FINANCE FUNCTIONS

A heterodox macroeconomic theory developed by Abba Lerner during World War II that seeks to eliminate economic insecurity (i.e., the business cycle) through government intervention in the economy. Finance function is the most important function of a business. Finance is, closely, connected with production, marketing and other activities. In the absence of finance, all these activities come to a halt. In fact, only with finance, a business activity can be commenced, continued and expanded. Finance exists everywhere, be it production, marketing, human resource development or undertaking research activity. Understanding the universality and importance of finance, finance manager is associated, in modern business, in all activities as no activity can exist without funds. Functional finance emphasizes the end result of interventionist policies on the economy and is based on three major beliefs: 1. It is the role of government to stave off inflation and unemployment by controlling consumer spending through the raising and lowering of taxes. 2. The purpose of government borrowing and lending is to control interest rates, investment levels and inflation. 3. The government should print, hoard or destroy money as it sees fit to achieve these goals.

Functional finance also says that the sole purpose of taxation is to control consumer spending because the government can pay its expenses and debts by printing money.

Finance functions include:

Investment Decision One of the most important finance functions is to intelligently allocate capital to long term assets. This activity is also known as capital budgeting. It is important to allocate capital in those long term assets so as to get maximum yield in future. Following are the two aspects of investment decision a. Evaluation of new investment in terms of profitability b. Comparison of cut off rate against new investment and prevailing investment. Since the future is uncertain therefore there are difficulties in calculation of expected return. Along with uncertainty comes the risk factor which has to be taken into consideration. This risk factor plays a very significant role in calculating the expected return of the prospective investment. Therefore while considering investment proposal it is important to take into consideration both expected return and the risk involved. Investment decision not only involves allocating capital to long term assets but also involves decisions of using funds which are obtained by selling those assets which become less profitable and less productive. It wise decisions to decompose depreciated assets which are not adding value and utilize those funds in securing other beneficial assets. An opportunity cost of capital needs to be calculating while dissolving such assets. The correct cut off rate is calculated by using this opportunity cost of the required rate of return (RRR).

Financial Decision

Financial decision is yet another important function which a financial manger must perform. It is important to make wise decisions about when, where and how should a business acquire funds. Funds can be acquired through many ways and channels. Broadly speaking a correct ratio of an equity and debt has to be maintained. This mix of equity capital and debt is known as a firms capital structure. A firm tends to benefit most when the market value of a companys share maximizes this not only is a sign of growth for the firm but also maximizes shareholders wealth. On the other hand the use of debt affects the risk and return of a shareholder. It is more risky though it may increase the return on equity funds. A sound financial structure is said to be one which aims at maximizing shareholders return with minimum risk. In such a scenario the market value of the firm will maximize and hence an

optimum capital structure would be achieved. Other than equity and debt there are several other tools which are used in deciding a firm capital structure.

Dividend Decision

Earning profit or a positive return is a common aim of all the businesses. But the key function a financial manger performs in case of profitability is to decide whether to distribute all the profits to the shareholder or retain all the profits or distribute part of the profits to the shareholder and retain the other half in the business. Its the financial managers responsibility to decide a optimum dividend policy which maximizes the market value of the firm. Hence an optimum dividend payout ratio is calculated. It is a common practice to pay regular dividends in case of profitability another way is to issue bonus shares to existing shareholders.

Liquidity Decision

It is very important to maintain a liquidity position of a firm to avoid insolvency. Firms profitability, liquidity and risk all are associated with the investment in current assets. In order to maintain a tradeoff between profitability and liquidity it is important to invest sufficient funds in current assets. But since current assets do not earn anything for business therefore a proper calculation must be done before investing in current assets. Current assets should properly be valued and disposed of from time to time once they become non profitable. Currents assets must be used in times of liquidity problems and times of insolvency.

TRANSFORMING THE FINANCE FUNCTION Developing finance capability, improved performance and better business relationships. Finance Transformation ensures that financial excellence and best practice is delivered efficiently and consistently through intelligent systems, processes and company culture. It helps the chief finance officer to develop the capabilities that will fulfill their responsibilities to the organization, meet stakeholder expectations and to maintain key business partnerships.

THE EXPANDING ROLE OF THE CHIEF FINANCIAL OFFICER The modern Chief Financial Officer is expected to fulfill an ever evolving and increasingly complex role, also known as the Four Faces of the CFO: Strategist - analyzing organizational performance and interpreting financial information to support the planning and execution of strategic initiatives across the organization. Catalyst - stimulating the wider organization to execute the changes necessary to support the effective performance of the steward, operator and strategist role. Operator - delivering efficient finance processes to support the production of financial information and driving the cost effectiveness agenda across the organization. Steward - providing control over the organizations assets, ensuring it meets its compliance obligations and directing the management of risk.

FUNDS

It is a source of supply; a stock. A sum of money or other resources set aside for a specific purpose. Fund may refer to funding is the act of providing resources, usually in form of money, or other values such as effort or time, for a project, a person, a business, or any other private or public institution

SOURCES OF FUNDS

A company might raise new funds from the following sources:

THE CAPITAL MARKETS:

i) New share issues, for example, by companies acquiring a stock market listing for the first time ii) Rights issues Loan stock Retained earnings Bank borrowing Government sources Business expansion scheme funds Venture capital Franchising. ORDINARY (EQUITY) SHARES Ordinary shares are issued to the owners of a company. They have a nominal or 'face' value, typically of $1 or 50 cents. The market value of a quoted company's shares bears no relationship to their nominal value, except that when ordinary shares are issued for cash, the issue price must be equal to or be more than the nominal value of the shares.

Deferred ordinary shares - are a form of ordinary shares, which are entitled to a dividend only after a certain date or if profits rise above a certain amount. Voting rights might also differ from those attached to other ordinary shares. Ordinary shareholders put funds into their company: a) by paying for a new issue of shares b) through retained profits. NEW SHARES ISSUES A company seeking to obtain additional equity funds may be: a) an unquoted company wishing to obtain a Stock Exchange quotation b) an unquoted company wishing to issue new shares, but without obtaining a Stock Exchange quotation c) a company which is already listed on the Stock Exchange wishing to issue additional new shares. The methods by which an unquoted company can obtain a quotation on the stock market are: a) an offer for sale b) a prospectus issue c) a placing d) an introduction. OFFERS FOR SALE: An offer for sale is a means of selling the shares of a company to the public. a) An unquoted company may issue shares, and then sell them on the Stock Exchange, to raise cash for the company. All the shares in the company, not just the new ones, would then become marketable. b) Shareholders in an unquoted company may sell some of their existing shares to the general public. When this occurs, the company is not raising any new funds, but just providing a wider market for its existing shares (all of which would become marketable), and giving existing shareholders the chance to cash in some or all of their investment in their company. When companies 'go public' for the first time, a 'large' issue will probably take the form of an offer for sale. A smaller issue is more likely to be a placing, since the amount to be raised can be obtained more cheaply if the issuing house or other sponsoring firm approaches selected institutional investors privately.

RIGHTS ISSUES A rights issue provides a way of raising new share capital by means of an offer to existing shareholders, inviting them to subscribe cash for new shares in proportion to their existing holdings. For example, a rights issue on a one-for-four basis at 280c per share would mean that a company is inviting its existing shareholders to subscribe for one new share for every four shares they hold, at a price of 280c per new share. A company making a rights issue must set a price which is low enough to secure the acceptance of shareholders, who are being asked to provide extra funds, but not too low, so as to avoid excessive dilution of the earnings per share. PREFERENCE SHARES Preference shares have a fixed percentage dividend before any dividend is paid to the ordinary shareholders. As with ordinary shares a preference dividend can only be paid if sufficient distributable profits are available, although with 'cumulative' preference shares the right to an unpaid dividend is carried forward to later years. The arrears of dividend on cumulative preference shares must be paid before any dividend is paid to the ordinary shareholders. From the company's point of view, preference shares are advantageous in that:

Dividends do not have to be paid in a year in which profits are poor, while this is not the case with interest payments on long term debt (loans or debentures). Since they do not carry voting rights, preference shares avoid diluting the control of existing shareholders while an issue of equity shares would not. Unless they are redeemable, issuing preference shares will lower the company's gearing. Redeemable preference shares are normally treated as debt when gearing is calculated. The issue of preference shares does not restrict the company's borrowing power, at least in the sense that preference share capital is not secured against assets in the business. The non-payment of dividend does not give the preference shareholders the right to appoint a receiver, a right which is normally given to debenture holders.

LOAN STOCK Loan stock is long-term debt capital raised by a company for which interest is paid, usually half yearly and at a fixed rate. Holders of loan stock are therefore long-term creditors of the company.

Loan stock has a nominal value, which is the debt owed by the company, and interest is paid at a stated "coupon yield" on this amount. For example, if a company issues 10% loan stocky the coupon yield will be 10% of the nominal value of the stock, so that $100 of stock will receive $10 interest each year. The rate quoted is the gross rate, before tax. Debentures are a form of loan stock, legally defined as the written acknowledgement of a debt incurred by a company, normally containing provisions about the payment of interest and the eventual repayment of capital. RETAINED EARNINGS For any company, the amount of earnings retained within the business has a direct impact on the amount of dividends. Profit re-invested as retained earnings is profit that could have been paid as a dividend. The major reasons for using retained earnings to finance new investments, rather than to pay higher dividends and then raise new equity for the new investments, are as follows:

a) The management of many companies believes that retained earnings are funds which do not cost anything, although this is not true. However, it is true that the use of retained earnings as a source of funds does not lead to a payment of cash. b) The dividend policy of the company is in practice determined by the directors. From their standpoint, retained earnings are an attractive source of finance because investment projects can be undertaken without involving either the shareholders or any outsiders. c) The use of retained earnings as opposed to new shares or debentures avoids issue costs. d) The use of retained earnings avoids the possibility of a change in control resulting from an issue of new shares. Another factor that may be of importance is the financial and taxation position of the company's shareholders. If, for example, because of taxation considerations, they would rather make a capital profit (which will only be taxed when shares are sold) than receive current income, then finance through retained earnings would be preferred to other methods. A company must restrict its self-financing through retained profits because shareholders should be paid a reasonable dividend, in line with realistic expectations, even if the directors would rather keep the funds for reinvesting. At the same time, a company that is looking for extra funds will not be expected by investors (such as banks) to pay generous dividends, nor over-generous salaries to owner-directors.

BANK LENDING

Borrowings from banks are an important source of finance to companies. Bank lending is still mainly short term, although medium-term lending is quite common these days. Short term lending may be in the form of: a) an overdraft, which a company should keep within a limit set by the bank. Interest is charged (at a variable rate) on the amount by which the company is overdrawn from day to day; b) a short-term loan, for up to three years. LEASING A lease is an agreement between two parties, the "lessor" and the "lessee". The lessor owns a capital asset, but allows the lessee to use it. The lessee makes payments under the terms of the lease to the lessor, for a specified period of time. Leasing is, therefore, a form of rental. Leased assets have usually been plant and machinery, cars and commercial vehicles, but might also be computers and office equipment. There are two basic forms of lease: "operating leases" and "finance leases". OPERATING LEASES Operating leases are rental agreements between the lessor and the lessee whereby:

a) the lessor supplies the equipment to the lessee b) the lessor is responsible for servicing and maintaining the leased equipment c) the period of the lease is fairly short, less than the economic life of the asset, so that at the end of the lease agreement, the lessor can either i) lease the equipment to someone else, and obtain a good rent for it, or ii) sell the equipment secondhand.

GOVERNMENT ASSISTANCE The government provides finance to companies in cash grants and other forms of direct assistance, as part of its policy of helping to develop the national economy, especially in high technology industries and in areas of high unemployment. For example, the Indigenous Business Development Corporation of Zimbabwe (IBDC) was set up by the government to assist small indigenous businesses in that country.

VENTURE CAPITAL Venture capital is money put into an enterprise which may all be lost if the enterprise fails. A businessman starting up a new business will invest venture

capital of his own, but he will probably need extra funding from a source other than his own pocket. However, the term 'venture capital' is more specifically associated with putting money, usually in return for an equity stake, into a new business, a management buy-out or a major expansion scheme. FRANCHISING Franchising is a method of expanding business on less capital than would otherwise be needed. For suitable businesses, it is an alternative to raising extra capital for growth. Franchisors include Budget Rent-a-Car, Wimpy, Nando's Chicken and Chicken Inn. Under a franchising arrangement, a franchisee pays a franchisor for the right to operate a local business, under the franchisor's trade name.

OTHER REFERENCES: SOURCES OF FUNDS: 1. They make profit by selling a product for more than it costs to produce. This is the most basic source of funds for any company and hopefully the method that brings in the most money. 2. Like individuals, companies can borrow money. This can be done privately through bank loans, or it can be done publicly through a debt issue. The drawback of borrowing money is the interest that must be paid to the lender. 3. A company can generate money by selling part of itself in the form of shares to investors, which is known as equity funding. The benefit of this is that investors do not require interest payments like bondholders do. The drawback is that further profits are divided among all shareholders. In an ideal world, a company would bring in all of its cash simply by selling goods and services for a profit. But, as the old saying goes, "you have to spend money to make money," and just about every company has to raise funds at some point to develop products and expand into new markets. When evaluating companies, it is most important to look at the balance of the major sources of funding. For example, too much debt can get a company into trouble. On the other hand, a company might be missing growth prospects if it doesn't use money that it can borrow.

SOURCES OF FUNDS from FORBES MAGAZINE 1. Bootstrapping. Self-funding from your savings (if you have it) is always preferred. Advantages: no time going hat-in-hand to investors and you don't have to relinquish any control in your company. For more on how to bootstrap, check out Bootstrap Business by Rich Christiansen, who has launched nearly 30 companies by that method. 2. Friends and family. Tap your inner circle before expanding your horizons. As a rule of thumb, professional investors like to see real skin in the game--your own, of that of people who trust you. 3. Small business grants. This bucket often gets overlooked, but it should be a major focus thanks to the Obama administration's initiatives to foster new alternative-energy sources and other technological breakthroughs. Nabbing federal or state funds can be an exhausting gauntlet (check out "One Energy start-up's Tireless Quest For Capital"), but at least the government doesn't charge interest or demand control. One smart approach: Team with a professor at your local university. Grants associated with commercializing products are favored over ones allocated for academic study only. If a professor does the application with you and get to publish the results, that's a win-win situation. 4. Loans or lines of credit. If your company needs only a temporary or small infusion of cash, try for a Small Business Administration loan (offered at a lower interest rate because it is guaranteed by the government) or a bank line of credit. Warning: Commercial banks are often dismissive of start-ups unless you have personal collateral at risk--say, your house. (For more on understanding what bankers really charge, check out "The True Cost of Debt.") 5. Incubators. A start-up incubator is a company, university or other organization that ponies up resources--laboratories, office space, consulting, cash, and marketing--in exchange for equity in young companies when they are most vulnerable. (For more, check out "Getting The Most out of a Business Incubator.") 6. Angel investors. For those looking for $25,000 to $250,000, angel networks can come in handy. Networking is critical here, and you need to find angels who understand your industry and share your passion. I've been on the selection committee of an angel group for years. To get started, go to www.AngelSoft.net and look up the group nearest you. (For more on raising money from angel investors, check out "Ten Ways To Attract Angel Funding" and "Wooing And Choosing The Right Backer.")

7. Venture capital. As a rule of thumb, don't try this one in the earlier stages; in fact, don't try it unless you need more than $1 million. VCs take their pound of flesh in equity and control. It's not the most efficient route, either: Prepare to spend at least six months searching for and closing the deal. Start your search within your local network of entrepreneurs. After that, hit the National Venture Capital Association Web site. 8. Bartering. Exchanging goods or services as a substitute for cash can be a great way to run on a little wallet. Example: trading free office space by agreeing to be the property manager for the owner. This technique can also work with legal, accounting and engineering services. (For more, see "Nine Effective Bartering Techniques.") 9. Form a partnership. A more established company may have a strategic interest in helping to develop your product---and be willing to advance funding to make it happen. I know several companies that develop customized social networks for large enterprises, with the expectation of using that funding and experience to compete in the consumer market some day. Licensing may not be as sexy as being a consumer brand, but it will cost you a lot less. (For more on navigating partnerships with large companies, check out "Top Tips: How Not to Bet Burned by the Big Boys.") 10. Commit to a major customer. Some customers would be willing to cover your development costs in order to be able to buy your product before the rest of the world can. Their advantage: control over your production process (to make sure it meets their requirements) and the promise of dedicated support. Even large companies look to their best customers to fund new projects--this is the essence of good business development.

DETERMINANTS OF FINANCIAL HEALTH Financial health or financial stability generally means the joint stability of key financial institutions operating within financial markets and the stability of those markets. For the financial institutions this means that they are sound, i.e. they have sufficient capital to absorb normal and abnormal losses, and have sufficient liquidity to manage operations and volatility.

The concept of financial stability is most often thought of in terms of avoiding financial crises but also managing systemic financial risk. If the latter is managed reasonably well by market participants, through their private risk

management and by the authorities through its banking supervision and market surveillance, then systemic financial crises will most likely not occur.

Financial stability depends critically upon the degree to which these conditions promote the following objectives:

1. Macroeconomic Requirements The following macroeconomic requirements are crucial for the maintenance of financial stability: 1. Macroeconomic policies should seek sustainable growth in line with the economy's potential, and avoid "stop and go" growth since it creates widespread uncertainty and risks of pervasive financial reverses. 2. Achieving and maintaining price stability is of equal importance to sustain incentives to enter into long-term contracts and to minimize distortions and the uncertainty about relative prices fostered by inflationary environments. 3. Sound public finances are essential: public deficit and debt levels should be sustainable and moderate. Public debt, especially that held externally, must be adequately diversified in terms of currency, maturity and the range of holders. Government pension systems and other public programs involving future commitments need to be adequately funded and consistent with the economy's capacity to meet the commitments. 4. There must be an adequate level of national saving, private and public, to finance domestic investment needs without unsustainable reliance on foreign borrowing. 5. Macroeconomic policy instruments must be adequate and consistent with the exchange rate regime: monetary authorities need to be free to pursue price stability as their overriding objective; and fiscal authorities must have the capability to control public expenditures and collect adequate revenues.

2. Structural Requirements in the Real Economy Structural policies should seek to ensure that relative prices are in line with economic fundamentals so that they provide proper financial incentives; and that structural conditions promote the efficient and sustainable

allocation of real and financial resources. Sound structural conditions promote the smooth adjustment of prices and quantities to changing economic conditions, and reduce risks that asset values will be impaired by sudden shifts of relative prices that have become misaligned in relation to their long-term fundamental determinants.

Important ingredients of sound structural conditions include: 1. Tax policies that minimize distortions to incentives; tax provisions whose distortion effects are magnified by inflation should be avoided; tax regimes should be stable and predictable. 2. Efficient, competitive and flexible markets - for products and productive factors such as land, labor and other basic resources that affect financial incentives. Structural policies affecting the financial sector, further discussed need to ensure its efficient operation, stability and robustness.

3. Institutional Infrastructure of Financial Markets The availability of information necessary for sound financial decisions, the ability to respond to incentives and the capacity to implement financial transactions efficiently all depend upon the quality of a number of infrastructure building blocks that support effective market functioning. These include the legal and judicial framework governing financial markets and operations, the accounting systems used to gather and disseminate information, the payment systems for executing transactions, and the infrastructure features of the markets themselves.

The basic functions of the legal/juridical framework in supporting the financial system are: 1. To establishes clearly the rights, responsibilities and liabilities of the parties to financial transactions; 2. To establishes codes that support market forces in maintaining appropriate incentives and adequate information; 3. To provides means to enforce legal obligations and claims efficiently.

INDICATORS OF FINANCIAL HEALTH

Surplus / (Deficit) Surplus / (Deficit) provides an indication of whether provincial government revenues are higher than expenses (resulting in a surplus) or lower (resulting in a deficit). It is among the most common financial measures used in assessing government performance. Following several years of modest surpluses, the provinces financial condition deteriorated, the result of the economic slowdown, continued cost pressures on social programs and weaker revenue. In 2011-2012, the deficit was reduced to $260.6 million from the budget estimate of $448.8 million, reflecting the government commitment to rebuild the provinces finances. The province continues to face a significant fiscal challenge with an imbalance between current revenues and spending, continued cost pressures on social programs and modest revenue growth projections. Net Debt Net debt is an indication of the extent to which provincial government liabilities exceed financial assets. The provinces net debt has trended sharply upwards over the last several years due to the economic slowdown, continued cost pressures on social programs, and weaker revenue. Without corrective action, net debt will continue to rise at an unsustainable level. Net Debt per Capita Net debt per capita is a statement of the net debt attributable to each New Brunswick resident. The level of net debt per capita has been trending upward significantly in recent years. According to estimates prepared by the Royal Bank of Canada, New Brunswicks net debt per capita was fifth highest among the provinces in 2011-2012. Debt Service Costs Debt service costs are an indicator of the provinces ability to satisfy existing credit requirements and can be impacted by variables outside the direct control of government including interest rates, financial markets and currency fluctuations. Public infrastructure investments also influence borrowing requirements. Increasing debt service costs result in less funding for essential government programs and services.

Technological Institute of the Philippines 363 P. Casal St., Quiapo, Manila

ASSIGNMENT

ENGINEERING MANAGEMENT

Submitted by: MAYOR, MARNEL R. BSChE/ CH41FB1

Submitted to: ENGR. JOCELYN DELGADO Professor

September 21, 2012