Bato Institute of Science and Technology

Dolho, Bato, Leyte

Business Finance
ABM 4
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Module 3 (Week 3)
Breakthrough to Financial
Management Part 3
Introduction
Finance is the life blood and nerve center of a
business, just as circulation of blood is essential in the human
body for maintaining life, finance is very essential to smooth
running of the business. It has been rightly termed as universal For example, if a company were to pay cash for
lubricant which keeps the enterprise dynamic. No business, a bond, another party is obligated to deliver a financial
whether big, medium or small can be started without an instrument for the transaction to be fully completed. One
adequate amount of finance. company is obligated to provide cash, while the other is
Right from the very beginning, i.e., conceiving an
obligated to provide the bond.
idea to business, finance is needed to promote or establish the
business, acquire fixed assets, make investigations such as Basic examples of financial instruments are
market surveys, etc., develop product, keep men and machine cheques, bonds, securities.
at work, encourage management to make progress and create There are typically three types of financial
values. Even an existing concern may require further finance instruments: cash instruments, derivative instruments,
for making improvements or expanding the business. and foreign exchange instruments.
Thus, the importance of finance cannot be over-
emphasized and the subject of business finance has become Types of Financial Instruments
utmost important both to the academicians and practicing
managers. The academicians find interest in the subject
because the subject is still in its developing stage and the
practicing managers are interested in the subject because
among the most crucial decisions of a firm are those related to
finance.

Learning Outcomes 1. Cash Instruments

At the end of this module, you should be able to:
1. Compared and contrasted the varied financial
instruments; and
2. Explained the flow of funds within an
organization – through and from the enterprise—
and the role of the financial manager.
Core Content
Lesson 5 – Varied Financial Instruments
What is a Financial Instrument?
Financial instruments are contracts for
monetary assets that can be purchased, traded, created,
modified, or settled for. In terms of contracts, there is a
contractual obligation between involved parties during a
financial instrument transaction.
Cash instruments are financial instruments with
values directly influenced by the condition of the
markets. Within cash instruments, there are two types;
securities and deposits, and loans.
✓ Securities: A security is a financial instrument
that has monetary value and is traded on the stock
market. When purchased or traded, a security
represents ownership of a part of a publicly-
traded company on the stock exchange.
✓ Deposits and Loans: Both deposits and loans are
considered cash instruments because they
represent monetary assets that have some sort of
contractual agreement between parties.
2. Derivative Instruments
Derivative instruments are financial
instruments that have values determined
from underlying assets, such as resources, currency,
bonds, stocks, and stock indexes.

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 The five most common examples of derivatives
instruments are synthetic agreements, forwards, futures,
options, and swaps.
✓ Synthetic Agreement for Foreign Exchange
(SAFE): A SAFE occurs in the over-the-counter
(OTC) market and is an agreement that
guarantees a specified exchange rate during an
agreed period of time.
✓ Forward: A forward is a contract between two
parties that involves customizable derivatives in
which the exchange occurs at the end of the
contract at a specific price.
✓ Future: A future is a derivative transaction that
provides the exchange of derivatives on a
determined future date at a predetermined
exchange rate.
✓ Options: An option is an agreement between two
parties in which the seller grants the buyer the
right to purchase or sell a certain number of
derivatives at a predetermined price for a specific
period of time.
✓ Interest Rate Swap: An interest rate swap is a
derivative agreement between two parties that
involves the swapping of interest rates where
each party agrees to pay other interest rates on
their loans in different currencies.
3. Foreign Exchange Instruments
Foreign exchange instruments are financial
instruments that are represented on the foreign market
and primarily consist of currency agreements and
derivatives.
In terms of currency agreements, they can be
broken into three categories.
✓ Spot: A currency agreement in which the actual
exchange of currency is no later than the second
working day after the original date of the
agreement. It is termed “spot” because the
currency exchange is done “on the spot” (limited
timeframe).
✓ Outright Forwards: A currency agreement in
which the actual exchange of currency is done
“forwardly” and before the actual date of the
agreed requirement. It is beneficial in cases of
fluctuating exchange rates that change often.
✓ Currency Swap: A currency swap refers to the
act of simultaneously buying and selling
currencies with different specified value dates.
Asset Classes of Financial Instruments
Beyond the types of financial instruments listed
above, financial instruments can also be categorized into
two asset classes. The two asset classes of financial
instruments are debt-based financial instruments and
equity-based financial instruments.
1. Debt-Based Financial Instruments
Debt-based financial instruments are
categorized as mechanisms that an entity can use to
increase the amount of capital in a business. Examples
include bonds, debentures, mortgages, U.S. treasuries,
credit cards, and line of credits (LOC).
They are a critical part of the business
environment because they enable corporations to
increase profitability through growth in capital.
2. Equity-Based Financial Instruments
Equity-based financial instruments are
categorized as mechanisms that serve as legal ownership
of an entity. Examples include common stock,
convertible debentures, preferred stock, and transferable
subscription rights.
They help businesses grow capital over a longer
period of time compared to debt-based but benefit in the
fact that the owner is not responsible for paying back any
sort of debt.
A business that owns an equity-based financial
instrument can choose to either invest further in the
instrument or sell it whenever they deem necessary.
Lesson 6 – Flow of Funds within an
Organization
What is flow of funds?
Flow means movement. The term movement
includes inflow and outflow. Here, flow of funds means
transfer of economic values from one asset of equity to
another. In other words, flow of funds refers to
movement of funds in the working capital.
A business transaction may bring a change in
working capital either in the form of decrease or increase.
If there is change in current assets and current liabilities
in the same direction and by the same amount, there will
be change only in their amount but no change in the
working capital. Hence, there is no flow of fund in such
type of transaction.
In simple words, there is a flow of funds if a
transaction affects:
✓ a current asset and a fixed asset or
✓ a fixed and a current liability or
✓ a current asset and a fixed liability or
✓ a fixed liability and current liability.
There is no flow of funds if the transaction assets
fixed assets and fixed liability or current assets and
current liabilities.
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 Any company, whether it’s a small-town bakery or
General Motors, needs money to operate. To make
money, it must first spend money—on inventory and
supplies, equipment and facilities, and employee wages
and salaries. Therefore, finance is critical to the success
of all companies. It may not be as visible as marketing or
production, but management of a firm’s finances is just
as much a key to the firm’s success.
Financial management—the art and science of
managing a firm’s money so that it can meet its goals—
is not just the responsibility of the finance department.
All business decisions have financial consequences.
Managers in all departments must work closely with
financial personnel. If you are a sales representative, for
example, the company’s credit and collection policies
will affect your ability to make sales. The head of the IT
department will need to justify any requests for new
computer systems or employee laptops.
Revenues from sales of the firm’s products
should be the chief source of funding. But money from
sales doesn’t always come in when it’s needed to pay the
bills. Financial managers must track how money is
flowing into and out of the firm (see (Figure)). They
work with the firm’s other department managers to
determine how available funds will be used and how
much money is needed. Then they choose the best
sources to obtain the required funding.
For example, a financial manager will track day-
to-day operational data such as cash collections and
disbursements to ensure that the company has enough
cash to meet its obligations. Over a longer time horizon,
the manager will thoroughly study whether and when the
company should open a new manufacturing facility. The
manager will also suggest the most appropriate way to
finance the project, raise the funds, and then monitor the
project’s implementation and operation.
Financial management is closely related to
accounting. In most firms, both areas are the
responsibility of the vice president of finance or CFO.
But the accountant’s main function is to collect and
present financial data. Financial managers use financial
statements and other information prepared by
accountants to make financial decisions. Financial
managers focus on cash flows, the inflows and outflows
of cash. They plan and monitor the firm’s cash flows to
ensure that cash is available when needed.
The Financial Manager’s Responsibilities and
Activities
Financial managers have a complex and
challenging job. They analyze financial data prepared by
accountants, monitor the firm’s financial status, and
prepare and implement financial plans. One day they
may be developing a better way to automate cash
collections, and the next they may be analyzing a
proposed acquisition. The key activities of the financial
manager are:
✓ Financial planning: Preparing the financial
plan, which projects revenues, expenditures, and
financing needs over a given period.
✓ Investment (spending money): Investing the
firm’s funds in projects and securities that
provide high returns in relation to their risks.
✓ Financing (raising money): Obtaining funding
for the firm’s operations and investments and
seeking the best balance between debt (borrowed
funds) and equity (funds raised through the sale
of ownership in the business).
The Goal of the Financial Manager
How can financial managers make wise planning,
investment, and financing decisions? The main goal of
the financial manager is to maximize the value of the
firm to its owners. The value of a publicly owned
corporation is measured by the share price of its stock. A
private company’s value is the price at which it could be
sold.
To maximize the firm’s value, the financial
manager has to consider both short- and long-term
consequences of the firm’s actions. Maximizing profits
is one approach, but it should not be the only one. Such
an approach favors making short-term gains over
achieving long-term goals. What if a firm in a highly
technical and competitive industry did no research and
development? In the short run, profits would be high
because research and development is very expensive.
But in the long run, the firm might lose its ability to
compete because of its lack of new products.
How Cash Flows through a Business
This is true regardless of a company’s size or
point in its life cycle. At Corning, a company founded
more than 160 years ago, management believes in taking
the long-term view and not managing for quarterly
earnings to satisfy Wall Street’s expectations. The
company, once known to consumers mostly for kitchen
products such as Corelle dinnerware and Pyrex heat-
resistant glass cookware, is today a technology company
that manufactures specialized glass and ceramic
products. It is a leading supplier of Gorilla Glass, a
special type of glass used for the screens of mobile
devices, including the iPhone, the iPad, and devices
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powered by Google’s Android operating system. The
company was also the inventor of optical fiber and cable
for the telecommunications industry. These product lines
require large investments during their long research and
development (R&D) cycles and for plant and equipment
once they go into production.
As the Corning situation demonstrates, financial
managers constantly strive for a balance between the
opportunity for profit and the potential for loss. In
finance, the opportunity for profit is termed return; the
potential for loss, or the chance that an investment will
not achieve the expected level of return, is risk. A basic
principle in finance is that the higher the risk, the greater
the return that is required. This widely accepted concept
is called the risk-return trade-off. Financial managers
consider many risks and return factors when making
investment and financing decisions. Among them are
changing patterns of market demand, interest rates,
general economic conditions, market conditions, and
social issues (such as environmental effects and equal
employment opportunity policies).
responsibilities include financial planning,
investing (spending money), and financing
(raising money). Maximizing the value of the
firm is the main goal of the financial manager,
whose decisions often have long-term effects.
Self-Assessment Questions
Posted separately as quiz assignment or assignment in your
google classroom.
References
Timbang, Ferdinand L.; “Financial Management, Part
1”;2015; C & E Publishing, Inc...
Brigham, Eugene F. and Ehrhardt, Michael C.;
“Financial Management: Theory and Practice”; 12th
Edition

https://corporatefinanceinstitute.com/resources/knowled
In-text Activity 1 ge/trading-investing/financial-instrument/
https://www.investopedia.com/terms/f/fund-flow.asp
? What is the role of financial management in a https://opentextbc.ca/businessopenstax/chapter/the-role-
firm? of-finance-and-the-financial-manager/
? How do the three key activities of the financial
manager relate?
? What is the main goal of the financial manager?
How does the risk-return trade-off relate to the
financial manager’s main goal?

ARGENE B. ABELLANOSA
Summary & Key Takeaways Instructor
❖ There are a lot of financial instruments, but each
0995-852-3831
financial instrument serves the purpose and needs
of an investor. For a risk-averse investor argene.abellanosa@gmail.com
investing in the bond market would be a better
option than investing inequities. Likewise
investing in the currency market depends on the
choice and objective of the investor. For some
businesses dealing with imports and exports
investing in currencies would be the right option.
❖ Flow of funds (FOF) are national financial
accounts that track the movement of money
among industries or sectors of the economy.
❖ Figures measuring the scale and scope of flow of
funds in a nation's economy are collected and
disseminated by the central bank for economic
analysis.
❖ Finance involves managing the firm’s money.
The financial manager must decide how much
money is needed and when, how best to use the
available funds, and how to get the required
financing. The financial manager’s