CHAPTER 1
INTRODUCTION TO FINANCIAL
MANAGEMENT (HISTORY,
NATURE AND SIGNIFICANCE OF
FINANCE)
EXPECTED LEARNING OUTCOMES
After studying this chapter, the learner should be
able to:
1. Explainthe major role of financial management
and the different individuals involved;
2. Distinguisha financial institution from financial
instrument and financial market;
3. Enumerate the varied financial institutions and
their corresponding services;
4. Compare and contrast the varied financial
instruments;
5. Explain the role of the financial manager.
AGREE OR DISAGREE
A BUSINESS DEPENDS
ON MANY FACTORS AND
THE MOST IMPORTANT
OF THEM IS FINANCE.
ETYMOLOGY OF THE WORD “FINANCE”
FINANCIUS, from the noun finis (end)
is the Latin etymological origin of
the modern English word FINANCE.
It migrated from Latin to old French
as FINAUNCE, from finer ( to pay a
ransom), whence also English fine (to
pay a penalty).
INTERRELATED MEANINGS OF FINANCE
1. The management of large
amounts of money – especially by
governments or large companies;
2. The giving of monetary support
for an enterprise and;
3. The monetary resources and
affairs of a government,
organization or person.
TYPES OF FINANCE
1. PUBLIC FINANCE
2.CORPORATE FINANCE
- Businesses bring in financing through equity investments
and credit arrangements, and by purchasing securities.
- start ups may receive investments from angel investors or
venture capitalists, and established companies may sell stocks
or bonds.
3. PERSONAL FINANCE
- earning more money and spending less money is
the basis of personal finance.
- individuals may earn more money by starting a
business, taking on additional jobs, or investing.
FINANCIAL MANAGEMENT WITHIN A
BUSINESS ORGANIZATION
BUSINESS – is an entity where the skills, energy, and
enterprise owners are linked with money, its sources,
and investments, and its success is measured by
wealth, or profit derived from its operation.
BUSINESS ORGANIZATION – is an entity formed for the
purpose of carrying on commercial enterprise.
FORMS OF BUSINESS ORGANIZATIONS
1. SOLE PROPRIETORSHIP – consists of one individual doing
the business.
ADVANTAGES:
1. Ease of formation and dissolution.
2. Typically, there are low start up costs and low operational
overhead.
3. Ownership of all profits.
4. Typically subject to fewer regulations.
5. No corporate income taxes instead, declared on the
owner’s individual income tax return.
SOLE PROPRIETORSHIP
DISADVANTAGES:
1. Unlimited liability.
2. Limited life.
3. Difficulty in raising a capital for start
up business. Common funding comes
from personal savings or personal
loans.
FORMS OF BUSINESS ORGANIZATIONS
2. PARTNERSHIP – consists of two or more individuals in business
together.
ADVANTAGES:
1. Synergy. There is clear potential for the enhancement of value
resulting from two or more individuals combining strengths.
2. Relatively easy to form however, considerable thought should
be put into developing a partnership agreement at the point of
formation.
3. Subject to fewer regulations than corporations.
4. There is stronger potential of access to greater amounts of
capital.
5. No corporate income taxes instead, declare income by filing a
partnership income tax return.
PARTNERSHIP
DISADVANTAGES:
1. Unlimited liability. General partners are
individually responsible for the obligations of the
business, creating personal risk.
2. Limited life. A partnership may end upon the
withdrawal or death of a partner.
3. There is real possibility of disputes or conflicts
between partners which could lead to dissolving
the partnership.
3. CORPORATIONS– are probably dominant
form of business organization in the
Philippines.
- it is a legal entity doing business, and is
distinct from the individuals within the
entity.
PUBLIC CORPORATIONS – are owned by
shareholders who elect a board of directors
to oversee primary responsibilities.
CORPORATIONS
ADVANTAGES:
1. Unlimited commercial life.
2. Greater flexibility in raising capital through the sale of stock.
3. Ease of transferring ownership by selling stock.
4. Limited liability.
DISADVANTAGES:
1. Regulatory restrictions.
2. Higher organizational and operational costs.
3. Double taxation.
FINANCIAL MANAGEMENT
FINANCIAL MANAGEMENT means:
1. Tocollect fund for the company at a low cost
and;
2. Touse this collected funds for earning
maximum profits.
Therefore: FINANCIAL MANAGEMENT means to
plan and control the finance of the company.
FINANCIAL MANAGEMENT
FROM THE PERSPECTIVE OF THE CORPORATION:
FINANCIAL MANAGEMENT deals with decisions that
are supposed to maximize the value of the
shareholders’ wealth.
- This means maximizing the market value of the
shares of stocks.
SHARES OF STOCKS
– represent the form of ownership in a
corporation.
To illustrate:
TELECOM INC shares closed at P2,200
on April 25, 2016. As of that date, Globe’s total
shares outstanding was P132,742, 402. the
market value of the shares as of that date was
more than P292 billion. This amount represents
the value of the shareholders’ wealth. As the
shares are actively traded in the Philippine Stock
Exchange (PSE), the price of the stocks and the
total market value of the shares may change
every trading day.
THE CHANGES IN THE PRICE OF A STOCK MAY VARY DUE TO
THE FOLLOWING:
Profitable operation
Nature of the business
Prospects of the business
Projected earnings and time frame for the realization of
such projected earnings
Ability to meet maturing obligations
Appropriate capital structure
Dividend policies
Investing decisions
Management and market sentiments
THE FINANCIAL MANAGER
Is a person who takes care of all the
important financial functions of an
organization.
MAIN FUNCTIONS OF A FINANCIAL MANAGER:
1.Raising of funds
2.Allocation of funds
Points to consider in allocating the funds:
The size of the firm and its growth capability
Status of assets whether they are long term or short term
Mode by which the funds are raised
3.Profit planning – proper usage of the profit generated
by the firm
4.Understanding capital markets – shares of the
company are traded on stock exchange and there is a
continuous sale and purchase of securities.
GUIDING PRINCIPLES FOR FINANCIAL MANAGEMENT SYSTEMS
1. CONSISTENCY – financial policies and systems must remain consistent
over time.
2. ACCOUNTABILITY – must be able to explain and demonstrate to all
stakeholders how you have used your resources and what you have
achieved.
3. TRANSPARENCY – must be open about its work and its finances,
making information available to all stakeholders.
4. INTEGRITY – must be open with honesty and propriety.
5. FINANCIAL STEWARDSHIP – must take good care of the financial
resources it has been given and ensure that they are used for the
purpose intended.
6. ACCOUNTING STANDARDS – systems for keeping records and
documentation must observe accepted external accounting
standards.
THE FINANCIAL INSTITUTIONS AND THE
FINANCIAL MARKETS
Is an establishment that conduct
transactions such as investments,
loans, and deposits.
Provide a mechanism for those with
excess funds (savers) to lend to those
who need funds (borrowers).
FLOW OF FUNDS
Financial system provides a transmission
mechanism between saver-lenders and
borrowers-spenders.
Savers benefit – earn interest
Investors benefit – access to money otherwise not
available
Economy benefit – efficient means of bringing
savers and borrowers together.
FLOW OF FUNDS
Funds flow indirectly from ultimate lenders
(households) through financial intermediaries
(banks or insurance companies) or directly
through financial markets (stock exchange, bond
markets) to ultimate borrowers (business firms,
government or other households.
MAJOR CATEGORIES OF FINANCIAL INSTITUTIONS AND
THEIR ROLES IN THE FINANCIAL SYSTEMS
1. COMMERCIAL BANKS
– accepts deposits and provide security and
convenience to their clients. - they also make
loans that individuals and businesses use to buy goods
and expand business operations.
- they also served often under-appreciated roles
as payments within the country and between nations
, eg. Debit cards, credit cards and cheques.
BDO UNIBANK INC. METROPOLITAN BANK AND TRUST COMPANY (METROBANK)
BANK OF THE PHILIPPINE ISLANDS LAND BANK OF THE PHILIPPINES
2. INVESTMENT BANKS
- is a financial intermediary that performs a variety of services for
businesses and government.
- these services include underwriting debt and equity offerings,
facilitating mergers and other corporate reorganizations, and acting as a
broker for institutional clients.
3. INSURANCE COMPANIES
– they pool risk by collecting premiums from a large group of people
who want to protect themselves and/or their loved ones against a
particular loss such as a fire, car accident, illness, lawsuit, disability or
death.
- they help individuals and companies manage risk and preserve
wealth.
4. BROKERAGES
- acts as an intermediary
between buyers and sellers
to facilitate securities
transactions.
- they are compensated
via commission after the
transaction has been
successfully completed.
5. INVESTMENT COMPANIES
– is a corporation or a trust through which individuals invest in
diversified, professionally managed portfolios of securities by
pooling their funds with those of other investors, eg. Mutual funds.
- they help individuals and companies manage risk and preserve
wealth.
6. NON BANK FINANCIAL INSTITUTIONS
A. SAVINGS AND LOANS – typically offers
lower borrowing rates than commercial
banks and higher interest rates on
deposits.
B. CREDIT UNIONS – typically higher rates on
deposits and charge lower rates on loans in
comparison to commercial banks.
- memberships are not open to public, but
rather restricted to a particular membership
group.
FINANCIAL MARKETS AND FINANCIAL INSTRUMENTS
FINANCIAL MARKETS
- is a market in which people trade financial
securities, commodities and other fungible items
of value at low transaction costs and at prices
that reflect supply and demand.
- some are relatively small with only few
participants, while others like the Philippine
Stock Exchange (PSE) and the Makati Stock
Exchange (MSE) markets trade trillions of Pesos
daily.
CAPITAL MARKETS – is one in which individuals and institutions trade
financial securities. They are intended for short term finance.
STOCK MARKETS – allow investors to buy and sell shares in publicly
traded companies.
BOND MARKETS – is a debt investment in which an investor loans
money to an entity (corporate or governmental), which borrows the
funds for a defined period of time at a fixed interest rate.
MONEY MARKETS - are also called as cash investments because of
their short maturities.
FOREIGN EXCHANGE (FOREX) AND THE INTERBANK MARKET –
facilitate the trading of foreign exchange.
PRIMARY MARKETS vs SECONDARY MARKETS
PRIMARY MARKETS – also known as “new issue markets”,
are facilitated by underwriting groups, which consists of
investment banks that will sell a beginning price range
from a given security and then oversee its sale directly to
the investors.
SECONDARY MARKETS – is where investors purchase
securities or assets from other investors, rather than from
issuing companies themselves.
THE OVER-THE-COUNTER (OTC) MARKETS – refer as a
dealer market. These are stocks that are not trading on
a stock exchange like PSE but instead from very small
companies.
FINANCIAL INSTRUMENTS
These are assets that can be traded.
TYPES OF FINANCIAL INSTRUMENTS
1. CASH INSTRUMENTS – are directly influenced and determined
by markets.
- these are securities that are easily transferable.
TYPES OF FINANCIAL INSTRUMENTS
2.DERIVATIVE INSTRUMENTS – is a financial contract
with a value that is derived from an underlying asset.
ASSET CLASSES
1. SHORT TERM DEBT BASED – last for one year or
less.
TREASURY BILLS OR T-BILLS – a short dated
government security, yielding no interest but
issued at a discount on its redemption price.
COMMERCIAL PAPERS – promissory notes issued by
financial institutions or large firms with very short
to short maturity period; usually 2 to 30 days, and
not more than 270 days, and secured only by the
reputation of the issuer.
ASSET CLASSES
2. LONG TERM DEBT BASED – last for more than a
year
BONDS - borrowers issued bonds to raise money
from investors willing to lend them money for a
certain amount of time.
CASH EQUIVALENTS - investments securities that
are for short term investing and they have a high
credit quality for loans.
SECURITIES – are stocks (share of ownership in a
corporation).
