BUSINESS FINANCE

CHAPTER 1
INTRODUCTION TO FINANCIAL MANAGEMENT
 INTRODUCTION TO FINANCIAL
MANAGEMENT
Financial management starts with a plan. This applies to both
individuals and components. It is not enough to have cash
and other resources today. Such resources, if not managed
properly, can be wiped out. Hence, financial management is
a must.
From the perspective of a corporation, financial management
deals with decisions that are supposed to maximize the value
of shareholders wealth. This mean maximizing the market
value of the shares of stocks. Shares of stocks represent the
form of ownership in a corporation.
 INTRODUCTION TO FINANCIAL
MANAGEMENT
To illustrate, Globe Telecom Inc, (Globe) shares closed at 2,200
on April 25, 2016. As of that date, Globes total shares
outstanding was 132, 742, 402. The market value of the shares as
of that date was more than 292 billion. This amount represent the
value of the shareholders wealth. As the shares are actively
traded in the Philippine stock exchange, the price of the stock
and the total market value of the shares may change every
trading day.
 INTRODUCTION TO FINANCIAL
MANAGEMENT
The changes in the price of a stock can be a confluence on
many factors: profitable operation, nature of the business,
prospect of the business, projected earnings and timeframe
for the realization of such projected earnings, ability to meet
maturing obligations, appropriate capital structure,
dividend policies, investing decisions, management and
market sentiment.
 INTRODUCTION TO FINANCIAL
MANAGEMENT
While profits significantly affects the price of a stock, finance
literature states that profit maximization should not be the
overriding objective of companys management, but
shareholders wealth maximization. Profits can be maximized by
taking more risks for example, borrowing more to finance
expansion and generate more revenues. While more borrowings
can increase profitability, it can also expose the company to
more risks and may even result in operating losses if some
external shocks occur and adversely affects the companys.
Inventors factor that risks in valuing a stock.
 INTRODUCTION TO FINANCIAL
MANAGEMENT
Shareholders wealth maximization tales into account the risk-
return trade-off of management decisions and prospects of a
company. For closely held corporations, the concept of
shareholders wealth maximization may be more difficult to apply
as there is no market price of the stock to look at. Nevertheless,
the management should still be aware of the variables that
influence the price of the stock because new investors may join
the company or the controlling stockholders may decide to list
the shares in the Philippine stock exchange in the future. When
the opportunities come, the factors which are considered
relevant in appropriately valuing a stock will be applied.
 SHAREHOLDERS WEALTH
MAXIMIZATION
Maximizing shareholders wealth through maximization of stock
price should be the overriding objective of management as it
covers the different facets of operating a company and it
considers the different stakeholders In the organization.
Stakeholders are not limited to the stockholders of the
company. Stakeholders also include management, employees,
suppliers, customers. For a longer and more sustainable
operations, the interest of these different stakeholders has to be
borne in mind.
 SHAREHOLDERS WEALTH
MAXIMIZATION
The stockholders have to be happy with their investments in
the company so that they will be encouraged to invest
more. More investments means more jobs can be created
 SHAREHOLDERS WEALTH
MAXIMIZATION
While profitability is a major driver for increasing the value of a
stock, there are other factors that influence share price. There are
many reasons why profit maximization should not be the
overriding objective of a company. One reason, as cited
previously, is that the company may need to borrow more just so
it can increase sales or augment production capacity.
 SHAREHOLDERS WEALTH
MAXIMIZATION
While borrowing is not necessarily bad, too much of it
exposes the company to bankruptcy risk. Also too much
focus on profits may force management to consider inferior
raw materials for production. While this may improve profits
in the short run, this may have adverse repercussions in the
long run. Management may also defer period. Again,
deferring such repairs and maintenance may impair the
efficiency of the production facilities in the long run.
 SHAREHOLDERS WEALTH
MAXIMIZATION
Maximizing shareholders wealth motivates members of top
management to develop a longer perspective for the company
that they manage. With this objective in mind, management will
try to make their customer happy by providing good products
and services at reasonable prices. To achieve this, management
may have to innovate, invest I technology, and be more
efficient in their production and operation. Management may
also need to consider setting aside a certain percentage of
income to research and development of further improve, and
possibly, expand the companys existing product and service
offerings.
 SHAREHOLDERS WEALTH
MAXIMIZATION
The interest of the employees has to be considered in
managing a company. Chances are, happy employees mean
more productive employees. If employees are happy I the
workplace ad they have sense of belonging in the company,
they will protect the interest of the company. In Filipino culture,
it is called malasakit. A close translation to English will probably
be solicitude or empathy. Unhappy employees can
damage the company, or they may do something that will taint
the image of the company.
 SHAREHOLDERS WEALTH
MAXIMIZATION
Paying suppliers and creditors on time is a good business
practice that will improve relationships with these parties. It is
important that management takes care of suppliers to ensure
good quality of materials at reasonable prices. Good
relationship with creditors enhance the probability of getting
credits facilities especially during times of emergencies.
 SHAREHOLDERS WEALTH
MAXIMIZATION
Compliance with requirements of regulatory agencies also
ensure more smooth operations. Non-compliance may result in
suspension of operations or unnecessary penalties. Disruption in
operations as a result of non-compliance with regulatory
requirements may also taint the image of the company which
may have adverse effects not just on the operations but also on
the cost of financing as well.
 SHAREHOLDERS WEALTH
MAXIMIZATION
Supporting the community where the company operates, in
whatever capacity it can increase the companys chances of
continuous operations in the area. Hiring employees form the
community promotes employees support for the company. The
company can also help in some civic-oriented activities like
planting trees in the area.
 SHAREHOLDERS WEALTH
MAXIMIZATION
Philex mining corporation is an example of a company
which has reforested more than 2,500 hectares of land
across itogon and tuba, benguet. For this, the company
has won several awards, some which were given by the
Philippine mine safety and environment associations
(PMSEA). In 2014, philex also joins forces with national
power corporation to reforest about 500 hectares of land
around san roque dams critical watershed area.
 SHAREHOLDERS WEALTH
MAXIMIZATION
Philex has also established adopt a school program where the
company helps in the renovation of schools in their host and
neighboring communities. In its mining area, the company also
provides free private elementary education through philex
mines elementary school. It has also awarded several
scholarships to students in their host
 FINANCIAL SYSTEM
The financial system links the savers and the users of
funds. Shown in Figure 1 is an overview of the financial
system.

Financial Intermediaries
Savers - Banks
Users of Funds
-Household - Insurance Corporation
- Stock exchange
(Borrowers/Investors)
-Individuals
-Households
-Companies - Stock brokerage firms
-Individuals
-Corporations - Mutual funds
-Companies
-Government - Other financial
-Government Agencies
agencies institutions
 FINANCIAL SYSTEM
Savings can come from households, individuals, companies,
government agencies, or any other entity whose cash inflows
are greater than their cash outflows. The financial system
through financial intermediaries provides a mechanism by
which these savings can be channeled to users of funds,
borrowers, and investors.
 FINANCIAL SYSTEM
Some of the financial instruments issued by users of funds such
as the shares of stocks and corporate bonds of publicly listed
companies and the debts securities issued by the national
government can be traded. The financial market provides
system for the trading of these securities. The Philippine stock
exchange (PSE) offers facilities for the trading of shares of
publicly listed companies.
 FINANCIAL SYSTEM
A company can become publicly listed through an initial public
offering (IPO) where shares will be offered to many investors. The
offering of the shares will be coursed through an investment
bank which will underwrite the offering of the shares. Corporate
bonds and government debt securities can be traded through
the Philippine dealing & exchange corp. (PDEx)
 FINANCIAL SYSTEM
As shown in figure 1 the same entities can be savers and
users of funds. One entity may have savings today but
may be needing funds in the future, for example, for
expansion.
The next section will discuss the different functions that
each financial intermediary may perform.
 BANKS
Banks provided mechanism where savers can put their excess
funds through deposits. Banks give the depositors interest on
the money deposited to them. To cover for the interest given
to depositors, banks lend the money to borrowers after
performing a credit investigation. Some of the deposits can
also be invested in some financial instruments like government
securities and corporate bonds banks can also serve as
conduits of investors in buying and selling both government
securities and corporate bonds. Banks have to be regulated
by the Bangko Sentral ng Pilipinas because they take
deposits, and there is public interest involved.
 Insurance companies
Insurance companies offer different products. Insurance
products can be broadly categorized into life insurance
products and non-life insurance products. Life insurance
products protect the insured from loss of life while non-life
insurance products protect the insured pays premiums to the
insurance companies. These premiums are used to fund claims.
Generally, the cash collected from the premium may cover
more than claims for most period. Hence, the excess cash can
be invested by insurance companies. There are guidelines In
investing that insurance companies have follow to ensure that
they have enough cash when claims are made. Insurance
companies are regulated by the insurance commission.
 STOCK EXCHANGE
The Philippine stock exchange (PSE) provides a system for the
trading of equity securities of publicly listed companies. These
equity securities are common stocks and preferred stocks. An
individuals who wants to invest and trade in the stock market
cannot go directly to PSE to buy and sell stocks. He has to
open an account with an accredited stock brokerage firm
where he can channel his buy and sell orders of equity
securities.
 Stock brokerage firm
Investing in the stock market has to be coursed through stock
brokerage firms. At present there are online brokers and live
brokers. With online brokers, one can trade in the stock market
through the internet. COL financial and BPI trade are two of the
online brokers in the Philippines. To trade online, one must have
an account and deposit with the online brokers.
 Stock brokerage firm
With live brokers, one needs a telephone to call brokers
ad place orders. Settlement of the transaction can be
arranged with the broker. Live brokers normally have their
messengers who deliver confirmation receipts as well as
collect and deliver checks. Confirmation receipts are
forms of evidence regarding the executed buy or sell
transaction that a client placed with his brokers.
 Mutual funds
Mutual funds provided opportunities for big and small investors
to invest in financial instruments which they would not have
considered on their own , or they may have considered but
do not have the time or the expertise to do it these include
investments like treasury bills.
With mutual funds, investments are pooled and the funds are
invested by professional managers for a fee. The fees are small
percentage of the funds invested.
 Mutual funds
Mutual funds cater to different investment objectives. There are
mutual funds which are limited only stocks while others are
restricted to fixed income instruments like bonds and treasury
notes. Others a combination of both stocks an fixed income
instrument.
It must be noted that when one invest in a mutual fund, he
become a part owner of that fund. To invest in mutual fund, he
has to buy shares of the mutual fund and the buying price
depends on the net asset value (NAV) of that fund when the
purchase is made. Note that the net asset value of a mutual
fund changes every day as the value of the financial
instruments where the funds are invested also changes.
 Mutual funds
As of January 31, 2016, the top mutual funds in the Philippines
are philam strategic growth fund, Inc. ALFM Growth fund, Inc.,
and the United fund, Inc.
Because NAV changes, an investors n mutual fund can also
lose the NAV can fall below the NAV when the investment
was made. However, because the funds is managed by
professionals, positive returns are expected over time. How
much one gains from investing in mutual funds may also
depend on the investment horizon of the investor
 Other financial institution
Other financial institution is include pension funds like
government service insurance system (GSIS) and social
security system (SSS), investment banks, and credit unions,
among others.
The descriptions of each of these financial institutions will
not be discussed In this chapter. It is sufficient to know that
there are different types of financial institutions and even
more are created over time.
 Financial instrument
Financial instrument are generally classified into two
major categories: equity securities and debt securities.
Equity securities include common stocks and preferred
stocks.
 COMMON STOCKS AND PREFERRED
STOCKS
Most companies have only common stocks in their stockholders
equity but some companies have both common stocks and
preferred stocks. PLDT and Globe have both common stocks
and preferred stocks in their stockholders equity.
As its name suggest, a preferred stocks has priority over a
common stocks in terms of claims over the asset of a company.
This means that if company is to be liquidated and its asset
have to be distributed, no asset will be distributed to common
stockholders unless all the claims of the preferred stockholders
have been given.
 COMMON STOCKS AND
PREFERRED STOCKS
Preferred stockholders also have priority over common
stockholders in cash divided declaration. No cash dividends
will given to common stockholders unless all the dividends due
to preferred stockholders are paid first.
If the preferred stockholders have preference over common
stockholders in terms pf claims over the asset of the company
and in cash dividend declaration, why would an investor be
willing to become common stockholders?
 COMMON STOCKS AND PREFERRED
STOCKS
There are benefits in being a common stockholders. Common
stockholders are the real owners of the company. Being residual
owners, the growth potential of their investments is unlimited. if
an investor has identified a good common stocks, its value can
multiply over time. At the height of the global financial crisis in
2008 and 2009, many fundamentally sound stocks went down.
One of them was universal robina corporation (URC) which went
down to around 5 after hitting a high of round 26.50 during that
period. As of august 26, 2014, URC closed at 163. 50. If one had
bought the stock in 2009 even at 10, investment would have
multiplied 16 times.
 COMMON STOCKS AND PREFERRED
STOCKS
One could have bought Jollibee food corporation (JFC)
stock at 40 on January 2009. As of august 16, 2014 , the stock
closed at 192.50. one could have bought PLDT at 2,100 in
the first quarter of 2009. As of august 26, 2014, the stock
closed at 3,390. The appreciation in value is not as high
URCs or JFCs but PLDT has distributed an annual cash
dividend of at least 150 per share since 2010. The dividend
yield is higher than the returns of most fixed income
instrument like time deposit.
 COMMON STOCKS AND PREFERRED
STOCKS
Unlike preferred stocks, the dividend per share for common
stock is not fixed. A common stock investor can receive more
cash dividends during period of unusual profitability. But during
periods of unprofitable operations, both preferred stockholders
and common stockholders may not receive dividend. The
company is not obligated to pay dividend if it is not in a position
to do so. For cumulative preferred stockholders, however,
unpaid dividends can accumulated and no cash dividends will
be paid to common stockholders unless all the dividends in
arrears for preferred stockholders are paid.
 COMMON STOCKS AND PREFERRED
STOCKS
Being the residual owners of a company, common
stockholders have voting rights, a privilege generally not
available to preferred stockholders. This means that if one
has if this happens, then he can influence the major
decisions made by a company as such major decisions are
approved by the board.
 Debt securities
The treasury bonds and treasury bills issued by national treasury
are forms of indebtedness of the national government. The
treasury bills which are in the tenors of 91 days, 182 days, and
360 days are auctioned at the national treasury every Monday
to accredited dealers. These are eventually farmed out to both
institutional and retails inventors on Wednesdays.
 Debt securities

Occasionally, the national treasury also issues retail treasury

bonds. A small investor can participate in these retails
treasury bonds. A small investor can participate in these retail
treasury bonds is paid quarterly. For treasury bonds, coupon
interest is paid quarterly. For treasury bonds. These are
normally in multiples of 5,000. Coupon interest on these retail
treasury bonds is paid quarterly. For treasury bonds, coupon
interest is paid semi-annually.
 Debt securities
Some publicly listed companies have also started issuing
corporate bonds. The tenors are usually 5 years, 7 years, and 10
years. GT capital, the holding company which is the biggest
stockholders of metrobank, has just finalized the interest rates
on its corporate bond issue which covers those three tenors.
PLDT and MERALCO are the other big publicly listed companies
which issued corporate bonds recently. Corporate bonds offer
slightly higher interest rates than government securities.
 Debt securities
Interest on investment in debt securities is subject to 20% final
tax. for bank deposits with tenors of at least 5 years, tax rate is
zero percent.
In terms of claims over the asset of a company, bondholders
have preference over preferred stocks and common stocks.
Also, interest due to them, just like bank creditors has to be
paid first before dividends are given to preferred and common
stockholders.
 ORGANIZATIONAL CHART AND THE
ROLES OF THE VP FOR FINANCE
Shown in figure 2 is a typical organizational chart.

Board of Directors

President

VP for Sales & VP for VP for

VP for Finance
Marketing Production Administration
 Board of directors
The board of directors is the highest policy-making body in a
corporation. The boards primary responsibility is to ensure that
the corporation is operating to serve the best interest of the
stockholders. The member of the board who are called directors
are elected by the stockholders. The ability to elect a directors in
the board is contingent on the amount of shares owned and the
number of directors in the board. If a stockholders owns 10% of
voting shares of the company, then this stockholder can elect
one director in the board. This is the reason why some investors
want to own the majority shares of a company if they want
control over the company. Owning majority of the shares means
having the right to elect majority of the directors in the board.
 Board of directors
The following are among the responsibilities of the board of
directors:
1. Setting policies on investments, capital structure, and dividends
2. Approving companys strategies, goals, and budgets
3. Appointing and removing members of the top management
including
president
4. Determining to managements compensation
5. Approving the information and other disclosures reported in the
financial statements
 President
The roles of a president in a corporation may vary from one
company to another. Among the responsibilities of a president are
the following:
1. Overseeing the operations of a company and ensuring that the
strategies as approved by the board are implemented as planned
2. Performing all areas of management: planning, organization, staffing,
directing and controlling
3. Representing the company in professional, social, and civic activities

The president cannot manage the company on his own, especially

when the corporation has become too big. To assist him the vice
president of different functional areas: finance, sales and marketing,
production and administration.
 VP for sales marketing
The following are among the responsibilities of VP for sales and
marketing:

1. formulating marketing strategies and plans

2. directing and coordinating company sales
3. performing market and competitors analysis
4. analyzing and evaluating the effectiveness and cost of
marketing methods
 VP for sales marketing
5. conducting or directing research that will allow the
company to identify new marketing opportunities, for
example, variants of the existing products/services already
offered in the market
6. promoting good relationships with customers and distributors
 VP for production
The following are among the responsibilities of VP for production:

1. Ensuring production meets customer demands

2. Identifying production technology/process that minimizes
production cost.
3. Coming up with a production plan that maximize the utilization
of the companys production facilities
4. Identifying adequate the competitively priced raw material
suppliers
 VP for Administration
The following are among the responsibilities of VP for
administration:
1. Coordinating the functions of administration, finance, and sales
and marketing departments
2. Assisting other departments in hiring employees
3. Providing assistance in payroll preparation
4. Determining the location and the maximum amount of office
space
needed by the company
5. Identifying means, processes, or system that will minimize the
operating costs of the company
 VP for finance
Show in figure 3 are the functions of VP for finance.

Financing
Investing
Operating
Dividend policies
 Financing decisions
Financing decisions include making decisions as to how to
finance long-term investments and working capital which deals
with day-to-day operations of the company.
The VP for finance is also responsible for determining the
appropriate capital structure of the company, that is, how much
of the total assets should be financed by debt and equity. This
responsibility is crucial because if the company is aggressively
financed, that is, it is heavily financed by debt, the company
becomes vulnerable to adverse economic conditions which
may result in higher volatility in earnings. The company can get
bankrupt because of too much debt.
 Financing decisions
Capital structure decisions vary from one company to another.
It is affected by the stability of cash flows, extent of fixed
operating expense and variable expense. Companies which
are capital intensive and are characterized by high-fixed
operating expenses such as utility and mining companies are
supposedly more conservatively financed. This means, these
companies have to be financed more by equity. These
companies have to generate high levels of revenues before
they can cover their expense adds up to the already high-fixed
operating expenses. This would mean higher revenues for profit
for profits to be made.
 INVESTING DECISIONS
To minimize the probability of failure, long-term investment
have to be supported by a capital budgeting analysis which is
among the responsibilities of a finance manager. Capital
budgeting analysis is a technique used to determine the
financial viability of a long-term investment. This require
forecasting the cost of investment can only be considered if it
satisfies certain financial parameters thats are acceptable to
the top management.
 INVESTING DECISIONS
The function of a finance manager is a crucial. Many
companies which suffered financial distress went through an
aggressive expansion heavily financed by debt. Among the
local companies which suffered a major setback because of
aggressive expansion are metro pacific corporation with
respect to their fort bonifacio global city development project
and belle resources as regards their initial venture in the casino
business. Both companies implemented these expansion right
before the 1997 asian financial crisis.
 OPERATING DECISIONS
Operating decisions deal with the daily operation of the
company. The role of the VP for finance is determining how
to finance working capital accounts such as accounts
receivable and inventories. Should the company finance
these two accounts substantially by short-term source of
financing or through long-term sources of financing?
 OPERATING DECISIONS
The decisions regarding the financing of these working
capital accounts depends on the appetite of top
management for risk. If the company is more aggressive,
then these accounts receivable and inventories can be
substantially financed by short-term sources.
Basically, short-term sources of funds are cheaper. Interest
on short-term loans is generally lower than the interest on
long-term loans. Hence, using short-term loans can boost the
profitability of a company.
 OPERATING DECISIONS
While financing through short-term sources of financing may
minimize the financing cost of the company, this however, has
a trade-off. Financing working capital accounts mostly through
short-term sources may expose the company to a liquidity
problem where obligations are already due but the company
does not have sufficient cash to pay for the obligations.
A more conservative management will opt to finance working
capital accounts mostly through long-term sources.
 Dividend policies
Some investors buy stocks because of the dividends they expect
to receive form the company. Non-declaration of dividends may
disappoint these inventors. PLDT and globe are two of the
Philippine-listed companies which have generously distributed
cash dividend for the last five years.
Two conditions must exist before a company can declare cash
dividends. First the company must have enough retained
earnings to support cash dividend declaration. When cash
dividends are declared, the retained earnings of a company go
down to the extent of such declaration. Second, the company
must have cash.
 Dividend policies
How much cash dividends a company declares is within the
purview of the VP for finance. There are several factors considered
in declaring cash dividend. Listed below are among these
considerations:
1. Availability of investment opportunities. This is especially true for
small and medium enterprises (SMEs) which access to long-term
sources of funds is limited. These SMEs may really heavily on
internally generated funds to finance expansion. Hence, the
decision to declare cash dividends can be substantially
influenced by the availability of investment opportunities.
 Dividend policies
2. Access long-term sources of funds. Publicly listed companies like PLDT,
Globe, or petron have better access to long-term sources of funds.
These companies can afford to declare cash dividends even if they are
faced with huge amount of investment, for long as their retained
earnings can support such declarations. This reason is these companies
are big, publicly listed, and have much their better access to long-term
sources of funds.
3. Capital structure. The capital structure of a company can depend
largely on the nature of its business. As previously stated, companies
which are capital intensive have to be more conservatively financed.
Therefore, the amount of cash dividends to be declared depends on
how such declaration can affect the capital structure of ac company.