FINANCE 101
What is Finance?
Decisions about money, or more appropriately, cash
flows. Finance decisions deal with how money is raised
and used by business, government, and individuals.
To make sound financial decisions, one must know the
six pillars of finance-
1. Money has a time value – the sooner cash is
received, the more valuable it is.
2. A trade-off exists between risk and the expected
return.
3. You need to diversify your investment to spread the
risks.
4. Financial market is efficient.
5. Management vs owners’ objectives.
6. Reputation matters – An individual reputation reflects
his/her ethical standards or behavior.
GENERAL AREAS OF FINANCE
Financial markets and institutions –
include banks, insurance companies, savings &
loans, credit unions, are an integral part of the
general financial services markets.
Investments – focuses on the decisions made
by businesses and individuals as they choose
securities for their investment portfolios.
Financial services – refers to functions
provided by organizations that deal with
management of money.
Managerial (business) finance – deals with
decisions that all firms make concerning their
cash flows – both inflows and outflows.
IMPORTANCE OF FINANCE IN NON-
FINANCE AREAS
Management – Strategic planning, one of the
most important activities of management cannot
be accomplished without considering how such
plans impact the overall financial well-being of
the firm.
Marketing – 4 Ps; product, price, place and
promotion- determine the success of products
that are manufactured and sold by companies.
Accounting – In many firms, it is often difficult to
distinguish between the finance and accounting
function. The two disciplines are closely related.
Accountants are involved in finance decisions and
finance managers are involved in accounting
decisions.
DEFINITION AND NATURE OF
ACCOUNTING
Accounting is defined as a service
activity.
Its function is to provide quantitative
information, primarily financial in nature,
about economic entities;
That is intended to be useful in making
economic decisions.
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IMPORTANCE OF FINANCE IN NON-
FINANCE AREAS
Information Systems- to make sound
decisions, finance managers rely on accurate
information that is available when needed.
Without appropriate information, decisions
relating to finance, management, marketing,
and accounting could prove disastrous.
Economics – Finance and economics are so
similar that some universities offer courses
related to these two subjects in the same
functional areas. Many tools used to make
financial decisions evolved from models
developed by economist.
PERSONAL FINANCE
Needs vs Wants
Living beyond our means because we fail to
know the difference between our needs and
wants.
Needs are man’s basic requirements to be
able to live.
Food – simple and nutritious food cooked at
home is a need; dining out in fancy restaurant is
really a want.
Clothing – we need clothes that are clean, neat,
and suited for our daily activities; expensive,
designer clothes just to be fashionable are wants.
PERSONAL FINANCE
Housing and Utilities – a room or a house big
enough for our own family with simple furniture,
stove, small TV set and a telephone or simple
cell phone are needs; a big house, expensive
furniture, a home entertainment system and
top of the line, mobile phones are wants.
Transportation – enough money to be able to
go to work and return home is a need. Owning
a motorcycle or a car are usually wants. There
are cases in which it will cost you less to own a
motorcycle or car than using the public
transport system. If this is so, then the vehicle
is a need. It is all right to buy it if you can afford
it.
PERSONAL FINANCE
Education & Insurance – Education, life and
health insurance especially if you have a family
dependent on you, are needs.
Leisure, Travel & Parties – we need recreation
to balance our life and help us cope with stress.
There are many things we can do for free to keep
our minds off our work and our problems.
We can arrange a gathering with friends by
asking them to bring food for sharing or take our
bike to the park to catch the fresh morning
breeze.
When we start spending for a leisure activities, it
becomes a want.
FINANCIAL LIFE STAGES
Start-up Stage – when your only source of
income is your salary or earnings provided by
your active participation in terms of time and
talent.
Build-up Stage – when you have income coming
from savings and investments, which contribute
at least 20% of your total income.
Asset Allocation Stage – when a good portion
of your income (30% - 60%) of your income is
being provided by your savings and investments.
Retirement Stage – when your income from
your savings and investments is your primary
source to support your living expenses
ULTIMATE GOAL: FINANCIAL
INDEPENDENCE
When is a person considered wealthy?
The concept of wealth is usually equated to
having lots of money.
Wealth is really a condition where your
present financial resources can support your
lifestyles over a long period of time even if
you do not work to generate income.
Even if you are not a millionaire, you can
consider yourself as a wealthy person if your
are satisfied living a simple way of life.
“IT
IS NOT HOW MUCH YOU
MAKE. IT IS HOW MUCH
MONEY YOU KEEP” – Robert
Kiloski (author of Rich Dad, Poor Dad)
TWO SOURCES OF INCOME
ACTIVE INCOME- income that comes directly
as a result of your hard work, skills, talent,
and time. There are two types of active
income:
Primary income – main source of income in
form of salaries, allowances, commissions,
professional fees.
Additional income – income from your
“sidelines”, buy & sell business, overtime,
etc.
Active income should only be spent for your
needs, not for your wants.
TWO SOURCES OF INCOME
PASSIVE INCOME – income generated by
your earning assets and investments. This
income does not depend on your active
participation in terms of time, skill or talent.
This is your income even if you do not work.
Many authors of business finance and
personal finance gurus believe that financial
independence can only be achieved through
Passive income
Without investment income, one cannot
achieve financial success or financial
independence.
8 WAYS TO INVEST YOUR
SAVINGS
1. Debt reduction
2. Government and corporate bonds
3. Special time deposits in banks
4. Pension plans
5. Start a business
6. Real estate
7. Mutual funds
8. Stock market
START SAVINGS EARLY
Make regular savings-
Monthly income - P20,000
Less: Savings - 5,000
Budget for expenses - P15,000
Time value of money-
P5,000 x 12 P60,000 annual savings
Total savings for 20 years = P1,200,000
Future value when invested at 12%pa for
20 years = P4,323,000
INVESTMENT IN
STOCKS
If you have P1.0 million in 2002, you can
either:
Putyour money in a savings account (BDO) to
earn 2% interest p.a. Today (2020) you will
have = P1,428,000 in your savings account, or
Buy the bank, BDO was selling its shares at
P16.69/share = 59,916 share. Today, these
shares are now worth at P145/share for a
total value of P8, 687,820; or
Buy, BPI shares. In 1990, it was selling
shares at P3.33/share. Today, it is worth
P88/share. Your P1.0 m will now have a
value of P26 m
RETURN ON INVESTMENT (ROI)
RISK-FREE INVESTMENT
Government securities- Tbills or Treasury
Notes (TN) - 2 – 3% p.a.
Inflation rate - 3 – 4%
Risk premium - 3 – 5%
ROI - 8 – 12%
INVEST EARLY AND INVEST LONG-TERM
If you invest P2,000/month or P24,000/year
starting at age 21 for 6 years, value of
your
investment by age 60 = P10,283,000
If you start at age 27, investing same
amount monthly, at retirement age of
60 you will have P5,200,000.
TARGET AMOUNT P5 M BY AGE 60
Starting Age No. of yrs Amnt
Required/Month
25 35 P1,537
30 30 2,533
35 25 4,236
40 20 7,274
45 15 13,114
50 10 26, 145
55 5 68,249
ROI at compounded rate of 8%/p.a.
