Finance Midterm Reviewer arial PDF

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LESSON 1: OVERVIEW OF FINANCEWhat is Finance?  Finance can be defined as the science and art of managing money (Gitman & Zutter, 2012). The word finance is derived from the Latin word “finer”, meaning “to end” or “to pay”.  According to Webster, finance may be defined as a noun and as a ve...

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BUSINESS FINANCE MIDTERM REVIEWER LESSON 1: OVERVIEW OF FINANCE • What is Finance?  Finance can be defined as the science and art of managing money (Gitman & Zutter, 2012). The word finance is derived from the Latin word “finer”, meaning “to end” or “to pay”.  According to Webster, finance may be defined as a noun and as a verb.  Noun: a system of money, credit, and investment.  Verb: to provide funds Finance vs Budgeting  Finance has a broader scope than

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budgeting. Business  A business is an organizational entity involved in the provision of goods and services to customers mostly to gain profit. Forms of business organizations • Sole Proprietorship  Owned and operated by one individual  Income generated is taxed at the proprietor’s personal tax rate  Not recognized as a separate legal entity  Owner faces liability with respect to his/her business • Partnerships  Involves two or more owners  Details of each partners responsibilities are outlined in a partnership agreement

Corporations Recognized as separate entities by the law Profits are taxed based on corporate tax rates Transfer of ownership is relatively easy Shareholders owns the corporation Examples of big listed companies: PLDT, Globe, BPI, Banco de Oro, San Miguel Corporation Corporations may either be privately owned or publicly owned. Privately-owned corporations are often owned by family members whose stocks may not be offered to outsiders unless consent by the family members is secured. Publicly-owned corporations are companies owned by unrelated investors and are traded in organized exchanges like the Philippine Stock Exchange (PSE).

KNOWING THE SHAREHOLDER • The overall objective of a shareholder is wealth maximization. • What defines a shareholders wealth? • Sample: You bought 10 shares of Globe Telecom at P2,510 on 9 September 2010. This brings your investments to P25,100. • What happens to the value of your investment if the price goes up to

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BUSINESS FINANCE MIDTERM REVIEWER P2,600 per share, or it goes down to P2,300 per share? CONTROLLABLE BY MANAGEMENT/INTERNAL: 1. Profitability. Profit is a measure of the financial performance of a company for a period of time. (Is a profitable company a successful company? Can success be attributed to profitability only?) 2. Cash flow: The amount of cash and cash-equivalents being transferred into and out of a business. 

Positive cash flow – liquid assets are increasing, be able to settle debts, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges.

3. Good liquidity and reasonable leverage position. Liquidity and leverage refers to the company’s management of the type and amount of assets and liabilities that it will hold in the course of its operations 4. Dividends. Holders of shares receive dividends from a corporation as returns of their investments in form of cash or other properties.

5. Competent management. Competent managers may have any of the following attributes: 1. Visionary 2. Decisive 3. People-oriented 4. Inspiring 5. Innovative 6. Respected 7. Experienced/Seasoned Manager  Coming up with corporate plans that improve the business prospects of the company.

UNCONTROLLABLE EXTERNAL FACTORS:  External Factors. These factors influence the general reaction of investors in making an investment decision 1. Macroeconomic conditions Economic factors that influence the state of the whole economy, such as changes in employment levels, gross national product (GNP), and prices (deflation or inflation) 2. Political stability a. the propensity of a government collapse either because of conflicts or rampant competition between various political parties. b. Economic growth and political stability are deeply interconnected. 3. Prospects of the industry where the company operates you must understand what is going on not just in your own business but also in your entire industry. 4. General market sentiment Market sentiment is the overall attitude of investors toward a particular security or financial market.  Market sentiment is the feeling or tone of a market, or its crowd psychology, as revealed through the activity and price movement of the securities traded in that market. In broadest terms, rising prices would indicate bullish market sentiment, while falling prices would indicate bearish market sentiment. 5. Flow of foreign funds invested in the stock market -

Role of Financial Management

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Financial management deals with decisions that are supposed to maximize the value of shareholders’ wealth. (Cayanan) The goal of financial management is to maximize the value of shares of stocks. Managers of a corporation are responsible for making the decisions for the company that would lead towards shareholders’ wealth maximization.

LESSON 2: INTRODUCTION TO FINANCIAL MANAGEMENT

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Shareholders ⬗ Elect the Board of Directors (BOD) ⬗ Each share held is equivalent to one voting right. ⬗ Since the BOD is elected by the shareholders, their responsibility is to carry out the objectives of the shareholders. Board of Directors (BOD) ⬗ The highest policy-making body in the corporation. ⬗ Primary responsibility – to ensure that the corporation is

operating to serve the best interests of the shareholders. ⬗ Since the BOD is elected by the shareholders, their responsibility is to carry out the objectives of the shareholders. ⬗ *Responsibilities of the Board of Directors (BOD) ⬗ Setting policies on investments, capital structure, and dividend policies. ⬗ Approving company’s strategies, goals, and budgets. ⬗ Appointing/removing members of top management, including the President. ⬗ Determining top management’s compensation. 3 President ⬗ 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. 4 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/directing research that will allow the company to identify new marketing opportunities, e.g.

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variants of the existing products/services already offered in the market. ⬗ Promoting good relationships with customers and distributors. 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. VP for Administration ⬗ 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 maximum amount of office space needed by the company. ⬗ Identifying means, processes, or systems that will minimize the operating costs of the company.

“Finance plays a critical role across every aspect of our business. We enable the business to turn ambition and strategy into sustainable, consistent, and superior performance.” 7

VP for Finance ⬗ Financing ⬗ Investing ⬗ Operating ⬗ Dividend Policies

⬗ 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 is to determine the appropriate capital structure of the company. CAPITAL STRUCTURE  Capital structure is the mix of different securities issued by a firm to finance its operations. SECURITIES  Bonds  Bank loans  Stocks 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 INVESTMENTS SHORT TERM ⬗ Short-term investment decisions are needed when the company is in an excess cash position. ⬗ The Financial Manager should be able to make use of financial planning tools, such as budgeting and forecasting. ⬗ The company should choose which type of investment it should invest in that would provide the most optimal risk and return trade-off. LONG TERM ⬗ Long-term investments should be supported by capital budgeting analysis which is among the

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BUSINESS FINANCE MIDTERM REVIEWER 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 to determine 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? a. Short term sources  Are those that will be payable in at most 12 months. This includes shortterm 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.  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). b. Supplier’s credit

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are the amounts owned to suppliers for the inventories they delivered or services they provided. c. Long Term sources Mature in longer periods. Since this will be paid much later, the lenders expect more risk and place a higher interest rate which make the cost of long term sources higher than short term sources.

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 ⬗ Paid by corporations to existing shareholders based on their shareholdings in the company as a return on their investment. ⬗ It is the role of the 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: ⬗ The company must have enough retained earnings (accumulated profits) to support cash dividend declaration. ⬗ The company must have cash. LESSON 3: FINANCIAL MARKETS •

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Financial markets are organized forums in which the suppliers and users of various types of funds can make transactions directly. They are the bridge between those with excess funds and those who need funds.

CLASSIFICATION OF FINANCIAL MARKETS 1. As to term or maturity Distinguished as to the term or maturity of the instruments they deal with.

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BUSINESS FINANCE MIDTERM REVIEWER a. Money market b. Capital market 2. As to type of issue – Differentiate the markets as to whether they deal with original issues (primary market) or previously owned securities or re-acquired securities (secondary market). a. Primary market b. Secondary market MONEY MARKET VS CAPITAL MARKET • Money markets are a venue wherein securities with short-term maturities (1 year or less) are sold. • Some individuals, businesses, governments, and financial institutions have temporarily idle funds that they wish to invest in a relatively safe, interest-bearing asset. MONEY MARKET • Debt securities of 1 year or less – Treasury bills or T-bills issued by the government (short-term secure investments issued by the Philippine government through the Bureau of Treasury (BTr). • Issued by companies needing shortterm funds and bought by investors with short-term excess of funds. • These securities have relatively low risk. • Money market securities are traded in massive quantities. • They have high liquidity – easily converted to cash GOVERNMENT SECURITIES • The Philippine Government issues two kinds of government securities (GS), treasury bills and treasury bonds. • The Bureau of Treasury originates their sale to the investing public through a network of licensed dealers.

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Generally considered the safest unsecured bonds, since the possibility of the Government defaulting on payments, is almost zero. TREASURY BILL • Treasury bills are government securities which mature in less than a year. • There are three tenors: – 91 days – 182 days – 364 days • The number of days are based on the universal practice around the world that the bills mature on a business day. CAPITAL MARKET • On the other hand, securities with longer-term maturities are sold in Capital markets. The key capital market securities are bonds (longterm debt) and both common stock and preferred stock (equity, or ownership). • Treasury bonds are government securities which mature beyond one year. • At present, there are five maturities of bonds: • 2 years • 5 years • 7 years • 10 years • 20 years • Other examples of long-term securities: • Long term loans • Mortgages • Financial leases (alternative way of financing whereby a licensed leasing company (the “Lessor’) purchases an asset on behalf of its customer (the “Lessee”) in return for a contractually agreed series of payments which usually include an element of interest. PRIMARY VS SECONDARY MARKETS

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When a company publicly sells new stocks and bonds for the first time, it does so in the primary market. In many cases, this takes the form of an initial public offering (IPO). An initial public offering (IPO) is the first time that the stock of a private company is offered to the public. The secondary market is where securities are traded after the company has sold all the stocks and bonds offered in the primary market. A broker typically purchases the securities on behalf of an investor

individuals, and purchase debt securities issued by firms or government agencies. - Ordinary commercial banks: perform the simpler functions of accepting deposits and granting loans. They do not do investment functions. - Expanded commercial or universal banks: (also called unibanks)- perform investment services; they are “expanded” because they function as an investment house and investing on stocks and bonds. 2.

FINANCIAL INSTITUTION/INTERMEDIARIES  Financial Institutions are intermediaries that channel the savings of individuals, businesses, and governments into loans or investments. They channel the funds from lenders to borrowers. They include the depository institutions and the nondepository institutions.  Financial intermediaries can be grouped into two basic categories: Depository &Non-depository institutions 1. Depository institutions – refers to financial institutions that accept deposits. It issues checking or current account, savings, and time deposit, and help depositors with money market placements. 2. Non-depository institutions – unlike depository institutions, which obtain funds by issuing deposits, issue contracts that are not deposits. DEPOSITORY INSTITUTIONS Depository institutions include: 1. Commercial banks - Commercial Banks - Individuals deposit funds at commercial banks, which use the deposited funds to provide commercial loans to firms and personal loans to

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Thrift banks - Engaged in accumulating savings of depositors and investing them; Provide short-term working capital and medium and longterm financing to businesses engaged in the agriculture, services, industry and housing. Savings and mortgage banks - are banks specializing in granting mortgage loans other than the basic function of accepting deposits. Private development banks - cater to the needs of agriculture and industry providing them with reasonable rate loans for medium and long-term purposes. Stock Savings and loan associations provide many of the same services to customers as commercial banks, including deposits, loans, mortgages, checks and debit cards. However, savings and loans associations place a stronger emphasis on residential mortgages, whereas banks tend to concentrate on working with large businesses and on unsecured credit services such as credit cards. Microfinance thrift banks - are small thrift banks that cater to small , micro, and cottage industries, hence, the term “micro”. They grant loans to small businesses like sari-sari stores, small bakeries, cottage industries, among others. Credit unions - are cooperatives organized by people from the same organization (whether formally or

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BUSINESS FINANCE MIDTERM REVIEWER informally organized) like farmers, fishermen, teachers, employees of a company, among others. 3.

Rural banks - are the more popular type of banks in the rural communities; their role is to promote and expand the rural economy in an orderly and effective manner by providing the people in the rural communities with basic financial services.

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2. NON-DEPOSITORY INSTITUTIONS Non-depository institutions can be classified into the following: 1. Insurance companies - are financial intermediaries that sell life insurance companies; Policyholders pay regular insurance premiums; Life insurance companies provide protection over a contracted period or term, which may be a year, five years, or for life. - Life insurance companies - Property insurance companies is insurance that protects against property losses to one’s business, home or car, and/or against legal liability that may result from injury or damage to the property of others - Casualty insurance companies does not only cover property but also individuals; it provides help if a person meets an accident at times, it is referred to as disability insurance - Homeowners insurance is insurance for the house and its contents. - Auto or vehicle insurance covers a person, his spouse, and his relatives who live in one home and other licensed drivers to whom the insurer gives permission to drive his car. - Flood insurance is becoming more and more popular nowadays as places that normally do not experience floods, become flooded due to extreme weather. - Windstorm insurance is a separate type of coverage that

protects one’s home or business against wind damage, as a result of a hurricane, hail, snow, sand, or dust. This is, however, more common in the U.S. where certain states are beset by hurricanes. Health insurance is a type of insurance that pays for medical expenses in exchange for premiums.

Fund managers – included among the fund managers are pension fund companies and mutual fund companies. - Pension fund companies sell contracts to provide income to policyholders during their retirement years. Pension funds can be funded by employees only or by both employees and their employers. SSS is a form of pension plan. - Mutual fund companies are companies engaged in the mutual funds market. They allow investors, including individuals, ...