BUSINESS FINANCE:

Financing and the Time

Value Of Money

Week 8
SOURCES AND USES OF
SHORT-TERM FUNDS
Suppliers Credit

• It refers to the extension of payment

due date by suppliers.
SOURCES AND USES OF
SHORT-TERM FUNDS
Advances from stockholders
or other owners
• These are personal funds advanced by a
stockholder to a company that usually
requires interest. These usually require
little to no interest on advances,
especially if the owner is advancing
funds to assist the company in sudden
liquidity crisis. This source, however, is
depended on the availability of funds of
an individual.
SOURCES AND USES OF
SHORT-TERM FUNDS
Credit cooperatives
• They provide lending services to its members.
Members usually pay contributions to the
cooperative.

Banks
• They provide several loan products catering to
different types of needs.

Credit Cards
• You just take note of the high interest rates on
this source of funds.
SOURCES AND USES OF
SHORT-TERM FUNDS
Lending Companies

• These are companies that are dedicated to lending.

They usually charge higher interest than banks, but
their credit requirements are more lenient compared
to banks.

Pawnshops

• They provide funds in exchange for collateral, usually

jewelry, or other items of value.

Informal lending sources

SOURCES AND USES OF
LONG-TERM PLANS
Equity investors

• These are the individuals/corporations which

are issued common stock. They share in the
ownership of the company. There are also
equity investors who do not have voting
rights in the company but have a share in
dividends, usually a fixed percentage. These
investors are issued preferred stock. Holders
of preferred shares are first to receive
dividends than common stockholders.
SOURCES AND USES OF
LONG-TERM PLANS
Internally-generated funds

• Not all profits are distributed to

stockholders .Most of the profits are re- invested
and used by companies to finance their needs.

Banks

• They provide long-term loans, depending on the

nature of the need. For example, a 5- year to 10-
year loan may be granted if the purpose of the
loan is construction of an office building.
SOURCES AND USES OF
LONG-TERM PLANS
Bonds

• These are debt investments where

an investor loans money to an entity
which borrows the funds.

Lending companies

• They can also provide long-term

loans
5C’S OF CREDIT
◦The institution’s primary consideration
in approving loan applications.

Character

• It is the willingness of the borrower to repay

the loan

Capacity

• It is the customer’s ability to generate cash

flows
5C’S OF CREDIT
Collateral

• This is a security pledged for payment of the

loan

Capital

• It is a customer’s financial resources

Condition

• This is the current economic or business

conditions
LIST OF BANK REQUIREMENTS
FOR LOAN APPLICATION FOR A
CORPORATION
◦Pre-approval Requirements:
Duly accomplished application form

Securities and Exchange Commission (SEC) registration

Articles of incorporation and by-laws

List of elected officers

Board resolution or corporate secretary’s certificate

regarding loan application
LIST OF BANK REQUIREMENTS
FOR LOAN APPLICATION FOR A
CORPORATION
◦Pre-approval Requirements:
Company profile or business background

List of major suppliers and customers with

contact information
Audited financial statements (2 to 5 years
depending on the bank)
Bank statements (most banks require bank
statements for the past 6 months)
LIST OF BANK REQUIREMENTS
FOR LOAN APPLICATION FOR A
CORPORATION
◦Pre-approval Requirements:
Collateral Copy of transfer certificate of title (TCT)
documents
such as the
or condominium certificate of title (CCT)
following:
Copy of tax declaration

Appraisal Fee with official receipt

LIST OF BANK REQUIREMENTS
FOR LOAN APPLICATION FOR A
CORPORATION
◦Pre-approval Requirements:
For Building plan or floor plan
constructio
n loan
Bill of materials and labor cost

Building specifications certified by

architect/civil engineer
Development permit

Copy of lease contracts (if applicable)

LIST OF BANK REQUIREMENTS
FOR LOAN APPLICATION FOR A
CORPORATION
◦Post-approval Requirements:
Original owner’s duplicate copy of TCT/CCT

Original certified true copy of latest tax declaration on land and

improvement

Master deed of declaration (for condominium)

Electronic-certified true copy of TCT/CCT with original official

receipt
LIST OF BANK REQUIREMENTS
FOR LOAN APPLICATION FOR A
CORPORATION
◦Post-approval Requirements:
Original certified true copy of tax
clearance
Original real estate tax receipts

Mortgage redemption insurance

Fire insurance
DISTINCTION BETWEEN SHORT-
TERM AND LONG-TERM FUND
◦Long-term financing - any financial
instrument with maturity exceeding one
year (such as bank loans, bonds,
leasing, and other forms of debt
finance), and public and private equity
instruments.
LONG-TERM FINANCING
Equity This includes preferred and common
financin stocks and is less risky with respect to
g
cash flow commitments

Corporat This is a bond issued by a corporation

e bond to raise money effectively to expand its
business

Capital These are form of convertible security

notes exercisable into shares
DISTINCTION BETWEEN
SHORT-TERM AND LONG-
TERM FUND
◦Short-term
financing – can be
used over a period of
up to a year to help
corporations increase
inventory orders,
payrolls, and daily
supplies
SHORT-TERM FINANCING
Commerci
al paper This is an unsecured promissory note
with a fixed maturity of 1 to 364 days
in the global money market

Promissor
y note This is a negotiable instrument
wherein one party makes an
unconditional promise in writing to
pay a determinate sum of money to
the other
SHORT-TERM FINANCING
Asset- This is a type of business financing that is
based secured by company assets. Most asset-
loan based loans are structured to work as
revolving lines of credit. This structuring
allows a company to borrow from assets on
an ongoing basis to cover expenses or
investments as needed
Repurchas
e
These are short-term loans arranged by
agreemen selling securities to an investor with an
ts agreement to repurchase them at a fixed
price on a fixed date.
SHORT-TERM FINANCING

Letter This is a document that a financial

of institution or similar party issues to
credit a seller of goods or services which
provides that the issuer will pay the
seller for goods or services the
seller delivers to a third-party buyer
THE TIME
VALUE OF
MONEY
THE TIME VALUE OF
MONEY
◦Time Value of Money – the concept
that money you have now is worth more
than the identical sum in the future due to
its potential earning capacity.
THE TIME VALUE OF
MONEY
◦This core principle of
finance holds that
provided money can
earn interest, any
amount
of money is worth mo
re the sooner it is
received.
DIVERSIFY YOUR RISKS
AND INVESTMENTS
Diversification

• It is a technique that reduces risk by

allocating investments among various
financial instruments, industries, and
other categories.
• It aims to maximize returns
by investing in different areas that
would each react differently to the
same event.
DIVERSIFY YOUR RISKS
AND INVESTMENTS
Compounding

• It is the ability of an asset to generate

earnings, which are then reinvested or
remain invested with the goal of
generating their own earnings.
• In other words, compounding refers to
generating earnings from previous
earnings
UNDERSTANDING THE
STOCK MARKET
◦The concept behind how
the stock market works is
quite simple.
◦Operating much like an
auction house, the stock
market enables buyers
and sellers to negotiate
prices and make trades.
UNDERSTANDING THE
STOCK MARKET
◦Investors can
then buy and
sell
these stocks am
ong
themselves, and
the exchange trac
ks the supply and
demand to each
KEEPING A BUDGET
◦It is needed to really
understand the
breakdown of your
company’s finances
and to learn how to
optimize them.
OPPORTUNITY COSTS

◦It represent the

benefits an
individual, investor or
business misses out
on when choosing
one alternative over
another.
OPPORTUNITY COSTS

◦While financial reports do not show

opportunity cost, business owners
can use it to make educated
decisions when they have multiple
options before them.
◦Bottlenecks are often a cause of
opportunity costs.
INTEREST RATE

◦ It is the rate a bank or other

lender charges to borrow its
money, or the rate a bank pays its
savers for keeping money in an
account.
◦The annual interest rate is
the rate over a period of one year
RISK
◦Risk is the potential for uncontrolled
loss of something of value.
◦Risk can also be defined as the
intentional interaction with uncertainty.
◦Uncertainty is a potential,
unpredictable, and uncontrollable
outcome; risk is an aspect of action
taken despite uncertainty.
ELEMENTS OF RISK
◦Systematic risk – It refers to
the risk inherent to the entire market or
market segment.
◦Systematic risk, also known as
“undiversifiable risk,” “volatility” or
“market risk,” affects the overall market,
not just a particular stock or industry.
◦This type of risk is both unpredictable and
impossible to completely avoid.
ELEMENTS OF RISK

◦Unsystematic risk – It is the risk that

is inherent in a specific company or
industry.
◦By investing in a range of companies
and industries, unsystematic risk can be
drastically reduced through
diversification.
◦Synonyms include
diversifiable risk, non-systematic risk,
residual risk and specific risk.
MEASUREMENT OF RISK

Mean Variance Approach

 It is used to measure the total risk that is
sum of systematic and unsystematic risks
Correlation or Regression
Approach
• It is used to measure the systematic risk
RETURN

◦A return is the change in price on

an asset, investment, or project
over time, which may be
represented in terms of price
change or percentage change.
◦A positive return represents a
profit while a
negative return marks a loss.
RETURN

◦It is measured as:

Total return = Cash payments

received + Price Change in Assets
Over the Period/Purchase price of
the asset
SIMPLE AND
COMPOUND
INTEREST
INTEREST
 Charge against the use of money
by the borrower
 Profit earned by the lender of
money
TWO TYPES OF
INTERESTS
 Simple Interest – the charging
interest rate r based on a principal
P over T number of years.

Interest = P x r x T
TWO TYPES OF
INTERESTS
◦Compound Interest - the interest
in the first compounding period is
added on the principal, which will
then be the basis for the interest to
be computed for the next period

Interest = (P x (1 +) (T x m)) – P
EFFECTIVE ANNUAL RATE
(EAR)
◦It is also important to look at
interest rates from the point of
view of borrowers.
EFFECTIVE ANNUAL RATE
(EAR)
 Single Amount (Lump Sum) - a
single cash outflow is made, and
the total receipts will be at a
single future date.
EFFECTIVE ANNUAL RATE
(EAR)
 Annuity - periodic stream of
equal cash flow at equal time
intervals (annually, monthly, etc.).
For example, payment for a
certain item shall be for 12 equal
monthly instalments of PHP1,000.
EFFECTIVE ANNUAL RATE
(EAR)
 Mixed Stream - unequal periodic
cash flows that reflect no
particular pattern.
PRESENT VALUE OF
MONEY
◦Present Value - answers the question:
How much must be invested today to
produce a certain amount in the future.
◦Since future value is calculated by
multiplying the present investment by 1
+ interest rate compounded by the
number of periods, we shall just reverse
the process.
PRESENT VALUE OF
MONEY
◦This method is called
discounting.

Present Value (PV) =

ILLUSTRATIVE EXAMPLE
◦A bank offers to sell a Treasury bond
that will pay P5,788.12 three years from
now. Banks are currently offering a
guaranteed 5% interest 3-year Time
deposit certificate. Given this scenario,
there is a need to decide whether to
invest the money in a treasury bond or
just invest it on a 3-year time deposit
certificate.
ILLUSTRATIVE EXAMPLE

◦Applying the formula using the

data above, to compute for the
present value:
PV=
= P5,000.00
ILLUSTRATIVE EXAMPLE
◦Therefore, the “fair price” or the most
amount to be paid for the bond is
P5,000.00, otherwise, it will not have
any difference by investing the money
in a time deposit certificate with a
guaranteed 5% interest in 3 years. It
will be better, if the offered price of the
bond is lower than P5,000.00.
FUTURE VALUE OF MONEY

◦A peso in hand today is worth more

than a peso to be received in the
future because if invested, it will
earn interest and yield more than a
peso in the future.
FUTURE VALUE OF MONEY

◦The process of conversion to future

values (FVs) from present values
(PVs) is called compounding.

FVN = PV (1+i)N
ILLUSTRATIVE EXAMPLE

◦Assume that P5,000 will be

deposited in a bank which pays a
guaranteed 3% interest each year.
How much would it be at the end of
Year 5?
ILLUSTRATIVE EXAMPLE

◦Multiply the initial amount and

each succeeding amount by (1 + i)
= (1.03). After a year, the interest
earned is P150.00 (P5,000 x 0.03)
and at the end of the second year,
the interest is P304.50 (P5,150 x
0.03).
ILLUSTRATIVE EXAMPLE

◦As the process continues, the

beginning balance is higher each
successive year due to the increase
in the interest earned each year.
ILLUSTRATIVE EXAMPLE
◦In the illustration above, the amount of
the beginning of each period is multiplied
by (1+i) = 1.03. If N=5, it is multiplied by
(1+i) five different times, which is the
same as multiplying the beginning by
(1+i)5. This concept can be extended,
and the result is a key equation:
FVN = PV (1+i)N
ILLUSTRATIVE EXAMPLE

◦Using this equation to find the FV

in the given illustration will be as
follows:
FV5 = P5,000 (1.03)5
= P5,796.37
 COMPUTING LOAN
AMORTIZATION USING
MATHEMATICAL
CONCEPTS AND THE
PRESENT VALUE
TABLES
LOAN VS. BOND
◦A loan is money lent at an interest rate
for a certain period. Loans are normally
secured from different financial
institutions, the most common of which,
are banks.

◦A bond is also a form of loan, but can

be traded through Philippine Dealing and
Exchange (PDEX) System
AMORTIZATION

◦Amortization can refer to a

process of clearing debt over time
in daily interest and principal
installments that are necessary to
repay the loan in full by its due
date
AMORTIZATION TABLE

◦An amortization table is a

schedule that lists each monthly
payment in a loan as well as how
much of each payment goes to
interest and how much to the
principal.
AMORTIZATION TABLE

◦Every amortization table contains

the same kind of information.
 Scheduled payments:
 Principal repayment
 Interest expenses
 Relationship of time value of
money in loan/bond pricing.
PRESENT VALUE OF
MONEY
◦To get the present value of a bond
maturing a year from now, let us
illustrate what we have learned in
the previous lesson regarding
present value.
PRESENT VALUE OF
MONEY
◦Let’s say that you are willing to invest a
sum of money that will yield PHP100,000
at the end of year 1, what amount should
you invest today?

◦If the investment earns 10%, then the

amount to be invested or the present
value should be equal to PHP100,000 x
(1/(1.101))=PHP90,909.09
PRESENT VALUE OF
MONEY
PRESENT VALUE OF
MONEY
◦If this amount will be received in 2
years, then the present value is
equal to P100,000x (1/(1.10)2) =
P82,644.63. We may also use the
present value table.
PRESENT VALUE OF INTEREST
PAYMENTS (ANNUITIES)
◦In addition to receiving the face
value at maturity, the
investor/lender also receives
periodic interest payments over the
life of the bond.
◦These periodic payments, as
mentioned in the previous module,
are called annuities.
PRESENT VALUE OF
INTEREST PAYMENTS
(ANNUITIES)
◦To illustrate, assume that you will
receive P10,000 annually for 3
years and the interest rate is 10%.
PRESENT VALUE OF
INTEREST PAYMENTS
(ANNUITIES)
◦From the table (or by using the
formula provided in the earlier
module), we get that the present
value of annuity factor for 3 periods
using 10% interest is 2.4869.
◦Multiplying this factor by
PHP10,000 provides a present value
of interest payments ofPHP24,868.6.
PRESENT VALUE OF
BONDS
◦To calculate the present value or the
price of a bond, we need to combine
both the present values of the face
value and the annuity payments.
◦In our previous example , suppose that
a bond with face value of PHP100,000
pays interest of 10% annually and
matures in 3 years. What is the price of
the bond?
PRESENT VALUE OF
BONDS
◦First, we find the present value of the
face value of the bond. That is equal to
PHP100,000 x (1/(1.10)3) = PHP75,131.40

◦Next, we compute for the present value

of annuity payments of P10,000 annual
interest (100,000 x.1). This was computed
earlier in our example, PHP24,868.6.
Therefore, the price of the bond is:
PRESENT VALUE OF
BONDS

◦Take note that interest payments may

be made semi-annually, or even
monthly. In this case, we need to
adjust the interest rates and time
periods accordingly. Differentiate
discount from premium bond pricing.
ANY QUESTIONS??