Republic of the Philippines

UNIVERSITY OF RIZAL SYSTEM

Province of Rizal
Angono Campus

COLLEGE OF ARTS AND LETTERS

Second Semester, SY 2022 – 2023

BUSINESS FINANCE
HANDOUT

DEFINITION OF FINANCE
Finance is usually related to money. The American Heritage Desk Dictionary define finance as the management of
money, banking, investments, and credit. It is also defined as a science of management of money and other assets.

This definition suggests that finance is directly related to money or to a business activity that primarily deals with money
transaction. Finance is both science and art of correct application of the economic and accounting concepts and principles
that define the system, structure, and process of management, allocation, and utilization of financial resources,
investments, and expenditures.

The use of information in financial decisions and activities emphasizes that finance is a science. The financial practices do
not remain static but become adaptive to the changes in the business environment. As business practices change
overtime, new financial theories are introduced by experts in the field of finance. Finance, therefore, is an art.

Today, finance functions as a separate field that operates closely with economic and accounting. Finance used to be
considered an integral part of economics. Economics is concerned with the efficient utilization of scarce resources to
satisfy human needs and wants. Economic variables such as price, demand, supply income and expenditures are the
focus of study in economic theories and principles.

Accounting is considered as the language of both business and finance. Accounting is an art of recording business
transaction and deals with the preparation of financial statements.

Public finance is the allocation of government income generates from either taxation or borrowings and the government
expenditure based on the approved national and local appropriation or budget. Public finance is also called as fiscal
administration.

Personal finance is a sub-category of private finance which is directed towards the management of personal resources
of an individual. Income is allocated based on individual's personal needs such as household expenses, education,
hospitalization and acquisition of personal and real properties.

Business finance focuses on handling and management of financial resources of a business organization. The three
major divisions of business finance are financial management, capital market and financial investment.
Financial management focuses on capital budgeting decision or investment decision on the acquisition of assets and its
corresponding financing scheme.

Capital market studies the different financial institutions and their functions that aid both private and public borrowers of
funds.

Financial investment includes business decisions about the value and price of stocks, bonds, and behavior of the
investors.

FINANCE can be defined as the science and art of managing money. (Gitman & Zutter, 2012) Finance is concerned with
decisions about:
1. How much of their earnings they spend?
2. How much they save or how much they need?
3. How they invest their savings?
4. How they raise additional funds they need? (Gitman)

BUDGETING is the act of estimating revenue (in the form of their allowance) and expenses over a period (in this case,
daily).

Forms of business organizations:

• Sole Proprietorship - A business owned by one person and operated for his or her own profit.
• Partnership - A business owned by two or more people and operated for profit.
• Corporation – An entity created by law owned by shareholders.

How and where can they buy stocks?

• 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.

Companies which are publicly listed are owned by unrelated investors and are traded in organized exchanges like the
Philippine Stock Exchange. While there are many stockholders, there is generally a group of investors or a family which
controls each listed company. For example, in the case of BPI, the biggest stockholder is Ayala Corporation and in the
case of Banco De Oro, it is SM Investment Corporation. Prices of stocks of listed corporations are driven by several
factors such as the earnings of the companies, the prospects of the industry where these companies operate, the general
market sentiment, and the economic prospects of the country, among others.

FACTORS THAT DEFINE SHAREHOLDER’S WEALTH

1. Measurement of the shareholder’s wealth
2. Factors that the Management can control and external factors that cannot be controlled by management.
3. Role of Financial Management

Measurement of the shareholder’s wealth

Assume a learner bought 10 shares of Globe Telecom at PHP2,510 each on September 9, 2010. This brings his
investments to PHP25,100. What happens to the value of his investment if the price goes up to PHP2,600 per share or it
goes down to PHP2,300 per share?

Shareholders’ wealth is measured based on the current market price of the corporation’s stocks. The market price
changes across different periods. Hence, the value of your investment changes in different points on time based on the
market value at that time.

Factors that the Management can control and external factors that cannot be controlled by management.

Controllable by Management Uncontrollable External Factors

• macroeconomic conditions
• profitability
• political stability
• having a good liquidity and reasonable
• prospects of the industry where the
leverage position
company operates
• dividends
• general market sentiment
• competent management which affects the
• flow of foreign funds invested in the
company’s operating efficiency
Philippine stock market
 • coming up with corporate plans that improve
the business prospects of the company

Profitability
Profit is a measure of the financial performance of a company for a period. Although it is a major driver for increasing the
value of stock, an investor should not rely on profits alone. Company has profits but its cash flow is negative.

• Company A is profitable but generated negative cash flows which resulted from the uncollected accounts receivable
of PHP100,000. Without adequate cash inflows to meet its obligations, the company will face liquidity problems,
regardless of its level of profits.
• Company B on the other hand has a positive cash flow but is unprofitable. This is a result of the company’s delay in
payment of its costs. Accordingly, the Company will soon have to pay the remaining PHP100,000 liability and its cash
will no longer be sufficient. Again, without adequate cash inflows to meet its obligations, the company will face liquidity
problems.
• Company C is profitable and has a positive cash flow. Based on the information provided, Company C seems to be
the best.

Good liquidity and reasonable leverage position.

Liquidity and leverage refer to the company’s management of the type and amount of assets and liabilities that it will hold
during its operations.

Dividends
Holders of shares receive dividends from a corporation as returns on their investments in form of cash or other properties.
Companies which have better dividend policies are generally more attractive than companies who do not pay out
dividends. Note that there may be times that companies do not pay out dividends because of future expansions. Same
with the other factors affecting share price, dividend policies should go hand in hand with other factors in determining
market price.

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.

Corporate plans that improve the business prospects.

Company A which is in the business of selling Halo-halo in the Dapitan area (or any other area) for 5 years. Company A is
consistently earning profits and has a positive cash flow. When asked how Company A sees itself after 5 more years,
Company A answered that it would continue to sell Halo-halo in Dapitan (or any other area).

On the other hand, Company B sells Budko Juice in Katipunan area (or any other area different from Company A’s area)
for 5 years. Company B is consistently earning profits and has a positive cash flow. When asked how Company B sees
itself after 5 more years, Company B answered that it has generated enough cash to expand its business to Cubao area
(or any other area) to take advantage of the growing demand of Buko Juice in Cubao. Between Company A and Company
B, which would be a better investment?

Company B. Since it has more concrete prospects allowing investors to hope for better revenues and net income.

External Factors
• These factors influence the general reaction of investors in making an investment decision.
• Its effect is not only to a specific company but on all companies or a group of companies under similar circumstances.
• Such factors are a result of the environment a company operates in rather than the decisions of the company’s
management.

Role of Financial Management

Financial management deals with decisions that are supposed to maximize the value of
shareholders’ wealth. (Cayanan)
• These decisions will ultimately affect the markets perception of the company and influence the share price.
• 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.

The Corporate organization Structure.

Illustrate the corporate organization structure and inform them that this 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 everyone in a
corporate organization should have an objective of shareholders’ wealth maximization.

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

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.

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 to 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:
- Coordinating the functions of administration, finance, and marketing departments.
- Assisting other departments in hiring employees.
- Aiding 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)

FUNCTIONS OF A FINANCIAL MANAGER

Four functions of a VP for finance (CFO) as follows:
1. Financing
2. Investing
3. Operating
4. Dividend Policies

FINANCING DECISIONS
This includes 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:
 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. If we used money from our borrowings, the asset bought is financed by debt.
• In the figure above, the total assets are financed by 60% debt and 40% equity. Accordingly, the capital structure is
60% debt and 40% equity.

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.

INVESTMENTS
This 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
It deals 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 must 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, 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.

Factors that affect the decision of management in paying dividends.

• Availability of financially viable long-term investment
• Access to long term sources of funds
• Management’s Target Capital structure

Recall that 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.