Week-1-7 CM MDL 3q Fin122

ASIAN INSTITUTE OF COMPUTER STUDIES (AICS)
MODULE 1
MODULE 3
AN INTRODUCTION TO FINANCIAL MANAGEMENT 2-9
SOURCES AND USES OF SHORT-TERM 31-31
Financial Institutions and the Key Individuals
Who Play Vital Roles AND LONG-TERM FUNDS
Financial Instruments and Financial Markets Sources of Funds for Business Operations
Financial Institutions and Financial Services Requirements of Applying for a Personal Loan
Financial Instruments Compared and Contrasted Flowchart of a Loan Application
The Flow of Money and the Role of the Financial Manager Obligations of Entrepreneurs to Creditor
Assessment Activities 10 Uses of Funds
Assessment Activities 32
MODULE 2
MODULE 4
FINANCIAL PLANNING 11-19
BASIC LONG-TERM FINANCIAL CONCEPTS 33-42
Steps in the Financial Process
Future Value and Present Value
The Budget Preparation
Nominal and Effective Interest Rates
Tools in Managing Cash, Receivables, and Inventory
Loan Amortization/Installment Loan
Applying Business Concepts in Financial
and Investment Problems
The Risk-Return Tradeoff
FIN122: Business Finance
1
What is finance?
Finance is the study of how individuals or businesses evaluate investment

opportunities, business proposals, and business projects, and raise capital to fund them.
Evaluating an investment means ensuring that the fund to be invested will create value to a
business or an individual in the form of profit. The main goal of finance is to maximize profit.
Financial management, on the other hand, means the efficient and effective
management of funds. To achieve this, it would be helpful to understand and apply financial
management tools, concepts, and theories.
Since funds are important to any business whether to start, sustain, or expand
operations, it also helps to understand how funds are raised. This chapter enables the
student to understand banks, nonbanks, and other financing companies, and their vital role
in raising funds.
Financial Institutions and the Key Individuals Who Play

Vital Roles
The Important Role of the Financial Institutions
The role of financial institutions in the money flow can be illustrated in figure 1.
The learners…
1. Explain the major role of financial management and the
different individuals involved
2. Distinguish a financial institution from financial instrument
and financial market
3. Explain the flow of funds within an organization – through
and from the enterprise- and the role of the financial manager
2
The Role of the Financial Institution you may be planning to attend a party you were invited to, so you start saving to be able to
afford a new shirt or a dress for that party. You plan for an event, and you save so that you
The flow of money begins with the individual who deposits in the bank, a financial
can afford to attend the event.
institution. This depositor opens a bank account and earns an interest from this account. In
turn, these funds are lent by the banks to businesses, the borrowers, who either start-up a The Borrower Who Needs the Funds
new project, a new line of product, or merely expand operations. As the business earns
The borrower is. the party at the other end. He is the small business owner. He is
profits, the borrower of the funds can pay interest on the loan, and the depositor receives
the one who needs the funds and borrows the funds through a bank. He needs the funds to
an interest on his bank account.
start a project or a business venture or expand his ongoing business. He knows where the
The role of the financial institution is always important in any growing economy. In funds can be placed or invested in so that the funds will grow. He evaluates his options such
Glen Arnold’s inspiring book Financial Markets, Financial Times, Guides, he explains that the as:
major financial markets and economies in the United Kingdom and the United States would
➢ a start-up (new business) venture.
not have grown without the significant role of financial institutions have played.
➢ an expansion, i.e., a purchase of a new equipment.
The main role of the financial institution is to act as financial intermediary. Acting ➢ equity in an ongoing business concern; and
as financial intermediary means to be in the middle, to be the go-between, or link between ➢ Investing in financial instruments (such as money market placements, treasury
the depositors who have the money and the borrowers who need the money. notes, corporate notes, corporate bonds, government bonds, local stocks, and
foreign stocks).
The offer to use the terminologies "sustainable" and "good returns over time" is
deliberate to emphasize that most funds especially public funds look for investment
opportunities that will sustain their requirements for about five years or more, in other Financial Instruments and Financial Markets
words long-term, and this is to differentiate some investor requirements of quick returns.
Financial institutions include banks and nonbanks. These are your commercial
Hence, financial management is the handling of all financial matters, including banks, universal banks, investment banks, investment companies, finance companies, life
analyzing financial statements, evaluating investment opportunities which happens before and nonlife insurance companies, mutual fund companies, and private equity firms.
one start investing, and raising capital or funds from different sources.
By understanding their role, you will appreciate why they are very important in the
The Key Individual Roles growth of any economy. They move funds that move businesses, which in turn move people
and bring their livelihoods forward, can you imagine a growing economy without them?
The Depositor Who Has the Funds
Financial instruments are the tools that help a business' daily operations, and
The depositor (refer to figure 1) is the person who has the money and deposits it in
eventually make it grow. These tools help the finance manager handle his cash, his short-
a savings account with a bank that pools this together with the savings from other
term operating requirements, and long-term business requirements.
depositors.
What are these financial instruments?
Why is he engaging in this activity? This is because he wants to afford certain things
in life—certain things like good food, quality clothes, medicine, a car, a house, a small Money market instruments are an inexpensive way for government and financial
business, or enough money for retirement. If you are in senior high school, you save a portion institutions to raise funds. These funds are usually available for short periods of time;
of your allowance because you want to go out with your friends at the end of the week. Or
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therefore, their rates are generally lower than funds which are available for use over longer An example of a long-term debt is a bond. It is a security that represents the debt
periods of time. of a government or business promising to pay a fixed interest to the holder of the bond for
a definite period.
Compared to savings deposits, money market instruments earn higher interest.
Investors who can be individuals or business owners’ avail of these instruments because of Another example of long-term debt is a note. A note is a security that has longer
their liquidity. They are available most of the time when needed and can be accessed when term than a money market instrument, but shorter term than a bond. Notes are like bonds
the business needs them. They are safe as these are quality investments for short periods in the sense that they make regular interest payments and have specified term until
but do not provide very high returns compared to long-term investments. maturity. In the Philippines, notes are longer-term debt securities, while in the United States
they are medium-term debt securities.
Table 1 is a list of the different money market instruments and their characteristics.
To the investor, long-term fixed income securities can generate recurring income
Table 1. The Different Money Market Instruments and Their Characteristics
that he can depend on. Returns on these types of securities tend to be higher that your
Financial Instrument Basic Characteristics money market instruments.
Money market debt:
Table 2. Financial Instrument and Their Basic Characteristics
Treasury bills • Issued by the treasury/government
• Matures within one year Financial Instrument Basic Characteristics
• Is generally default-free as government will exert all Long-term debt:
effort to pay Treasury notes and bonds • Issued by the government
• Notes mature in two, five, or ten years
Commercial papers • Issued by financially-sound businesses to fund • Bonds mature longer (ten years or more)
investments in inventories and receivables • No default risk as governments exert all efforts to
• Maturity is about nine months pay
• Generally low default risk as businesses have good • The price of bonds usually falls, becoming less
credit standing attractive as interest rates in the markets rise
Money market funds • Issued by banks or mutual fund companies Federal agency debt • This is a United States type of long-term debt and
• No specific maturity dates not applicable in the Philippine setting
• The degree of default risk is low • Issued by federal agencies and is like treasuries
• These funds are usually invested in money market • Has long-term maturity (i.e., up to thirty years)
instruments, treasuries, and commercial papers • Has low default risk
Commercial credit, credit • Issued by banks, credit unions, finance companies Municipal bonds, local • Issued by local governments
card debt • Maturity date varies government bonds • Matures longer (i.e., up to thirty years)
• Default risk varies • Riskier than government securities
Long-term debts are also available to the borrower for his business needs. The Corporate bonds • Issued by corporations
interest rate that these debts charge is higher than money market instruments and is usually • Matures in forty years, (some bonds like Walt Disney
locked in over the entire life of the debt. and Coca-Cola have issued 100-year bonds)
• Riskier than government securities and rely on the
financial soundness of the company
4
A stock is a type of security that signifies ownership in a corporation (not in a sole Financial institutions help in funding important government projects and extend advisory
proprietorship or partnership) and represents a claim on part of the corporation’s assets and services to help in nation building. A financial institution can be a bank or nonbank.
earnings. There are two main types of stocks: preferred and common.
Here are the different kinds of banks:
Preferred and common stocks are financial instruments businesses can use to raise
1. Thrift Banks
funds for their long-term requirements. Should your business expand, you can issue (sell)
preferred and common stock to potential investors. Thrift banks are deposit-taking financial institutions that also extend credit to the
consumer market. Thrift banks usually cater to the countryside or rural areas as compared
Table 3. Preferred and Common Stocks with Their Basic Characteristics
to commercial banks which focus mainly on the top companies located in the major cities,
Financial Instruments Basic Characteristics
2. Commercial Banks
Preferred Stock • Issued by corporations in exchange for units of
ownership Commercial banks are mainly deposit-taking financial institutions that extend credit
• Has no maturity date to the retail and consumer market. They deal with the "mom and pop stores" and their
• Pays dividends when declared
transactions are usually many but small, denominated in the local currency.
• More risky than corporate bonds
• Has no voting rights A commercial bank and a universal bank will have the same major role in raising
• Has preference over common stocks in asset funds for businesses that are starting up or expanding. However, their focus will largely
liquidation, hence the term (preferred) differ, in part, due to their license and the target market they serve. Commercial banks
Common Stock • Units of ownership in a public corporation collect and safekeep the funds of savers/depositors. Accounts such as savings and checking
• Pays dividends when declared
accounts provide a fast and efficient way for bank clients to access their money and use their
• Owners are entitled to vote on the selection of
money to pay bills and other short-term requirements, such as electricity bills, grocery bills,
directors and other important matters.
• In the event of a corporate liquidation, claims of medical bills, educational bills, transportation expenses, and rest and recreation expenses.
preferred stockholders take precedence over Commercial banks also lend the money of savers/depositors too small to medium
common stockholders
enterprises that will pay them an interest regularly in exchange for the use of their funds.
• For the most part, common stockholders enjoy
The spread between the rates paid to depositors and the rate received by the bank from the
potential profits from the capital appreciation of
their stock borrower will pay banking costs which will include employee salaries, office rent, electricity,
and other business costs.
Financial Institutions and Financial Services 3. Universal Banks
Financial Institutions Support Nation Building Universal banks lend to multinational companies or companies with global
presence. Their transactions are larger than commercial banking transactions and are
Different Types of Financial Institutions denominated in multicurrency’s and not just limited to the local currency.
The role of the financial institution is critical because economies have grown and expanded
from the simple communities that thrive in barter or exchange trading to large and modern
communities that experience the benefits of science, technology, and progress.
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Universal banks are like commercial banks except that their clientele is mostly, the 2. Investment Companies -Investment companies are regulated by the Securities and
larger corporations. They are usually multinationals, unlike the retail clientele of the Exchange Commission (SEC) and perform similar functions as banks in the sense that they
commercial banks. can provide funding to companies or raise funds through bond issuances or initial public
offerings.
Also, universal banks offer an expanded line of financial services due to an
3. Mutual Funds - Mutual funds are collective investments or funds of small investors
expanded license to engage with clients.
pooled together and managed to be able to reach maximum returns. Mutual funds, though
4. Investment Banks small individually, are big collectively. In the US, mutual funds amount to billions of dollars
in value put together.
Investment banks are known to successfully raise funds for big corporations and 4. Insurance Companies- Insurance companies sell insurance coverage to provide
governments. They deal with the "big ticket items" and can raise funds from the "investing guarantee of compensation for specified death, illness, accident loss, or damage to property
public" through bond issuances and initial public offerings. in return for payment of a premium. Purchasing insurance protects the owner from these
unforeseen events that may happen any time. The insurance premiums paid annually for
Investment banks also lend or provide funding to businesses but in a somewhat
protection is managed by the insurance company so that in due time when there is an
more creative manner and more specialized than the commercial banks. They will raise funds
insurance claim, the owner can count on the service he paid for and will be able to go about
from what is called the investing public or the man on the street—you and me.
his life despite the damage or loss.
How investment banks raise funds from the public: Insurance companies sell life and nonlife insurance products. This nonbank financial
institution's role is to offer security and stability during times of death of a loved one, loss of
a. They will identify the business who needs the financing. property, other business risks, or uncertainty.
b. They will talk and negotiate with the business on the following: An insurance policy holder buys peace of mind and protection from business
discontinuity. He pays regular insurance premiums for five or ten years, in exchange for an
➢ amount that needs to be raised. amount (insurance) that will cover a death in the family, loss of property due to fire, a lost
➢ in what denominations to use. car due to accident, or damaged equipment. It offers him peace of mind knowing that if such
➢ how much investment rate to pay the investing public; and an event happens, he can go on with his normal routine or that his family can live a normal
➢ how much fee to charge for putting all the fund raising and lending life.
together. What does the insurance company do with the premiums collected? The insurance
company entrusts this to a fund manager or portfolio manager who takes care of the funds
c. Once in agreement, they will execute the fund raising.
as if it were his own. He keeps safe the funds and grows the funds in preparation for the
d. Monitor the financial soundness and viability of the issuer. event that it was put up for in the first place, in the event of death, fire, or loss of property.
The activity, hence, is a form of savings, and as the funds are built and invested and grown
e. Monitor payments to investors. over time, they are being prepared for use in the future.
The nonbanks that lend or raise funds for businesses are the following: 5. Private equity funds - Private equity funds are not regulated by government or any
regulatory body. They are funds managed by private fund managers and private investors
1. Leasing Companies - Leasing companies are not banking and are not governed by and hence, the owners can invest more aggressively in the financial markets. Private equity
the central banks. Yet leasing companies also extend credit or financing to companies that funds finance businesses and projects. In the United Kingdom, there are a lot of private
need it for their projects. equity funds to invest in because the investment market is more mature than in the
Philippines.
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Financial Instruments Compared and Contrasted
Clients mainly households and small firms

Commercial Papers
CORE BANKING
Numerous, small transactions Commercial papers are mainly borrowings of corporations usually with good credit standing.
Holding deposits
Making loans Extensive branch network for clients Funds raised through commercial paper borrowing are used to finance inventories and
receivables. This means that while inventories are not yet sold or are not yet converted into
CORPORATE BANKING cash, corporation8 resort to financing by issuing commercial papers. Also, while not yet
Holding deposits receiving payments in cash, companies survive through commercial paper financing.
Making loans
Commercial papers mature in about nine months and, hence, are short-term compared to
Plus:
Cash management Clients mainly are large firms notes and bonds. Their credit risk or the chance of them not paying is also lower as these
Guarantees Fewer larger transactions are borrowings of companies with sound financial statements, and moreover, because
Forex risk management Branch network-transaction usually foreign maturity is shorter.
Overseas trade currency
Syndicated lending
Treasury Notes
Interest rate risk management
Notes are borrowings of governments. When governments embark on long-term
INVESTMENT BANKING: CORPORATE AND infrastructure projects, for example, to ensure the viability of businesses, building new roads
GOVERNEMNT ASSISTANCE and bridges, they borrow by issuing notes. Notes have very long-term maturity, which means
Financial advice that governments have more time before they pay back the financial institution. The
Syndicated lending Clients are mainly large companies
Large transactions maturity of notes may extend up to ten years. Their credit risk is low because governments
Bond issuance
Underwriting, M and A Income is fee-based have better resources than corporations given their more predictable revenues through
Risk management No branch networks taxes. Moreover, governments usually exhaust all avenues before defaulting on an
Privatization of government-owned Worldwide and multicurrency obligation.
companies
Government or Corporate Bonds
INVESTMENT BANKING: MARKET ACTIVITIES
Trading of securities Bonds are borrowings of governments or corporations. Like notes, bonds are issued to
Brokerage finance very long-term projects of governments or corporations. For corporations, these
Market making Clients are mainly large companies projects may be capital-intensive projects like building a new factory or financing a new
Asset management Large transactions manufacturing plant. Bonds have a longer maturity compared to notes; some may even take
Advisory wealth management Income is fee-based up to thirty or forty years to mature. Bonds' prices are inversely related to the prevailing
Private banking No branch networks
Private equity investment interest rate in the market. Why?
Worldwide and multicurrency
When market rates move up, they become more attractive investments than bonds, hence
investors sell their bonds to move to the market. This behavior of selling bonds causes bond
prices to go down.
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Stocks and/or a mobile phone, to enable the trading of financial instruments. A good example of
Stocks are shares issued by businesses. They raise funds by selling part of their companies this is the National Association of Securities and Dealers Automated Quotation (NASDAQ).
to potential stock investors. Stock investors become part owners of corporations. Why invest Mutual funds or investment funds are pooled investments. They are investments
in stocks? of small investors pooled together and managed collectively to afford investment outlets in
the bigger global landscape. Mutual funds are invested in money market instruments, notes,
Stock investors are part-owners. bonds, and stocks. They finance important projects of large corporations and governments.
Because stock investors are part-owners of business, they have a say on who will be the They move global financial markets and though are small individually, they are very
leaders of their business by voting for their Board of Directors. Also, through voting, they will important collectively. In the US, mutual funds amount to trillions of dollars in value. They
have a say on other important matters that shape the business. are measured on a net asset value per unit. As each unit increases in value, so does the value
of the ownership of mutual fund owner.
Stock investors benefit from growth potential.
Stock investors also benefit from investing in businesses that have growth potential, as
businesses grow in sales, revenues and profits grow as well over the years. Their intrinsic The Flow of Money and the Role of the Financial
value increases. Hence, the value of the shares of the businesses also increases in value. The Manager
stockholder benefits from this increase in the value of the shares of the company. His
investment in the shares of stock increase in value, He experiences capital appreciation. Referring back to figure 1, the flow of funds to businesses begin with the source of
funds, the one who has the money to lend, the one who saves and deposits with the bank
Stock investors receive cash. or any financial institution. When money is deposited to a bank, this same money looks for
When businesses are successful, they share their wealth to their stockholders for supporting outlets so that it can grow. This same money finds itself in the hands of businessmen who
them throughout the years. They do this by either declaring stock dividends or cash borrow the money lent through the banks or financial institutions. In exchange for borrowing
dividends. Stock investors receive cash from cash dividends, or additional shares in a the money from the depositor, the borrower pays interest. Where does the financial
business through stock dividends which they eventually can liquidate or encash. manager put this borrowed money?
Remember that the goal of finance is to maximize profit. Therefore, it is expected
Mutual Funds/Investment Funds that the financial manager invests this money in projects that are worthwhile. He invests it
Financial markets are the platform where financial instruments are offered, bought, in a new business venture, or a new manufacturing plant. Also, he can invest it to expand his
and sold. In simple terms, it is where you can find the financial instruments like money already thriving business because he has dreams of a bigger enterprise. Sometimes, he
market instruments, notes, and bonds that you need to manage your business daily, and the invests this money to train his people to continue servicing his customers and to continue
financial instruments you need to grow your business exponentially. doing a good job.
If the classroom is the structure where effective learning happens, your financial What is the goal of all his endeavors? He aims to make money work for him, to
markets will be the structure where your financial instruments become more effective as a make money grow, and to make his business earn profits so that,
tool to your enhanced business proposition. ➢ he can pay his employees and in turn, his employees can feed their families and
Over the counter (OTC) markets also provide an alternative platform for financial send their children to school.
instruments. The difference between a financial market and an over-the-counter market is ➢ he can pay the rent or amortization on his office property.
the physical structure. Financial markets like the stock exchange have a physical structure ➢ he can pay his creditors the interest from the borrowed money; and
and are more organized. A good example is the Philippine Stock Exchange (PSE). An OTC ➢ he can reinvest some of the profits to the business, thereby sustaining all who
market platform only needs a telephone, and some electronic gadgets like a computer depend on it.
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What is a worthwhile business?

A worthwhile business is a business worth giving your time and attention to because
it achieves the goal of financial soundness, liquidity, profitability, and nation building. The
role of the financial manager is to ensure that the entire flow of money happens and is
completed up to the payments of interest on the borrowed loan after money is invested in
a worthwhile business.
Before credit is extended, there is an evaluation of the business done to ensure that
the money borrowed is paid back on time. What kind of evaluations and tests are done?
What are the important questions asked?
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Name: _____________________________________________________________ 3. What is financial management?

a. It deals with financial statement analysis, evaluating investment
Year & Section: ______________________________________________________ opportunities, among others.
b. It refers to the efficient and effective management of funds.
c. Both a and b
4. The primary role of a financial institution is to act as the link between the depositors who
Important have the money and the borrowers who need the money.
RemInderS a. True
b. False
• Tear this activity sheet and submit on the scheduled date along with the other 5. Financial instruments are tools that help a finance manager handle his cash, his short-
activity (ies) the instructor may have asked the students to do on a separate paper. term operating requirements, and long-term business requirements.
• If you are sending something you’ve done online such as MS presentation (s), a. True
pictures, pdfs and alike as an attachment, then you may send them to my email b. False
at msac021095@gmail.com following this format: c. Partly true and partly false
(SECTION_LASTNAME_FIRSTNAME_ACTIVITYNAME e.g.
IC1MA_BINABAN_PRINCESS_SCAVENGERS HUNT), or send a digital copy from
your flash drive together with this activity sheet.
Find the words related to the topic. And define each word based on your understanding or
what you have learned in this module.
A. Encircle the letter of the correct answer.

1. What is finance?
a. It is the study of how firms and individuals make decisions and how these
decision-makers interact.
b. It is the study of how entities evaluate investment opportunities business
proposals, business projects, and raise capital to fund them.
c. It is the study of the economy, including growth in incomes, changes in
prices, and the rate of Unemployment.
2. What is the primary goal of finance?
a. To minimize risks
b. To maximize liquidity
c. To maximize profit
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Financial institutions are intermediaries that play a vital role in nation building. They source
funds for businesses to engage in projects that are profitable, maximize shareholder wealth,
and build communities. Is there a project you have in mind that is worthwhile, has potential
to earn profits, and will benefit your community in the long term? List down those projects.
What financial institutions can help you achieve your dream of a sustainable business for
your shareholder or community?
References:
Exploring Small Business and Personal Finance, Pages 1-17, Authors Kenneth L. Yumang,
Tyrone Panzer L. Chan PAO, Patricia Pefianco-Benito, Erlinda C. Pefianco, Ed. D, project
director
11
Steps in the Financial Planning Process
The financial planning process is articulated in a called the financial plan. The financial plan
is divided into:
1. The long-term financial plan, also known as strategic financial plan.
2. The short-term financial plan, also known as the operating financial
Financial planning is often defined as the forecasting of a business' future financing

requirements.
A long-term financial plan involves forecasting the financing requirements of a

business three- to five- years down the road. On the other hand, the short-term financial
plan involves forecasting the financing requirements of a business within a year or less, and
as is expected is more detailed than the former.
Developing the long-term financial plan takes precedence over the short-term
financial plan as it will set the overall direction in developing the latter.
Basically, developing the long-term plan comes down to a few simple steps:
a. Forecast your sales.
In doing sales forecasting, it helps if it starts with an understanding of the industry

your business belongs to, knowing your target market segment from that industry, and
ultimately, forecasting your market share in terms of sales from that segment.
Forecasted sales may increase based on the target increase in market share, or due
to the increase of the market itself.
For example, a business is targeting an increase of 10% from the existing market.
Your sales forecast thus can be a growth of 10% for the following year. If you are expecting
The learners… that the entire market will increase by 10%, you will determine how much of that increase
1. Identify the steps in the financial planning process you will be capturing. If your forecast is 8%, then this will be your sales growth target for the
2. Illustrate the formula and format for the preparation of following year.
budgets and projected financial statement
3. Explain tools in managing cash, receivables, and inventory A fundamental truth in business is that a business acquires assets to generate sales.
If it wants to increase sales, then it must acquire more assets. This relationship is captured
by the capital intensity ratio, which is calculated as total assets divided by total sales.
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a peso worth of sales. On the other hand, a ratio of 0.31 means that it takes PO.31 worth of The derived percentages are then used as weights in preparing the pro forma
assets to generate a peso worth of sales. income statement and balance sheet. It is interesting to note that pro forma is a Latin word
which means "as a matter of form" and is used to emphasize projected figures.
Let us say a business wants to increase sales by 25%, then its assets need to increase
by 25% as well. To increase its assets by 25%, then the other side of the balance sheet needs e. Calculate your External Financing Need (EFN).
to increase as well, as the balance sheet needs to be balanced.
EFN, also known as Additional Funds Needed (AFN) and Discretionary Financing
b. Compute the dividend payout ratio and the plowback ratio. Needs (DFN), is the required additional financing, through the additional issuance of interest-
bearing debt and common stock, to acquire the needed assets.
If the business pays any cash dividend, then this dividend amount should be divided
by net income to get the dividend payout ratio. This ratio tells us the proportion of net Below is an example.
income paid out as dividends.
Let us say sales are forecasted to grow 20% next year. Obviously, this translates to
If the business does not pay any dividend, then it is equal to zero. The plowback a 20% growth in assets. Then, use the percent of sales approach to calculate the weights
ratio, also known as retention ratio, is 100%. needed in preparing the pro forma income statement. As you can see, costs and net income
were 55% and 31.50% of sales, respectively. Furthermore, the dividend payout ratio is 0%.
The plowback ratio is the proportion of net income that does not get paid out in
cash dividends. Therefore, if a business has earnings of P5 million and pays out P3 million in
dividends, then the payout ratio is 60%. On the other hand, the plowback ratio is 40%.
c. Identify your spontaneously generated funds.
From the word "spontaneous," which means "done naturally," these funds come
about because of normal business operations. If a business wants to increase its sales, then
it must load up on its inventory, otherwise it would have just very few items or units to sell.
Loading up on inventory will "naturally" increase its accounts payable. It also must
hire additional workers, which will "naturally" increase its accrued wages. Further, increasing
sales often comes with higher profit, which serves to "naturally" increase its accrued taxes.
To sum up, accounts payable and accrued expenses "naturally" increase because of
higher sales. To prepare the pro forma income statement, simply increase sales by 20%. Then,
multiply the resulting figure by 55% to get the costs. To get the addition to retained earnings,
d. Use the percent of sales approach to prepare the pro forma financial statements.
simply subtract dividends paid from net income.
This approach calls for dividing expenses, assets, and liabilities by the sales figure.
This sales figure can be based on the latest available financial statement, the average figure
the past few years, or a combination of both.
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Now, we are ready to prepare the pro forma balance sheet. Simply multiply the
weights by the projected sales figure. Cash increased to 1,779,516.48, which is computed by
multiplying 16% by 11,121,978. Note that cash still accounts for 16% of the projected sales
figure. We apply the same process to accounts receivable, inventory, and PPE-net. Summing
them up, we get 33,365,934, which marks a 20% increase from the initial total asset figure
of 27,804,945 and matches the projected increase in sales.
As you can see from the balance sheet below, your spontaneously generated funds
are accounts payables and accrued expenses. The capital intensity ratio is three, which
means that it takes P3 to generate a peso of sales. Just like what we did earlier, we use the
percent of sales approach to calculate the weights needed to prepare the pro forma balance
sheet. As we have computed, cash and accounts receivables are 16% and 44% of sales,
respectively. While on the liabilities side, accounts payable and accrued expenses are 30%
and 10% of sales, respectively.
On the liabilities and equities side, we just retain the initial figures of all the other
line items except for the spontaneously-generated funds – accounts payables and accrued
expenses – and the retained earnings. To get the new figures for accounts payables and
accrued expenses, just multiply their respective weights by the projected sales figure. In
reference to the new figure for retained earnings, simply add the pro forma net income
(since dividend payout ratio is 0%) to the initial retained earnings.
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To complete the process, add total liabilities to total owner’s equity. As we can see, Just like the long-term plan, preparing the cash budget comes down to a few simple steps:
this amounts to 32,049,833. This figure is what is known as External Financing Needed (EFN).
1. Forecast the business' monthly sales. Again, this can be done using historical figures.
This example is less than the projected total asset figure, which means the business needs
an additional financing of 1,316,101. This 1,316,101 can come in the form of additional 2. Forecast the cash sales and the credit sales from the projected monthly sales. Cash sales
borrowings or additional capital infusion. A negative EFN, on the other hand, means that the are preferable to credit sales. If sales are made on credit, then estimate when those
business will have extra funds. receivables will be collected.
3. Consider other cash receipts. Other cash receipts are sources of cash other than sales such
as interest payment received, among others.
The Budget Preparation
4. Sum up the total cash receipts.
As mentioned earlier, the short-term financial plan involves forecasting the 5. Forecast the business' monthly purchases.
financing requirements of a business within a year or less. This financing requirement comes
in the form of cash. Contrast this one with the financing requirement from a long-term 6. Forecast the cash purchases and the credit purchases from the projected monthly
financial plan. purchase. If purchases are made on credit, then forecast when those payables will be paid.
The primary tool in short-term financial planning is the cash budget, also known as cash 7. Consider other cash disbursements. Other cash disbursements include wages and salaries,
forecast. It plots the business projected cash inflow and outflow and is typically done taxes, capital expenditures, rent, and interest payments.
monthly and is used to cover a year’s time. An example of a cash budget is shown below.
8. Sum up the total cash disbursements.
9. Subtract the total cash disbursements from the total cash receipts to get the net cash
flow.
1 0. Add the beginning cash balance to the net cash flow to get the ending cash balance. The
ending cash balance of the previous month is the beginning cash balance of the following
month.
11. Subtract the minimum cash balance from the ending cash balance. The minimum cash
balance, also known as target cash balance, is the minimum cash balance the business needs
to have on hand, to conduct its day to day operations. If the minimum cash balance is greater
than the ending cash balance, then short-term financing is required. If, on the other hand,
the minimum cash balance is less than the ending cash balance, then the business has excess
cash.
It is divided into three parts, which are as follows:
Consider the situation that follows.
1. Cash Receipts
2. Cash Disbursement Sales in January and February were 150,000 and 220,000, respectively. Sales of
3. Excess cash balance/required total financing 380,000, 340,000, and 295,000 have been forecasted for March, April, and May,
15
respectively. Thus, we are trying to develop a cash budget for March to May. Based on Taxes of 40,000 will be paid in April while capital expenditure in the form of new
historical data, 15% of the business sales are in cash form, 55% have generated accounts machinery costing 200,000 will be purchased and paid in full in March.
receivables collected after one month, and the remaining 30% have generated accounts
Furthermore, an interest payment of 110,000 is due every month. A 150,000
receivables collected after two months. It also receives a monthly interest payment of
principal payment is also due in May.
150,000 from a bank certificate of deposit.
Let us now prepare a cash receipt schedule using steps 1 to 4 articulated above.
First, we plot the sales figures for each month. Then, we compute the cash sales.
For March, cash sales are 57,000 since it is 15% of the forecasted sales. Then, 55% and 30%
of the forecasted sales are collected after one month and two months, respectively. So, the
business gets to collect 209,000 and 1 14,000 in April and May, respectively. Furthermore,
First, we plot the purchase figures for each month. 80% of a given month's sales are
it also receives 150,000 a month and this is considered as other cash receipts. To complete
the process, sum everything up. This results in cash receipts of 373,000 for March. purchases. So, for March, we got 304,000 (80% of 380,000). 5% of which was paid in cash.
Since 80% and 15% accounts payables are paid after a month and two months, respectively,
Let us now prepare the cash disbursement for the same period using steps 5 to 8 then it pays 243,200 in April and 45,600 in May.
articulated above.
Then, we consider other cash outlays such as rent and tax payments, among others.
Consider the case that follows. To complete the process, sum everything up. This results in total cash disbursements of
530,500 in March.
Purchases represent 80% of sales. Of this amount, 5% is paid in cash, 80% and 15%
are paid after one month and two months, respectively. After the purchase, the business And now, we are ready to prepare the cash budget. We use steps 9 to 11 to do this.
also pays a rent of 15,000 every month.
Consider the information below:
Wages are 5% of monthly sales. On the other hand, fixed salary cost for the year is
144,000, or 12,000 per month, At the end of February, the cash balance was 70,000. It wants to have a target cash
balance of 90,000.
16
It simplifies the formula in the below illustration:
Let us take liquidity analysis to the next level. A business purchases raw material to
manufacture the products they sell. Often, these raw material purchases are acquired on
credit. Once those products are sold, they are either paid in full immediately or are paid later
or a combination of the two. Ideally, you would want to receive the full payment for the sales
right away and use that money to pay your raw materials. However, the reality is that there
is a mismatch in the timing of the cash receipts (the cash inflows) and the cash payment for
First, we need to consider target cash balance of 90,000 and the ending cash the raw materials. Therefore, we need to know how long, on average, it takes for the
balance in February. Then, we subtract cash disbursements from cash receipts to get the net business to pay its suppliers and to collect on its sales.
cash flow. So, in March, the net cash flow was —157,000. Then we add the beginning cash
balance, which is just the ending cash balance of the previous month. So, we add —157,000 The time from raw material purchase to the cash receipt is called the Operating
to 70,000 to get the ending cash balance for March, which is —87,000. Then we add the Cycle. This cycle is composed of two periods. These are the Inventory Period, known as Age
minimum cash balance to this figure to get either the needed financing or excess balance. of Inventory, and the Accounts Receivable Period, known as Age of Receivables. The former
Since the figure is negative, then it is a financing need. Often, this financing need is covered refers to the time it takes for the business to sell its finished product from the time it
by notes payables. purchased its raw materials. On the other hand, the latter is the time it takes for the business
to collect on the sale of the finished product. Add the two periods together to get the
operating cycle. Obviously, a shorter cycle is much preferred.
Cash Conversion Cycle, also known as Cash Cycle, is the time it takes for the
business to collect on its accounts receivables after it has paid for its raw materials. It is
Tools in Managing Cash, Receivables, and Inventory calculated by subtracting the Accounts Payable Period from the Operating Cycle. Accounts
Payable Period is defined as the time it takes for the business to pay for its raw materials
A close relation of the current ratio which you learned in chapter 2 is the Net from the time they are acquired. Just like the Operating Cycle, a shorter cycle is much
Working Capital (NWC). This is computed by subtracting the business' current liabilities from preferred.
its current assets. One thing to remember is that an NWC of zero is equivalent to a current
ratio of one. Just like the current ratio, NWC is also a measure of liquidity and as such, a Let us compute the Operating Cycle and the Cash Conversion Cycle of Good Food
higher NWC means the business is more liquid. Snack House for 2014. As we already know, the Inventory Period is 91 days, while the
Accounts Receivable period is 41 days. Therefore, the Operating Cycle is 132 days (91 days
+ 41 days). This means that the business gets to collect the cash from its sales 132 days after
it buys the raw materials.
17
Let us now go to the Accounts Payable Period. Just like the Accounts Receivable
Period, it is computed by dividing 365 days by the Accounts Payable Turnover Ratio (APT
Ratio), which in turn is calculated by dividing Cost of Goods Sold or Total Purchases by the
Average Payables. The Cost of Goods Sold is 6,228,552 while the Average Payables is 514,114
and therefore the Accounts Payable Turnover is twelve days. To compute the Accounts
Payable Period, simply divide 365 days by twelve days, which yields thirty days. This figure
means that the business pays for its raw materials thirty days after purchasing them.
To compute the Cash Conversion Cycle, simply subtract the Accounts Payable
Period from the Operating Cycle. This computation yields 103 days, which means there is a
103-day gap between the time the business pays for its raw materials and the time it collects
the payment on its sales. To tide over this 103-day gap, it can either borrow money or hold
liquid reserves in the form of cash.
As mentioned earlier, you want a shorter Operating and Cash Conversion Cycle. To
achieve this, ideally you would want to collect the cash that is owed to you right away and
pay your obligations at the latest possible time. However, the reality is that you need to
18
extend some sort of credit to your customers to grow your sales and you need to pay your profitability as current liabilities are cheaper than long-term debt. However, the drawback
obligations a bit earlier to make your creditors happy. in having more current liabilities is that it exposes the business to liquidity risk.
To manage the two cycles—actually, to shorten them, you need to manage their
individual component periods. First, we have the inventories. The objective of inventory
management is to shorten the time your products stay in your inventory. In other words,
you want to sell your goods as fast as you can. But if you cannot speed up sales, then you
reduce your inventory of products without losing sales due to stockouts.
Second, we have accounts receivables. The objective of accounts receivables

management is to collect your accounts receivables in full as soon as possible without
resorting to intimidation and high-pressure collection tactics. To achieve this, you need to
carefully choose which customer to give credit to.
The 5Cs of Credit is a set of guidelines of carefully selecting your customers.
1. Character. This refers to the customer's track record of settling its obligations on
time. Often, customers without a track record should not be given credit.
2. Capacity. This refers to the capacity of the customer to repay you. This is typically
done through financial statement analysis.
3. Capital. This refers to the customer's level of capital in relation to its debt level.
4. Collateral. This refers to the value of the assets that the customer has and plans to
use to secure the credit.
5. Conditions. This refers to the general global and home country macroeconomic
conditions and the industry-specific conditions.
While liquidity is important, there is a price to pay for too much liquidity. A business
that is very liquid as evidenced by high liquidity ratios might be considered not at risk of
going bankrupt but is not being profitable. It should be noted that current assets are less
profitable than fixed assets. Think about it. If all a business has are its current assets, would
it be able to manufacture its products to sell? The answer is clear. A business cannot References:
manufacture its products without fixed assets.
Exploring Small Business and Personal Finance, Pages 41-55, Authors Kenneth L. Yumang,
Therefore, holding other things constant, a business having more current assets, is Tyrone Panzer L. Chan PAO, Patricia Pefianco-Benito, Erlinda C. Pefianco, Ed. D, project
predisposed to being less profitable though more liquid. director
This trade-off between profitability and risk is also evident in current liabilities. Name: _____________________________________________________________
Having more current liabilities, holding other things constant, will provide a big boost to its
19
Year & Section: ______________________________________________________ 3. Various businesses prefer a longer operating cycle.
a. True
b. False
Important 4. What does an operating cycle of 60 days mean?
RemInderS
a. There is a 60-day difference between the time the firm collects on its sales
and the time it pays its suppliers.
• Tear this activity sheet and submit on the scheduled date along with the other
b. It takes about 60 days for the firm to convert its raw materials purchases
activity (ies) the instructor may have asked the students to do on a separate paper.
to the receipt or collection of cash payment.
• If you are sending something you’ve done online such as MS presentation (s),
pictures, pdfs and alike as an attachment, then you may send them to my email 5. What does a cash cycle of four days mean?
at msac021095@gmail.com following this format:
(SECTION_LASTNAME_FIRSTNAME_ACTIVITYNAME e.g. a. There is a four-day difference between the time the firm collects on its
IC1MA_BINABAN_PRINCESS_SCAVENGERS HUNT), or send a digital copy from sales and the time it pays its suppliers.
your flash drive together with this activity sheet. b. It takes about four days for the firm to convert its raw materials purchases
to the receipt or collection of cash payment.
6. What are the 5Cs of Credit?
a. It refers to a set of guidelines for carefully selecting your customers.

b. It refers to character, capacity, capital, collateral, and conditions.
c. Both a and b
Encircle the letter of the correct answer.
1. In which document is the firm's strategic plan and operating financial plan
articulated?
a. Prospectus
b. Financial Plan
c. Special Power of Attorney
Do a research, search for a certain company or a business and search its financial plan. Then,
2. What is the operating cycle?
make an analysis or observation based on their financial plan.
a. The time it takes the business to collect on its receivables after it has paid for its
raw materials.
b. The time it takes the business to convert the purchase of raw materials to the
receipt or collection of cash payment.
20
Sources of Funds for Business Operations
Short-term Funds
Funds for short-term and daily business operations are generally different from
funds allocated to long-term projects like a business expansion. Banks are usually your good
source of short-term funds. These funds you may use as working capital for your daily
business operations.
What are short-term funds and where are they used?
Short-term funds are used for business operations' working capital. This means that
when you need to finance accounts receivables or inventory, a business entrepreneur
usually turns to the banks for short-term financing. While sales are bought on credit or
inventory needs to be paid, business may tum to the banks for short-term financing while
cash has not yet been received or paid.
Funding Working Capital

Savings accounts and current accounts are sources of working capital. Working
capital, as defined by Eugene F. Brigham and Joel F. Houston in Essentials of Financial
Management, are the current assets of your business that are used in operations. These
usually are your cash, cash equivalents or marketable securities, accounts receivables, and
inventory. A Short-term debt, for example, a thirty-day bank loan, can finance a business'
inventory. A short-term debt is usually a one-year loan or less. This means that a business
can borrow to purchase his inventory while he is waiting for cash or available funds to arrive.
Uses of Working Capital

Net working capital or working capital is defined as current assets fewer current
liabilities. Working capital helps carry out the normal operations of business. Working capital
is used to generate sales and profits for a business. Cash is churned to either invest in
The learners… inventory or to pay off short-term obligations so that the cost of doing business is reduced.
1. Compare and contrast the loan requirements of the different
banks and nonbank institutions and cite these institutions in Marketable securities are used to generate investment income through capital
the locality appreciation in stock investments or trading through bond investments. Accounts
21
receivables increase sales by making buying more attractive to the customer with the than a hundred branches located all over the country to lend better service to their
availability of credit. customers. This brings the bank closer to the customers.
Inventory is your product roster. The more interesting your inventory, the greater Other services of commercial banks include:
potential sales for your business because your customer will always be attracted to what you
▪ loans for vehicles or home improvement.
offer.
▪ requiring collateral, security, and credit history for loans.
What Are Long-term Funds and Why Do Companies Need Long-term Funds? ▪ personal installment loans and credit card loans; and
▪ offering passbook, loans, and second mortgages.
Long-term funds are usually used for start-up business requirements, or capital Universal Banks
expenditures or business expansion for existing businesses. This means that when a business
Universal banks are also commercial banks but are licensed to do more
owner sees the need or the opportunity for his business to grow some more, he may invest
sophisticated banking services than commercial banks. Their clientele comprises of the top
in a building or equipment that will sustain the growth of his operations. The funds he will
corporations of the country and global businesses. Universal banks have business dealings
use for the building or the equipment may usually be financed by long-term funding from
with top business corporations locally and globally, and lend to these top business
the banks. These may include a five-year or a twenty-year loan.
conglomerates, manage their corporate funds, invest their portfolio, and advise these
However, in a corporate setup, long-term funds may come from two major companies on financial market movements and directions. Their transactions are usually
sources—debt and equity from the investing public. Corporations may acquire debt by bigger in size than commercial bank transactions, multicurrency, and global in nature.
issuing bonds or may raise capital by issuing preferred stock and common stock.
Investment Banks
Banks
Investment banks are like universal banks in terms of sophisticated banking
A bank is a financial intermediary that brings together depositors and borrowers. services. Unlike commercial banks, they do not have branches all around the country. They
are more specialized and deal with top corporations, global businesses, and governments.
Banks are a major source of funding for our working capital requirements. A They perform market making activities such as trading, fund management, and portfolio
business can deal with different types of banks. These are enumerated below. management.
Commercial Banks Here is a list of banks in the Philippines — 46 universal and commercial banks in the
Commercial bank clients are mostly retail customers. They are the moms and dads Philippines (21 universal and 25 commercial banks in the Philippines), as of July 2020.
in the neighborhood who are either employed, self-employed, or who have small businesses UNIVERSAL BANKS (21 BANKS):
to operate. Its main business is lending.
1. Al-Amanah Islamic Investment Bank of the Philippines
Transactions of commercial banks are many and usually not very large in size. To be able to 2. ANZ Banking Group Ltd.
reach more clientele, the commercial bank puts up many branches in different locations. 3. Asia United Bank Corporation
The objective is to be closer to their market so that they may service them better and faster. 4. Bank of the Philippine Islands
5. BDO Unibank, Inc.
In the Philippines, the larger commercial banks include Banco De Oro (BDO), Union 6. China Banking Corporation
Bank, Metrobank, and Bank of the Philippine Islands (BPI). Each of these banks has more 7. Deutsche Bank AG
22
8. Development Bank of the Philippines 22. Robinsons Bank Corporation

9. East West Banking Corporation 23. Shinhan Bank – Manila Branch
10. The Hongkong & Shanghai Banking Corporation 24. Sumitomo Mitsui Banking Corporation – Manila Branch
11. ING Bank N.V. 25. United Overseas Bank Limited, Manila Branch
12. Land Bank of the Philippines
13. Metropolitan Bank & Trust Company NEW FOREIGN COMMERCIAL BANKS
14. Mizuho Bank, Ltd. – Manila Branch
15. Philippine National Bank Of the 20 foreign commercial banks above, 10 were established in the Philippines under RA
16. Philippine Trust Company No. 10641 (amending RA No. 7721), which allowed the full entry of foreign banks into the
17. Rizal Commercial Banking Corporation country, signed into law by President Benigno S. Aquino III in July 2014.
18. Security Bank Corporation
19. Standard Chartered Bank 1. Sumitomo Mitsui Banking Corp. (from Japan)
20. Union Bank of the Philippines 2. Cathay United Bank (from Taiwan)
21. United Coconut Planters Bank 3. Shinhan Bank (from South Korea)
4. Industrial Bank of Korea
5. United Overseas Bank (UOB) (from Singapore)
COMMERCIAL BANKS (25 BANKS) 6. First Commercial Bank (from Taiwan)
7. Hua Nan Commercial Bank (from Taiwan)
1. Bangkok Bank Public Co. Ltd. 8. Chang Hwa Commercial Bank, Ltd. – Manila Branch
2. Bank of America, N.A. 9. CIMB Bank Philippines (from Malaysia)
3. Bank of China Limited – Manila Branch 10. Industrial and Commercial Bank of China Ltd. (from China)
4. Bank of Commerce
5. The Bank of Tokyo-Mitsubishi UFJ, Ltd. Notes:
6. BDO Private Bank, Inc.
7. Cathay United Bank Co., Ltd. – Manila Branch – Of the 25 commercial banks, 20 are foreign banks.
8. Chang Hwa Commercial Bank, Ltd. – Manila Branch
9. CIMB Bank Philippines Inc. – UOB of Singapore has been here in the Philippines since 1999. It started as a commercial
10. Citibank, N.A. bank here after acquiring Westmont Bank, then converted into a thrift bank, then ceased
11. CTBC Bank (Philippines) Corp. banking operations and turned into a collections company in 2016, after UOB applied for a
12. First Commercial Bank, Ltd., Manila Branch new banking license in 2015.
13. Hua Nan Commercial Bank, Ltd. – Manila Branch
14. Industrial Bank of Korea – Manila Branch – Deutsche Bank moved up from commercial to universal status in 2011.
15. JP Morgan Chase Bank, N.A. – The long-awaited merger of Philippine National Bank and Allied Banking Corp. took effect
16. KEB Hana Bank — Manila Branch via a share swap deal on February 9, 2013.
17. Maybank Philippines, Inc.
18. Mega International Commercial Bank Co., Ltd. – East West Bank moved up from commercial to universal status in July 2012.
19. MUFG Bank, Ltd.
20. Philippine Bank of Communications – Robinsons Bank received its commercial banking license in October 2011, following its
21. Philippine Veterans Bank merger with Robinsons Savings Bank in May 2011.
23
– Export and Industry Bank was closed on April 26, 2012 by the BSP and taken over by the ▪ offer single payment or partial payment loans.
PDIC on April 27, 2012. It was the first commercial bank to fail since the year 2000 when
Private Equity Funds
Urban Bank failed. Export and Industry Bank acquired failed Urban Bank in 2001.
Private equity funds are funds of private investors used to finance lucrative projects
– There were only 16 commercial banks in the Philippines in 2013.
that are projected to give good returns. They are big in Europe because the market has
Nonbanks grown and investors have become more sophisticated, more knowledgeable, and are trying
to move away from regulated investments and funds.
Nonbanks are financial intermediaries as well but are supervised and regulated by
another government body, the Securities and Exchange Commission (SEC). Banks, on the
other hand, are regulated by its central Bank. In the Philippines, it is the Bangko Sentral ng
Pilipinas (BSP). Requirements of Applying for a Personal Loan
Life insurance companies, investment companies, finance companies, and
Lending happens when the owner of a property or money allows another party the
mortgage companies are examples of nonbank financial intermediaries.
use of the property or money. The borrower promises to return the property or money after
Investment Companies an agreed period. The payment for the use of the property or money is called interest. The
agreement is usually documented through a promissory note, connoting a promise to pay
Investment companies pool your money together with the money of other back the owner for the use of the property or cash.
investors and invest these in financial instruments—stocks, bonds, currencies, commodities,
financial derivatives. They manage this pool of funds which are called mutual funds. These Debt is the obligation to pay back property or cash borrowed in accordance with an
accounts are not covered by deposit insurance. Mutual funds are sold based on a net asset agreement, and this may be in the form of notes, bonds, or mortgages.
value per unit. Investors may come in and out of mutual funds. There are different types
A credit is a loan or money extended to a person or business in exchange for a
ranging from aggressive mutual funds invested in stocks, to conservative mutual funds
return. Once issued, it becomes a debt of the borrower. When this money is extended, there
invested in money-market instruments and fixed-income securities.
is a pre-agreed covenant, such as how long the credit payment is extended, for how much,
Insurance Companies how much will be returned (above the original price), how frequent the payments, and at
what interest rate.
Insurance companies sell coverage or protection from events such as (1) a death of
a loved one, (2) fire, or (3) accident. Insurance premiums are paid by the owner/buyer over The credit analyst holds the important role of analyzing the financial track record
a period such as from five to ten years, in exchange for coverage for the events mentioned. of the person or the business that borrows, as well as its financial transactions. He
In return, the insurance companies manage the premiums by investing the same in financial determines the credit rating of the borrower by looking at trends and forecasting potential
instruments that offer good returns—i.e., stocks, bonds, currencies, commodities, financial payback on the loan.
derivatives, or real estate. If any of the above occurs, the insurance owner is compensated
What affects credit ratings?
through the insurance claim.
➢ Ability to repay the loan. This mainly focuses on the security of the person's job,
Other services that an insurance company offers include:
business and/or the security of the company that employs you. This looks at the
▪ lend on cash value of the insurance policy; and condition of the borrower. Does he could pay back the loan borrowed?
24
What is bankruptcy?
➢ Character of borrower. Are you trustworthy? Do you have a history of trouble with If you suffer from debt problems, the last remedy is to declare bankruptcy.
the law? How long have you lived in your present address? These are the questions Bankruptcy is a legal process wherein assets of a debtor are distributed to creditors to be
asked to establish the character of the borrower and his attitude, priorities able to pay his debts. Bankruptcy also includes a plan to repay creditors on an installment
regarding debt payments. Will he prioritize debt payments, or will he delay them? basis. Declaring bankruptcy severely damages one's credit rating.
Will he exhaust all efforts to be able to make good his promise to pay or will he
relax and dillydally and not take his debts seriously? What is your personal net worth?
Your net worth is the value of your assets, cash, savings, real estate, cars, stock,
➢ Capacity to pay the loan. Does he hold a stable job or have a stable source of income bonds, jewelry collection, insurance, and art collection. The net worth value is deducted
if he is in business? What are the other sources of income and what are the current from your debt including credit card debts, monthly bills, auto loans, home loans, and
debts? These will determine the borrower's capacity to pay his credit card debts. Is medical bills.
he in a situation wherein he can afford to pay his debts?
A personal balance sheet sample below will allow you to identify your short-term
assets as well as your long-term assets.
➢ Capital and personal assets. Determine the value of cash, property, and other
investments. Do assets exceed liabilities? Will savings and the value of property be
able to pay for all debts?
➢ Collateral and size of business assets. If payments to credit card debts are delayed
and/or irregular, this may be an early indication of cash flow and liquidity problems,
which could eventually escalate to major problems such as bankruptcy. When this
situation happens, the creditor will look at real assets or property that can be
liquidated and sold. Such proceeds will be used to pay off the loan.
The credit bureau is the agency that gathers information about the credit history of
the borrower and sells this information for a fee. In the Philippines, the banks keep credit
information private and confidential. This is for security reasons. Unlike in the US where
credit bureaus have been recognized and existed for quite some time, the credit information
in the Philippines is more limited.
A personal budget helps you track your financial assets and financial activities. A
What is insolvency? successful and effective budget will have the following:
Insolvency is the inability to pay debts on time when they are due. It is not the same ➢ Information based on past spending and expectations
as bankruptcy. Insolvency is insufficiency of cash flow and is temporary. It is a matter of ➢ No single expense, rent, or utilities should consist of 50% of your gross income
timing. Why is it important to know between the two? Insolvency or illiquidity is already an ➢ Must be flexible for modification if important considerations change, i.e., income,
indication of trouble. The acknowledgement of insolvency is a step toward managing your marital status, new spending habits, new medical expenses
credit better.
25
➢ Easy access any time—file folders, a notebook, a computer file may be used to store ➢ What is his business?
the budget. These may be very helpful especially if there is a need to scribble
If it is a Business Loan, the application will ask for information to be able to
information that randomly surfaces and needs to be changed.
determine the capacity of the business to repay the loan.
What affects your personal buying decision?
➢ What is the nature of the business?
➢ Personal values ➢ How long has the business been in operation?
➢ Available time for research ➢ How much revenues accrued in the last three years?
➢ Take home pay ➢ How much were profits for the last three years?
➢ Access to the product/service ➢ What is the size and value of the business?
➢ Benefits of a brand ➢ What is the size and value of the properties of the business?
When buying a car, for example, what are the major considerations? As soon as all pertinent information is available, the Loan Officer will forward the
application form to his manager who will forward the same to the Credit Officer, who will
➢ Mechanism to improve performance such as larger engine, anti-lock brakes, cruise
assess the credit paying ability and request for loan approval from the Credit Committee.
control
➢ Convenience like stereo and tinted windows Credit Committee
➢ Visual options like style
This group of officers represents the financial institutions, creditors and/ or
Loan Amortization and the Loan Application Process investors that have claims on a company that is in financial difficulty or bankruptcy. Their
role begins with approving the credit line and credit terms for a business, monitoring the
Lending is the commercial bank's bread and butter. This is where banking earns and
payments schedule as agreed on, and filing for bankruptcy or initiating the claims procedures
pays its employees, whose salaries, in turn, are reserved for several purposes. What are the
if the business operations fail.
mechanics of lending, credit, and how does the loan application process work?
Credit Ratings
When a borrower visits the bank to borrow for a housing loan, for example, he talks
to a bank officer and fills out a housing loan application form. Credit ratings are a way to formally evaluate the credit history of a person or
company and includes a forecast of the capability to repay obligations. It will normally begin
What information will he put that the banks needs to know before he is granted a
with the company's three- to five- year financial statements, a review of its business
loan?
operations, a review of the economic conditions the company operates in, the stability and
Because his loan is a Persona/ Loan, he will be assessed based on his personal credibility of the business owners and management, and a forecast on revenues and the
financial capacity. bottom line.
➢ What is his age? What Is a Credit Analyst?

➢ What is his occupation?
The credit analyst evaluates the borrower's financial standing by reviewing his
➢ Where does he live?
financial statements. The borrower here is usually a company or corporation. The credit
➢ How many cars does he have?
analyst evaluates statistics and analyzes corporate records including (1) payment plans, (2)
➢ How many children does he have?
savings data, (3) payment history, and (4) purchase activity. Based on these records, the
26
credit analyst makes a recommendation to his lending officer whether to extend credit to ➢ What are his/her assets?
the borrower or not, after determining his credit worthiness and/or credit limit. ➢ What are his/her liabilities?
➢ Are the assets enough to pay for the debts?
The credit analyst's job involves a lot of critical thinking, judgment, and decision-
making. Collateral. If the loan extended to the borrower is not paid, the creditor will look at
real estate owned, or any other savings, as these can be offered to secure a loan.
The Very Important Cs of Credit
➢ What assets do you have to secure the loan (a vehicle, your home, furniture)?
Character. Who is the borrower? The credit analyst establishes his identity and
➢ What investments or savings do you have (stocks or bonds)?
character, and his willingness to pay his loans.
Conditions. General economic conditions such as unemployment and recession can
This enables the lender (banks) extending credit to determine whether the
affect the ability to pay a loan. This important C focuses on the security of your job and the
borrower will remain committed to his promise to pay the loan or money borrowed.
company that employs you.
Character is something in the attitude or discipline in the borrower, which is beyond the
numbers in his business statements or the capability to pay. It is in the character of the Improving Your Credit Score
person who, despite financial difficulties, would be able to find a way to pay back money he
➢ Pay your bills on time.
owes the banks and his creditors because it is in his value system that whatever he borrows
➢ Lower your balances.
must be paid back.
➢ Set a monthly date wherein you can pay a certain amount regularly if you are not
➢ How long has credit been used before? able to pay the entire balance.
➢ How long has the borrower lived in the present address? ➢ Target paying the entire balance all the time
➢ How long has he held the same job? ➢ Delay or forgo unimportant purchase like luxury items.
➢ Use credit wisely.
Capacity. This is establishing the income and debts that the borrower already has.
This will affect his capacity to afford any additional debts. If the amount is already big relative Protecting Your Credit from Theft or Loss
to income, lenders would probably no longer extend the additional credit, as his ability to
pay now diminishes. Establishing the sources of income, employment stability, cash flow of Credit can be stolen from you. If you never charged those goods and services,
the business, and stability of business operations involves answering the following: someone else may have had used your name, and used your personal information to commit
frauds. Impostors deceive others by using a different identity, your name, Social Security
➢ Who is the current employer and how much is the current salary? System (SSS) number, someone else's credit card, or other personal information for their
➢ What are other sources of income? own purpose. This is a crime called identity theft and is a fast-growing financial crime.
➢ What are the current debts?
What should you do?
Capital. This is establishing the borrower's assets, cash, property, personal
possessions, and investments in stocks or bonds. The lender will investigate the borrower's ➢ Report the crime to the credit bureau immediately.
total assets if these exceed his liabilities or total debts. They will establish if there is enough ➢ Report the crime to the creditor immediately.
to pay for all debts, so even if income is lost, selling these assets would be able to pay for all ➢ file a police report immediately.
the debts. How do you prevent this?
27
➢ Shred papers that contain personal information, especially financial. The Annual Percentage Rate
➢ Be sure your credit card is returned after a purchase.
The annual percentage rate (APR) is the cost of credit on a yearly basis expressed in
➢ Keep a record of credit card numbers.
percentage points. An APR of 18% means that you pay PI 8.00 for every P100.00 you charge
➢ Keep records separate from your cards.
the credit card company or for every P100.00 you owe. The credit card company must inform
Signs of debt problems you in writing before you sign any agreement, relative to the finance charge and the APR.
➢ Only minimum monthly payments are paid.

➢ There is a struggle to make monthly payments on credit card bills. The illustration that follows will help.
➢ The total balance on the credit card bills increases every month.
➢ Loan payments are missed or are very late. How much interest would you pay if you borrowed P100.00 for six months at an APR of
➢ Savings are used to pay for food and utilities. 18%?
➢ Notices are sent by creditors.
➢ You borrow money to pay off old debts.
➢ You exceed credit limits.
➢ You have been denied credit because of bad credit report.
What is Personal Bankruptcy?
When an individual suffers from extreme case of debt problems, is there a relief?
As a last resort, he can declare bankruptcy. This is a legal process where he sells some or all
his assets, or his assets are distributed to his creditors because he is unable to pay his debts.
It may also include a plan to repay creditors on an installment basis. This severely damages
one's credit rating.
The Cost of Credit

If you are taking out a loan or borrowing or applying for a credit card, you should
first figure out how much the loan will cost you. This step will help you understand if you can
afford the loan or not. On this basis, you will decide whether to borrow or defer from
borrowing.
There are two costs that a credit card holder should know:
The Finance Charge
This is the total amount you pay to use credit. In most cases, this is the amount
paid to the credit card company for any unpaid balance. The finance charge is calculated
using the annual percentage rate.
28
Sole Proprietorship and the Business Documentation Requirements

Flowchart of a Loan Application
Starting up your own small business would be a very interesting project to start with
your group of friends. Usually, it starts with a need. For example, are you dissatisfied with
the taste of certain food that you would rather create your own food instead? Perhaps you
should go into the food business. Or are you frustrated with the choice of clothing or shoes
you find in the market? Are the choices either always too big or always too small for you
because you are not quite adult but already past your teens? Maybe, joining the clothing or
shoe business is for you. It all starts from something small.
How do you begin?
As discussed during the early parts of the book, where to look for financing is a critical part
of any start-up project. For bigger projects, it is usually referred to as capital ventures
possibly financed by private venture capitalist. For this discussion, we are limiting it to small
business projects, sole proprietorship, and financing support for these business ventures.
29
Requirements with complete name and account number may be included as part of the submission of
requirements as proof of regular loan payments.
Identification
What is bad credit? How does bad credit happen?
Because the type of business being discussed is a sole proprietorship, the valid
identification will be that of the business owner. This means that his ID is required as part of Bad credit happens when companies are unlikely to pay their debts. They are either
the submission of requirements. The following may be accepted: illiquid, meaning that their debts are not paid on time, or could go bankrupt, which means
that their assets even if sold, would not be enough to pay for their debts.
➢ Passport ID
➢ Any government-issued ID Bad credit happens when company sales do not grow over time and when company
➢ School ID expenses increased faster than sales. Therefore, growing companies are always on the
➢ Voter’s ID lookout for new products and new business opportunities.
➢ Picture in the ID must be clear
➢ The ID must have a recent signature.
Bureau of Internal Revenue (BIR) Registration Certificate, Obligations of Entrepreneurs to Creditors

Department of Trade and Industry (DTI) Certificate
Another requirement for business loan documentation is the Bureau of Internal A key partner of the entrepreneur is his creditor bank. His bank extends him a line
Revenue (BIR) Registration Certificate and the Department of Trade and Industry (DTI) for his daily business requirements as well as his requirements for longer term capital
Certificate. Both ensure that the business had gone through the proper procedures and expansion, for example. In return, the entrepreneur keeps his promise to pay back his
compliance with the Bureau of Internal Revenue and the Department of Trade and Industry. creditor banks by ensuring that he is financially capable and that his business is sustainable.
Certificates must be updated and not expired. How can he ensure that this happens?
Business Permit Business activities such as annual corporate planning, strategic planning, a review
of his business from the top-level help, includes a forecast of where the economy is going. A
The business permit must be current and updated. If the business is undergoing
forecast includes an analysis of a company's strengths, weaknesses, opportunities, and
renewal, a clear copy of the business permit application for renewal must also be submitted
threats. It can enhance its competitiveness and, hence, its profitability and sustainability. A
as part of the requirements for a business loan. If the application for renewal is just waiting
scan of the macroeconomic background his business operates in will help him foresee the
for its release, the official receipt or proof of payment must be submitted. Once the updated future of his business and helps communicate to his creditor bank the prospects of business
and current business permit has been released, this too must be submitted as part of the picking up.
requirements of the loan.
The Business Owner and Creditor as Partners in Growing a Business
Settlement Bank Account
The Business Entrepreneur Complies with Regulation
This facilitates the more efficient payment of interest on the loan. If this will involve
electronic or mobile or internet funds transfer to the bank account, this procedure must be As business expands aided by funding via the financial institutions, the
indicated. The business owner may also opt for payment through bank checks. Passbooks entrepreneur gives his skills and know-how to grow the business, employ, and train people
and monitor his business operations. He hopes to be on top of a business that is profitable
30
and sustainable. One of his partners in business that ensures this success is the financial For Capital Expenditures, To Reinvest in the Business, For Business Expansion
institution, which provides the funds and offers financial services and financial advice. To
assist the financial institution to facilitate the service, the entrepreneur does the following: Long-term funds can be used for capital expenditures or long-term investment
opportunities such as investing in real estate, a condominium, or investing in a new product
➢ Continuous submission of financial reports to assure regular and prompt payments launch. Usually, good long-term investments are found in markets that are less competitive
of his obligations where barriers to entry are high to keep out would-be competitors. A strong brand
➢ Yearly walk through of business operations to review, assess, and improve the reputation usually makes it difficult for competitors to enter the market.
business
➢ Annual corporate planning to determine what needs to be done to increase sales Funds used for long-term investments as opposed to your day-to-day operations
➢ Annual strategic planning to identify growth areas in the business and to assess are usually:
where innovation can help business efficiency 1. revenue enhancing because of research and development.
➢ Regular discussions on cost and operating controls 2. cost reducing new equipment or technology; and
➢ Financial management in identifying where to source funds, how to raise cheap 3. required investments due to a government regulation on health or pollution
funds, how to keep costs down, and paying debts on time control.
➢ Managing debts, avoiding delayed payments, avoiding bankruptcy and during
bankruptcy, the orderly liquidation of assets, and payment to creditors For Debt Servicing
Funds are also used to pay for debts. As a rule, debts should be self-liquidating. This
means that the maturity of the debt should match the length of time the debt is needed. If
a business borrows for seasonal expansion, like Christmas inventory, this should be financed
with short-term debt or current liability. The cash needed to pay this short-term loan should
Uses of Funds be generated from the Christmas sale and immediately paid.
For Working Capital

Your business working capital is used for the business' day-to-day activities, and this
refers to the current assets and the current liabilities of the company.
What are your current assets?
Cash, accounts receivables, inventory, and accounts payables are resourcing a

business can work with to be able to generate sales and revenues. How much of these should
a business hold, or how much to carry a decision that the business makes is based on References:
statistics and data it gathers. Too much inventory carried can be costly. On the other hand, Exploring Small Business and Personal Finance, Pages 57-76, Authors Kenneth L. Yumang, Tyrone
too little inventory may limit sales for the company. Panzer L. Chan PAO, Patricia Pefianco-Benito, Erlinda C. Pefianco, Ed. D, project director
Also, if credit has been extended to the business, where should the funds be https://www.workingpinoy.com/2011/01/list-of-banks-in-philippines-universal-banks-commercial-
invested? Should the funds be invested in inventory or elsewhere? banks
31
Name: _____________________________________________________________ b. Il only

c. l and I l
Year & Section: ______________________________________________________
2. The capacity to pay a loan does not affect one's credit rating.
a. True
b. False
Important
RemInderS 3. What is the inability to pay debts on time when they become due?
a. bankruptcy
• Tear this activity sheet and submit on the scheduled date along with the other b. insolvency
c. solvency
pictures, pdfs and alike as an attachment, then you may send them to my email 4. What do you get if you deduct the value of all your debts from the value of all your assets?
at msac021095@gmail.com following this format:
(SECTION_LASTNAME_FIRSTNAME_ACTIVITYNAME e.g. a. net worth
IC1MA_BINABAN_PRINCESS_SCAVENGERS HUNT), or send a digital copy from b. credit rating
your flash drive together with this activity sheet. c. level of solvency
5. What do you call the agency that gathers information about the credit history of the
borrower and sells these for a fee?
a. credit ratings agency

b. investment bank
c. credit bureau
1. Which statement/s is/are false?
I. Short-term funds are used to finance working capital requirements while long-term
funds are used to finance capital expenditures.
II. Commercial banks are investment banks but are also licensed to do more
sophisticated banking services than investment banks.
III. Bankruptcy is a legal process wherein assets of a debtor are distributed to creditors 1. When you are in a credit bind, what is the best way to address your problem to
to be able to pay his debts. immediately get back to your feet?
a. All statements are false.
32
2. When your business is going through financial difficulty like declining sales and
declining profits, what steps should you take to slowly recover and get back on
track?
3. What types of funding can you access to support your road to recovery?
Think of a business you want to put in the future, then simply express it in drawing. 80pts.
33
Time Value of Money and Opportunity Cost

The concept of time value of money states that a peso today, all things being equal,
has greater value than a peso in the future because of the opportunity to invest that peso
today and earn interest.
In making decisions, for example, choosing between a European or an Asian trip,

you must carefully weigh all considerations including the costs. Choosing one option means
letting go of the other option. So, the cost of choosing the European trip means losing the
opportunity to go on an Asian trip, or vice versa. This concept holds true when spending your
money. Because money is a limited resource, you cannot spend money and save that money
at the same time. If you decide to save, then the opportunity for you to spend has just been
given up. As what was stated earlier, the money that you save can earn interest.
Therefore, opportunity cost is anything given up after choosing an option. In

finance, it is the possible income from one option or investment opportunity given up.
Good money management is a decision to invest either in money market, fixed-

income securities, stocks, bonds, real estate, or in small business venture. If you decide to
spend the money instead of investing it, you are foregoing the opportunity to earn interest
from investing this money. If you decide to invest in financial instruments—fixed-income
securities, bonds, or stocks—you are saying no to investment in real estate and a start-up
business.
How do you determine the amount of interest that you will earn? The annual
interest is the additional money earned from money in an account.
To illustrate:
You deposited ₱10,000 in a savings account.
The bank pays an interest of 3% annually.
How much interest will this account earn in one year?
The learners…
1. Calculate future value and present value of money Formula:
2. Compute loan amortization using mathematical concepts and the Principal x annual interest rate x time = Interest earned for one year
present value tables
Solution:
3. Apply mathematical concepts and tools in computing for finance
₱10,000 x 0.03 x 1 = ₱300
and investment problems
4. Explain the risk-return trade-off Answer: The account will earn ₱300 for one year.
34
To illustrate:
You deposited ₱10,000 in a savings account.
The account pays 3% annual interest.
What is Future Value? The account earned ₱300 in interest after the first year
How much will the account earn after two year?
How would you know, given that you have choices, and will reject one investment
avenue by going with another, if your choice was a good choice?
Solution:
The future value of money is the amount your original funds will be worth in the Year 1: (₱10,000 x 0.03) = ₱300.00
future, based on earning an interest rate over a period. Year 2: (₱10,000 + ₱300) x 0.03 = ₱309.00
Compute how much your savings will earn by multiplying the principal and the Using the formula, FVn=PV (1+i) n,
interest rate. Then, add this interest amount. This new amount will also earn interest, which
will again be added to the new principal which will again earn interest the following year. FVn = ₱10,000 (1+0.03)2 = ₱10,609.00
This is the reason why future value is also known as compounding. Compounding makes
Explanation:
money increase over time, given a certain interest rate.
You will earn ₱300.00 in interest on the first year.
KEY TAKEAWAYS You will earn ₱309.00 in interest on the second year.
The future value of your original money at the end of the second year is ₱10,609.00
▪ Future value (FV) is the value of a current asset at some point in the future based
on an assumed growth rate.
▪ Investors can reasonably assume an investment's profit using the future value (FV)
calculation.
▪ Determining the future value (FV) of a market investment can be challenging
because of the market's volatility.
▪ There are two ways of calculating the future value (FV) of an asset: FV using simple
interest and FV using compound interest.
The formula to compute for future value of money is
Where: FV = Future value in n period
PV = Present value or the money invested today
i = interest rate
n = number of periods
35
What is Present Value? is a better investment. You also need to consider the initial capital required. If you know the
present value of an investment as well as the present value of the other investments, you
Present value is today’s worth of future money.
can compare with their respective value today. Present value will tell you the initial amount
An investor puts his money in stocks, bonds, or any other investment with an of money required to achieve your target return at a given interest rate at a certain number
objective of earning income. The investment plus the earned income is the future value of of periods. Therefore, you consider the investment with a lower present value but with a
money. Present value is determining today’s worth of this future value (investment + earned higher possible return.
income). It is also known as discounting.
Returns on investments will be received in the future and you want to buy that
Using the previous illustration on future value, the P10,609.00 worth of money in investment now. Being able to compute for the various investment returns based on an
two years at 3% interest rate has a present value of P10,000.00. Refer to the timeline below: interest rate and an initial required investment will help an investor decide which investment
to choose from.
Factors that determine the present value of an investment include:
1. The rate that the market gives

2. The cash flows expected
3. Number of periods these cash flows will continue
The formula to compute for the present value of money is
Having Fun with the Math of it
Where: Unfortunately, we cannot escape the math that comes with business and finance.
Fortunately, the math need not be confusing or complicated. Let us introduce and discuss in
PV = Present Value
this chapter the math that you will most likely need and meet along the way. We can assure
FV= Future value in n period you that the discussion will be light, fun, and enjoyable.
n = number of periods Nominal interest rate or sometimes called annual percentage rate or quoted rate
indicates the interest rate paid or earned in one ear without compounding. It is commonly
I = interest rate known as simple interest rate.
Why Do We Need to Compute for Present Value? On the other hand, the effective annual rate which is also known as effective
interest rate indicates the compound interest rate paid or earned in one year. This is the true
Various investment options have different required capital and expected rate of
amount of the interest you pay or earn in one year.
return. Most of the time, you have the information about an investment's future value.
However, it does not always mean that an investment with a greater future absolute value
36
Effective interest rate is the one which caters the compounding periods during a Illustration for One Year
payment plan. The nominal interest rate is the periodic interest rate times the number of
periods per year. For example, a nominal annual interest rate of 12% based on monthly
compounding means a 1% interest rate per month (compounded).
KEY TAKEAWAYS
▪ Different types of interest rates, such as real, nominal, effective, and annual, are
set apart by critical economic factors.
▪ The nominal interest rate, or coupon rate, is the actual price borrowers pay lenders,
without accounting for any other economic factors.
▪ The real interest rate accounts for inflation, giving a more precise reading of a
borrower's buying power after the position has been redeemed.
▪ The effective interest rate includes the impact of compounding, in which a bond
might pay interest annually but compounds semiannually, increasing the overall
return.
Below illustrate the nominal and effective interest rates in action.
If you deposit P100 in a savings account, how much interest will you earn in two
years?
a. Using 4% annual percentage rate

b. Using 4% interest rate compounded monthly
Annual percentage rate:
Principal x rate x period = interest earned
Year 1: P100 x 0.04 x 1year = P4.00
Year 2: P100 x 0.04 x 1year = P4.00
The total interest earned for two years is P8.00.
Effective annual rate: At the end of two years, you will have P108.31 (P100 + 8.31). You earned P8.31 in
compounded interest for the two years.
i. Principal x annual interest rate = interest earned for the 1st month
12
ii. (Principal + Previously Earned Interest) x Annual Interest rate / 12 = Interest
earned for a given month
37
Where: FV = Future Value in n period 6 983.33 819.21 164.12 5,390.52

PV = Present value or the money invested today 7 983.33 840.86 142.47 4,549.66
i = interest rate 8 983.33 863.08 120.25 3,686.58
m = number of compounding periods per year 9 983.33 885.89 97.44 2,800.70
n= number of years 10 983.33 909.31 74.02 1,891.39
11 983.33 933.34 49.99 958.05
12 983.33 958.05 25.32 0.00
The monthly factor rate is used to determine the amount of payment for the loan
monthly (principal plus interest). Every month, the amount below is paid.
P10,000 x 0.0983333 = P983.33 (a)
Charmaine Reyes is a single working mom. She has been employed by a retail mall for a little
over a year and wants to purchase an appliance through a bank loan available to her. How The amount of interest paid on the loan is determined by using the monthly
much should she budget for her loan amortization of this purchase? How will she know how effective interest rate. Of the total amount paid monthly above, the monthly interest is
much to pay? computed as follows:
P10,000 x 0.02643 = P264.30 (b)
Illustration:
Installment loan amount: P10,000 The amount of principal is determined by subtracting the interest payment (b) from
Installment term: 12months the principal payment (a). This bank product will vary from bank to bank and your credit
Monthly add-on rate: 1.50% standing.
Monthly effective interest rate: 2.643% P983.33 – P264.30 = P719.03
Monthly factor rate: 0.0983333
The amount above is used to compute for the new outstanding principal which
Installment Loan Payment becomes smaller each month until the entire loan is fully paid.
Loan amount: P10,000 (1.50% x 12) + 1= 1.18
Installment term: 12months The illustration above helps you understand and make full use of credit
1.18 / 12 = 9.83%
Monthly Rate: 1.50% opportunities available to you. A necessary purchase can in time be fully paid with discipline
Monthly effective: 2.643% and perseverance. The amount can be computed as explained above.
Monthly Factor Rate: 0.098333333
TOTAL PRINCIPAL INTEREST OUTSTANDING

PAYMENT
10,000.00
1 983.33 719.03 264.30 9,280.97
2 983.33 738.03 245.30 8,542.94 One of the most effective ways to understand the basic concepts of finance is
3 983.33 757.54 225.79 7,785.40 through personal finance. How does one source his funding, create a budget, monitor the
4 983.33 777.56 205.77 7,007.84 budget, and control his costs, to ultimately maximize his revenues and reduce his
5 983.33 798.11 185.22 6,209.73 expenses.
38
Plan Your Budget Now Personal Investments

The Various Investment Portfolio Types: Which One Are You?
The Teenager's Personal Budget
Budget for the Month P4,000 Before an investment portfolio is setup or designed, it is critical to define the risk
Daily allowance P200 appetite of the investor. The process is a must preparation without which the investment
Daily cost for lunch 75 P1,500 portfolio will likely fail to achieve its objectives. A good analogy we can offer would be
Others 900 preparing and/or dressing up for a special occasion. One would have to know certain
Savings monthly P1,600 information so as not to look inappropriate.
Savings yearly P19,200 ▪ What is the occasion? a baptism, a wedding, or a dinner party?
Savings, three years P57,600 ▪ The occasion will help determine what you will wear.
If invested in the stock market, how much will P50,000 grow? ▪ What will be the weather?
▪ How long will the event be held and where?
Assuming that in a period of 10 years, the stock market will grow 3.5x, from an index ▪ Who will be hosting and who will be the guests?
of 2,000 to an index of 7,000, your P50,000 investment could potentially reach P175,000 in Understanding the risk appetite of the investor will likewise require certain
the same time frame. knowledge and information about the investor.
That amount is no small feat and especially if you compare that to the returns that ▪ What is the age of the investor?
a fixed-income investment will give you.
If he is in his 20s-aos, he can afford to take more risks with his investments, going
for more percentage allotted to stock investments or real estate property where the
10-YEAR GROWTH OF THE PHILIPPINE STOCK MARKET
investment returns tend to be higher although longer-term.
If he is in his 30s—40s, married, with perhaps two kids, he will have to temper his
risk taking as he now will have monthly requirements given that he is keeping house With a
growing family. Hence, he will need to allot more to fixed income securities that give regular
cash flows, money market placements, bonds to cover monthly expenses in, including food
for the family, tuition and fees, rent, water, and electricity. He may, however, keep some of
his stock investments, albeit with a lower exposure.
If he is in his 40s—60s, he becomes more conservative with his investments and

becomes more risk averse. That would mean less stock investments exposure (maybe 10%),
with the rest of his investments in money market instruments, fixed income securities,
bonds—both corporate and government.
If he is in his 60s onward, he may want to keep his entire investments in fixed
income and shorter to medium-term duration (maturity). This is because at this stage of his
39
life, he may need more monthly income requirements, usually food, medicine, water, and Being young however, he can afford to be partially aggressive, time on his side, and hence
electricity. capable of investing in the stock market and riding the waves that go up and down.
Other considerations include:
▪ Gender: Is the investor male or female? Real Estate
▪ Civil status: Is the investor single or married? Investors who like real estate may be categorized under "old school" or traditional.
▪ Does he have children, dependents? Wealthy families hold on to more tangible assets like real estate, and in the Philippines, many
▪ Where does his income come from? still consider real estate as reliable and stable.
▪ What is his objective for investing? There are several advantages and disadvantages to investing in real estate.
▪ to afford luxury vacations
▪ to be able to send his children to school Advantages
▪ to start saving up for retirement 1. Hedge against inflation. Real estate investments can be used to hedge against
inflation. This means that when the prices of goods and commodities move up,
Money market, fixed-income securities, and bonds the purchasing power of the consumer goes down, or he can afford less now
An investment portfolio that consists of money market instruments, fixed-income than before. If he has real estate investments, he can be assured that its value
securities, and bonds are for investors that are conservative. Conservative investors are over time will increase and, therefore, his real estate proceeds. When he sells
usually older, more mature, and have dependents or a family to take care of. He would likely them, he can cover expenses that he has consumed over time.
be looking for a fixed amount of income to generate regularly because he has regular 2. Rent income. Real estate investments may provide you with regular rent
monthly bills to pay for, such as house rent, car amortization, groceries, medicines, income, or cash flows. Your property can be leased or rented out to an investor
transportation costs, electricity, and children’s education. who has use for it. The property can either to put up as commercial business,
to rent it out, or to use it to warehouse his business inventory.
Stocks 3. They are real and tangible properties, assets owned by the investor or by the
Stock investors are more aggressive investors. They are younger and usually do not business. Assets that can be sold to pay off the debts of the investor or the
have dependents yet. Their investment horizon or timetable for expecting investment debts of the business.
returns is longer and, hence, stock investors have the luxury of time to wait for stock markets
to recover in case they have gone down temporarily. Unlike the conservative investor, stock Disadvantages
market investors do not necessarily need a monthly income. Their long-term view on 1. Real estate investments are illiquid investments. They cannot easily be
investment returns afford them to ride out bear markets which will temporarily suspend converted into cash. It may take months or years to sell a property, and hence,
income to them. their conversion to cash or cash flows may limit the investor. Meantime, while
these assets are not yet liquidated, the owner's debts are increasing due to
A combination of fixed-income and stocks interest rates.
Investors who will design a more balanced investment portfolio will have another 2. Although they offer some protection against inflation, real estate investments
set of investment profit and investment risk appetite. He will most likely be middle aged, may also experience a decline in value. When inflation goes down, the price of
with a small family depending on him, hence, his need for a regular and fixed income stream. everything else goes down, the value of real estate investments may also go
down and, therefore, the owner may have to experience selling his property
40
for less than he initially acquired it for. This can be very dangerous to the real a business entails so much more than giving money in exchange for a certificate and waiting
estate investor because if he is depending on his real estate's value to increase for regular cash flows or capital appreciation to happen. It means:
and cover his debts, what will happen if the value of his real estate goes down? ▪ knowing why you are in business and what you are in business for.
3. Lack of diversification. Because real estate investments are expensive, one can ▪ setting goals and targets and achieving them on time.
only invest in one or two properties. This means that the investor loses his ▪ knowing the right people to hire and knowing how to motivate them to achieve
opportunity to invest in other types of investments or securities that offer your targets as a business.
better features like liquidity. ▪ delivering the goods and services to your customer.
4. Management and operating expense issues come with real estate investments. ▪ keeping costs down; and
This pertains to looking for reliable tenants, incurring operating expenses in ▪ keeping the company profitable so that there is money to pay the business' debts,
maintaining the property like replacing worn out carpeting or keeping the the salaries of the employees, and having some left for improving the business
garden in order, or fixing the bathroom tiles. Other investment outlets do not further, to keep it growing and sustain all those who depend on it.
carry this burden.
The Entrepreneur
A start-up project is another investment option. It is not a financial product or a
marketable security such as a stock or a bond that will give you a certificate as evidence of
your investment in the company's stock or bond. Current events and updates are especially important discussions for business
A business has real assets such as inventories, plant, and equipment. A business landscape (whether in the Philippines or outside) as they affect the latter.
also incurs debts and obligations to finance its operations. A business uses financial The concept of risk-return tradeoff explains that there is a commensurate return
instruments to finance its expansion and uses marketable securities to increase its revenues for every risk a business owner or investor takes, and that the return expected is usually
and finance its operations. greater for more risk taken. Hence, the common business term "the greater the risk, the
To journal what is happening to the business and monitor its growth, and report its greater the potential return" or "no pain, no gain."
health to the owners, the business prepares regular financial statements. These financial
statements will regularly tell if the assets of the business are growing and if the debts and An example of a situation for a risk-return tradeoff:
obligations of this business is being paid. The financial statements are the report card of the 1. a business can enhance its profitability by carrying less cash and marketable
business. The statements of a business include: securities since these earn very low rates in the market.
▪ the balance sheet that shows the assets of the business and its liabilities and 2. the funds, instead, are put into more risk, such as a higher investment in inventories
the value of the owner's equity. that can generate more sales for the company.
▪ the income statement that shows if the business is earning. It reports the 3. if the company can sell more from this inventory, then it is able to generate more
revenues and costs and expenses of a business during a period. It is also called return for the risk it entered.
the Profit and Loss Statement. 4. however, the tradeoff can be complex: if the additional investment in inventory
Setting up a business as another investment option is the riskiest choice for an does not generate more sales, perhaps because of a slowdown in the economy or
investor who wants to grow his money. Why? This is because unlike a marketable security, the quality of the product being sold; or for some other reason, when the business
41
has carried less stable cash and marketable securities to pay for the short-term
loans it used to finance this additional inventory; and
5. the higher the risk the business takes, the higher the potential to earn, as well as
the potential to lose which can lead to delayed payments on short-term debts that
financed the inventories in the first place.
THE DYNAMICS OF RISK-RETURN TRADEOFF
LOW RISK
The bottom-left corner of the graph shows that there is low return for low-risk financial
instruments. Government-issued bonds, for instance, US Treasuries, are the lowest risk
financial instruments because they are backed up by the federal government. But due to the
relatively non-speculative nature of the bonds, they have low returns than bonds issued by
corporations. In fact, while assessing the expected return of instruments, the return on
government bonds is the risk-free rate. Knowledge, technology, and changing markets have made competing for customer
tougher. On top of this, there are many more challenges that a business owner is faced with
HIGH RISK today, compared to ten years ago. Some of these challenges include:
As we move along the upward sloping line in the graph, the risk rises and so does the ▪ International conflicts/events
potential return. This is understandable as investors parting with their money for riskier ▪ Extreme weather events
assets would demand better returns than a risk-free security; else they have no reason to ▪ Failure of national governance
take that risk. This is the reason why the bonds issued by governments and corporations for ▪ State collapse or crises
the same duration have different yields as with corporate bonds, there is also a default risk ▪ Unemployment and underemployment
priced into them which is not the case with federal bonds. ▪ Natural catastrophes
▪ Failure of climate change adaptation
PORTFOLIO ▪ Water crises
So, it may seem like government bonds should form a significant portion of an investment ▪ Data fraud or theft
portfolio given their near risk-free nature and the stability of returns. However, much higher ▪ Cyber-attacks, computer hackers
returns provided by other instruments like high yield bonds, and other asset classes like
equities is what induces investors to assume higher risk even though there is a possibility of
capital loss there.
42
Name: _____________________________________________________________ 3. Check if your answer is correct by calculating the FV of your answer in item 2 and
the interest earned.
Year & Section: ______________________________________________________
a. FV P1,000,000; Interest: P393,000.11
b. FV P1,000,000; Interest: P390,000.11
c. FV P1,000,000; Interest: P394,000.11
Important
4. The risk-return tradeoff can be summed up by which phrase?
RemInderS
a. Time is gold.
b. No pain, no gain.
• Tear this activity sheet and submit on the scheduled date along with the other
c. A penny saved is a penny earned.
pictures, pdfs and alike as an attachment, then you may send them to my email 5. Discounting basically looks for which type of value?
at msac021095@gmail.com following this format: a. Present value
(SECTION_LASTNAME_FIRSTNAME_ACTIVITYNAME e.g. b. Future value
IC1MA_BINABAN_PRINCESS_SCAVENGERS HUNT), or send a digital copy from
your flash drive together with this activity sheet. 6. Compounding basically looks for which type of value?
a. Present value
b. Future value

1. How much would you have at the end of five years if you invested P50,000 at 10.5%
interest rate?
a. P63,814.08
b. P82,372.34
c. P142,650.71
2. If you want to have a million pesos in five years, how much should you How will you explain the quotation “the greater the risk, the greater the potential return”
deposit/invest right now at 10.5% interest rate? and “no pain, no gain”. Is there a difference between the two? Explain.
a. P350,506.50
b. 783,526.17
c. 606,999.89
43
Describe yourself at the past, present (Present Value) and your future (Future
Value). What will you do to achieve your dreams?
References:
Exploring Small Business and Personal Finance, Pages 77-92, Authors Kenneth L. Yumang, Tyrone
Panzer L. Chan PAO, Patricia Pefianco-Benito, Erlinda C. Pefianco, Ed. D, project director
https://efinancemanagement.com/investment-decisions/risk-return-trade-off
44

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ASIAN INSTITUTE OF COMPUTER STUDIES (AICS)

FIN122: Business Finance

Finance is the study of how individuals or businesses evaluate investment

Financial Institutions and the Key Individuals Who Play

Financial Institutions and Financial Services 3. Universal Banks

Financial Instruments Compared and Contrasted

Clients mainly households and small firms

What is a worthwhile business?

Name: _____________________________________________________________ 3. What is financial management?

A. Encircle the letter of the correct answer.

Steps in the Financial Planning Process

1. The long-term financial plan, also known as strategic financial plan.

2. The short-term financial plan, also known as the operating financial

Financial planning is often defined as the forecasting of a business' future financing

A long-term financial plan involves forecasting the financing requirements of a

a. Forecast your sales.

In doing sales forecasting, it helps if it starts with an understanding of the industry

c. Identify your spontaneously generated funds.

It simplifies the formula in the below illustration:

Second, we have accounts receivables. The objective of accounts receivables

The 5Cs of Credit is a set of guidelines of carefully selecting your customers.

6. What are the 5Cs of Credit?

a. It refers to a set of guidelines for carefully selecting your customers.

Sources of Funds for Business Operations

What are short-term funds and where are they used?

Funding Working Capital

Uses of Working Capital

8. Development Bank of the Philippines 22. Robinsons Bank Corporation

➢ What is his age? What Is a Credit Analyst?

➢ Only minimum monthly payments are paid.

What is Personal Bankruptcy?

The Cost of Credit

The Finance Charge

Sole Proprietorship and the Business Documentation Requirements

How do you begin?

Bureau of Internal Revenue (BIR) Registration Certificate, Obligations of Entrepreneurs to Creditors

For Working Capital

What are your current assets?

Cash, accounts receivables, inventory, and accounts payables are resourcing a

Name: _____________________________________________________________ b. Il only

a. credit ratings agency

Encircle the letter of the correct answer.

1. Which statement/s is/are false?

a. All statements are false.

Time Value of Money and Opportunity Cost

In making decisions, for example, choosing between a European or an Asian trip,

Therefore, opportunity cost is anything given up after choosing an option. In

Good money management is a decision to invest either in money market, fixed-

Where: FV = Future value in n period

PV = Present value or the money invested today

Factors that determine the present value of an investment include:

1. The rate that the market gives

The formula to compute for the present value of money is

Having Fun with the Math of it

Below illustrate the nominal and effective interest rates in action.

a. Using 4% annual percentage rate

Where: FV = Future Value in n period 6 983.33 819.21 164.12 5,390.52

TOTAL PRINCIPAL INTEREST OUTSTANDING