Grade 12

BUSINESS FINANCE
Module 1: Introduction to Financial Management
(Week 1 and 2)
2nd Semester, S.Y. 2020-2021

Prepared by:
RAKIM L. PEREZ
TEACHER

____________________________________________________________________________
MDM-Sagay College, Inc.
Office: Feliza Bldg., Marañon St. Pob 2, Sagay City
Campus: National Highway, Poblacion 2, Sagay City, Negros Occidental
Tel.# 488-0531/ email: mdm_sagay2000@[Link].

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Module 1: Introduction to Financial Management

Lesson 1. The Definition, Nature, Function, and History of Accounting

Learning Outcomes: At the end of the lesson, the student should be able to:
1. Explain the major role of financial management and the different individuals
involved.
2. Enumerate the varied financial institutions and their corresponding services.

What I know

Activity 1.
1. Give examples of a particular set of people that you might seen in an organizational
chart that has a role in the decision making of the company. After you identify,
explain it’s role in the decision making of the company.
2. If you are going to save your money, where would you keep it?
3. What business you would like to try. Now, suppose that you had the business
running and is profitable for some time. Then decides to expand your business but
does not have enough cash to pay for the expansion. Where can you get the
additional funding?

What’s New

The Corporate organization Structure

Illustrate the corporate organization structure and this particular set of people each
play a role in the decision making of the company.

From the diagram presented, emphasize that 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 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.

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Discussion of the roles of each position identified.

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. Ask the learners again what the objective of the shareholders is
just to refresh.

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:
- Setting policies on investments, capital structure and dividend policies.
- Approving company’s strategies, goals and budgets.
- Appointing and removing members of the top management including the
president.
- Determining top management’s compensation.
- Approving the information and other disclosures reported in the financial
statements (Cayanan, 2015)

President (Chief Executive Officer): The roles of a president in a corporation may vary
from one company to another. Among the responsibilities of a president are the following:
- Overseeing the operations of a company and ensuring that the strategies as
approved by the board are implemented as planned.
- Performing all areas of management: planning, organizing, staffing, directing and
controlling.
- Representing the company in professional, social, and civic activities.

Although the president carries out the decision making for all functions, it would be
difficult for him/her to do this alone. The president cannot manage the company on his
own, especially when the corporation has become too big. To assist him are the vice
presidents of different functional areas: finance, marketing, production and
administration.

Determine from the list of roles written on the board the functions that pertain to the
respective VPs. Add the following functions if needed:

VP for Marketing: The following are among the responsibilities of VP for Marketing
- Formulating marketing strategies and plans.
- Directing and coordinating company sales.
- Performing market and competitor analysis.
- Analyzing and evaluating the effectiveness and cost of marketing methods
applied.
- Conducting or directing research that will allow the company identify new
marketing opportunities, e.g. variants of the existing products/services already
offered in the market. - Promoting good relationships with customers and
distributors. (Cayanan, 2015)

VP for Production: The following are among the responsibilities of VP for Production:
- Ensuring production meets customer demands.
- Identifying production technology/process that minimizes production cost and
make the company cost competitive.
- Coming up with a
production plan that maximizes the utilization of the company’s production
facilities.
- Identifying adequate and cheap raw material suppliers. (Cayanan, 2015)

VP for Administration: The following are among the responsibilities of VP for

Administration:

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 - Coordinating the functions of administration, finance, and marketing
departments.
- Assisting other departments in hiring employees.
- 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. (Cayanan, 2015)
Finally, focus the learners’ attention to the role of the VP for finance as this is where the
rest of the topics for this course will revolve.

What is It

Functions of a Financial Manager

Identify the four functions of a VP for finance (CFO) as follows:
- Financing
- Investing
- Operating
- Dividend Policies

Upon the operations of a company there are situations when we are faced with
lack of funds. 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.).
The role of the VP for Finance of the Financial Manager is to determine the
appropriate capital structure of the company. Capital structure refers to how much of
your total assets is financed by debt and how much is financed by equity. To illustrate,
show/draw the figure below:

Let us recall that Assets = Liabilities + Owner’s Equity.

- To be able to acquire assets, our funds must have come somewhere. If it was
bought using cash from our pockets, it is financed by equity.
- On the other hand, if we used money from our borrowings, the asset bought is
financed by debt.
- In the figure above, the total assets is financed by 60% debt and 40% equity.
Accordingly, the capital structure is 60% debt and 40% equity.
If you think that there is an ideal mix of debt and equity across corporations?

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- Answer: No. The mix of debt and equity varies in different corporations depending on
management’s strategies. It is the responsibility of the Financial Manager to determine
which type of financing (debt or equity) is best for the company.

Investing as where to put your excess cash to make it more profitable. We

expand that definition by including cash held taken from funds as a result of financing
decisions.

Investments may either be short term or long term.

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 an most optimal risk and return trade off.

Long term investments should be supported by a capital budgeting analysis which is

among the responsibilities of a finance manager.

• Capital budgeting analysis is a tool to assess whether the investment will be

profitable in the long run. This is a crucial function of management especially if
this investment would be financed by debt.
• The lenders should have the confidence that the investments that management
will push through with will be profitable or else they would not lend the company
any money.

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. Why does a Financial Manager need
to choose which source of financing a company should use? What do they need to
consider in making this decision?
- Short Term sources are those that will be payable in at most 12 months. This
includes short-term loans with banks and suppliers’ credit. For short-term bank
loans, the interest rate is generally lower as compared to that of long-term loans.
Hence, this would lead to a lower financing cost.
- Suppliers’ credit are the amounts owed to suppliers for the inventories they
delivered or services they provided. While suppliers’ credit is generally free of
interest charges, the obligations with them have to be paid on time to maintain
good supplier relationship. Such relationships should be nurtured to ensure
timely delivery of inventories.
- Short term sources pose a trade-off between profitability and liquidity risk.
Because this source matures in a short period, there is a possibility that the
company may not be able to obtain enough cash to pay their obligation (i.e.
liquidity risk).
- Long term sources, on the other hand, mature in longer periods. Since this will
be paid much later, the lenders expect more risk and place a higher interest rate
which makes the cost of long term sources higher than short term sources.
However, since long term sources have a longer time to mature, it gives the
company more time to accumulate cash to pay off the obligation in the future.
- Hence, the choice between short and long term sources depends on the risk
and return trade off that management is willing to take.

Dividend Policies. Recall that cash dividends are paid by corporations to existing
shareholders based on their shareholdings in the company as a return on their
investment. Some investors buy stocks because of the dividends they expect to receive
from the company. Non-declaration of dividends may disappoint these investors. Hence,

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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.

One of the functions of a finance manager is investing and its available cash may
be used to invest in long term investments that would increase the profitability of the
company. Some small enterprises which are undergoing expansion may have limited
access to long term financing (both long term debt and equity). This results to these
small companies reinvesting their earnings into their business rather than paying them
out as dividends.

On the other hand, a company which has access to long term sources of funds
may be able to declare dividends even if they are faced with investment opportunities.
However, these investment opportunities are generally financed by both debt and
equity.
- The management usually appropriates a portion of retained earnings for
investment undertakings and this may limit the amount of retained earnings
available for dividend declaration.
- Creditors are not willing to finance entirely the cost of a company’s long
term investment. Hence, the need for equity financing (e.g. internally generated
funds or issuance of new shares).
- Examples of these companies are publicly listed companies such as
PLDT, Globe Telecom, and Petron. PLDT and Globe are two of the Philippine
listed companies which have generously distributed cash dividends for the last
five years (information as of 2014).

For companies which have limited access to capital and have target capital
structure, they may end up with a residual dividend policy. This means that when
companies are faced with investment opportunities, internally generated funds will be
used first to finance these investments and dividends can only be declared if there are
excess funds.

LESSON 2: Financial Instruments and Financial Institutions

1. 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.

Let’s us recall the following definitions:

- A 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)

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 • 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. On the other hand,
investors buy debt securities of equity instruments in hopes of receiving returns through
interest, dividend income or appreciation in the financial asset’s price.

Identify common examples of Debt and Equity Instruments.

- Debt Instruments generally have fixed returns due to fixed interest rates. Examples of
debt instruments 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.

- 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.
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. (Cayanan, 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.

2. Financial Markets

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.
• However, suppliers of funds or the holders of the securities may decide to sell
the securities that have previously been purchased. The sale of previously
owned securities takes place in secondary markets.
• The Philippine Stock Exchange (PSE) is both a primary and secondary
market.

Money Markets vs. Capital Markets

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 • 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.
• 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 (equity, or ownership).

3. Financial Institutions
Identify 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.

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. Conversely, when they invest in debt or equity
securities already held by investors, they are transferring ownership of the securities
among investors.

Pension Funds - Financial institutions that receive payments from employees and
invest the proceeds on their behalf.

Other financial institutions include 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.

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 What’s More
Multiple Choice
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.
5. A financial manager must choose between four alternative Assets: 1, 2, 3, and 4.
Each asset costs $35,000 and is expected to provide earnings over a three-year period
as described below.

Based on the profit maximization goal, the financial manager would choose _____.
A. Asset 1. B. Asset 2.
C. Asset 3. D. Asset 4.

What I Have Learned

Terms Defined

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 1. Primary Market - Financial market in which securities are initially issued; the only
market in which the issuer is directly involved in the transaction.
2. Public offering - The sale of either bonds or stocks to the general public.
3. Private placement - The sale of a new security directly to an investor or group of
investors.
4. Secondary market - Financial market in which preowned securities (those that
are not new issues) are traded.
5. Money market - A financial relationship created between suppliers and users of
short-term funds.
6. Capital market - A market that enables suppliers and users of long-term funds to
make transactions.

What I Can Do

Multiple Choice
1. The primary goal of the financial manager is
A. minimizing risk. B. maximizing profit.
C. maximizing wealth. D. minimizing return.
2. 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.
3. The wealth of the owners of a corporation is represented by
A. profits. B. earnings per share.
C. share value. D. cash flow.
4. 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.
5. 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.
6. Profit maximization as a goal is not ideal because it does NOT directly consider
A. risk and cash flow. B. cash flow and stock price.
C. risk and EPS. D. EPS and stock price.
7. Profit maximization as the goal of the firm is not ideal because
A. profits are only accounting measures.
B. cash flows are more representative of financial strength.
C. profit maximization does not consider risk.
D. profits today are less desirable than profits earned in future years.
8. Profit maximization fails because it ignores all EXCEPT
A. the timing of returns. B. earnings per share.
C. cash flows available to stockholders. D. risk.
9. The key variables in the owner wealth maximization process are
A. earnings per share and risk. B. cash flows and risk.
C. earnings per share and share price. D. profits and risk.
10. Cash flow and risk are the key determinants in share price. Increased cash flow
results in ________, other things remaining the same.
A. a lower share price B. a higher share price
C. an unchanged share price D. an undetermined share price
11. Cash flow and risk are the key determinants in share price. Increased risk, other
things remaining the same, results in
A. a lower share price. B. a higher share price.
C. an unchanged share price. D. an undetermined share price.

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12. Financial managers evaluating decision alternatives or potential actions must
consider
A. only risk. B. only return.
C. both risk and return. D. risk, return, and the impact on share price.
13. A financial manager must choose between four alternative Assets: 1, 2, 3, and 4.
Each asset costs $35,000 and is expected to provide earnings over a three-year period
as described below.
Based on the profit maximization goal, the financial manager would choose

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

14. A financial manager must choose between three alternative investments. Each
asset is expected to provide earnings over a three-year period as described below.
Based on the wealth maximization goal, the financial manager would.

A. choose Asset 1. B. choose Asset 2.

C. choose Asset 3. D. be indifferent between Asset 1 and Asset 2.

Assessment
Multiple Choice
1. A ______ is one financial intermediary handling individual savings. It receives
premium payments that are placed in loans or investments to accumulate funds to cover
future benefits.
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

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 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.

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
11. 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.
12. 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.
13. Long-term debt instruments used by both government and business are known as
A. bonds. B. equities.
C. stocks. D. bills.

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