SH1663

Introduction to Finance
I. Financial Management
A. Classifications of Finance
As a form of negotiation
o Direct finance
Finance involved in direct borrowing.
It is lending to the ultimate borrowers. In direct finance, the individual, or the deficit
unit, borrows directly from the lender, or the surplus unit.
The market where direct finance happens is called the direct market.
o Indirect finance
Uses financial intermediaries when borrowing.
They act as middlemen between the borrowers and lenders.
The market where indirect finance happens is called the intermediation market.
As to user
o Public finance
This deals with the revenues and expenses of the government. It is about managing
the governments sources and uses of funds. Like all individuals and entities, the
government is both a borrower and a lender. Government spending and borrowing
are part of public finance.
o Private finance
All finance other than public finance.
Further divided into:
Personal finance Finance conducted by individuals/ consumers
Finance of non-profit organizations Finance conducted by charitable, civic,
or religious organizations.
Business finance It deals with financing for business firms or for commercial
use, the goal of which is to make a profit.

B. Types of Businesses
As to nature or purpose
o Service These refer to businesses or professionals who render personal service.
o Trading or merchandising These businesses are engaged in buying and selling
products.
o Manufacturing These include firms who buy raw materials to process and convert
them to finished products, which they sell.
o Banking and finance These organizations focus on money as the main product of their
business. Their products are money and credit.
o Mining or extractive industry These companies extract natural resources like oil, gas,
gold, copper, and cement.
o Construction These are businesses that build houses, buildings, schools, roads and
other infrastructures. They are similar to manufacturing in a sense that they start with
raw materials, but their end product is different.
o Genetic industries These are firms involved in the production or reproduction of
certain species of plants and animals, either for sale or for reproduction.

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As to ownership
o Sole or single proprietorship
Advantages
Ease of formation The business is easy to start because only one (1) person
makes the decision to go into the business.
Needs only minimum capitalization Because these businesses only have one
(1) owner who can provide capital; the starting capital is usually small.
Sole decision maker The owner has total control of his business.
Easy to terminate The business is easy to discontinue because it is owned by
only one (1) person and there are not many assets to sell and liabilities to pay.
Disadvantages
Unlimited liability A sole proprietor is responsible for the liabilities of the
business to the extent of his personal assets, that is, the creditors of a sole
proprietorship can run after the personal assets of the owner to the extent of the
liabilities of the business.
Limited access to capital If the business has large earning potential, it is
possible that the owner, being alone, will not be able to provide the capital
needed to expand the business.
Limited skills, talents, and capabilities The owner can only use his/her own
skills, talents, and capabilities. If the business grows, the business owner may
need additional training or knowledge.
Inability to attack or retain good employees The owner may not be able to
give a good employee a competitive salary because the business is small.
Limited term of existence The life of a sole proprietorship is dependent on its
owner.
Difficulty in measuring success In a sole proprietorship, business funds and
expenses usually mix with the funds and expenses of the owner, making it
difficult to measure actual business performance and profitability of the
business.
Personal problems may hinder operation/ success Personal problems may
interrupt or hinder effective decision-making.

o Partnership
Advantages
Ease of formation Mere agreement between partners, even if it is not written,
can create a partnership.
Allows pooling of financial resources Partnerships can pool resources and
raise more capital for the business.
Allows pooling of skills, expertise, and experience of partners that may
contribute to successful business operation.
Less government control and supervision than corporations

Disadvantages
Limited life A partnership is dissolved when a partner dies, withdraws,
becomes insolvent or bankrupt, or becomes incapacitated, or when a new
partner or new partners join the partnership.

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Unlimited liability General partners are answerable to debts to the extent of

their personal assets. Limited partners have only limited liabilities.
Mutual agency All partners may be held liable for the actions of any other
partners, so long as their actions are within the scope of the business operations
of the partnership.

o Corporation
Advantages
Legal capacity to act as a legal entity The corporation is considered a legal
person with perpetual existence. It exists until it is liquidated. Death or change
in ownership has no effect in the organization.
Limited liability of shareholders The liability of the owners towards the
creditors is limited to their investment in the company. In the case of liquidation
of the company, if the companys assets are insufficient to meet the liability,
nothing is required to be contributed by the owners.
Transferability of shares The ownership is represented by the number of share
certificates held by a person, and this makes the transfer of ownership very easy.
Greater ability to acquire funding Additional capital can be easily raised
through stock markets. A publicly-held corporation, in particular, can raise
substantial amounts by selling shares or issuing bonds.
Disadvantages
Complex formation Establishing a corporation is a complex process and
requires registration with the government and listing on stock exchange.
Agency problem Normally the corporations have a large number of
shareholders, they delegate the governance function to a group of persons called
the board of directors. The board of directors would then hire management to
look after the operations of the corporation. In this situation, the management is
an agent of the owner. The agency problem occurs when the management acts
in their own interests rather than the interest of the owners of the corporation.
Double taxation In corporations, there is double taxation. First of all, the
corporate income is taxed at a flat rate. Then, the dividends paid to the
shareholders are also taxed.

o Cooperative
Advantages
Easy formation Compared to the formation of a company, the formation of a
cooperative is easy. People who would like to form cooperatives only need to
register themselves with the Cooperative Development Authority.
Limited liability Like the corporation, the liability of members is limited to
the extent of their capital.
Perpetual existence A cooperative has a separate legal entity. Therefore, the
death, insolvency, or retirement of the members does not affect the existence of
the cooperative society.
Social service The basic philosophy of cooperatives is self-help and mutual
help.

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Democratic management The cooperative is managed by the elected

members. Every member has equal rights through its single vote and can take
part in the formulation of the policies of the society. Unlike corporations, all the
members have only one vote, regardless of their contribution.
Disadvantages
Limited sources The financial strength of cooperatives depends on the
contributions of its members. Because most members of cooperatives belong to
the lower and middle class, cooperatives are not suitable for large scale
businesses which require huge capital.
Insufficient management A cooperative is managed by the members only.
Minimal financial returns Cooperatives are formed to provide service to
members rather than a return on investment. It may be difficult to attract
potential members seeking a financial return.

II. Financial Institutions

A. Financial Institutions
Banks
o Thrift banks These are deposit-taking financial institutions that also extend credit to
the consumer market. They usually cater to the countryside or rural areas.
o Commercial banks These are deposit-taking financial institutions that extend credit
to the retail and consumer markets. They collect and safely keep the funds of savers and
depositors. Savings and checking accounts provide a fast and efficient way for clients
to access their money. They also lend to small-medium enterprises that will pay them
an interest regularly for the use of their funds.
o Universal banks Universal banks lend to multinational companies. Their transactions
are larger than commercial banks and are denominated in multi-currencies, not just
limited to the local currency. They also have an expanded line of services compared to
commercial banks.
o Investment banks These banks focus on raising funds for big corporations and
governments through bond issuances and initial public offerings.

Nonbanks
o Leasing companies Leasing companies are not banks and are not governed by a
central bank. However, they also extend credit or financing to companies.
o Investment companies These are institutions regulated by the Securities and Exchange
Commission and perform similar functions as banks.
o Mutual funds These are collective investments or funds of small investors pooled
together and managed to be able to reach maximum returns. Mutual funds, though small
individually, are big collectively.
o Insurance companies These companies sell insurance coverage to provide a guarantee
of compensation for specified death, illness, accident, loss, or damage to property in
exchange for payment of a premium. They may sell life and non-life insurance products.
The premiums collected is entrusted to a portfolio manager who takes cares of the
funds.
o Private equity funds These entities are not regulated by the government or any other
regulatory body.

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B. Financial Instruments and Financial Markets

Money market instruments An inexpensive way for governments and financial
institutions to raise funds. These funds are usually available for only a short period of time,
therefore their rates are generally lower than funds which are available for use. They also
earn a higher interest. People avail money market funds because of their liquidity. They
are available most of the time when the person needs them. Some examples of the money
market funds are:
o Treasury bills These are issued by the Treasury/ Government. They mature within
one year and are generally free from default risks because the government will exert all
effort to pay.
o Commercial papers These are issued by financially sound businesses to fund
inventories and receivables. They mature in less than one year and have low default
risk because businesses usually have good credit standing.
o Money market funds These are issued by banks or mutual fund companies. They have
no specific maturity date. The default risk is low, and they are usually invested in money
market instruments, treasuries, and commercial papers.
o Consumer credit/credit card debt These are issued by banks, credit unions, or finance
companies. The maturity rate and default risk both vary.
Long-term debts The interest rates on long-term debts is higher than the money market
instruments and are usually locked in over the entire life of the debt. Examples of long-
term debts are:
o Treasury notes and bonds These are issued by the government. Treasury notes mature
in 2, 5, or 10 years, while bonds mature longer (10 years or more). They have no default
risk because governments will exert all efforts to pay. However, the price of bonds
usually falls, becoming less attractive as the interest rates in the markets rise.
o Municipal bonds / local government bonds They are issued by local governments and
matures longer than treasury notes and bonds (i.e, up to 30 years). They are riskier than
government securities.
o Corporate bonds These are issued by the corporation and have a maturity date of
more than 30 years. They are riskier than government securities and rely on the financial
soundness of the company.

III. The Role of Financial Manager

A. Goals of the Financial Manager (The Flow of Money)
Acquisition of funds with the least cost from the right sources at the right time It is
important to use networking to find the rough sources of funds. Funds can come from
banks, nonbanks or individual and corporate investors.
Effective cash management To manage cash effectively, companies need a detailed cash
flow budget. The cash flow budget can also be used to take advantage of cash discounts in
paying trade payables, prioritizing the use of cash, and other similar strategies to manage
cash.
Effective working capital management Current assets and current liabilities are used in
current operations. Managing the right combination of assets and liabilities allows the
company to have a good capital position that will enhance the firms stability and liquidity.
Effective inventory management Overstocking and understocking are undesirable for the
management. Maintaining the right inventory gives the company an edge over its
competitors.
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Effective investment decisions Any excess cash needs to be invested to earn income, either
in the form of interest or dividends. Too much cash lying in the bank or checking accounts
is not advisable.
Proper asset selection Selecting the right machinery and equipment needed is important
to attain its production goal and attain sales.
Proper risk management The financial manager must also be able to evaluate the risks
associated with certain business decisions. Buying stocks or investing in something needs
risk analysis and assessment. In general, the riskier the project, the higher the return.
B. Tools of Financial Managers
Financial policy-making This involves selection of financial goals, development of
financial policies, and designation of the finance department in the organization to
accomplish the finance function. It is important that the financial goals are clear, especially
to managers and employees.
Financial planning and budgeting Forecasting is an integral part of the planning process.
A company forecasts future demand for its product, and based on this forecast, prepares a
budget. Then, actual performance is compared to these budgets to determine which actions
need correction.
Financial analysis This is the process of evaluating business performance, projects,
investment options, and other finance-related activities to determine feasibility and
profitability. A business is considered profitable if it attains a consistent rate of return on
all its investments, including the companys operations.

References:
Benito, P. P., Chan Pao, T. P., & Yumang, K. (2016). Exploring small business and personal finance
in senior high. Quezon City: Phoenix Publishing House.
Bragg, S. (2015). Corporation advantages and disadvantages. Retrieved from Accounting Tools:
http://www.accountingtools.com/questions-and-answers/corporation-advantages-and-
disadvantages.html
Cooperative. (2015). Retrieved from Government of Western Australia Small Business Development
Corporation: https://www.smallbusiness.wa.gov.au/business-topics/planning-
structures/business-structures/cooperative/
Lopez-Mariano, N. D. (2014). Elements of finance. Quezon City: Rex Book Store.
Obaidullah, J. (2013). Corporation . Retrieved from Accounting Explained:
http://accountingexplained.com/misc/forms-of-business/corporation
Reddy, P. (2012). What are the advantages and disadvantages of cooperative society? Retrieved
from Preserve Articles: http://www.preservearticles.com/201101193579/advantages-and-
disadvantages-of-cooperative-society.html
Sinha, D. (2015). Advantages and disadvantages of cooperative society - discussed! Retrieved from
Your Article Library: http://www.yourarticlelibrary.com/business/cooperative/advantages-
and-disadvantages-of-cooperative-society-discussed/40799/

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