Department of Education

Bureau of Learning Delivery Teaching and

Learning Division

BUSINESS FINANCE

Quarter 1 Week 2 Module 3

Learning Competencies:
• Distinguish a financial institution from financial
instrument and financial market.(ABM_BF12-IIIa-2)
 Learning Module for Business Finance

HOW TO USE THIS MODULE?

PARTS OF THE MODULE

• Check your Understanding - It will verify how you learned from the lesson.

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LESSON
The Flow Of Funds Within An Organization-
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Through And From The Enterprise

When you finish this module, you should be able to:

• enumerate the varied financial institutions and their corresponding services
• compare and contrast the varied financial instruments
• explain the flow of funds within an organization – through and from the
enterprise—and the roles of a financial manager
Specifically, this module will help you to:

➢ prepare a diagram illustrating how the financial system works

➢ define Financial Markets, Financial Institutions and Financial Instruments
➢ identify the types of financial markets, financial
institutions and financial instruments

Let us start your journey in learning more on the the

Flow of Funds within an organization- through and
PRETEST from the Enterprise. I am sure you are ready and
excited to answer the Pretest. Smile and Enjoy!

MULTIPLE CHOICE QUESTIONS

Directions: Choose the letter corresponding to the correct answer for each of the
questions provided below. Encircle your answer.
1. The is created by a financial relationship between suppliers and
users of short-term funds.

A. financial market C. Stock Market

B. money market D. capital market

2. Firms that require funds from external sources can obtain them from
.

A. financial market C. financial institutions

B. private placement. D. all of the above

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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
5. A financial manager must choose between four alternative Assets: 1, 2,
3, and each asset costs Php35,000.00 and is expected to provide
earnings over a three-year period as described below.

Year 1 Year 2 Year 3

1. ₱ 2,100,000.00 ₱ 1,500,000.00 ₱ 600,000.00

2. ₱ 900,000.00 ₱ 1,500,000.00 ₱ 2,100,000.00

3. ₱ 300,000.00 ₱ 200,000.00 ₱ 1,900,000.00

4. ₱ 600,000.00 ₱ 1,200,000.00 ₱ 1,200,000.00

Based on the profit maximization goal, the financial manager would

choose .

A. Asset 1. B. Asset 2. C. Asset 3. D. Asset 4.

II. TRUE or FALSE

Directions: Before each statement on the space provided, write TRUE if the
statement is correct or FALSEif the statement is incorrect.
1. To achieve 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.

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2. Dividend payments change directly with changes in

earnings per share.
3. The wealth of corporate owners is measured by the share price of
the stock.
4. Financial markets are intermediaries that channel the savings of
individuals, businesses, and government into loans or
investments.
5. 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.

Great, you finished answering

LOOKING BACK TO YOUR LESSON the questions. You may request
your facilitator to check your work.
Congratulations and keep on
learning!

Recall from the previous discussions, that one of the functions of a financial
manager is financing and investing of funds. Now, if you are going to save the
money, where would you keep it? Maybe, you will place it in Banks, Piggy bank,
Investments – stocks, mutual funds, insurance, etc.

Activity I. If you place your money in a business opportunity, what business industry
you would like to try and why? You may write your answers on the box.

Activity 2. Now, that you have a business running and profitable, you decide to
expand but do not have enough cash to pay for the expansion. Where can you get the
additional funding?

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You will not be able to find someone to invest your money to get funds
to start your expansion. Here is where the Financial System comes in. But
before we go further with our topic on Financial System, let us asses your
in-depth knowledge on it.

Part I. TRUE OR FALSE

Directions: Before each statement, write TRUE if the statement is correct or FALSE if
the statement is incorrect. Write your answer on the space provided before each
number.

1. The wealth of corporate owners is measured by the share price of

the stock.
2. Risk and the timing of cash f l o w s are t h e key
determinants of share price, which represents the wealth of the
owners in the firm.
3. 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.
4. An increase in firm risk tends to result in a higher share price since
the stockholder must be compensated for the greater risk.
5. Stockholders expect to earn higher rates of return on investments
of lower risk and lower rates of return on investments of higher
risk.

BRIEF INTRODUCTION
Let us analyse the situation so you can easily understand the next topic. If
Company A knows that Company B needs funds, or if Company B knows that
Company A is willing to invest funds, Company A and B may agree to make a
private placement. However, if these facts are unknown to them, Companies A and B
can go to a Financial Market which is an organized forum that lets A, along with other
suppliers of funds, and B, along with other users of funds, meet and make
transactions. Once A and B have met in the Financial Market, they can now agree to
make a private placement.

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If the two companies do not want to make an effort to find counterparty in

the Financial Markets, they may go to a Financial Institution. Financial Institutions
serve as an intermediary to the suppliers and users of funds. Moreover, financial
institutions actively participate in the financial markets as both suppliers and users
of funds.

Financial System
This is a diagram of a Financial System. The solid lines represent the flow of
cash/funds, while the broken lines represent the flow of financial instruments which
represent obligations to transfer cash or other assets in the future.

Source:TeachingGuideforSeniorHighSchool,BusinessFinance,Pu
blishedbytheCommissiononHigherEducation,2016

How transactions between suppliers and users of funds take place? How
would they prove that there was a transaction so that the demander will be able to
repay the supplier on time and at the right amount? You may write your answers on
the box.

Due to the increased need for security for the performance of obligations
arising from these transactions, the transfers of funds from one party to another are
made through Financial Instruments.

Financial Instruments
When a financial instrument is issued, it gives rise to a financial asset on
one hand and a financial liability or equity instrument on the other.
Recall from your ABM class the following definitions:

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Financial Asset is any asset that is:

• Cash
• An equity instrument of another entity
• A contractual right to receive cash or another financial asset from another
entity.
• A contractual right to exchange instruments with another entity under
conditions that are potentially favorable. (IAS 32.11)
• Examples: Notes receivable, loans receivable, investment in stocks, investment
in bonds
A Financial Liability is any liability that is a contractual obligation:
• To deliver cash or other financial instrument to another entity.
• To exchange financial instruments with another entity under conditions that
are potentially unfavorable. (IAS 32)
Examples: Notes Payable, Loans Payable, Bonds Payable

An Equity Instrument is any contract that evidences a residual interest in the

assets of an entity after deducting all liabilities. (IAS 32) Examples: Ordinary Share
Capital, Preference Share Capital.

When companies are in need of funding, they either sell debt securities (or
bonds) or issue equity instruments. The proceeds from the sale of the debt
securities and issuance of bonds will be used to finance the company’s plans.

Common examples of Debt and Equity Instruments

Debt Instruments have fixed returns due to fixed interest rates.

Examples of debt instruments are as follows:

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• Treasury Bonds and Treasury Billsare sued 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 a r e 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. 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:

Preferred Stock has priority over a common stock in terms of claims over the
assets of a company. This means that if a company 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.
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. (Cayanan, A. 2015)

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.

Which of the financial instruments presented to you find the most

appealing to you? Please on the box your answers.

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Financial Markets

Let us now classify Financial Markets into comparative groups:

Primary vs. Secondary Markets

To raise money, users of funds will go to a primary market to issue new securities
(either debt or equity) through a public offering or a private placement. The sale of
new securities to the general public is referred to as a public offering and the first
offering of stock is called an initial public offering.

The sale of new securities to one investor or a group of investors (institutional

investors) is referred to as a private placement. The sale of previously owned
securities takes place in secondary markets. The Philippine Stock Exchange (PSE)
is both a primary and secondary market. Gitman, L. J. & Zutter C. J. (2012) &
(Cayanan, A. 2015).

Money Markets vs. Capital Markets

Money markets are a venue wherein securities with short-term
maturities 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.

On the other hand, 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 (Gitman, L. J. & Zutter C. J. 2012) & (Cayanan, A. 2015).
Financial Institutions: Roles and Purposes

The following are examples of financial institutions.

Commercial Banks - Individuals deposit funds at commercial banks, which use the
deposited funds to provide commercial loans to firms and personal loans to
individuals, and purchase debt securities issued by firms or government agencies.

Insurance Companies - Individuals purchase insurance (life, property and casualty,

and health) protection with insurance premiums. The insurance companies pool
these payments and invest the proceeds in various securities until the funds are
needed to pay off claims by policyholders. Because they often own large blocks of a
firm’s stocks or bonds, they frequently attempt to influence the management of the
firm to improve the firm’s performance, and ultimately, the performance of the
securities they own.

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Mutual Funds - Mutual funds are owned by investment companies which enable
small investors to enjoy the benefits of investing in a diversified portfolio of
securities purchased on their behalf by professional investment managers. When
mutual funds use money from investors to invest in newly issued debt or equity
securities, they finance new investment by firms.

Pension Funds – these are financial institutions that receive payments from employees
and invest the proceeds on their behalf.

Otherfinancial institutionsinclude pension funds like Government Service

Insurance System (GSIS) and Social Security System (SSS), unit investment
trust fund (UITF), investment banks, and credit unions, among others.

ACTIVITIES

Let us check your understanding of the topic.

Activity 1 Financial Institutions

Directions: Complete the chart. Identify the roles of the following financial
institutions

FINANCIAL INSTITUTIONS ROLES/PURPOSES

Commercial banks
Insurance Companies
Mutual funds
Pension Funds
Other Financial Institutions

Activity 2
Question for reflection: How would you relate the role of financial managers,
role of financial markets and role of investors?

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Activity 3 TRUE or FALSE

Direction: Before each statement on the space provided, write TRUE if the statement is
correct or FALSE if the statement is incorrect.

1. High cash flow is generally associated with a higher share price

whereas higher risk tends to result in a lower share price.
2. 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.

3. To achieve 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.
4. Dividend payments change directly with changes in earnings per share.
5. The wealth of corporate owners is measured by the share price of the
stock.
6. 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.
7. 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.
8. An increase in firm risk tends to result in a higher share price
since the stockholder must be compensated for the greater risk.
9. Stockholders expect to earn higher rates of return on
investments of lower risk and lower rates of return on
investments of higher risk.
10. The key capital market securities are bonds (long-term debt) and
both common stock and preferred stock (equity, or ownership).

• The financial institutions serve as an intermediary to the suppliers and users

of funds and actively participate in the financial markets as both suppliers
and users of funds.
• Financial Instruments are the transfers of funds from one party to
another.
• Financial Asset is any asset that is in the form of Cash, an equity instrument
of another entity, a contractual right to receive cash or another financial
asset from another entity.

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• Equity Instrument is any contract that evidences a residual interest in the

assets of an entity after deducting all liabilities.
• Debt Instruments generally have fixed returns due to fixed interest rates.
• 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.
• Common debt instruments are Treasury Bonds, Treasury Bills and
Corporate Bonds
• Types of equity instruments are Preferred Stock and Common Stock.
• Primary market issues new securities, either debt or equity through a
public offering or a private placement.
• Money markets are a venue wherein securities with short-term maturities
(1 year or less) are sold.
• Capital markets are securities sold with longer-term maturities.
• Examples of financial institutions are: Commercial Banks, Insurance
Companies, Mutual Funds, Pension Funds and other financial institutions.
•
CHECK YOUR UNDERSTANDING

Activity 1. TRUE or FALSE

Directions: Before each statement on the space provided, write TRUE if the
statement is correct or FALSE if the statement is incorrect.

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. Preferred stock is a special form of stock having a fixed
periodic dividend that must be paid prior to payment of any
interest to outstanding bonds.

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Activity 2 MULTIPLE CHOICE

Direction: Choose the letter corresponding to the correct answer for each of the questions
provided below.
1. Corporate owners receive realizable return through
A. earnings per share and cash dividends.
B. increase in share price and cash dividends.
C. increase in share price and earnings per share.
D. profit and earnings per share.

2. The wealth of the owners of a corporation is represented by

A. profits.
B. earnings per share.
C. share value.
D. cash flow.

3. 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 stockholders

4. The goal of profit maximization would result in priority for

A. cash flows available to stockholders
B. risk of the investment
C. earnings per share.
D. timing of the returns

5. Profit maximization, as a goal, is not ideal because it does NOT consider

A. risk and cash flow.
B. cash flow and stock price.
C. risk and EPS.
D. EPS and stock price.

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POSTTEST

MULTIPLE CHOICE
Directions: Choose the letter corresponding to the correct answer for each
of the questions provided below. Encircle the letter of the correct answer.

1. A is one financial intermediary handling individual

savings and receives premium payments that are placed in loans.
A. life insurance company
B. commercial bank
C. savings bank
D. credit union

2. The key participants in financial transactions are individuals, businesses, and

governments. Individuals are net of funds, and businesses are net of funds.
A. suppliers; users
B. purchasers; sellers
C. users; suppliers
D. users; providers

3. Which of the following is not a financial institution?

A. A pension fund
B. A newspaper publisher
C. A commercial bank
D. An insurance company

4. A is set up so that employees of corporations or governments can receive

income after retirement.
A. life insurance company
B. pension fund
C. savings bank
D. credit union

5. A is a type of financial intermediary that pools savings of individuals and

makes them available to business and government users. Funds are obtained
through the sale of shares.
A. mutual fund
B. savings and loans
C. savings bank
D. credit union

6. Most businesses raise money by selling their securities in a.

A. a direct placement.
B. a stock exchange.
C. a public offering.
D. a private placement.

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7. Which of the following is not a service provided by financial institutions?

A. Buying the businesses of customers
B. Investing customers’ savings in stocks and bonds
C. Paying savers’ interest on deposited funds
D. Lending money to customers

8. Government usually
A. borrows funds directly from financial institutions.
B. maintains permanent deposits with financial institutions.
C. is a net supplier of funds.
D. is a net demander of funds.

9. By definition, the money market involves the buying and selling of

A. funds that mature in more than one year.
B. flows of funds.
C. stocks and bonds.
D. short-term funds.

10. 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

To further explore the concept learned today and if it possible to

connect the internet, you may visit the following link:

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WEBSITES:

To further explore the topic, you may visit the link:

https://www.suomenpankki.fi/en/financial-stability/the-financial-system-in-
brief/

Books
Cayanan, A. & Borja (forthcoming). Business Finance. Quezon
City. Rex Bookstore.
Gitman, L. J. & Zutter C. J. (2012), Principles of Managerial Finance (13th Ed), USA:
Prentice-Hall
Teaching Guide for Senior High School, Business Finance, Published by the
Commission on Higher Education, 2016

Websites

https://www.suomenpankki.fi/en/financial-stability/the-financial-system-in-
brief/, Retrieved June 19, 2020
https://www.yourarticlelibrary.com/macro-economics/national-income-
macro-economics/flow-of-funds-accounts-meaning-limitation-and-
importance/30779, Retrieved June 19, 2020
https://en.wikipedia.org/wiki/Flow_of_funds, Retrieved June 19, 2020
https://www.researchgate.net/publication/242549124_Using_Flow_of_Funds_to
_Explain_the_Financial_Markets_Crisis, Retrieved June 19, 2020
https://www.suomenpankki.fi/en/financial-stability/the-financial-system-in-brief/

Acknowledgment

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