps in Financial Decision Making

CONFLICT OF INTERESTS: SHAREHOLDERS VERSUS MANAGERS – THE AGENCY PROBLEM

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Name: ___________________________________ Course/ Year Level: _