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Business Finance Q3
Business Finance Q3
Business Finance Q3
(Q3)
Subject Description: This subject deals with the fundamental principles, tools,
and techniques of the financial operation involved in the management of
business enterprises. It covers the basic framework and tools for financial
analysis and financial planning and control, and introduces basic concepts and
principles needed in making investment and financing decisions. Introduction to
investments and personal finance are also covered in the course. Using the dual-
learning approach of theory and application, each chapter and module engages
the learners to explore all stages of the learning process from knowledge,
analysis, evaluation, and application to preparation and development of financial
plans and programs suited for a small business.
Content Standards:
The learners demonstrate an understanding of:
Performance Standards:
The learners shall be able to:
1. define finance;
2. describe who are responsible for financial management within an
organization;
3. describe the primary activities of the financial manager;
4. describe how the financial manager helps in achieving the goal of the
organization;
5. describe the role of financial institutions and markets;
6. illustrate the financial planning process;
7. prepare budgets such as projected collection, sales budget, production
budget, income projected statement of comprehensive income, projected
of financial position, and projected cash flows statement;
8. describe concepts and tools in working capital management;
9. distinguish debt and equity financing;
10. identify the bank and nonbank institutions in the vicinity that are
possible sources of funds, and enumerate their requirement and
process for loan application;
11. distinguish simple and compound interest;
12. solve exercises and problems in computing for time value of
money with the aid of present and future value tables;
13. prepare loan amortization tables;
14. compute for the net present value of a project with a conventional cash-
flow pattern;
15. describe the risk-return tradeoff;
16. identify the types of investments particularly bank deposits , insurance,
real estate , hard assets, mutual funds, and stocks and bonds;
17. indicate the advantages and disadvantages of each type of investment;
18. explain the risks inherent in each type of investment;
19. identify money management philosophy; and
20. apply basic personal finance principles and practices in earning,
spending, saving, and investing money.
Subject Requirements:
Assessment Tasks
Written Works - 40%
Performance Tasks (Activity) - 60%
Quarterly Grade 100%
Introduction
Learning Outcomes
Business finance is also referred to as, managerial finance, corporate finance, and
financial management (Cabrera, 2013). The author then emphasized that financial management
is a part of a larger discipline called finance, which is a body of facts, principles, and theories
relating to raising and using money by individuals, businesses, and governments.
Mejorada (2006) defined business finance as the art and science of managing the
financial resources of a business. As such, it is concerned with the allocation, procurement, and
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efficient utilization of financial resources to enable business, attain its predetermined objectives
relative to growth, stability, profitability, and liquidity. The author added that business finance,
involves determination of the requirements for funds, making funds available at least cost and
seeing to it that funds are being used as planned to optimize operations and increase the value
of the business itself and consequently, to enable the business contribute to the economic growth
of the community and the social being of its population.
In business finance, there are individuals who are involved in maximizing shareholder’s
wealth. As illustrated in the book by Rodriguez, Yusoph, Rodriguez, and Dy (2016), the different
individuals involved are shown below:
From diagram presented above, each line is working for the interest of the person on the
line above them. Since the managers of the company are making decisions for the interest of the
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board of directors and the board of directors does the same for the interest of the shareholders,
it follows that the goal of each individual in a corporate organization should have an objective of
shareholders’ wealth maximization (Rodriguez et al., 2016).
Rodriguez et al., (2016), defined the key roles of the shareholders, board of directors,
president, and vice-president for marketing, production, administration and finance for as follows:
Shareholders:
The shareholders elect the Board of Directors (BOD). Each share held is equal to one
voting right. Since the BOD is elected by the shareholders, their responsibility is to carry out the
objectives of the shareholders otherwise; they would not have been elected in that position.
Board of Directors:
The board of directors is the highest policy making body in a corporation. The board’s
primary responsibility is to ensure that the corporation is operating to serve the best interest of
the stockholders. The following are among the responsibilities of the board of directors:
The roles of a president in a corporation may vary from one company to another.
Among the responsibilities of a president are the following:
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Performing all areas of management: planning, organizing, staffing, directing and
controlling and representing the company in professional, social, and civic activities.
VP for Marketing:
VP for Production:
VP for Administration:
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Providing assistance in payroll preparation, payment of vendors, and collection of
receivables.
Determining the location and the maximum amount of office space needed by the
company.
Identifying means, processes, or systems that will minimize the operating costs of the
company.
VP for Finance:
The four functions of a VP for finance (CFO) as cited in the book of Rodriguez et al.,
(2016) are as follows:
Financing
Financing decisions include making decisions on how to fund long term
investments (such as company expansions) and working capital which deals with the day
to day operations of the company (i.e., purchase of inventory, payment of operating
expenses, etc.)
Investing
Short term investment decisions are needed when the company is in an excess
cash position. To plan for this, the Financial Manager should be able to make use
of Financial Planning tools such as budgeting and forecasting. Moreover, the
company should choose which type of investment it should invest in that would
provide a most optimal risk and return trade off.
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Operating
Operating decisions deal with the daily operations of the company. The role
of the VP for finance is determining how to finance working capital accounts such
as accounts receivable and inventories. The company has a choice on whether to
finance working capital needs by long term or short term sources.
Dividend Policies
Some investors buy stocks because of the dividends they expect to receive
from the company. Non-declaration of dividends may disappoint these investors.
Hence, it is the role of a financial manager to determine when the company should
declare cash dividends. Before a company may be able to declare cash dividends,
two conditions must exist:
1. The company must have enough retained earnings (accumulated
profits) to support cash dividend declaration.
2. The company must have cash.
The financial system links the savers and users of funds. The concept lies on one entity
may have savings today but eventually may be needing funds in the future such as business
expansion and the like (Cayanan & Borja, 2017).
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Figure 1.1 Financial Systems
Source: Gitman (2014)
Financial Market
Financial markets are organized forums in which the suppliers and users of various
types of funds can make transactions. There are different classifications of financial market as
cited in the book of Rodriguez et al., (2016).
Primary Market - Financial market in which securities (either debt or equity) are
initially issued through a public offering or a private placement; the only market in which
the issuer is directly involved in the transaction.
Money markets are a venue wherein securities with short-term maturities (1 year
or less) are sold. They are created because some individuals, businesses,
governments, and financial institutions have temporarily idle funds that they wish to
invest in a relatively safe, interest-bearing asset. At the same time, other individuals,
businesses, governments, and financial institutions find themselves in need of
seasonal or temporary financing.
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Capital markets are a venue where in securities with longer-term maturities are
sold in Capital markets. The key capital market securities are bonds (long-term debt)
and both common stock and preferred stock (equity, or ownership).
Financial Institutions
Rodriguez et al., (2016) defined financial institutions as intermediaries that channel the
savings of individuals, businesses, and governments into loans or investments.
As cited in the book of Cayanan & Borja (2017) the examples of financial intermediaries
are banks, insurance companies, stock exchange, stock brokerage firms, mutual funds and other
financial institutions such as Government Service Insurance System (GSIS), Social Security
System (SSS), credit unions and investment banks.
Financial Instruments
Debt Instruments generally have fixed returns due to fixed interest rates. Examples of debt
Instruments as cited in the book of Rodriguez et al., (2016) are as follows:
• Treasury Bonds and Treasury Bills are issued by the Philippine government. These bonds
and bills have usually low interest rates and have very low risk of default since the government
assures that these will be paid.
• Corporate Bonds are issued by publicly listed companies. These bonds usually have higher
interest rates than Treasury bonds. However, these bonds are not risk free. If the company
which issued the bonds goes bankrupt, the holder of the bonds will no longer receive any
return from their investment and even their principal investment can be wiped out.
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Equity Instruments generally have varied returns based on the performance of the issuing
company. Returns from equity instruments come from either dividends or stock price appreciation.
The following are types of equity instruments as drawn from the book of Rodriguez et al., (2016):
• Preferred Stock has priority over a common stock in terms of claims over the assets of a
company. This means that if companies were to be liquidated and its assets have to be
distributed, no asset will be distributed to common stockholders unless all the claims of the
preferred stockholders have been given. Moreover, preferred stockholders have also priority
over common stockholders in cash dividend declaration. Dividends to preferred stockholders
are usually in a fixed rate. No cash dividends will be given to common stockholders unless all
the dividends due to preferred stockholders are paid first.
• Holders of Common Stock on the other hand are the real owners of the company. If the
company’s growth is spurring, the common stockholders will benefit on the growth. Moreover,
during a profitable period for which a company may decide to declare higher dividends,
preferred stock will receive a fixed dividend rate while common stockholders receive all the
excess.
Finance manager is one of the important role players in the field of finance function.
He must have entire knowledge in the area of accounting, finance, economics and management.
His position is highly critical and analytical to solve various problems related to finance
(Paramasivan & Subramanian, 2009). The author added that a finance manager performs the
following major functions:
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how the finance is mobilized and where it will be available. It is also highly critical in nature.
3. Investment Decision
The finance manager must carefully select best investment alternatives and consider
the reasonable and stable return from the investment. He must be well versed in the field of capital
budgeting techniques to determine the effective utilization of investment. The finance manager
must concentrate to principles of safety, liquidity and profitability while investing capital.
4. Cash Management
Present day’s cash management plays a major role in the area of finance because
proper cash management is not only essential for effective utilization of cash but it also helps to
meet the short-term liquidity position of the concern.
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Assessment Task
TASK NO. 1-1 (WRITTEN WORK)
Direction: Read and analyze each item. Circle the letter of the best answer.
1. The ______ is created by a financial relationship between suppliers and users of
short-term funds.
A. financial market
B. money market
C. stock market
D. capital market
2. Firms that require funds from external sources can obtain them from _____.
A. financial markets.
B. private placement.
C. financial institutions.
D. All of the above.
3. The major securities traded in the capital markets are ____.
A. stocks and bonds.
B. bonds and commercial paper.
C. commercial paper and Treasury bills.
D. Treasury bills and certificates of deposit.
4. The primary goal of the financial manager is _____.
A. minimizing risk.
B. maximizing profit.
C. maximizing wealth.
D. minimizing return
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5. Wealth maximization as the goal of the firm implies enhancing the wealth of
A. the Board of Directors.
B. the firm's employees.
C. the federal government.
D. the firm's stockholder
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C. financial institutions.
D. all of the above
___1. Primary and secondary markets are markets for short-term and long-term
securities, respectively.
___2. Financial markets are intermediaries that channel the savings of individuals,
businesses, and government into loans or investments.
___3. The money market involves trading of securities with maturities of one year or
less while the capital
market involves the buying and selling of securities with maturities of more than one
year.
___4. Holders of equity have claims on both income and assets that are secondary to
the claims of creditors.
___5. Business finance is also referred to as, managerial finance, corporate finance,
and financial management.
___6. The stakeholders elect the Board of Directors (BOD).
___7. Each share held is equal to one voting right.
___8.High cash flow is generally associated with a higher share price whereas higher
risk tends to result in a lower share price.
___9.When considering each financial decision alternative or possible action in terms
of its impact on the share price of the firm's stock, financial managers should accept
only those actions that are expected to increase the firm's profitability.
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___10.To achieves the goal of profit maximization for each alternative being
considered, the financial manager would select the one that is expected to result in the
highest monetary return.
___11.Dividend payments change directly with changes in earnings per share.
___12.The wealth of corporate owners is measured by the share price of the stock.
___13. Risk and the magnitude and timing of cash flows are the key determinants of
share price, which represents the wealth of the owners in the firm.
___14.When considering each financial decision alternative or possible action in terms
of its impact on the share price of the firm's stock, financial managers should accept
only those actions that are expected to maximize shareholder value.
___15.An increase in firm risk tends to result in a higher share price since the
stockholder must be compensated for the greater risk.
Given that you have excess funds, where will you invest the funds? Why? Your
choices are time deposits, corporate bonds, and stocks.
Summary
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Financial system shows the different providers and users of funds and the role of financial
intermediaries such as banks, insurance companies, and stock brokerage firms among
others.
Organizational structure covers the roles of different managers in a corporation from the
board of directors to the president and the different vice presidents. The roles of a financial
manager in operating, investing, financing, dividend policies were highlighted.
References
Cabrera, M.E., (2013) Financial Management Principles and Applications.
Conanan.
Cayanan A.S., & Borja DV.H.,. (2017). Business Finance. Rex Book Store Inc.
(RBSI).
Gitman, Lawrence J. (2014). Principles of Financial Management . New York:
Pearson.
Mejorada N.D., (2006). Business Finance and Philippine Business Firms.
Goodwill Trading Co., Inc.
Paramasivan C., & Subramanian T., (2009 ). Financial Management. New Age
International (P) Limited Publishers.
Rodriguez J.A., Yusoph A.B., Rodriguez R.A., and Dy D.C., (2016). Teaching
Guide for Senior High School Business Finance. Commission on Higher
Education.
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MODULE 2
FINANCIAL PLANNING PROCESS
Introduction
Learning Outcomes
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3. explain tools in managing cash, receivables, and inventory (ABM_BF12-
IIIc-d-12).
Financial planning refers to the process of determining the best uses of the financial
resources of an organization to attain its predetermined objectives and the procurement of the
required funds at least cost (Mejorada, 2006).
The following steps in financial planning must be followed as cited in the book of
Cayanan & Borja (2017) in order to fully achieve the goals of an organization.
1. Set goals or objectives. The authors emphasized that the goals of the company can be
divided into short- term, medium-term and long-term goals.
Short term goals can be for a year.
Medium-term goals can be between one to three years.
Long-term goals can be five or 10 years or even longer.
2. Identify resources. Resources include production capacity, human resources who will man
the operations and financial resources.
3. Identify goal-related tasks. In this step, management must figure out how to achieve an
objective.
4. Establish responsibility centers for accountability and timeline. If tasks are already
identified to achieve goals, the next important step to do is to identify which department
should be held accountable for the task.
5. Establish an evaluation system for monitoring and controlling. The management must
establish a mechanism which will allow plans to be monitored. This can be done through
quantified plans such as budgets and projected financial statements.
6. Determine contingency plans. These are alternative plans to minimize the adverse effect
on the company.
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Mejorada (2006), states that the preparation of budget estimates starts with sales
forecasting, the cornerstone in budgeting. The sales budget is then prepared based on sales
forecasts depending on the level operations at which management would want to operate. The
planned budgeted sales volume serves as the basis in determining production or purchase
volume, costs and expenses involved The types of budgets as cited in the book of Cayanan &
Borja (2017) are as follows :
1. Sales Budget
Cayanan & Borja (2017) defined sales budget as the most important financial
statement account in forecasting because all other accounts in the financial statements
are affected by sales. The authors emphasized that, the financial manager must be able
to support this figure with reasonable assumptions. They also added that following
external and internal factors should be considered in forecasting sales:
Example of External Factors
• Gross Domestic Product (GDP) growth rate
• Inflation
• Interest Rate
• Foreign Exchange Rate
• Income Tax Rates
• Developments in the industry
• Competition
• Economic Crisis
• Regulatory Environment
• Political Crisis
2. Production Budget
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A production budget provides information regarding the number of units that should
be produced over a given accounting period based on expected sales and targeted level
of ending inventories (Cayanan & Borja, 2017).
Quarter
1 2 3 4 Year
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The ending inventory level of the present quarter will be the beginning inventory
level of the next quarter.
The target level of ending inventories of the fourth quarter is the same as that
for the year while the beginning inventory of the first quarter is the same as the
beginning inventory for the year.
The required production in the fourth quarter is 28, 500 units.
3. Operating Budget
Operations budget refers to the variable and fixed costs needed to run the
operations of the company but are not directly attributable to the generation of sales
(Cayana & Borja 2017).
4. Cash Budget
The cash budget forecasts the timing of these cash outflows and matches them
with cash inflows from sales and other receipts. The cash budget is also a control tool
to monitor the way the company handles cash (Rodriguez et al., 2016).
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Collection from
two months
prior sales 60,000 66,000 75,000 84,000
Total
Collections 40,000 144,000 220,000 247,000 275,000 926,000
Assume selling price is PHP100/unit. Sales for each month are expected to be
collected as follows:
Month of sales : 20%
A month after sales: 50%
2 months after sales: 30%
2. Basis for Preparing Cash Budget – Total Payments for Purchases and Total Cash
Disbursements
Production
Budget Jan Feb March April May Total
Required
Production 2050 2200 2500 2800 3000 12550
Payment
from 150,000
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previous
month sales
Payment
from two
months prior
sales - 102,500 110,000 125,000 140,000 477,500
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Principal
Payment 20,000 20,000
Total Cash
Disbursements 53,000 157,500 148,000 321,000 193,000 872,500
If the ending cash balance after payment of all required disbursements is less
than the required ending balance, the company needs to borrow additional cash from
short term borrowings to meet its required ending balance. Should the ending cash
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balance exceed the company’s minimum cash requirement the next period, the
company may be able to repay the loan plus accrued interest.
Should the Company have excess cash above its required maintaining cash
balance, the company may invest this cash on short term investments so that it will
have an opportunity to earn additional profits. If the company’s cash balance would
then fall below its minimum cash requirement, the company may withdraw the
investment to be able to meet the required cash balance.
1. Forecast sales. In making financial projections, start with the statement of comprehensive
income. The most important account to forecast is the sales.
2. Forecast cost of sales and operating expenses. This includes whether a cost should be
classified as variable or fixed.
3. Forecast net income and retained earnings. There should be information on income taxes
and how much financing cost a company will have. Financing costs will be based on the
amount of loans the company has and the payment terms for these loans. There should
also be assumptions on the interest rates for the projection period.
4. Determine balance sheet items that will vary with sales or whose balances will be highly
correlated with sales. Examples of these accounts are, accounts receivables, inventories,
accounts payable, and accrued expenses payable.
5. Determine payment schedule for loans. Basis will be the disclosures provided in the notes
to the financial statements or the plans of management on how to pay the loans if no
details about payment terms are provided in the notes to the financial statements.
6. Determine external funds needed (EFN). This amount is more of a balancing figure or
squeeze figure. The formula for EFN will be = Change in Total Assets – (Change in Total
Liabilities + Total Change in Stockholders Equity).
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7. Determine how the external funds will be financed. Once the EFN is computed, the
management decides on how to finance it either through debt or equity or a combination
of debt and equity.
The president of ANG XHA KiT Food Corporation had instructed the Vice President for
Finance to prepare the 2015 projected financial statements based on their most recent planning
workshop. Based from the result of the planning workshop, the following assumptions were
prepared for the 2015 projected financial statements.
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New loans 3,500,000will be incurred on December 31, 2015 payable at the
rate of 500,000 every June 30 and December 31. Annual interest rate is
expected at 8%.
Other non- current assets and other current liabilities will remain unchanged.
Income tax rate is 30% of the income before taxes . Seventy-five percent of the
income tax expense will be paid in 2015 while the balance will be paid in 2016.
Cash dividends of 2,000,000 will be paid in 2015.
Cost of Sales and Sales in 2014 is 41,954,730 and 52, 501, 085 respectively.
Income before taxes on 2015 will be 3,900,875.
Projected Financial Statements of ANG XHA KIT Food Corporation as drawn from the example
in the book of Cayanan & Borja (2017).
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ANG XHA KIT Food Corporation
Projected Statement of Financial Position
December 31, 2015
2014 2015
Assets
Current Assets
Cash 1,062,527 1,166,574
Trade Receivables 2,300,500 2,529,502
Inventories 4,849,304 5,336,210
Other Current Assets 1,050,000 1,155,024
9,262,331 *10,187,311
Non-Current Assets
Property, Plant & Equipment 12,200,000 14,100,000
Other Non- Current Assets 835,689 835,689
Total Non-Current Assets 13,035,689 14,935,689
Total Assets 22,298,020 *25,123,000
Stockholder's Equity
Capital Stock 8,000,000 8,000,000
Retained Earnings 4,478,559 5,209,171
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Total Stockholder's Equity 12,478,559 13,209,171
Total Liabilities and Stockholder's Equity 22,298,020 25,123,000
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Cash Ending 686,576
Working Capital refers to the current assets used in the operations of the business.
This includes cash, accounts receivable, inventories and prepaid expenses. The amount of
resources that a company sets aside to these working capital accounts can be reduces by current
liabilities such as trade accounts payable and accrued expenses payable. The difference between
these current assets and current liabilities used in the operations of the business is net working
capital (Cayanan & Borja, 2017).
The author added that efficient management of working capital accounts can improve
the earnings of the company. This earnings can come from savings in financing costs and
minimizing possible impairment losses from inventories. Factors affecting the firm’s working
capital policy as stated in the book of Cabrera (2013) are as follows:
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Figure 2.1. Operating Cycle
Source: Rodriguez J.A., Yusoph A.B., Rodriguez R.A., and Dy D.C., (2016). Teaching
Guide for Senior High School Business Finance. Commission on Higher Education.
The types of working capital as stated in the book of Rodriguez et al., (2016) are
permanent and temporary working capital. Permanent Working Capital is the minimum level of
current assets required by a firm to carry-on its business operations given its production capacity
or relevant sales range. Temporary working capital is the excess of working capital over the
permanent working capital given its production capacity or relevant
sales range.
Bugay is managing the working capital of SR Ice Cream. SR Ice Cream is engaged in
the selling of different ice creams. The following are the sales volume, and the working capital
needed based on the recent years:
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Analysis and Explanation by Rodriguez et al., (2016)
We can see that the working capital never goes below PHP120, 000. That is the
permanent working capital requirement.
The maximum temporary working capital is PHP180, 000 (difference between the
PHP300, 000 working capital and the permanent working capital of PHP120, 000) at the peak
season with PHP900, 000 sales level. For the 4th Quarter, the temporary working capital is
PHP30, 000 (difference between the PHP150, 000 working capital and the permanent working
capital of PHP120, 000).
Cayanan & Borja (2017) enumerated the three types of working capital financing
policies management. These are maturity working capital financing policy, aggressive working
capital financing policy and conservative working capital financing policy.
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Figure 2.2. Maturity Working Capital Financing Policy
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Figure 2.3. Aggressive Working Capital Financing Policy
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Figure 2.4. Conservative Working Capital Financing Policy
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Assessment Task
35
c. Most firms attempt to find a golden mean by financing all fixed assets and
part of current assets with equity and long-term debt. Such firms may
invest cash surpluses during part of the year and borrow during the rest of
the year.
d. All of the above affect short-term financing.
5. The type of company most likely to need short-term financing is one that
a. has no seasonality and no growth in sales from year to year
b. sells only for cash
c. has a high degree of seasonality
d. has lower total fixed costs than total variable costs
6. When a firm finances long-term assets with short-term sources of funding, it:
a. reduces the risk of cash shortage
b. will have higher interest expenses
c. improves the leverage ratio
d. is ignoring the principle of matched maturities
7. The first step in developing a pro forma income statement is to:
a. build a sales forecast
b. determine the cost of goods sold
c. determine the production schedule
d. determine cash budget
8. Working capital management involves investment and financing decisions related
to:
a. plant and equipment and current liabilities.
b. current assets and capital structure.
c. current assets and current liabilities.
d. sales and credit.
9. The goal of managing working capital, such as inventory, should be to minimize
the:
a. costs of carrying inventory
b. opportunity cost of capital
c. aggregate of carrying and shortage costs
d. amount of spoilage or pilferage
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10. Temporary working capital supports
a. the cash needs of the company.
b. acquisition of capital equipment.
c. payment of long term debt.
d. seasonal peaks.
Case 1. Determine the number of units to be produced in 2022 given the following
information:
Inventories at the Beginning of the Year 300,000 units
Projected Sales in 2022 6,000,000 units
Target Level of Ending Inventories 500,000 units
Case 2. Given the following information, estimate the quarterly production in 2020.
Requirements:
1. Determine the production for each quarter in 2020.
2. How many units are expected to be produced in 2020?
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3. How many units are expected to be sold in 2020?
TASK NO. 3 (PERFORMANCE TASK )
Summary
Financial planning refers to the process of determining the best uses of the financial
resources of an organization to attain its predetermined objectives and the procurement
of the required funds at least cost.
Working Capital refers to the current assets used in the operations of the business.
The three types of working capital financing policies management are maturity working
capital financing policy, aggressive working capital financing policy and conservative
working capital financing policy.
References
Cayanan A.S., & Borja DV.H.,. (2017). Business Finance. Rex Book Store Inc.
(RBSI).
Mejorada N.D., (2006). Business Finance and Philippine Business Firms.
Goodwill Trading Co., Inc.
Rodriguez J.A., Yusoph A.B., Rodriguez R.A., and Dy D.C., (2016). Teaching
Guide for Senior High School Business Finance. Commission on Higher
Education.
38
MODULE 3
SHORT TERM AND LONG TERM FUNDS
Introduction
The total financing requirement of the business may be financed by short-term and
long long-term funds depending on how conservative or aggressive a management is. It is
therefore imperative for a businessman to have adequate knowledge of the different sources of
financing and the costs involved (Mejorada, 2006).
Learning Outcomes
Cayanan & Borja (2017) defined the sources of financing into two categories: debt and
equity financing. The following section describes the features of each source.
Debt Equity
It can be in the form of borrowing from banks and other lending institutions or issuance
of debt securities like commercial papers and bonds. For some companies, it can also be in the
form of advances from stockholders to expedite the process of raising funds. It also creates a
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contractual obligation for the borrower to pay the interest and the principal. Payments have to be
made on time because unpaid interest and principal will lead to penalties and more interest. The
author then added that despite of the disadvantage; companies still resort to borrowing to fund
their working capital requirements and expansions.
If managed properly and if taken in reasonable amounts, debt financing can help the
company grow. Among the benefits as enumerated in the book of Cayanan & Borja (2017) are as
follows:
Equity Financing
Equity financing refers to issuance of new shares of stocks and retained earnings
plowed back into operations of the company. The latter is also called as internally generated
funds. Equity financing is the safest source of financing for a company because it does not require
ay mandatory payment of dividends. If you own enough shares of a company, you can end up
controlling its operating and financing decisions. It also provides financial flexibility (Cayanan &
Borja, 2017). The author enumerated also the disadvantages of Equity Financing:
As defined in the book of Cayanan & Borja (2017), short term funds are normally used
to finance the day-to-day operations of the company. The examples of different sources of short
term funds are as follows:
1. Suppliers Credit – refers to the extension of payment due date by suppliers.
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For example, the terms 2/10 (2% discount if paid within 10 days) with the due date
of 60 days will result in annual interest of (2/98)*(360/50 days), or 14.69%. Therefore,
by not availing of the discount, the one who ordered the supplies from the supplier
in effect borrowed at 14.69%. It may also be viewed as the opportunity cost forgone.
2. Advances from stockholders or other owners – personal funds advanced by a stockholder
to accompany that usually require 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.
3. Credit cooperatives – provided lending services to its members. Members usually pay
contributions to the cooperative.
4. Banks – provides several loan products catering to different types of needs.
5. Credit Cards – just take note of the high interest rates on this source of funds.
6. 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.
7. Pawnshops – provides funds in exchange for collateral, usually jewelry, or other items of
value.
8. Informal lending sources.
Cost (Interest)
Informal lending sources like 5/6 may be the most expensive.
Availability of short-term funds
Informal lending sources like 5/6 are most available because there are no formal
requirements to avail of the facility.
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.
Flexibility
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This pertains to the ability of the company to access funds. or 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 and Stability of operating cash flows.
` Long-term funds are used for long-term investments or sometimes called capital
investments. This includes expansion, buying new equipment, or buying a piece of land which will
be the site of future expansion. It can also be used to finance permanent working capital
requirements (Cayanan & Borja, 2017).
The author enumerated the different sources of long-term funds:
1. 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 stockholders.
2. 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.
3. 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.
4. Bonds – these are debt investments where an investor loans money to an entity which
borrows the funds.
5. Lending companies – they can also provide long-term loans.
The company’s capital structure is a major consideration for deciding which long-term
sources of funds to utilize. The target would be to balance debt and equity and come up with the
minimum cost of capital (Rodriguez et al., 2016).
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Rodriguez et al., (2016) enumerated the institution’s primary consideration in approving
loan applications as follows:
• 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
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.
Analysis and Interpretation of 5C’s as discussed in the book of Rodriguez et al., (2016).
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1. Character: Check Joe’s Restaurant’s payment history and experience in the business. The
fruitfulness of the business proves Mr. Salazar and the BOD’s ability to manage the
business well.
2. Capacity: The positive income from the business and positive cash flows from operations
proves the borrower’s capacity. Current assets also show that the borrower has funds
easily available for repayment if necessary. The term of the loan, should be adjusted to
the cash flow of the borrower.
3. Collateral: The property pledged serves as collateral. Its value is usually greater than the
loan to provide the bank security for sudden changes in value of the collateral, as well as
to compensate the bank for the collateral’s illiquid nature.
4. Capital: The audit financial statements give a preview of the borrower’s resources.
5. Condition: The income statement shows that the business is earning and is even growing.
The business has already grown to 3 branches. This shows a preview of the growth in the
food industry. Learners may also research on other business growth trends to know about
macroeconomic conditions.
The following are the steps in Loan Application as enumerated in the book of Rodriguez
et al., (2016).
1. Loan applicant inquires with the loan officer to apply for a loan.
2. The loan officer provides the loan applicant a loan application form and interviews the
client. The loan officer then decides what type of loan product the borrower qualifies in,
and then provides them a list of requirements.
3. The applicant then submits the requirements along with the loan application form. If the
collateral is required, the corresponding mortgage documents are made ready.
4. The loan officer then forwards the documents to the credit evaluation department.
5. The credit evaluation department checks whether the applicant provided the complete
documents.
6. Credit investigation is done, and the credit worthiness of the loan applicant is evaluated.
7. The credit analyst prepares a recommendation and will present the recommendation
before a loan committee who approves the loan application. The loan committee is
generally composed of top executives from the bank.
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8. If the loan is approved, then the post-approval requirements will be sent to the loan
applicant for compliance.
Pre-approval Requirements:
• Duly accomplished application form
• Securities and Exchange Commission (SEC) registration
• Articles of incorporation and by-laws
• List of elected officers
• Board resolution or corporate secretary’s certificate regarding loan application
• Company profile or business background
• List of major suppliers and customers with contact information
• Audited financial statements (2 to 5 years depending on the bank)
• Bank statements (most banks require bank statements for the past 6 months)
• Collateral documents such as the following:
• Copy of transfer certificate of title (TCT) or condominium certificate of title (CCT)
• Copy of tax declaration
• Appraisal Fee with official receipt
• For construction loan
• Building plan or floor plan
• Bill of materials and labor cost
• Building specifications certified by architect/civil engineer
• Development permit
• Copy of lease contracts (if applicable)
Post-approval Requirements:
• Original owner’s duplicate copy of TCT/CCT
• Original certified true copy of latest tax declaration on land and improvement
• Master deed of declaration (for condominium)
• Electronic-certified true copy of TCT/CCT with original official receipt
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• Original certified true copy of tax clearance
• Original real estate tax receipts
• Mortgage redemption insurance and Fire Insurance
Assessment Task
TASK NO. 1 (WRITTEN WORK)
Direction: Suppose that you are an owner of a lending institution, create your own
company and formulate necessary policies before engaging in a loan agreement with
a possible creditor.
Company Policies
Loan Requirement :
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TASK NO. 2 (WRITTEN WORK)
Direction: Explain briefly.
1. What are the disadvantages and advantages of equity and debt financing?
2. Discuss when to use short –term and long-term funds in business?
3. Identify the different sources of short –term and long-term funds.
4. Discuss how the following companies coming from different sectors should be
finances (capital structure). Justify your answers.
a. Ayala Lands
b. Jollibee Food Corporation
Underlying Questions:
What are the possible effects of this financing on the capital structure of your
chosen company?
How will this financing affect the statement of comprehensive income?
Summary
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References
Cayanan A.S., & Borja DV.H.,. (2017). Business Finance. Rex Book Store Inc.
(RBSI).
Mejorada N.D., (2006). Business Finance and Philippine Business Firms.
Goodwill Trading Co., Inc.
Rodriguez J.A., Yusoph A.B., Rodriguez R.A., and Dy D.C., (2016). Teaching
Guide for Senior High School Business Finance. Commission on Higher
Education.
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