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BUSINESS FINANCE

UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

Chapter 1: Overview to Financial Management

What is Finance?

 Finance is a body of facts, principles, and theories relating to raising and using money by individuals, businesses and governments.  It involves the ways people and organizations raise and allocate capital, use monetary resources, and account for the risks involved.  It is also the study of how to value all sort of things such as valuation of a business enterprise, the payments left on a mortgage of a property, the purchase of an entire company or a personal decision to retire early.

Subfields of Finance  Study of corporate finance or financial management  Study of investments  Study of financial institutions and markets.

o Study of Financial Management The Financial Management process has three major functions, namely, a. financial analysis and planning b. utilization of funds, and c. acquisition of funds from investors Specifically, financial management involves decisions, among others, about;     

how to organize the firm in a manner that will attract capital how should capital be raised (i.e., debt or equity) which projects to fund how should the resources (long-term and short-term) be allocated and managed how to minimize taxation

o Study of Investments 

This involves methods and techniques for making appropriate decisions about what kind of securities to own, which firms’ securities to buy or how to pay that investor back in the form that the investor wishes.

o Financial Institutions and Markets 

These institutions help facilitate the capital flows between investors and companies. This sub-area involves the firms initially acquiring capital and then investors’ ongoing securities trading.

BUSINESS FINANCE

UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

FINANCIAL MANAGEMENT

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Financial Management, also referred to as managerial finance, corporate finance and business finance, is a decision-making process concerned with planning, acquiring, and utilizing funds in a manner that achieves the firm’s desired goals. Financial Management is a part of a larger discipline called finance. While getting the needed funds in the most suitable way and on the best terms possible is clearly a central part of the finance job, the finance function is much broader than one of funds procurement or supply.

OBJECTIVE OF FINANCIAL MANAGEMENT 

The goal of financial management is to maximize the current value of ownership in a business firm.  The above-stated goal considers the fact that the residual owners in a firm are entitled only to what is left after employees, suppliers, creditors and anyone else with a legitimate claim are paid their due.

SIGNIFICANCE OF FINANCIAL MANAGEMENT o Applicability o Chances of Failure o Return on investment SCOPE OF FINANCIAL MANAGEMENT o Traditional Approach  Procurement of short-term as well as long-term funds from financial institutions.  Mobilization of funds through financial instruments such as equity shares, preference shares, debentures, and so forth.  Compliance with legal and regulatory provisions relating to funds procurement, use and distribution. o Modern Approach  The total funds requirements of the firm  The assets or resources to be acquired and  The best pattern of financing the assets.

Chapter 2: Role of the Finance Manager

BUSINESS FINANCE

UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

Role of the Finance Manager  In striving to maximize owners’ or shareholders’ wealth, the financial manager makes decisions involving planning, acquiring, and utilizing funds which involve a set of risk-return trade-offs. These financial decisions affect the market value of the firm’s equity shares which leads to wealth maximization.

Figure 2.1. Role of the Finance Manager

Financial Manager makes decisions involving

Analysis and Planning

Acquisition of Funds

Impact on Risk and Return

Affect the Market Value of the Business Firm

Lead to Shareholder's Wealth Maximization

THE FINANCE ORGANIZATION

Utilization of Funds

BUSINESS FINANCE

UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

Broadly considered, the finance function is much the same as its basic aspects in all businesses. The ways in which business firms organize to carry out the finance function may be different.

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In a small business, the head of the firm (President or General Manager) often assumes direct responsibility for marketing, production, finance and still other functions such as human resources management, security, etc. In medium-size business concerns, a separate department headed by an officer with the title as Finance Manager may be assigned primary responsibility for the narrower funds supply aspects of the finance function. Still, in some business firms, responsibilities in the broad financial area are divided between a treasurer and a controller. In very large concerns, both the treasurer and the controller report to a chief financial officer who often ha the title, Vice-President – Finance.

RELATIONSHIP WITH OTHER KEY FUNCTIONAL MANAGERS IN THE ORGANIZATION  Finance is one of the major functional areas of a business. For example, the functional areas of business operations for a typical manufacturing firm are manufacturing, marketing and finance. Manufacturing deals with the design and production of a product. Marketing involves the selling, promotion, and distribution of a product. Manufacturing and marketing are critical for the survival of a firm because these areas determine what will be produced and how these products will be sold. Thus, finance is an integral part of total management and cuts across functional boundaries.

TYPES OF FINANCIAL DECISIONS The four (4) major types of decisions that the Finance Manager of a modern business firm will be involved are: 1. 2. 3. 4.

Investment decisions Financing decisions Operating decisions Return of capital decisions

BUSINESS FINANCE

UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

1. Investment decisions  The investment decisions are those which determine how scarce or limited resources in terms of funds of the business firms are committed to projects.  Because the firm has numerous alternative uses of funds, the finance manager strives to allocate funds wisely within the firm. This task requires both the mix and type of assets to hold. The asset mix refers to the amount of money invested in current and fixed assets.  The investment decisions should aim at investments in assets only when they are expected to earn a return greater than a minimum acceptable return which is also called as hurdle rate. 

The following areas are examples of investing decisions of a finance manager: a. Funds allocation and its rationing b. Determination of the total amount of funds that a firm can commit for investment c. Evaluation and selection of capital investment proposal d. Prioritization of investment alternatives e. Determination of the levels of investments in working capital f. Determination of fixed assets to be acquired g. Asset replacement decisions h. Purchase or lease decisions i. Restructuring reorganization mergers and acquisition j. Securities analysis and portfolio management

2. Financing decisions  Financing decisions assert that the mix of debt and equity chosen to finance investment should maximize the value of investments made.  These decisions should consider the cost of finance available in different forms and the risks attached to it.  Financing decisions call for good knowledge of costs of raising funds, procedures in hedging risk, different financial instruments and obligation attached to them.

3. Operating decisions

BUSINESS FINANCE

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UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

 This third responsibility area of the finance manager concerns working capital management. The term working capital refers to a firm short-term asset (i.e., inventory, receivables, cash and short-term investments) and its short-term liabilities (i.e., accounts payable, short-term loans).  This also involves a number of activities related to the firm’s receipts and disbursements of cash. Some issues that may have to be resolved in relation to managing a firm’s working capital are: a. The level of cash, securities and inventory that should kept on hand. b. The credit policy (i.e., should the firm sell on credit? If so, what terms should be extended?) c. Source of short-term financing (i.e., if the firm would borrow in the short-term, how and where should it borrow?) d. Financing purchases of goods (i.e., should the firm purchase its raw materials or merchandise on credit or should it borrow in the shortterm and pay cash?)

4. Return of capital decisions  The return of capital (or dividend distribution to corporate owners) decision is concerned with the determination of quantum of profits to be distributed to the owners, the frequency of such payments and the amounts to be retained by the firm.

 To summarize, the basic objective of the investment, financing, operating and return of capital is to maximize the firm’s wealth. If the firm enjoys the stability and growth, its shares prices in the market will improve and will lead to capital appreciation of shareholders’ investment and ultimately maximize the shareholders’ wealth.

Chapter 3: Financial Environment, Part 1 (Legal Forms of Business Organization, Financial Markets and institutions)

BUSINESS FINANCE

UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

The Organization of the Business Firm  The business firm is an entity designed to organize raw materials, labor, and machines with the goal of producing goods and/or services. Firms, - purchase productive resources from households and other firms - transform them into a different commodity, and - sell the transformed product or service to consumers.

Legal Forms of Business Organization -

Business firms can be organized in one of three ways: as a proprietorship, a partnership, or a corporation.

A. Sole Proprietorship  is a business owned by a single person who has complete control over business decisions. This individual owns all the firm’s assets and is responsible for all its liabilities.  From a legal point of view, the owner of a proprietorship is not separable from the business and is personally liable for all debts of the business.  From an accounting prospective, however, the business is an entity separate from the owner (proprietor). Therefore, the financial statements of the business present only those assets and liabilities pertaining to the business.  Among the advantages of a sole proprietorship are: 1. Ease of entry and exit- A sole proprietorship requires no formal charter and is inexpensive to form and dissolve. 2. Full ownership and control- The owner has full control, reaps all profits and bears all losses. 3. Tax savings- The entire income generated by the proprietorship passes directly to the owner. 4. Few government regulations- A sole proprietorship has the greatest freedom as compared with any form of business organization.  Major disadvantages of the proprietorship form include: 1. Unlimited liability- The owner is personally liable or responsible for any and all business debts.

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UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

2. Limitations in raising capital- Resources may be limited to the assets of the owner and growth may depend on his or her ability to borrow money. 3. Lack of continuity- Upon death or retirement of the owner, the proprietorship ceases to exist. 

The “Owner’s Capital” Section in the Statement of Financial Position of a Sole Proprietorship is presented below Owner’s Equity or Net Worth Jose del Pilar, Capital

Pxxxx

B. Partnership  is a legal arrangement in which two or more persons agree to contribute capital or services to the business and divide the profits or losses that may derived therefrom.  Partnership may operate under varying degrees of formality. For example, a formal partnership may be established using a written contract known as the partnership agreement which is filed with the Securities and Exchange Commission.  A general partnership is one in which each partner has unlimited liability for the debts incurred by the business.  A limited partnership is one containing one or more general partners and one or more limited partners.  Advantages of a partnership include among others the following: 1. Ease of formation- Forming a partnership may require relatively little effort and low start-up costs. 2. Additional sources of capital- A partnership has the financial resources of several individuals. 3. Management base- A partnership has a broader management base or expertise than a sole proprietorship. 4. Tax implication- A partnership like a proprietorship does not pay any income taxes. The income or loss of the business is distributed among the partners in accordance with the partnership and each partner reports his or her portion whether distributed or not on personal income tax return.  Disadvantages of partnership are:

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UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

1. Unlimited Liability- General partners have unlimited liability for the debts and litigations of the business. 2. Lack of Continuity- A partnership may dissolve upon the withdrawal or death of a general partner, depending on the provisions of the partnership. 3. Difficulty of transferring ownership- It is difficult for a partner to liquidate or transfer ownership. It varies with the conditions set forth in the partnership agreement. 4. Limitations in raising capital- a partnership may have problems raising large amounts of capital because many sources of funds are available only to corporations. 

The “Partner’s Capital” Section in the Statement of Financial Position of a Partnership is presented below Partner’s Equity or Net Worth Jose del Pilar, Capital

Pxxxx

Marcelo de Guzman, Capital

Pxxxx

C. Corporation  an artificial being created by law and is a legal entity separate and distinct from its owners.  This legal entity may own assets, borrow money and engage in other business entities without directly involving the owners.  In many corporations, owners who are also called shareholders do not directly manage the firm. Instead, they select managers designated as the Board of Directors to run the firm for them.  The incorporation process is initiated by filing the articles of incorporation and other requirements with the SEC.

 Advantages of a corporation are: 1. Limited liability- Shareholders are liable only to the extent of their investment in the corporation. Thus, shareholders can only lease what they have invested in the firm’s shares, not any other personal assets. 2. Unlimited Life- Corporations continue to exist even after the death of the owners.

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UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

3. Ease in transferring ownership- Shareholders can easily sell their ownership interest in most corporations by selling their stock without affecting the legal form of business organizations. 4. Ability to raise capital- Corporations can raise capital through the sale of securities such as bonds to investors who are lending money to the corporations and equity securities such as common stock to investors who are the owners.  Disadvantages of a corporation include: 1. Time and cost of formation- Registration of public companies with the SEC may be time-consuming and costly. 2. Regulation- Corporations are subject to greater government regulations than other forms of business organizations. Shareholders cannot just withdraw assets from the business. 3. Taxes- Corporations pay taxes on income they have earned. The complexity of the subject of taxation demands the advice of a qualified tax accountant. 

The “Shareholder’s Equity” Section in the Corpirate Statement of Financial Position of a Partnership is presented below Shareholder’s Equity Ordinary shares, P100 par value Authorized, 10,000 shares Subscribed and paid up, 5,000 shares Additional paid in capital Retained earnings Total Shareholder’s equity

Pxxx,xxx xx,xxx xx,xxx Pxxx,xxx

Financial Markets and Financial Institutions

Financial Markets -

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are the meeting place for people, corporations and institutions that either need money or have money to lend or invest. Participants in the financial markets also include national, state, and local governments; their markets are referred to as public financial markets. Large corporations raise funds in the corporate financial markets.

BUSINESS FINANCE

UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

 Financial market functions as both primary and secondary market for debt and equity securities. 

Primary Market - refers to original sale of securities by governments and corporations. In a primary market transaction, the corporation or the government is the seller and the transaction raises money for the corporation or government. - Corporations engage in two types of primary market transactions, public offerings and private placements.

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Secondary Market - popularly known as Stock Market or Exchange. Two broad segments of the stock markets: 1. The Organized Stock Exchange. The stock exchanges will have a physical location where stocks buying and selling transactions take place in the stock exchange floor. 2. The Over-the-Counter (OTC) Exchange. Where shares, bonds and money market instruments are traded using a system of computer screens and telephones.

Stock Exchange- is an entity (a corporation or mutual organization) which is in the business of bringing buyers and sellers of stocks and securities together. -

The purpose of stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a market place, virtual or real.

Structure and Functions of the Financial Markets

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Types of Markets 1. Physical asset markets versus financial asset markets. - Physical asset markets (also called tangible or real asset markets) are for products such as wheat, autos, real estate, computers and machinery. - Financial asset markets, on the other hand, deal with stocks, bonds, notes and mortgages. It also deals with the derivative securities

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UNIT 1- INTRODUCTION TO FINANCIAL MANAGEMENT

whose values are derived from changes in the prices of other assets. 2. Spot markets versus future markets. - Spot markets are markets in which assets are bought or sold for “on-the-spot” delivery. - Future markets are markets in which participants agree today to buy or sell an asset at some future time. 3. Money markets versus capital markets. - Money markets are financial markets in which funds are borrowed or loaned for short periods (less than one year). - Capital markets are financial markets for stocks and for intermediate or long-term debt (one year longer). 4. Primary markets versus secondary markets. - Primary markets are the markets in which corporations raise capital by issuing new securities. - Secondary markets are the markets in which securities and other financial assets are traded among investors after they have been issued by corporations. 5. Private markets versus public markets. - Private markets are markets in which transactions are wor...