BUSINESS FINANCE

GRADE 12

CHAPTER 1: INTRODUCTION TO MANAGEMENT

Finance
 It is a field that deals with the study of investment. It includes the dynamic of assets and liabilities over time
under conditions of different degrees of uncertainty and risk.
 Provide funding for a person or enterprise.
 The management of large amounts of money especially by governments or large company.

Financial Management
 Deals with decisions that are supposed to maximize value of shareholders’ wealth. This means maximizing the
market value of the shares of stocks. Share of stocks represent the form of ownership in a corporation.

Financial System

Savers Financial Intermediaries Users of Funds

(Borrowers/Investors)
 Household  Banks  Household
 Individuals  Insurance Companies  Individuals
 Corporations/Companies  Stock Exchange  Corporations/Companies
 Government Agencies  Stock brokerage firms  Government Agencies
 Mutual Funds
 Other Financial Institutions

As shown in the figure above, the same entities can be savers and users of funds, one entity may have savings today but
may be needing funds in the future.

FINANCIAL INTERMEDIARIES
 Banks – provide mechanism where savers can put their excess funds through deposits. Banks give 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 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 – 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 the 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 premiums may cover more than claims
for most periods.

 Stock Exchange – The Philippine Stock Exchange (PSE) provides a system for the trading of equity securities of
public listed companies. These equity securities are common stocks and preferred stocks. An individual 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 order equity securities.

 Stock Brokerage Firms – 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 broker.

 Mutual Funds – provide opportunities for big and small investors to invest financial instruments which they
would not have considered on their own, or they have may have considered but do not have the time or the
expertise to do it. These include investments in the stock market instruments like Treasury bills. Mutual Funds
cater to different investment objectives. There are mutual funds which are limited only to stocks while others
area restricted to fixed income instruments like bonds and treasury notes. Others provide a combination both
stocks and fixed income instruments.
As of January 31, 2016 the top mutual funds in the Philippines:
 Philam Strategic Growth Fund, Inc.
 ALFM Growth Fund, Inc.
 BUSINESS FINANCE
GRADE 12
 PAMI Equity Index Fund, Inc.
 Sun Life Prosperity Philippine Stock Index Fund, Inc.
 United Fund, Inc.

Other Financial Institutions

 Government Service Insurance System (GSIS)
 Social Security System (SSS)

Financial Instruments – are generally classified into two major categories:

 Equity securities
 Debt securities

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
stakeholders’ equity.
Preferred stockholders also have priority over common stockholders in cash dividend declaration. No cash
dividends will be given to common stockholders unless all the dividends due to preferred stockholders are paid first.

Debt Securities
The Treasury bonds and Treasury bills issued by the 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 both institutional and retail investors on
Wednesdays.
Occasionally, the national Treasury also issues retail Treasury bonds. These are normally in multiples of P5, 000.
Coupon Interest on these retail Treasury bonds is paid quarterly. For treasury bonds, coupon interest is paid semi –
annually.

Self-Test Questions
1. Explain why the same company can be a saver and a user of funds.

2. What is the role of financial intermediaries in the financial system?

3. Explain the role of the banks in the financial system.

4-5. Explain the differences among common stocks, preferred stocks, and debt securities.
 BUSINESS FINANCE
GRADE 12

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 and Marketing VP for Finance VP for Production VP for Administration

Board of
Directors

President

VP for Sales VP for VP for

VP for Finance
and Marketing Production Administration

Board of Directors
The board of directors is the highest policy – making body in corporation. The board’s responsibility is to ensure
that the corporation is operating to serve the best interest of the stockholders. The members of the board who is called
directors are elected by the stockholders. The ability to elect a director in the board is contingent on the amount of
shares owned and the number of directors in the board. To illustrate, assume that there are ten directors in the board. If
a stockholder owns 10% of the voting shares of the company, then this stock holder 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 that
company. Owning majority of the shares means having the right to elect majority of the directors in the board.

The following are among the responsibilities of the board directors:

1. Setting policies on investments,, capital structure, and dividends
2. Approving company’s strategies, goals and budgets
3. Appointing and removing members of the top management including the president
4. Determining top management’s compensation
5. Approving the information and other disclosure 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, organizing, staffing, directing and controlling
3. Representing the company in professional, social and civic activities

VP for Sales and 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 competitor analysis
4. Analyzing and evaluating the effectiveness and cost of marketing methods applied
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:
 BUSINESS FINANCE
GRADE 12

1. Ensuring production meets customer demands

2. Identifying production technology/process that minimizes production cost and makes the company cost
competitive
3. Coming up with a production plan that maximizes the utilization of the company’s production facilities
4. Identifying adequate and competitively priced raw materials 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 systems that will minimize the operating costs of the company

VP for Finance
Shown 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 investment and working capital
which deals the 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.

Capital structure decisions vary from one company to another. It is affected by the stability of cash flow, extent
of fixed operating expenses and variable expenses and variable expenses. 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 equity. These companies have to
generate high levels of revenues before they can cover their expenses. If these companies are heavily financed by debt,
then interest expense adds up to the already high-fixed operating expenses. This would mean higher revenues for profits
to be made.

Investing Decisions

To minimize the probability of failure, long-term investments 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 requires forecasting the cost of investment can only be
considered if it satisfies certain financial parameters that are acceptable to the top management.

This function of a finance manager is 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 right before the 1997 Asian financial crisis.

Operating Decisions

Operating decisions deal 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. Should the company finance these
two accounts substantially by short-term sources of financing or through long-term sources of financing?
 BUSINESS FINANCE
GRADE 12
The decision regarding the financing of these working capital accounts depends on the appetite of the 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.

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 exposes 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 from the company. Non-declaration
of dividends may disappoint these investors. PLDT and Globe are two of the Philippine-listed companies which have
generously distributed cash dividends for the last five years.

Two conditions must exist before a company can declare 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.

How much cash dividends a company declares is within the purview of the VP for Finance. There are several
factors considered in declaring cash dividends. Listed below are among these considerations:

1. Availability of investments opportunities. This is especially true for small and medium enterprises (SMEs)
which access to long-term sources of funds is limited. These SMEs may rely 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.
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 amounts of investments, for as long as their retained earnings can support such
declaration. The reason is these companies are big, publicly listed, and have much 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 a company.
 BUSINESS FINANCE
GRADE 12

CHAPTER 2: REVIEW OF FINANCIAL STATEMENT PREPARATION, ANALYSIS AND INTERPRETATION

Basic Financial Statement

This section discusses the four basic financial statements and the kind of information that can be found and
generated from each report.

 Statement of Financial Position or Balance Sheet

-Is the new name that the International Accounting Standards Boards (IASB)2 suggested for the
“balance Sheet” since 2009 to better reflect the kind of information found in the financial report. This financial
report provides information regarding the liquidity position and capital structure of a company as of a given
date. It must be noted that the information found in this report are only true as of a given date. For example, if a
company reported a cash of P1, 500, 000 as of December 31, 2014, this cash balance is only true as of the end of
December 31, 2014. By January 1, 2015, that cash balance may no longer be the same. More cash may have
been received from sales or interest income or some cash may have been spent for operating expenses on
January 1, 2015.

Liquidity refers to the ability of a company to pay maturing obligations. The current assets of a company
are compared with its current liabilities to determine its paying capacity. Generally, assets which are expected to
be converted to cash within one such as accounts receivable and inventories are classified as current liabilities.

Capital structure provides information regarding the amount of assets financed by debt or liabilities and
equity. For example, if a company has P1 million assets and has liabilities of P400, 000, its capital structure is
40% liabilities (400 000 ÷ P 1 000 000) and 60% equity (P 1 000 000  P400 000) ÷ (P 1 000 000). While debt or
liabilities are not necessarily bad in business, too much of it is not also god as it exposes the company to higher
probability of bankruptcy.

 Statement of Profit or Loss or Income Statement

-Also known as income statement provides information regarding the revenues or sales, expenses, and
net income of a company over a given accounting period. This accounting period may be for a month, a quarter
or a year. The income reported by a company is not that useful if the accounting period is not stated. In
analyzing earnings performance, a comparison with the previous periods and with other companies, especially
those coming from the same industry, is a must. Such comparison will not be made possible without knowing
the accounting periods covered in the statement of profit or loss.

In analyzing statement of profit or loss, it is important to identify how much of the income comes from
core business and how much comes from the non-core business. Core business refers to the main business of a
company. For example, sales of products such as C2, Blend 45 and its other branded products should be the core
business of Universal Robina Corporation (URC). However, it can also generate interest income from its deposits
or other investments. In analyzing URC’s statement of profit or loss, more emphasis should be made on its core
business because if something goes wrong with this main operation, uncertainties may arise regarding the
ability to continue operating in the future.
I an actual statement of profit or loss of a company is examined, one will realize that this financial
statement is not easily found. This is because the International Accounting Standards Board (IASB) which serve
as the source of our generally accepted accounting principles gives the preparers of financial statements of two
options on how to present their statements of profit or loss. The first option is to present it as a separate
financial statement. The second option is to present it together with other comprehensive income (OCI). OCI
represents transactions that are not reported in the profit or loss of statement but affects the stockholder’s
equity. Transactions of this nature are better discussed in more advanced accounting courses. While the
transactions related to the statement of profit or loss and OCI can be combined with the second option,
information for each have to be distinctly presented in the financial statement. Mot listed companies in the
Philippines follow the second option.

 Statement of Cash Flows

-provides an explanation regarding the change in cash balance from one accounting period to another.
The cash flows are also classified into three main categories: operating, investing, and financing.
-is a very important financial statement because it provides information regarding the quality of
earnings in the company as shown in the cash flows from operating activities. In this section, the income reported from
 BUSINESS FINANCE
GRADE 12
the statement of profit or loss which is based on accrual principle is converted to cash. This is a very important piece of
information found in this financial report because a company may have so much reported net income, but if such
income is not translated into cash, then that income is useless. One cannot use net income to pay debt or to pay the
salaries of employees. Cash is needed.

The cash flows from investing activities provide information regarding the future direction of the company. This
section shows how much investment the company is making over a given accounting period. Expansions allow
companies to grow. Note, however, that expansions or investments are not always good especially when management
has undertaken them too aggressively and are also financed aggressively.

To find out if a company, which is undergoing expansion, will potentially encounter liquidity problems in the
future, an examination of the third section of the statement of cash flows has to be made. The cash flows from financing
activities provide information whether there is a proper matching of investing and financing activities. An expansion
which will take a longer period of time to realize the benefits warrants a more patient source of financing such as equity.
If loan is to be incurred to partially finance this kind of expansion, the tenor of loan has to be studied properly and a
reasonable amount of equity must also be provided to minimize the probability of liquidity problems in the future.

 Statement of Changes in Stockholder’s Equity

-This financial statement provides and explains the changes in the stockholder’s equity account from
one accounting period to another. The changes may be due to the following:

1. Profit or loss for the accounting period

2. Cash dividend declaration
3. Issuance of new shares of stocks
4. Other transactions that affect the stockholder’s equity such as other comprehensive income, treasury
stocks and revaluation of assets.

 Notes to Financial Statements

The notes to financial statements are integral part of the financial statements. Among the additional
information that the notes to financial statements provide are the following:

1. Brief description of the company. Information may include the nature of business of the company and
the owners behind the company.
2. Summary of significant accounting policies. This is very important because the existing generally
accepted accounting principles provide alternative accounting policies to companies. It is therefore
important to find out what specific accounting policies are used by the company.
3. Breakdown of amounts found in the financial statements. The company’s property, plant, and
equipment (PPE) account may have too many components. Putting all the details on the face of the
balance sheet may make the balance sheet too long. An alternative presentation is to provide a single
amount on the face of the balance sheet for PPE but the breakdown of PPE can be presented in the
notes to financial statements.

Review of the Financial Statement Preparation

1. Analyzing Business Transaction

2. Recoding in the journal
3. Posting to ledger accounts
4. Preparing the unadjusted trial balance
5. Making the adjusting entries
a. Accruals. These include unpaid salaries for the accounting period, unpaid interest expense, or unpaid
utility expenses.
b. Prepayment. If a company has prepaid expenses such as prepaid rent or prepared insurance, then the
correct balances for these accounts have to be established at the end of the accounting period to reflect
their correct balances.
c. Depreciation and amortization expenses. Are recognized at the end of each accounting period through
adjusting entries.
d. Allowance for uncollectible accounts. Bad debt expense from accounts receivable is also recognized
through adjusting entries.
6. Preparing Adjusted trial balance
 BUSINESS FINANCE
GRADE 12
7. Preparing the Financial Statements
8. Making the Closing entries
9. Post – closing trial balance.

Financial Statement Analysis

Financial Statement analysis can be used by managers, equity investors, creditors, regulators, labor unions,
employees, the public and potential investors and creditors. It is used for investment and credit decisions. It is also used
for regulating companies such as what the Energy Regulatory Commission does for the power distribution companies
and other energy companies.

Profitable Ratios
The following are used to measure the profitability of a company:

Return on Equity (ROE)

ROE is a profitability measure that should be of interest to stock market investors. It measures the amount of
net income earned in relation to stockholders’ equity. ROE is computed as follows:
ROE = Net Income ÷ Stockholders’ Equity

Return on Assets (ROA)

Return on assets measure the ability of a company to generate income out of its resources. Below is the formula
for computing ROA:
ROA = (Operating Income ÷ Total Assets) x 100%

Gross Profit Margin

Gross Profit Margin = (Gross Profit ÷ Sales) x 100%

Operating Profit Margin and Net Profit Margin

Operating Profit Margin measures the amount of income generated from the core business of a company. It is
computed as the difference between revenues and the sum of cost revenues and operating expenses.
Formula: Operating Profit Margin = (Operating Income ÷ Sales) x 100%

Net Profit Margin

Net Profit margin measures how much net profit a company generates for every peso of sales or revenue that I
generates.
Formula: Net Profit Margin = (Net Income ÷ Sales) x 100%

Liquidity Ratios
Liquidity Ratios measure the ability of a company to pay maturing obligations from its current assets. Two
commonly used liquidity ratios will be discussed in this section. These are the current ratio and acid – test ratio sometimes
called quick asset ratio.

Leverage Ratios
It show the capital structure of a company, that is, how much of the total assets of a company is financed by debt
and how much is financed by stockholders equity.
A question may be raised as to what an appropriate capital structure is, that is, a combination of debt and equity,
for a company. The capital structure of a company is influenced by the following factors:

1. Nature of Business. If a company is in a risky business and operating cash flows are uncertain like mining
operations, it has to be more conservatively financed. Conservatively financing means there should be
more stockholder’s equity. If the business is characterized by stable operating cash flows like what is true
for SM malls where cash flows from rent are almost certain, then a more aggressive capital structure can
be considered. Stable operating cash flows allow the company to pay periodic debt amortizations.

2. Stage of business development. A company which is just starting its operations may encounter difficulties
borrowing from banks. Banks generally look for the historical performance of a company in making
decisions regarding loan applications. A new company does not have that historical record.
 BUSINESS FINANCE
GRADE 12
3. Macroeconomic conditions. If macroeconomic conditions are good as measured by gross domestic
product (GDP) and this trend is expected to continue in the foreseeable future, then management can
take a more aggressive stance in financing the company’s operations to take advantage of the
opportunities.

4. Prospects of the industry and expected growth rates. If the industry where the company operates has
good prospects and growth rates are expected to be high management can consider borrowing more to
expand operations. Otherwise, if the prospects are bleak, it is better to have low debt ratios.

5. Bond and stock market conditions. The ability of a company to raise more funds from the stock market
and the bond market also depends on how bullish players are in these markets.

6. Financial flexibility. Refers to the ability of a company to raise funds, be it the stock market or the bond
market, when the need for cash arises. Companies which have low leverage ratios have more financial
flexibility as compared to companies which have higher leverage ratios.

7. Regulatory environment. There are operations which are heavily regulated such as banks which are
monitored by the Bangko Sentral ng Pilipinas (BSP). Banks as required by BSP, have to maintain a minimum
level of capital adequacy ratio, a kind of leverage ratio applied to banks.

8. Taxes. Interest expense provides tax shield while cash dividend does not provide tax shield. Interest
expenses are allowed to be deducted from operating income to compute taxable income.

9. Management style. Some managers are aggressive and some are conservative. Management style
definitely contributes to the kind of capital structure a financing activities a company will embrace.

The following leverage ratios will be discussed in this chapter:

Debt Ratio
 Measures how much of the total assets are financed by liabilities.
Debt Ratio = Total Liabilities ÷ Total Assets

 Debt to Equity Ratio

 Is a variation of the debt ratio. A debt to equity ratio of more than one means that a company
has more liabilities as compared to stockholder’s equity.
Debt of Equity Ratio = Total Liabilities ÷ Total Stockholder’s Equity

Interest Coverage Ratio

 Provides information if a company has enough operating income to cover interest expense.
Interest Coverage Ratio = EBIT ÷ Interest Expense

Efficiency Ratios or Turnover Ratios

Efficiency ratios, otherwise, known as turnover ratios, are called as such because they measure the
management’s efficiency in utilizing the assets of the company.

 Total Asset Turnover Ratio

Measure the company’s ability to generate revenue for every peso of asset invested. It is an indicator of
how productive the company is in utilizing its resources.
Formula: Asset Turnover Ratio = Sales ÷ Total Assets
 BUSINESS FINANCE
GRADE 12

 Fixed Asset Turnover Ratio

If a company is heavily invested in property, plant, and equipment (PPE) or fixed assets, it pay to know
how efficient the management of these assets is. This can be applied to companies which are
characterized by high PPE such as utility companies. It can also applied to manufacturing companies.
Formula: Fixed Asset Turnover Ratio = Sales ÷ PPE

 Accounts Receivable Turnover Ratio

Measures the efficiency by which accounts receivable are managed. A high ratio means efficient
management of receivables.
Formula: Accounts Receivable Turnover Ratio = Sales ÷ Account Receivable

 Inventory Turnover Ratio

Measures the company’s efficiency in managing its inventories.
Formula: Inventory Turnover Ratio = Cost of Sales ÷ Inventories

 Accounts Payable Turnover Ratio

It provides information regarding the rate which trade payables are paid. Any operating company will
prefer to have longer payment period for its accounts payable but this should be done only with the
concurrence of the suppliers.
Formula: Accounts Payable Turnover Ratio ÷ Trade Accounts Payable

 Operating Cycle and Cash Conversion Cycle

By adding the average collection period and days’ inventories, the operating cycle can be computed.
This operating cycle covers the period from the time merchandise is bought to the time the proceeds
from the sale are collected. Managers of companies will prefer to have a short operating cycle as
compared to a long one.
Operating Cycle = Days’ Inventories + Days’ Receivable

Vertical Analysis and Horizontal Analysis

 Vertical Analysis or sometimes called common size analysis is an important financial statement analysis tool.
With vertical analysis, all accounts in the statement of financial position are presented as a percentage of a total
assets while all accounts in the statement of profit or loss are presented as a percentage of sales or revenues.

 Horizontal or Trend Analysis is a financial statement analysis technique that shows changes in financial
statement accounts over time. Changes can be shown both in absolute peso amounts in percentage.
To compute for the change, simply get the difference from one period to another. The earlier period is used as
the base period.

Quality of Earnings
There are information the financial statements that should be looked into. Among these are the ff.
1. If the income from the core business?
2. How much of the net income translates in cash flows?
3. Is the income stable?

Limitations of Financial Statement Analysis

While financial statement analysis is a very powerful tool in understanding a company, it has a limitations too.
Among them are as follows:
1. Financial Analysis deals only with quantitative data.
2. Management can take short – run actions to influence ratios.
3. Different companies may use different accounting principles though they came from the same industry.
4. Different formulas can be used in computing financial ratios.
5. The amounts found in the financial statements are already part of historical data.
6. A financial ratio standing alone is useless.
 BUSINESS FINANCE
GRADE 12
CHAPTER 3
Planning and Working capital Management

Planning is very much related to another management function, controlling. These two management functions reinforce
each other, and both are very important for the success of an organization.

Management planning is about setting the goals of the organization and identifying ways to achieve them. This may be
broken down into long term and short term plans. Long term plans are reflected in company’s business strategy. In the
process of planning, resources have to be identified. These resources include manpower resources, production capacity
and financial resources.

Steps in Planning
1. Set goals or objectives
2. Identify Resources
3. Identify goal – related tasks.
4. Establish responsibility centers for accountability and timeline.
5. Establish an evaluation system for monitoring and controlling.
6. Determine contingency plans.

Budget Preparation
1. Sales budget
2. Production budget
3. Operating budget
4. Cash budget

 Sales Budget
The most important financial statement account in forecasting is sales because almost all other accounts
in the financial statements affected by sales.

 Production Budget
Production budget is a schedule which provides information regarding the number of units that should
be produced over a given accounting period based on expected sales and targeted level of ending
inventories.
Required Production of Units = Expected Sales + target Ending Inventories – Beginning Inventories

 Projected Financial Statements

Steps:
1. Forecast sales.
2. Forecast cost of sales and operating expenses.
3. Forecast net income and retained earnings.
4. Determine balance sheet items that will vary with sales or whose balances will be highly
correlated with sales.
5. Determine payment schedule for loans.
6. Determine external funds needed (EFN).
7. Determine how external funds needed will be financed.

Working Capital Management

Refers to the current assets used in the operations of the business. This includes cash, accounts receivable,
inventories and prepaid expenses.

Working Capital Financing Policies

These are three types of working capital financing policies management can choose from. These are:
1. Maturity – matching working capital financing policy.
2. Aggressive working capital financing policy.
3. Conservative working capital financing policy.

Maturity – Matching Working Capital Financing Policy

Aggressive Working Capital Financing Policy
Conservative Working Capital Financing Policy
 BUSINESS FINANCE
GRADE 12

CHAPTER 4: SOURCES AND USES OF SHORT TERM AND LONG TERM FUNDS

Debt Financing – can be a form of borrowing from banks or other lending institutions or issuance of debt securities like
commercial papers and bonds.

Equity Financing - refers to issuance of new shares of stocks and retained earnings plowed back into the operations of
the company.

Sources and Uses of Short Term Funds – are normally used to finance the day – to – day operations of the company.

Sources and Uses of Long Term Funds – are used for long term investments or sometimes called capital investments.
This includes expansion, buying new equipment, or buying piece of land which will be the site of future expansion. Long
term funds can also be used to finance permanent working capital requirements.

Duties of the Borrower to Creditor

1. Pay the creditors
2. Provide the collaterals as agreed upon the loan negotiation with proper documentation.
3. Comply with the provisions of the loan covenant such as maintaining certain liquidity and leverage ratios.
4. Notify the creditor if the company is acquiring another company or the company is now the subject of
acquisition.
5. Do not default on the loans as much as possible.

CHAPTER 5: Basic Long Term Financial Concepts

Time value of money

“A peso today is worth more than tomorrow”. All individuals and businesses face the same two basic finance
related problems:
1. Where to put the money?
2. Where to get the money?

The concept of Interest

The most basic finance – related formula is the computation of interest. It is computed as follows:
I=PxRxT

I = Interest
P = Principal
R = Rate
T = Time Period

Simple Interest – If the interest earned or incurred is always based on the original principal, then simple interest is
assumed.

Compound Interest – the usual assumption in most business transactions is to use compound interest. Is simply earning
interest on interest.

Future Value of Money – Future value = Initial Value x (1+R) T

Where R = Interest rate and T= Time Period

Multiple Cash Flow – Simply get the present values of the individual cash flows and add them together. Since the value
refer to the same date (today) these are value additive.

Loan Amortization – A classic example of a business transaction that pays out an equal cash flow stream regularly is an
amortizing loan.

Effective Annual Interest Rate – Interest Rate are normally quoted as annual rates but the compounding frequency may
differ per transaction.
Equation: Effective Annual Rate = (1+R/M) M-1
Where:
R= Annual Interest Rate
M= Frequency of Compounding
 BUSINESS FINANCE
GRADE 12
CHAPTER 6: INTRODUCTION TO INVESTMENTS

Risk Aversion – means that individuals maximize returns for a given level of risk or minimize risk if the returns are the
same. Risk averse individuals would require a higher return if the risk level increases.

Investments and the Risk Premium – Bron and Reily (2014) defined investment as “the current commitment of dollars
for a period of time in order to derive future payments that will compensate the investor for:
 The time the funds are committed;
 The expected rate of inflation during this time period; and
 The uncertainty of future payments”.

Brown and Reily (2014) identified the major sources of risks as follows:
1. Business Risk – related to the company’s products and its operating strategy.
2. Financial Risk – refers to the risk created by the choice of capital structure – the financing mix of the issuing
company.
3. Liquidity Risk – is the uncertainty that an investment can be converted to cash at a known price.
4. Exchange Rate Risk – if the investment is denominated in another currency different from that of the local
currency of the investor.
5. Country Risk – is associated with political and economic uncertainty of a particular business environment.

Deposits - deposit instruments are provided by financial institutions, mostly banks. The major deposit instruments
include the following:
1. Savings Account
2. Checking Account
3. Time Deposit Account
(
Government Securities – fall under the category of debt securities and most of them are also classified as fixed income
instruments. The National Government through the Bureau of Treasury issues debt securities known as Treasury bills (T-
bills) and Treasury Bonds (T-bonds)

Risk Measures and Risk Reduction

Risk Measure – Single Asset – A basic risk measure for a single asset is the variance and standard deviation (square root
of the variance) of returns. The variance (o²) is computed as follows:

ⁿ
o² = Σ (Rt – Rmean)²
ᵀ-¹ ⁿ

Where:
Rt = Return for a Particular Period
Rmean = Average Return
n = Number of Periods

Computing the variance involves the following steps:

1. Get the mean.
2. Get the difference of each return and the mean.
3. Get squared difference.
4. Add the squared difference.
5. Divide by the number of periods.

Risk – Return Measure

Assets should be compared based on both risks and return. The coefficient of variation is simple of variation is a
simple risk – return measure o compare various assets,
 BUSINESS FINANCE
GRADE 12
CHAPTER 7: MANAGING PERSONAL FINANCE

Financial Planning and Individuals Life Cycle

The financial plans of an individual depend on his financial objectives that are very much affected by the
stage he is at an individual life cycle. Brown and Reily (2014) identified the four life cycle phases as follows:
1. Accumulation Phase
2. Consolidation Phase
3. Spending Phase
4. Gifting Phase

Basic Principles of Personal Finance

Keown (2010) summarized the basic principles of personal finance management in the following points.
1. The best protection is knowledge.
2. Nothing Happens without a Plan
3. The time value of money
4. Taxes affect personal Finance Decissons
5. Stuff happens ,, or the importance of Liquidity
6. Waste Not, Want not 9Smart Spending Matters)
7. Protect yourself Against Major Catastrophes
8. Risk and Return Go Hand in Hand
9. Mind Games and Your Money
10. Just Do it!