Professional Documents
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Financial Management Part 3 Updated
Financial Management Part 3 Updated
Financial Management
Part 3
GSBM
Confidential — SyCip Gorres Velayo & Co. 2019 USSC Status Meeting
Agenda
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Topic 1
Multinational Financial
Management
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
1. To broaden their markets. After a company has saturated its home market, growth opportunities are often
better in foreign markets. Thus, such home grown firms as Coca-Cola and McDonald’s are aggressively
expanding into overseas markets, and foreign firms such as Sony and Toshiba now dominate the U.S.
consumer electronics market.
2. To seek new technology. No single nation holds a commanding advantage in all technologies, so
companies are scouring the globe for leading scientific and design ideas. For example, Xerox has introduced
more than 80 different office copiers in the United States that were engineered and built by its Japanese joint
venture, Fuji Xerox.
3. To seek production efficiency. Companies in high-cost countries are shifting production to low-cost
regions. For example, GE has production and assembly plants in Mexico, South Korea, and Singapore, and
Japanese manufacturers are shifting some of their production to lower-cost countries in the Pacific Rim. BMW,
in response to high production costs in Germany, has built assembly plants in the United States. The ability to
shift production from country to country has important implications for labor costs in all countries.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
4. To avoid political and regulatory hurdles. The primary reason Japanese auto companies moved
production to the United States was to get around U.S. import quotas. Now Honda, Nissan, Toyota, Mazda,
and Mitsubishi are all assembling vehicles in the United States.
US Import quotas control the amount or volume of various commodities that can be imported into the
United States during a specified period of time. Quotas are established by legislation, Presidential
Proclamations or Executive Orders. Quotas are announced in specific legislation or may be provided for in the
Harmonized Tariff Schedule of the United States (HTSUS).
Imports into the U.S. of foreign automobiles, mainly from Japan, have been restricted since April 1981
by a so-called " voluntary restra int agreement." The quotas were imposed in response to pleas by the U.S.
auto industry that it needed time to grow strong enough to compete with the imports on the free market.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
5. To seek raw materials. Many U.S. oil companies, such as ExxonMobil, have major subsidiaries around the
world to ensure access to the basic resources needed to sustain the companies’ primary business lines.
ExxonMobil has 37 oil refineries in 21 countries and is the seventh largest refinery in the world with a daily
barrel production of 605,000.
Currently, Jamnagar Refinery Complex located in the Jamnagar Special Economic Zone (SEZ) is by
far the largest oil refinery in on Earth and the de facto petroleum hub of the world with daily barrel production
of 1,240,000.
6. To diversify. By establishing worldwide production facilities and markets, firms can cushion the impact of
adverse economic trends in any single country.
For example, General Motors softened the blow of poor sales in the United States during a recent
recession with strong sales by its European subsidiaries.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
A foreign direct investment (FDI) is an investment made by a firm or individual in one country into business
interests located in another country. Generally, FDI takes place when an investor establishes foreign business
operations or acquires foreign business assets in a foreign company.
A foreign direct investment (FDI) is an investment in the form of a controlling ownership in a business in one
country by an entity based in another country.
The investment may be made either "inorganically" by buying a company in the target country or "organically"
by expanding the operations of an existing business in that country.
Foreign direct investment (FDI) is an investment from a party in one country into a business or corporation in
another country with the intention of establishing a lasting interest. Lasting interest differentiates FDI from
foreign portfolio investments, where investors passively hold securities from a foreign country. A foreign direct
investment can be made by obtaining a lasting interest or by expanding one’s business into a foreign country.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
► Net foreign direct investment into the Philippines surged by 46.9 percent year-on-year to USD 637 million in August
2020( USD 434 million in August 2019), the fourth straight month of increase, owing to investors’ renewed confidence as
the national government’s fiscal stimulus and central bank’s accommodative monetary policy stance to mitigate the impact
of COVID-19 pandemic gained traction along with the easing of quarantine measures in the country..
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
1. Different currency denominations. Cash flows in various parts of a multinational corporate system will be
denominated in different currencies. Hence, an analysis of exchange rates must be included in all financial
analyses.(IAS 21:The Effects of Changes in Foreign Exchange Rates).
Example:
ExxonMobil is a large oil company that conducts business across the world. It is headquartered in the United
States but has many subsidiaries spread out globally, such as Esso Australia and Mobil Producing Nigeria.
Esso Australia would conduct its business in Aussie Dollars and Mobil Producing Nigeria would conduct its
business in Nigerian Naira.
When ExxonMobil is preparing its financial statements, it will require that both Esso Australia and Mobil
Producing Nigeria convert their financial figures into U.S. dollars, because it is the currency of the United
States, where ExxonMobil is headquartered. The U.S. dollar is the reporting currency. If Esso Australia reported
AUD 1 million, it would convert that AUD 1 million into USD, which is approximately $650,000(Assuming $.65=
AUD 1). ExxonMobil would then use the $650,000 figure in its consolidated financial reporting.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
3. Language differences. The ability to communicate is critical in all business transactions, and here U.S.
citizens are often at a disadvantage because they are generally fluent only in English, while European and
Japanese businesspeople are usually fluent in several languages, including English. Thus, they can penetrate
U.S. markets more easily than we can penetrate theirs.
4. Cultural differences. Even within geographic regions that are considered relatively homogeneous, different
countries have unique cultural heritages that shape values and influence the conduct of business. Multinational
corporations find that matters such as defining the appropriate goals of the firm, attitudes toward risk, dealings
with employees, and the ability to curtail unprofitable operations vary dramatically from one country to the next.
5. Role of governments. Most financial models assume the existence of a competitive marketplace in which
the terms of trade are determined by the participants. The government, through its power to establish basic
ground rules, is involved in the process, but its role is minimal. Thus, the market provides the primary barometer
of success, and it gives the best clues about what must be done to remain competitive.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Mutinational vs. Domestic Financial Short-term political risk (1=low, 7=high), 2019 - Country
Management rankings: The average for 2019 based on 201 countries was
3 index points.The highest value was in Afghanistan: 7 index
points and the lowest value was in Andorra: 1 index points.
6. Political risk. A nation is free to place The indicator is available from 1960 to 2020. Below is a chart
constraints on the transfer of corporate for all countries where data are available.(Source
resources and even to expropriate, without TheGlobalEconomy.com)
compensation, assets within its boundaries.
This is political risk, and it tends to be largely
a given rather than a variable that can be
changed by negotiation. Political risk varies
from country to country, and it must be
addressed explicitly in any financial analysis.
Another aspect of political risk is terrorism
against U.S. firms or executives. For
example, U.S. and Japanese executives
have been kidnapped and held for ransom
with some killed to prove that the kidnappers
were serious in several South American
countries.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
A. Exchange Rates
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Direct Quotation
The value of the number of U.S. dollars required to purchase
one unit of a foreign currency. Direct quotations have a dollar sign in
their quotation and state the number of dollars per foreign currency
unit, such as dollars per euro.
Indirect quotations
The exchange rates represent the number of units of a foreign
currency that can be purchased for one U.S. dollar; these are called
indirect quotations. Indirect quotations often begin with the foreign
currency’s equivalent to the dollar sign and express the foreign
currency per dollar, such as euros per dollar.
The values shown in Column 1 of Table 26-1 are the number of U.S.
dollars required to purchase one unit of a foreign currency; this is called a direct
quotation. Direct quotations have a dollar sign in their quotation and state the
number of dollars per foreign currency unit, such as dollars per euro. Thus, the
direct U.S. dollar quotation for the euro is $1.2841, because 1 euro could be
bought for 1.2841 dollars.
The exchange rates given in Column 2 represent the number of units
of a foreign currency that can be purchased for one U.S. dollar; these are called
indirect quotations. Indirect quotations often begin with the foreign currency’s
equivalent to the dollar sign and express the foreign currency per dollar, such
as euros per dollar. Thus, the indirect quotation for the euro is €0.7788. (The “€”
stands for euro, and it is analogous to the symbol “$.”)
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Cross Rates
The exchange rate between any two currencies other than dollars is called a cross rate .
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
*Refer to history of Floating Exchange Rates via the Bretton Woods Agreement
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Currency Appreciation
Suppose the dollar cost of a pound is $1.9069. If there were increased demand for pounds caused by a
U.S. trade deficit with Great Britain, then the price of pounds might increase to $2. In this situation, the pound is
said to be appreciating, because a pound would now buy more dollars. In other words, a pound would now be
worth more than it was. This is called currency appreciation.
Currency Depreciation.
Conversely, the dollar would be depreciating, because the dollar now buys fewer pounds (a dollar would
previously buy 1/1.9069 = 0.5244 pound, but afterward it would buy only 1/2= 0.5 pound. This is called currency
depreciation. Notice that the more costly pound would make British imports more expensive to U.S. consumers,
which would reduce imports and consequently, the demand for pounds until the exchange rate reached
equilibrium.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Example
In 1985, it cost Honda Motors 2,380,000 yen to build a particular model in Japan and ship it to the
United States. The model carried a U.S. sticker price of $12,000. Because the $12,000 sales price was the
equivalent of (238 yen per dollar)($12,000)=2,856,000 yen, which was 20% above the 2,380,000 yen cost, the
automaker had built a 20% markup into the U.S. sales price. However, three years later the dollar had
depreciated to 128 yen. Now if the car still sold for $12,000, the yen return to Honda would be only (128 yen per
dollar)($12,000) =1,536,000 yen, and the automaker would be losing about 35% on each auto sold. Therefore,
the depreciation of the dollar against the yen turned a healthy profit into a huge loss. In fact, for Honda to
maintain its 20% markup, the model would have had to sell in the United States for 2,856,000 yen/(128 yen per
dollar) $22,312.50. This situation, which grew even worse, led Honda to build its most popular model, the
Accord, in Marysville, Ohio.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
What is the difference between free-floating and managed floating exchange rate?
Managed floating exchange rates are also known as a dirty float because the government is trying to intervene
so that exchange rate volatility becomes more moderate.
That policy contrasts with the free-floating exchange rate (also known as clean float), where the exchange rate
is determined only by supply and demand on the market and is without government intervention.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
C. Pegged Rates
In a pegged exchange rates system, a country locks, or “pegs,” its currency’s exchange rate to another
currency or basket of currencies. It is common for a country with a pegged exchange rate to allow its currency to
vary within specified limits or bands (often set at 1% of the target rate) before the country intervenes to force the
currency back within the limits.
Examples in which a currency is pegged to another country’s currency include Bhutan’s ngultrum, which
is pegged to the Indian rupee; the Falkland Islands’ pound, which is pegged to the British pound; and
Barbados’s dollar, which is pegged to the U.S. dollar.
An example of a currency being pegged to a basket is China, where the yuan is no longer just pegged
to the U.S. dollar but rather to a basket of currencies. Interestingly, the Chinese government will not reveal the
currencies that make up the basket, but the U.S. dollar is still likely an important component.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Example
From 1991 through early 2002, Argentina had a fixed exchange rate of 1 peso per U.S. dollar. Imports
were high, exports were low, and the Argentinean government had to purchase huge amounts of pesos to
maintain that artificially high exchange rate. The government borrowed heavily to finance these purchases, and
eventually it was unable to continue supporting the peso. (Indeed, the government defaulted on some of its
obligations.) As a result, the government had to devalue the peso to 1.4 pesos per dollar in early 2002. Notice
that this made the peso weaker: Before the devaluation, 1 peso would buy 1 dollar, but afterward 1 peso would
buy only 71 cents (1.4 pesos per dollar 1/1.4= 0.71 dollar per peso). The devaluation lowered the prices of
Argentine goods on the world market, which helped its exporters.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
D. No Local Currency
A few countries don’t have their own separate legal tender, but instead use the currency of another
nation.
Example
Ecuador has used the U.S. dollar since September 2000. Other countries belong to a monetary union,
such as the 12 European Monetary Union nations whose currency is the euro, which is allowed to float. In
contrast, member nations of the Eastern Caribbean Currency Union, the West African Economic and Monetary
Union (WAEMU), and the Central African Economic and Monetary Community (CAEMC) use their respective
union’s currency, which is itself pegged to some other currency. For example, the Eastern Caribbean dollar is
pegged to the U.S. dollar, and the CFA franc (used by both the WAEMU and CAEMC) is pegged to the euro.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Example
Suppose a U.S. firm must pay 500 million yen to a Japanese firm in 30 days, and the current spot rate is
115.1145 yen per dollar. Unless spot rates change, the U.S. firm will pay the Japanese firm the equivalent of
$4.344 million (500 million yen divided by 115.1145 yen per dollar) in 30 days. But if the spot rate falls to 100
yen per dollar, for example, the U.S. firm will have to pay the equivalent of $5 million.
The treasurer of the U.S. firm can avoid this risk by entering into a 30-day forward exchange contract.
This contract promises delivery of yen to the U.S. firm in 30 days at a guaranteed price of 115.1145 yen per
dollar.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
B. Interest Parity
Interest rate parity(IPP) means that investors should expect to earn the same return on security
investments in all countries after adjusting for risk.
It recognizes that when you invest in a country other than your home country, you are affected by two
forces returns on the investment itself and changes in the exchange rate. It follows that your overall return will
be higher than the investment’s stated return if the currency in which your investment is denominated
appreciates relative to your home currency. Likewise, your overall return will be lower if the foreign currency you
receive declines in value.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Where:
rh = is the periodic interest rate in the home country
rf = is the periodic interest rate in the foreign country
and the forward and exchange rates are expressed as direct quotations (that is, dollars per foreign currency).
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Assuming the direct spot quotation is 0.81573 dollar per Swiss franc (1/1.2259 Swiss francs per dollar). where
1.2259 is the spot rate and the direct 180-day forward quotation is 0.83132(1/1.2029) where 1.2029 is the
180-day forward exchange rate. Using Equation earlier, we can solve for the equivalent home rate or rh.
The periodic home interest rate is 3.9494%, and the annualized home interest rate is (3.949%)(2)
=7.90%, the same value we found above. After accounting for exchange rates, interest rate parity states that
bonds in the home country and the foreign country must have the same effective rate of return. In this
example, the U.S. bond must yield 7.90% to provide the same return as the 4% Swiss bond.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
The accompanying table provides information collected during May 2006. The first column shows the
price of a Big Mac in local currency. For example, a Big Mac costs 48 rubles in Russia. The second column shows
the cost in dollars (based on the actual exchange rate in the fourth column), which is the amount you would pay in
that country if you exchanged dollars for local currency and then purchased a Big Mac at the local price. For
example, the exchange rate is 27.1 rubles per dollar, which means that a Big Mac in Russia costs $1.77 = 48
rubles/(27.1 rubles per dollar). The third column backs out the implied exchange rate that would hold under PPP.
For example, the 48 ruble price of a Big Mac in Russia compared to the $3.10 price in the United States gives us
the implied PPP exchange rate of (48 rubles per Big Mac)/($3.10 per Big Mac) = 15.5 rubles per dollar. The
last column shows how much the local currency is over- or undervalued relative to the dollar. The ruble’s implied
PPP exchange rate of 15.5 rubles per dollar is 43% less than the actual exchange rate of 27.1 rubles per dollar, so
the ruble is 43% undervalued relative to the dollar.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
NPV 2.65
The current dollar cost of the project is £20 multiply by1.8000 $/£ = $36
million. The Year 1 cash flow in dollars is £7 multiply by 1.7553 $/£ = $12.29
million. The net present value is $2.92 million.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Cash Management
The goals of cash management in a multinational corporation are similar to those in a purely domestic
corporation:
(1) to speed up collections, slow down disbursements, and thus maximize net float;
(2) to shift cash as rapidly as possible from those parts of the business where it is not needed to those
parts where it is needed; and
(3) to maximize the risk-adjusted, after-tax rate of return on temporary cash balances. Multinational
companies use the same general procedures for achieving these goals as domestic firms, but because
of longer distances and more serious mail delays, such devices as lockbox systems and electronic
funds transfers are especially important.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Multinational Financial Management
Inventory Management
As with most other aspects of finance, inventory management for a firm in a multinational setting is
similar to but more complex than for a purely domestic firm. First, there is the matter of the physical location of
inventories.
For example, where should ExxonMobil keep its stockpiles of crude oil and refined products? It has refineries
and marketing centers located worldwide, and one alternative is to keep items concentrated in a few strategic
spots from which they can then be shipped as needs arise. Such a strategy might minimize the total amount of
inventories needed and thus might minimize the investment in inventories.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Topic 2:
Financial Management
in Not-for-Profit Businesses
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Profit(Investor-Owned) Organizations
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Not-for-Profit Organizations
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
From a financial management perspective, the primary goal of investor-owned firms is shareholder
wealth maximization, which translates to stock price maximization. Because not-for-profit businesses do not
have stockholders, shareholder wealth maximization cannot be the goal of such organizations. Rather, not-for-
profit businesses serve and are served by a number of stakeholders, which include all parties that have an
interest (financial or otherwise) in the organization.
For example, a not-for-profit hospital’s stakeholders include its board of trustees, managers, employees,
physicians, creditors, suppliers, patients, and even potential patients (i.e., the entire community). While
managers of investor-owned companies can focus primarily on the interests of one class of stakeholders—the
stockholders—managers of not-for-profit businesses face a different situation. They must try to please all the
stakeholders because there is no single, well-defined group that exercises control.Typically, the goal of a not-for-
profit business is stated in terms of some mission.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Sec. 87. Definition. - For the purposes of this Code, a non-stock corporation is one where no part of its income
is distributable as dividends to its members, trustees, or officers, subject to the provisions of this Code on
dissolution: Provided, That any profit which a non-stock corporation may obtain as an incident to its
operations shall, whenever necessary or proper, be used for the furtherance of the purpose or purposes for which
the corporation was organized, subject to the provisions of this Title.
Sec. 88. Purposes. - Non-stock corporations may be formed or organized for charitable, religious,
educational, professional, cultural, fraternal, literary, scientific, social, civic service, or similar purposes, like trade,
industry, agricultural and like chambers, or any combination thereof, subject to the special provisions of this
Title governing particular classes of non-stock corporations.
The Securities and Exchange Commission (SEC) of the Philippines serves as the registration authority for non-stock
corporations. Some non-stock corporations register as foundations.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
1. It has been argued that fund capital has zero cost. The rationale here is that contributors do not expect a
monetary return on their contributions.
2. The second position also assumes a zero cost for fund capital, but here it is recognized that, when inflation
exists, fund capital must earn a return sufficient to enable the organization to replace existing assets as they
wear out.
Example:
Assume that a not-for-profit firm buys a building that costs $1,000,000. Over time, the cost of the
building will be recovered by depreciation, so, at least in theory, $1,000,000 will be available to replace the
building when it becomes obsolete. However, because of inflation the new building now might cost $1,500,000. If
the firm has not increased its fund capital by retaining earnings, the only way to finance the additional $500,000
will be through grants and contributions, which may not be available, or by increasing its debt and hence its debt
ratio, which might not be desirable or even possible.
Therefore inflation rate must be built into the firm’s cost of capital estimate
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
3. The third position is that fund capital has some cost but that it is not very high. When a not-for-profit firm either
receives contributions or retains earnings, it can always invest those funds in marketable securities rather than
purchase real assets. Thus, fund capital has an opportunity cost that should be acknowledged, and this cost is
roughly equal to the return available on a portfolio of short-term, low-risk securities such as T-bills.
4. Finally, others have argued that fund capital to not-for-profit businesses has about the same cost as the cost
of retained earnings to similar investor-owned firms. The rationale here also rests on the opportunity cost
concept, but the opportunity cost is now defined as the return available from investing the fund capital in
alternative investments of similar risk.
In general, the opportunity cost principle applies to all fund capital—this capital has a cost that is equal
to the cost of retained earnings to similar investor-owned firms. However, contributions that are designated for a
specific purpose may indeed have a zero cost: since the funds are restricted to a particular project, the firm does
not have the opportunity to invest them in other alternatives.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Not-for-profit businesses do not have access to the equity markets—their sole source of “equity” capital
is through government grants, private contributions, and profits. Thus, managers of not-for-profit businesses do
not have the same degree of flexibility in either capital investment or capital structure decisions as do their
counterparts in for-profit firms. For this reason, it is often necessary for not-for-profit businesses
(1) to delay new projects because of funding insufficiencies and
(2) to use more than the theoretically optimal amount of debt because that is the only way that needed
services can be financed.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Although these actions may be unavoidable, managers must recognize that such strategies do increase
costs. Project delays result in needed services not being provided on a timely basis, and using more debt than
the optimal level pushes the firm beyond the point of the greatest net benefit of debt financing, which increases
its capital costs. Therefore, if a not-for-profit firm is forced into a situation where it is using more than the optimal
amount of debt financing, its managers should plan to reduce the level of debt as soon as the situation permits.
A firm that has an adequate amount of fund capital can operate at its optimal capital structure and thus
minimize capital costs. If sufficient fund capital is not available, a not-for-profit firm may be forced to rely too
heavily on debt financing, resulting in higher capital costs. Also, its weakened financial condition may prevent it
from acquiring capital equipment that would increase its efficiency and improve its services, thus hampering its
overall operating performance.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Project Analysis
The primary goal of a not-for-profit business is to provide some service to society, not to maximize
shareholder wealth. In this situation, capital budgeting decisions must consider many factors besides the
project’s profitability. For example, noneconomic factors such as the well-being of the community must also be
taken into account, and these factors may outweigh financial considerations.
Nevertheless, good decision making, designed to ensure the future viability of the organization, requires
that the financial impact of each capital investment be fully recognized. Indeed, if a not-for-profit business takes
on unprofitable projects that are not offset by profitable projects, the firm’s financial condition will deteriorate, and
if this situation persists over time it could lead to bankruptcy and closure. Obviously, bankrupt businesses cannot
meet community needs.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
In general, the same project analysis techniques that are applicable to investor-owned firms are also applicable
to not-for-profit businesses. However, two differences do exist. First, since some projects of not-for-profit
businesses are expected to provide a social value in addition to a purely economic value, project analysis
should consider social value along with financial, or cash flow, value. When social value is considered, the total
net present value (TNPV) of a project can be expressed as follows:
Here, NPV is the standard net present value of the project’s cash flow stream, and NPSV is the net present
social value of the project. The NPSV term clearly differentiates capital budgeting in not-for-profit businesses
from that in investor-owned firms, and it represents the firm’s assessment of the project’s social value as
opposed to its pure financial value as measured by NPV.
A project is deemed to be acceptable if its Not all projects have social value, but if a
project does, this value should be recognized in the decision process.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
First, consider how we might quantify the social value of services provided. When a project produces
services to individuals who are willing and able to pay for those services, the value of those services is captured
by the amount the individuals actually pay.
Thus, one approach to valuing the services provided to those who cannot pay, or to those who cannot
pay the full amount, is to use the average net price paid by individuals who do pay.
This approach, inspite of potential problems mentioned here, still seems reasonable. To assign a social
value on the basis of the price that others are willing to pay for those services.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
Because the second alternative exists, it is reasonable to argue that providers should require a return on
the social value stream that approximates the return available on the equity investment in for-profit firms offering
the same services.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Not-for-Profit Businesses
A non-profit with good liquidity and good profitability, but concerns about solvency has enough resources on hand
and is currently able to generate enough resources to cover its expenses. An organization with these characteristics could
consider investing in additional capital equipment or facilities that might help it expand its client or customer base. It might
also expand or extend its programs to include new lines of business that will allow it to tap into new clients/customers. If
long-term liabilities are part of the solvency concern it could consider restructuring or re-negotiating those liabilities.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Topic 3:
Financial Management
Government
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Government
https://www.coa.gov.ph/index.php
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Government
Volume I - Accounting Policies, Guidelines and Procedures, and Illustrative Accounting Entries
It contains the general provisions, basic standards and policies, the specific guidelines and procedures for each
standard, and the illustrative entries for typical transactions of national government agencies.
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
Financial Management in Government
https://drive.google.com/file/d/1vCNkghUV_ZUOVvhDspoem3qdUOkaJY2P/view?usp=sharing
https://drive.google.com/file/d/1Mr84Lwia95UZLCEiUQtZ3bxkaerGCS0L/view?usp=sharing
Confidential — SyCip Gorres Velayo & Co. Philippine Christian University-Graduate School of Business Management 2019 USSC Status Meeting
THANK YOU
Confidential — SyCip Gorres Velayo & Co. 2019 USSC Status Meeting