module

1. Prepared by:
DEXTER R. LABANTINO, MBA
BRYAN T. CUISIA
2019 Revision
Republic of the Philippines
OCCIDENTAL MINDORO STATE COLLEGE
Labangan, San Jose, Occidental Mindoro
website: www.omsc.edu.ph email address: omsc_9747@yahoo.com
Tele/Fax: (043) 457-0231 CERTIFIED TO ISO 9001:2015
CERT. NO.: 50500643 QM15
A Module
in
Basic Finance

2. Lecture
Vision
A premier higher education institution that develops globally competitive, locally responsive,
innovative professionals and life-long learners.
Mission
The OMSC is committed to produce intellectual and human capital by developing excellent
graduates through outcomes-based instruction, relevant research, responsive technical advisory
services, community engagement, and sustainable production.
Instructions:
1. Prepare ½ crosswise yellow paper.
2. During the 30 minutes quiz, each student is not allowed to talk nor leave the room,
any form of cheating will be penalized.
3. If the student has question/s about the examination. He/ She must approach the
Instructor.
4. Using of cellular phone is discouraged.
5. Write and discuss comprehensively the following;
 OMSC Vision
 OMSC Mission
TOPICS
1. VM of the institutions
2. Gender Equality
3. Core Values
LEARNING OUTCOMES
At the end of the lesson, you should be able to internalize the VM and
Core values of the College.
LESSON 1
ORAL PRESENTATION IN EDUCATION
TOPIC 1: VM of OMSC
Task/Activity

3. Lecture
What does gender equality mean?
This is the different behaviors, aspirations and needs of women and men are considered,
valued and favored equally. It is not explained as the rights of men and women to be the
same but it is about the responsibilities and opportunities to both of them as human.
What is the example of gender equality?
This is the level of holding of same position of male and female employees but receiving
same salaries regardless other factors such as, experience, education level and others. It
is showing respect and equality.
Five Gender Issues
1. Sexual violence
2. Exploitation
3. Unequal division of unpaid care and domestic work
4. Discrimination in public office
5. Climate change and disasters disproportionate on women and children
What causes gender inequality?
It is a result of the persistent discrimination of one group of people based upon gender
and it manifests itself differently according to race, culture, politics, country and
economic situation
Group Activity
Each group will collaboratively discuss their differences and encountered unequal
treatment and will share it to the class in five minutes.
Lecture
Obedience to God
This is a biblical request, compliance with an order, and encouragement to people as
manifested in Genesis 22;18, NIV “ And through your offspring all nations on earth will be
blessed, because you have obeyed me.” Jesus Christ we find the perfect model of
obedience. As his disciples, we follow Christ’s example as well as his commands. Our
motivation for obedience is Love.
Mindfulness
It refers to a straightforward word suggesting the mind is fully attending to what is
happening, to what you are doing, to the space you’re moving through. It is our ability to
be fully present and aware of where we are and what we’re doing, and not overly reactive
or overwhelmed by what’s going on around us
TOPIC 2: Gender Equality
Task/Activity
TOPIC 3: Core Values
If you love me, you will keep my commandments. (John14:15)

4. Service-orientedness
It is expected from the students and to those working in OMSC their quality and fouced
on the customers needs and requirements. This will integrate values over anything else
and responds to them quickly and efficiently.
Commitment
It is a process of engaging in a obligation that sometime restricts freedom of action. It
involves dedicating yourself to something, like a person or a cause. It also obligates you
to do something completely and adequately.
Integrity and Ingenuity
Integrity
This is a value of quality of being honest and having strong moral principles. Having
integrity means doing the right thing in a reliable way. It’s a personality trait that we
admire, since it means a person has a moral compass that doesn’t waver.
8 Things to Know About Mindfulness
1. It is not obscure or exotic.
2. It is not a special added thing we do.
3. You don’t need to change.
4. It has potential to become a transformative
social phenomenon
5. Anyone can do it.
6. It’s a way of living
7. It’s evidence-based
8. It sparks innovation
What makes a great customer service person?
 Communication skills are essential to get a good customer service job. Self-
Control is importance to have patience for those customers that no one really
wants to deal with. The more patient you are, the better off you will be when
working in customer service.
How do you show commitment?
1. show love and loyalty
2. Express respect and appreciation
3. Convey honesty and trust
4. Work as a team and compromise
5. Disagree agreeably.

5. Ingenuity
It is a trait or quality of being original and inventive. A person’s ingenuity I a quality of
being skillfulness in conception of designs and working out how to achieve things or skill
at inventing new things.
Accountability
This is a noun that describes accepting responsibility, and it can be personal or public. It
is an act of admitting you made a mistake to your previous decisions and actions.
Nationalism
It refers to the way of thinking that says that some groups of humans such as ethnic
groups should be free to rule themselves. It seeks to preserve and foster a nation’s
traditional culture and cultural revivals have been associated with nationalist movements.
It also encourages pride I national achievements and closely like patriotism.
Furthermore, Nationalism is an ideology and movement that promotes the interest of a
particular nation in a group of people especially with the aim of gaining and maintaining
the nation’s sovereignty over its homeland.
Your task for this lesson is to prepare and deliver a 10 to 15-minute oral
presentation in small groups. The objectives of your presentations are as follows:
 present the common thought of OMSC Vision and Mission
 present the individual differences of each members
 report on the individual behavior adjustments to be made
 report on the response of the target audience
 describe and reflect on personal experiences of different attitudes
 evaluate the overall performance of the members
Five behaviors that signify integrity
1. Taking responsibility for their action.
2. Putting others’ needs above their own.
3. Offering to help others in need
4. Giving others the benefit of the doubt.
5. Choosing Honesty in all things.
TEN ways to make your self Accountable at work, on life and with money
1. Create a personal Mission Statement
2. Set Micro-Goals
3. Use Lists Wisely
4. Make Yourself Accountable
5. Reward Yourself
6. Do one Task at a time
7. Emphasize your strength, improve your weakness
8. Value your time
9. Seek Feedback
10. Review yourself
ASSESSMENT: ORAL PRESENTATION

6. THE PHILIPPINE ECONOMY
Although most Filipinos dream of affluence, it seems to be one that is impossible
to attain. This is mostly so because the Philippine economy has always been saddled with
difficulties which appeared to be insurmountable. Low productivity in the workplace,
graft and corruption in the government, the declining value of the peso, and an
unfavorable balance of trade are only some of the more serious concerns affecting
Philippine economy development.
In spite of the great obstacles hampering economic growth, the Philippine
economy continues to grow, albeit very slowly. Moreover, the Philippine economy does
not fare well in comparison with other countries situated in the Far East.
Business success has always been associated with economic growth. Adequate
capital, is a prerequisite of the existence of business firms. Since this is so, business
success is highly dependent on the availability of capital. Apart from availability, however,
its proper management is a key ingredient in the survival and growth of business.
Studies made along the topic of managing the finance activities of business
indicate that a major reason for business failure is the businessman’s lack of sufficient
skills in managing finance. This alone provides us with enough reason to study business
finance.
THE ROLE OF BUSINESS
Under the free enterprise system, the growth of the economy lies in the ability of
private individuals to achieve economic objectives. The quest for profit is usually
undertaken by engagement in business activities. Business firms and government are
oriented towards the provision of goods and services to the society. Regarding this task,
however, private business firms assume the major role. Under the system, firms are free
to compete with each other. This atmosphere makes possible the offering of new or
LESSON 2
The Nature, Aims, and Organizing A Business
TOPICS
1. The Philippine Economy and the Role of Business
2. Business Defined, Kinds and Objectives of Business
3. Reasons for Engaging in Business
4. Business Prospecting and Promotion
LEARNING OUTCOMES
At the end of the lesson, you should be able to identify the roles,
objectives of Business.
TOPIC 1: The Philippine Economy and the Role of Business

7. improved products and services to the society. The standard of living is raised or lowered
depending to a large extent on the performance of business firms.
Business is largely responsible for bringing into the market a wide array of
products and services which were not previously available. High technology items like the
latest cellphone models, video equipment, portable computers, and many others find
their way in the open market. This happens even as business continues to provide
mankind with basic necessities like food and shelter. Even movies of different kinds are
made possible by business firms. Such is the importance of the role attributed to business
that even communist countries like China and Vietnam have allowed, to a great extent,
the operation of business entities as a means to develop their economies. Profit-making
has been adapted as a measure to motivate enterprising persons to engage in business.
BUSINESS DEFINED
Business is any lawful economic activity concerned with the production and/or
distribution of goods and services for profits. Whether or not it actually makes profits is
immaterial. An entity is still a business if its objective is to make profits.
KINDS OF BUSINESS
Business may be classified in several ways. As to the nature of the principal activity
performed, it consists of three main divisions:
1. Commerce;
2. Industry; and
3. Services.
Commerce
Business firms which are engaged in the buying and selling of goods and services
are classified as those falling under commerce. Also included are trading, merchandising,
and marketing (see Figure 1). Examples of commerce as a kind of business are
supermarkets, dry goods store, peddlers, sari-sari stores, importers, and many others.
Figure 1. Kinds of Business
TOPIC 2: Business Defined, Kinds and Objectives of Business
BUSINESS
Assembling
of goods
Insurance
and
Financing
Transportation
Warehousing
Grading
Merchandising
Finance
Recreation
Personal
Construction
Manufacturing
Extractive
Genetic
Marketing
Buy and sell
Trading
Industry Services
Commerce

8. Industry
Industries are those which are mainly concerned with production. Goods
produced are those which may be intended for ultimate consumption and which are
called consumer’s goods, or those which are intended for use of business and industry
and which are called producer’s goods.
Industry may be further classified into the following: (1) genetic; (2) extractive; (3)
manufacturing; and (4) construction.
Genetic industries are business involved in agriculture, forestry, and fish culture.
Extractive industries are business involved in the extraction of goods from natural
resources which include mining, lumbering, hunting and fishing.
Manufacturing industries are those which convert raw materials into finished
products. Examples of these are firms engaged in the manufacture of drugs, plastics, food,
liquor, footwear, motor cars, tools, office supplies, household appliances, and many
others.
Construction industries consist of firms engaged in building infrastructures like
airports, seaport, dams, and highways. Those involved in the construction of dwelling
houses are included.
Services
A service business is one which sells services to buyers. Service firms may be
classified as: (1) recreation, such as movie houses, television and radio stations, theaters
for drama and stage presentations, and the like; (2) personal, such as restaurants, barber
shops, transportations, hotels, tailoring shops, and the like; and (3) finance, such as banks,
insurance companies, investment houses, financing institutions, credit unions, savings
and loans associations, and the like.
OBJECTIVES OF BUSINESS
A business firm is established primarily for profit. At times, however, short-term
and long-term profits are sacrificed in order to attain other goal such as:
1. Political influence;
2. Family control of the business; and
3. Community involvement.
The first stage in life cycle of a business is organization. Much of what will help happen to
the firm in the later stages depends on the first few steps in the organization process.
Because of the magnitude of the capital required in establishing a corporation, the
activities undertaken in the organization stage are more sophisticated and many take a
year or several years before actual operations begin. This does not mean, however, that
small business do not deserve careful thought and analysis before they start operating.
The importance of the organizational stage cannot be over emphasized. Business
failures have become common occurrences because of defects in planning at the
organizational stage. Business failures happen to companies regardless of industry
classification and the amount of capital investment.
TOPIC 3: Reasons for Engaging in Business

9. The most common reasons for business failures include the following:
1. Bad or improper management practices, including poor cost controls and poor
hiring practices;
2. Poorly focused and executed marketing or inadequate marketing;
3. Poor location;
4. Failure to invest in new products and efficient technology; and
5. Lack of adequate financing.
WHY PERSONS ENGAGE IN BUSINESS
Prospective investors would want to engage in a business venture for one reason
or another. They hope to enjoy certain values, which are derived from such undertaking.
These values include the following:
1. Provision of employment to people;
2. Profits;
3. Service to the community;
4. Personal satisfaction;
5. Means to earn a living;
6. Achievement of power; and
7. Protection of one’s self and family.
It is well-known that entrepreneurs venture into business for economic reason as
a primary motive. Some do it to utilize skill and previous work experience. The last two
reasons are not far-fetched. A skilled person who cannot get employment would be
forced to engage in business just to maintain his skill, hoping that someday, it would be
more useful. In the same light, some individuals think that the experience they have are
much too valuable to be ignored, so they try to use it by operating a business.
Sometimes, situational conditions pave the way to persons to engage in business.
A fine example is a disabled individual who decided to go into business because he cannot
get employment anywhere.
ENTREPRENEURSHIP
To engage in business, a person or group of persons has two options: (1) to buy
an existing business, or (2) to create a business that he will operate. The person who
chooses option two will be referred to as an entrepreneur. He owns his business but his
functions are vastly different from those of another type of business owner, the
stockholder of a corporation.
The entrepreneurs’ functions are:
1. To supply the capital of the firm;
2. To organize production by buying and combining inputs;
3. To decide on the rate of output in the light of his expectations about demand;
and
4. To bear the risk involved in these activities.
Studies have shown that successful entrepreneurs are likely to be over-achievers,
and likely to do well if they are also reasonable risk-takers, self-confident, hard workers,
goal setters, accountable, and innovative. However, even if there are successful
entrepreneurs, statistics show that there is also a big number of failures. This indicates
that the task of the entrepreneur is not easy.

10. BUSINESS PROSPECTING
When a determined individual has finally decided to go into business, it will not
be wise for him to grab the first opportunity that comes along. First, he should carefully
scan the environment for other possible openings. He should prepare a list of alternative
business opportunities and he should make his choice from that list.
The Search for Business Opportunities
A person searching for a suitable business opportunity should learn the ways of a
talent scout or a salesman looking for a prospect.
The talent scout, aware of the requirements of the market – whether radio,
television, recording, or the movies – goes around searching. He stays longer, however,
in places where talents abound. The scout does not forget that there are lots of good
talents but only a few of them can be classified as commercial or one who can satisfy a
big market.
The salesman, on the other hand, prepares a list of his prospects and from there
makes his evaluation and decides on who is worth seeing. The salesman should also not
forget that there are prospects of better quality than others.
Like a talent scout, the prospective businessman should have the skill to choose
an opening that will be commercial and will bring him enough revenues. Also, like a
salesman, the prospective investor should have the skill to pick the right business
opportunity from his list and which is of better quality than the others indicated in the
same list.
Business opportunities come in several forms. They could be a result of any of the
following:
1. Increasing demand for basic commodities due to an increase in population;
2. Rising prices (or cost) of existing products like construction materials;
3. Relaxation of government policies like the lifting of import restrictions;
4. The development of new service concept like the issuance and delivery of
passports through courier services;
5. The development of a new product concept like the engine that runs on water;
6. The increasing demand for the specialized services like manpower export
services, health and fitness services, management consultancy, and skills
training;
7. The increasing requirements of the wholesale and retail industry; and
8. Many others.
BUSINESS PROMOTION
Business promotion refers to discovery and exploration of a business opportunity
with the purpose of converting it into a going concern.
The three steps involved in business promotion are the following:
1. Discovering the idea for a new business;
2. Determining the feasibility of the idea; and
3. Assembling the needed resources to start the business.
TOPIC 4: Business Prospecting and Promotion

11. Discovery
The identification of an idea for a new business is the first step in business
promotion.
The new business idea may spring from various opportunities. A seasoned CD
salesman may organize his own recording company. A college professor may open his
own school. A retired military officer may set up a security agency.
The business promoter may also be induce to consider certain product ideas
because of the availability of materials. For instance, suppliers of marble products are
attracted by Romblon and Gapan (in Neuva Ecija) where marble abounds. Bagoong and
patis factories are established in areas near the coastlines of Malabon (Metro Manila),
Lingayen, (Pangasinan), and Balayan (Batangas).
Authors of books and composers of music may seek the commercial exploitation
of their work. The inventor of the new process or formulation of a new product may also
seek prospective investors to exploit or use his invention. Filipinos are currently building
inroads into the development of drugs extracted from local herbs. A particular gadgets
has already been introduced that help reduce gas consumption of vehicles.
Determination of Feasibility
Once a choice has been made on the business idea to adapt, its feasibility should
be determined. Oftentimes, a feasibility study is required. If the idea is found not to be
feasible, it should be discarded and a new one considered for determination of feasibility.
The feasibility study is a detailed investigation and analysis of a proposed business
venture to determine its vitality. According to the need, the study must contain some or
all of the following aspects:
1. Management study including proponents, personnel, and organization;
2. Marketing study;
3. Production facilities and the product;
4. Taxation and legal aspects;
5. Financing aspects;
6. Profitability; and
7. Social desirability.
Management Study. It is in this particular portion of the feasibility study where
the following aspects are determined:
1. The appropriate form of organization;
2. The internal structure of the organization;
3. The owners; and
4. The staffing pattern of the organization.
Marketing Study. This portion should provide the following information:
1. The future total demand for the product;
2. The competitive situation of the product in the industry;
3. An estimated annual sales volume;
4. Future selling prices; and
5. The marketing program.
Technical Study. In this particular aspect of the feasibility study, the following
requirements should be determined:
1. The manufacturing process selected, if applicable;
2. The rated capacity of the plant;
3. The design of the machinery;

12. 4. The location and lay-out of the plant;
5. The specifications of the structures; and
6. The requirements for operation.
Taxation Study. The tax burden applicable to the project should be shown in this
portion of feasibility study. An important factor that must be considered is that the design
of the project must be such that the tax burden is legally minimized.
Financing Study. The source of financing for the project is discuss in this portion.
Particular attention is given to selecting the most attractive financing scheme using
factors of cost and availability.
Profitability. The rate of return using various approaches is shown in this
particular aspect of the feasibility study.
Social Desirability. This particular aspect is optional. When it is included, however,
it should provide a description of the social returns applicable to the project. It should
present the benefits that will be afforded by the project of the community. Examples are
reduction of prices and provision of employment.
Assembling the Needed Resources
Once the feasibility of a proposed business project is determined by the experts,
the proponent may proceed to assemble the needed resources. This is made prior to the
start of business operations. The sources needed may comprise of the following: (1) initial
capital required; (2) the essential properties; (3) process; (4) personnel.
Initial Capital Requirements. A new business project requires initial capital to take
care of the following:
1. Cost of organization;
2. Working capital;
3. Acquisition of fixed assets; and
4. Reserves.
The cost of organizing a business includes payments made for business permits
and license, incorporation taxes, business name, and the like. Also included are lawyer’s
fees for initial legal requirements like the preparation of building or office contracts,
articles of incorporation, architect’s fee for construction plans of buildings, and
management consultancy fees. Whenever applicable, the following may also be included:
promoter’s fee and the cost of obtaining franchise, license for patents on required
inventions, and license for copyrights on required literary or artistic works.
Working capital is required to finance inventories and supplies, salaries and
wages, power, water, rent, insurance, transportation, advertising and sales promotion.
Manufacturing obligations of the firm and the financing of credit sales will also require
sufficient amount of working capital.
Fixed assets may be acquired through purchase or lease depending on the nature
and requirements of the firm. Fixed assets refer to business assets, which are acquired
for continued use in the production of goods or services. Examples are land, machinery,
buildings, furniture, fixtures, and equipment.
A reserve fund is required to take care of difficulties encountered due to
insufficient income generated by the firm. Failure to provide for this possibility may
jeopardize the firm’s operation.
Sources of Initial Capital. A new business project may initially be financed by using
any or a combination of various sources. The management of the firm about to start
operations will have to use time and expertise to avail of credit facilities offered by
suppliers and financing institutions.

13. A new firm may be financed by one or a combination of the two main sources of
capital: (1) the owners; and (2) the creditors. In single proprietorships and partnerships,
the owners may use their savings or sell some of their properties to provide the initial
capital. The initial fund requirements for the new corporation are raised through the sale
of common stock to the founder of the firm and a small group of intimates. Creditors
consist of friends and relatives, the government, financing institutions, and suppliers.
Retention of Control. There is possibility that at the promotion stage, outsiders
may deprive the promoter and the founders of control over the new business idea. It is,
therefore, important that certain control measures be instituted to protect the interests
of the promoter and the founders. These can be attained by using any or a combination
of the following: (1) leases; (2) options and contracts; (3) franchises and concessions; and
(4) patents and copyrights.
A lease involves an agreement over the use of real property for a period of time.
Leases are used to obtain initial control of the land and buildings required. The conditions
imposed in lease agreements vary. Some leases requires a fixed rental, while some
require other considerations. A common practice is one undertaken by some banks. The
agreements requires that the bank construct a building within the lot agreed upon; the
bank uses the building and the lot free of rental or any fee from the owner within a
stipulated period, after which the ownership of the building is passed on to landowner.
An option is an agreement whereby one person grants another the right to buy a
certain property at an agreed price, at or within a stated future time. Certain sums of
money are required for options, which may or may not be credited as part of the purchase
price.
The retention of required skills and properties can be achieved with the use of
contracts. The fulfillment of such contracts, however, may be jeopardized by some events
like the death of the person possessing the required skill, the destruction of the property
stipulated in the contract, and adverse effects of legal claims to the title of the property
by other parties. These risk can be partly taken care of by life insurance, title insurance,
accident insurance, and property insurance.
After the option or the contract has been signed, there is the possibility that the
owner of the subject property or the promoter may perform acts inimical to the interest
of the investors. This can be avoided by drawing options and contracts with enough
safeguards to protect the investors.
A franchise is an exclusive right granted by the franchisee to the franchisor for the
operation of a public utility service, or the selling or distribution of a product in a specified
area. Public utility franchises are those who granted by the government, like those for
electricity and water services. The other type of franchise is the business format franchise
which involves the exploitation of goods and services, identified by a trademark or a
tradename. It includes the preparation of the blue print of a successful way of carrying on
a business in all aspects. McDonald’s, Jollibee, Shakey’s, Handyman, and others have
become hallmarks of the development of the business format franchising in the
Philippines.
A concession is the right granted by the government to a concessionaire for the
exploitation of natural resources placed at his disposal for a sum consisting of a minimal
periodic payment plus a percentage of the income from sales.
A patent gives the holder the sole right to make, use, or sell his invention during
the period the patent remains in force. Patent rights can be obtain for new products, a
new substitute for existing products, as well as new production or marketing techniques.
The patent holder may license others to make use of his invention in return for payment
of royalties.

14. A copyright gives the holder the monopoly on the exploitation of a literary or
artistic work for a certain period subject to renewal. A variety of rights are protected by a
copyright. For instance, copyright in relation to a musical composition gives the holder
the exclusive right to:
1. Print, reprint, publish, copy, distribute, and sell a work;
2. Make any translation or other version or extracts or arrangements or
adaptations of work;
3. Dramatize a work if it be a non-dramatic work; to convert a work into a non-
dramatic work if it be a drama;
4. Publicly perform or represent a work in any manner or by any method
whatever for profit of otherwise;
5. Produce or reproduce a work in any manner or by any method whatever for
profit or otherwise. If not reproduced in copies for sale, to sell manuscripts or
any records whatever of a work; and
6. Make any other use or disposition of the work consistent with the laws of the
land.
A copyright holder may license others to make use of his rights in return for
payment of royalties. Copyright laws protect the holder for a certain period. The term of
protection for copyright in a musical work, for instance, shall be the lifetime of the creator
and fifty (50) years after his death. Royal payments for patents and copyrights are no
longer required when they have expired and have been reverted to public domain.
Valuation. The correct valuation of the property and services to be acquired by
the new business project is a very important step in the assembly of needed resources. In
some cases, stocks are issued as payment for the required property and services. Unless
a conservative valuation is used, stocks may be issued whose nominal value may be higher
than the amount representing the real assets of the business project.
Promoting a business may not succeed due to any of the following:
1. Overvaluation of property and services;
2. Inadequate sampling or overestimation of the potential market;
3. Underestimation of the expenses of establishing a business;
4. Inability to raise sufficient capital;
5. Managerial and personnel difficulties; and
6. Unforeseen changes in the state of the entire economy.
The Promoter
The promoter is the person responsible for the formation of a company. He sees
for the opportunity for a new business; interests other people in it; makes the business’
blue print; arranges for the initial funds, labor, and skills required; and sets the business
going.
The promoter is motivated by any or a combination of the following:
1. The promoter’s fee;
2. Shares of stock or bond in the new business project;
3. A management position in the new business project;
4. A new customer for his products or services; and
5. The desire to contribute to the economic growth of the local community.

15. Figure 2. Procedure in organizing a business
Promoters may be classified as follows:
1. Professional promoters – they are those whose main occupation is business
promotion;
2. Side-line promoters – they are persons who perform promotion activities
occasionally;
3. Banking promoters – they are banking institutions which provide business
promotion services to their clients;
4. Financial promoters – they consist of investment houses engaged in the
promotion of certain business ventures through the sale of securities; and
5. Subdivision promoters – they are those engaged in the development of new
subdivisions.
Liability of Promoters. The promoter undertakes to pursue his job with the
capacity of a temporary trustee. He cannot legally bind the firm into contracts and deeds
unless approved by the owners or the board of directors. This is legally tenable because
the promoter cannot act as the agent of a corporation still to be formed, hence, he does
not have a principal to present.
The nature of the job of the promoter provides him with an opportunity to make
excessive gains at the expense of the owners. Professional ethics, however, require that
he can only make profits up to the amount previously agreed upon. A secret profit made
at the expense of the firm is a ground for the cancellation of the promoter’s contract. In
other countries, he may even be sued for the recovery of profits he may have made or
obtained as compensation or for any losses he may have caused.
THE DECISION TO ENGAGE
IN BUSINESS IS MADE
Form a new business Buy an existing business
Prepare a list of opportunities
Analyze opportunities
Make a choice
If not feasible
Determine feasibility
If feasible
Assemble needed resources

16. True or False. Write T if the statement is correct; write F if the statement is incorrect.
1. Business is any unlawful economic activity concerned with the production and/or
distribution of goods and services for profit.
2. Genetic industries are involved in fishing, mining, lumbering and hunting.
3. The major kinds of business are commerce, industry, and service.
4. Business continues to provide mankind the basic necessities like food and shelter.
5. Government are means to develop a country’s economy.
6. Business has always been associated with economic growth.
7. A major reason for business failure is the businessman’s lack of sufficient skills in
managing finance.
8. Business and economy has an inverse relationship with each other.
9. One of the economic contributions to our economy is tax.
10. Examples of services are hotels, barbershops, and restaurants.
Test I. Write the correct answer.
1. It is the lawful or any legal entity for the purpose of profit.
________________________. Business
2. Kinds of business are classified in several ways like ___________________,
__________________ and _____________________.
3. __________________ is business firms engaged in buying and selling of goods and
services.
4. Genetic industries are businesses involved in ___________________,
__________________ and __________________.
5. __________________ is the first stage in the life cycle of business.
6. Businesses engaged in skills like restaurants are classified as
___________________.
7. __________________ are the business concerned with production.
8. __________________ are businesses involved extraction of goods from natural
resources.
9. __________________ is the process of determining what business to do and
preparing list of alternative business opportunities.
10. The entrepreneurs’ functions are to _____________________ and to
__________________.
11. __________________ is the provision of money for commercial use.
12. __________________ means realizing the highest possible income.
13. It refers to a time when a company decides on obtaining a higher rate of return
on its investment. It is __________________.
14. __________________ is the common product of financial accounting.
15. __________________ are essential elements in the planning and control of the
financial affairs of the business.
ASSESSMENT: TRUE OR FALSE
ASSESSMENT: IDENTIFICATION

17. Direction: Read each statement carefully and select the letter of the correct answer.
1. Which does not belong to the group?
a. Manufacturing c. Trading
b. Extractive d. Genetic
2. Businesses involved in agriculture, forestry, and fish culture.
a. Extractive c. Genetic
b. Construction d. Manufacturing
3. The primary objective of business is
a. political influence. c. community involvement.
b. earn profit. d. family control
4. Which does not belong to the group?
a. Commerce c. Recreational
b. Personal d. Finance
5. It is any lawful economic activity concerned with the production and/or distribution
of goods and services for profit.
a. Commerce c. Business
b. Trading d. Service
6. If import is greater than export, the balance of trade is
a. favorable c. no effect
b. unfavorable d. none of these
7. It includes buy and sell, trading, marketing and merchandising.
a. Service c. Business
b. Commerce d. Industry
8. If import is less than export, the balance of trade is
a. favorable c. no effect
b. unfavorable d. none of these
9. Which of the following is not a reason for the decline of our economy?
a. low productivity in the workplace
b. decline in the value of peso
c. favorable balance of trade
d. graft and corruption.
10. What is the relationship of business to economy?
a. direct c. no effect
b. inverse d. none of these
ASSESSMENT: MULTIPLE CHOICE

18. 11. This is the first step in the life cycle of a business
a. Promotion c. Prospecting
b. Organization d. Planning
12. Refers to discovery and exploration of a business opportunity with the purpose of
converting it into a going concern.
a. Feasibility study c. Business promotion
b. Business prospecting d. Business discovery
13. They are those whose main occupation is business promotion.
a. Side – line promoter c. Subdivision promoter
b. Financial Promoter d. Professional promoter
14. Includes payments made for business permits and licenses, incorporation taxes,
business names and the like.
a. Cost of organization c. Fixed assets
b. Working capital d. Reserves
15. It is required to take care of difficulties encountered due to insufficient income
generated by the firm
a. Fixed assets c. Reserves
b. Working capital d. Initial capital
16. Involves an agreement over the use of real property for a period of time
a. Copyright c. Franchise
b. Concession d. Lease
17. Gives the holder the sole right to make, use, or sell his invention during the period
until it remains in force.
a. Franchise c. Patent
b. Option d. Copyright
18. The rate of return using various approaches is shown in this particular aspect of the
feasibility study
a. Technical c. Financing
b. Marketing d. Profitability ,
19. It is a detailed investigation and analysis of a proposed business venture to
determine its viability.
a. Business promotion c. Business prospecting
b. Feasibility study d. Organization
10. It is the person responsible for the formation of a company.
a. Promoter c. Proprietorship
b. Entrepreneur d. Stockholder

19. BASIC CONCEPTS
Terms, unless they are clearly defined, are sometimes confusing. As some of them
are related, it is important to define them and discuss their relationship with other
relevant terms.
Finance
Finance may be defined as the study of the acquisition and investment of cash for
the purpose of enhancing value and wealth.
Categories of Finance. Finance, in general, is divided into categories according to
the type of entity or organization served. They are the following:
1. Public finance
2. Private finance
Public Finance. Public finance is that category of general finance, which deals with
the revenue and expenditure patterns of the government and their various effects on the
economy.
Private Finance. This category deals with the area of general finance not classified
under public finance. It is subdivided into the following:
1. Personal finance;
2. The finance of non-profit organizations; and
3. Business finance.
Personal finance is concerned with the fundamentals of managing one’s own
personal money affairs. The finance of non-profit organizations includes private
undertakings such as charity, religion, and some private educational institutions.
LESSON 3
Fundamental Concepts and Tools of Business Finance
TOPICS
1. Basic Concepts
2. The Goals of Business Finance
3. The Financial Statements and Its Significance
4. The Budget and Its Significance
5. The Annual Reports
LEARNING OUTCOMES
At the end of the lesson, you should be able to present the
fundamental concepts and tools related to business finance.
TOPIC 1: Basic Concepts

20. DEFINITION OF BUSINESS FINANCE
The term business finance refers to the provision of money for commercial use.
Business finance, however, is more than just the provision of money. It is also concerned
with the effective use of funds. As such, it covers the financial management of private
profit seeking concerns in the business of service, trade, manufacturing, mining, public
utilities, and financing. With the foregoing requirements, business finance may be defined
as the procurement and administration of funds with the view of achieving the objectives
of the business.
Specifically, however, business fiancé may be concerned with three aspects:
1. Small business finance;
2. Corporation finance; and
3. Multinational business finance.
It must be made clear that there are similarities and differences between the three
aspects of business finance.
Figure 3. Categories of Finance
THE GOALS OF BUSINESS FINANCE
Private business is established primarily for profit. This end, however, can be
achieved by the effective management of the various business functions. One of these is
the finance function. Like the other functions, it has its own goals. The goals of business
finance are variously expressed as follows:
1. Maximizing profit;
2. Maximizing profitability;
3. Maximizing profit subject to cash constraint;
4. Maximizing net present worth; and
5. Seeking an optimum position along a risk-return frontier.
FINANCE
Public Finance Private Finance
Finance of Non-
Profit Organization
Personal
Finance
Business
Finance
Corporation
Finance
Multinational
Business
Finance
Small
Business
Finance
TOPIC 2: The Goals of Business Finance

21. Maximizing Profit
Maximizing profit means realizing the highest possible peso or dollar income. A
firm, for instance, may seek to double its peso or dollar income for the current year. This
framework, however, is not very useful in making sound financial decisions. The amount
of profit earned by the firm is not adequate to evaluate its performance. For instance, the
net income earned by XYZ Company for a certain year in the amount of ₱480 million does
not provide much useful information for the investor or financial manager. This is true
even if the same amount represents an increase from previous year’s profits of the firm.
Maximizing Profitability
When a firm decides on obtaining a higher rate of return on its investment, it is
said to be maximizing profitability. The following data show an improvement in the
company’s performance.
MIKAELA COMPANY
2005 2006
Net Worth ₱100,000,000 ₱200,000,000
Net Profit 1,000,000 5,000,000
Return on Investment 10% 25%
Maximizing Profit Subject to Cash Constraint
In the quest for profit maximization, undue emphasis is sometimes placed on cash
balances. Maintaining too large a cash balance reduces the chance of a favorable rate of
return, while running out of cash when needed is disastrous. The ideal set-up is to
maximize profits, while at the same time maintaining a cash balance that can take care of
cash requirements anytime. This condition is especially critical in the operation of banks.
Maximizing Net Present Worth
Under the net present worth concept, the objective of the firm is to maximize the
current value of the company to its owners. The net present worth of the firm is equal to
the value now of the firm plus values arising in the future. The present worth of values
arising in the future are computed and added to the present worth of the other values of
the firm. Present values may be better understood by way of knowing the concept of the
time value money.
Time Value Money. This concepts indicates that money increases in value with
the passing of time. A peso today could be deposited in a bank and made to earn interest.
This capacity to earn makes the peso today worth more than the peso that would be
received in the future. Thus, to be able to find out the present worth of a peso that would
be received in the future, the corresponding interest (or discount) should be deducted
from that future peso.
Calculation of Present Worth. The present worth of a value to be received in the
future is illustrated as follows:
Question: what is the value today of ₱100,000 to be received next year assuming
that the prevailing rate of interest is ten percent (10%) per annum?
Solution:
Value today
of next year’s = amount = ₱100,000 = ₱90,909.09
₱100,000 1+rate of 1.10
interest

22. Seeking an Optimum Position Along a Risk-Return Frontier
A firm can set a goal of achieving the best possible combination of risk and return.
A little more risk may be accepted, for instance, for an expected additional rate of return.
Definition of Return on Investment or Net Worth. The net income generated by
the use of investments or the next worth of a firm is referred to as return of investment.
When it is expressed in percentage, it is called the rate of return.
Definition of Risk. Uncertainty as to loss is called risk. When used in finance, the
term applies to the potential incurrence of loss of money or its equivalent. Risk is
discussed at length in a succeeding chapter.
Calculation of Expected Value using Risk and Return Factors. The optimum
position of risk and return may be determined by calculating the expected value of
alternative decisions. The expected value of a return on investment is equal to the return
times the percentage of probability that it will happen (called the risk factor). An
illustration is provided as follows:
Alternative Return on Probability Expected Value
Net Worth
(A) (B) (AxB)
1 ₱100 million 60% ₱60 million
2 ₱200 million 50% ₱100 million
(optimum position)
3 ₱300 million 30% ₱90 million
THE FINANCIAL STATEMENT
Financial statements are those that present financial information to various
interested parties. Inasmuch as the finance manager is responsible for managing the
financial activities of the firm, he is naturally one of the most concerned about getting
relevant information through the use of financial statements, but only two of them are
important from the point of view of business finance, these are: (1) the balance sheet;
and (2) the profit and loss statement.
The Balance Sheet
The balance sheet is the statement produced periodically, normally at the end of
financial year, showing an organization’s assets, liabilities, and the interest of the owners.
Assets. The assets action of the balance sheet shows everything that the firm owns
and which has monetary value. Assets are classified into four items and are presented in
the balance sheet in the order of how quick they can converted into cash. The
classifications are as follows:
1. Current Assets. These are composed of cash, bank deposits, and other items
readily convertible into cash like accounts receivable, stocks and work-in-process,
and marketable securities;
2. Trade Investments. These are composed of investments in subsidiary or associated
companies;
3. Fixed Assets. These items show the firm’s ownership of property like hand,
buildings, plan and machinery, equipment, vehicles, furniture and fixtures, all
valued at cost less depreciation written off; and
4. Intangible Assets. These items present goodwill, patents, copyright which are
attributed to the firm.
Liabilities. The liabilities section of the balance sheet shows the profile of the
debts of the company. They are classified into several items and are presented first and
TOPIC 3: The Financial Statements and Its Significance

23. referred to as current liabilities. Long-term liabilities are those which are payable after
one year. The following are common liability items:
1. Accounts Payable. These are usually composed of debts payable within a few days,
weeks, or months, like those incurred in the purchase of raw materials and stocks.
2. Loans and Notes Payable. These are debts evidenced by promissory notes and
oftentimes backed up by collaterals. Creditors of this type of liability are
composed of banks, suppliers, financing companies, and the public.
3. Advances from Customers. Sometimes, customers are required to make down-
payments before orders are processed. Inasmuch as this is not yet earned by the
company, they are considered liabilities.
4. Accrued Expenses. These represents obligations, which have been incurred but not
yet paid.
5. Mortgage Payable. This comprises borrowings and other sources of funds. This
item also represents long-term debts and is usually secured by land, buildings, or
equipment.
6. Bonds Payable. When a large amount of long-term debt is sought by the firm from
a large number of creditors, bonds are usually issued. The amount borrowed is
divided into denominations like ₱500, ₱1,000, ₱5,000, and individual bond
certificates are issued in these amounts. Each creditor holds the bond, or the
promise to pay, for his share of the company’s debt.
Net Worth. The net worth section of the balance sheet shows the interest of the
owner or owners in the company.
In a single proprietorship, the owner’s interest usually appears as a single account,
for instance, “Isabelo Musngi, Capital”. This represents sums invested by the owner,
which is increased by profits and decreased by losses and withdrawals.
In a partnership, the interest of the partners are presented separately like the
following:
Francisco Taguinod, Capital ₱10,000,000
Clarita Navarro, Capital ₱20,000,000
Angelita Ballesteros, Capital ₱30,000,000
Total Net Worth ₱60,000,000
The Net Worth section of a corporation’s balance sheet will appear as follows:
1. When the shares of stock have par value:
Capital Stock ₱50,000,000
2. When the share of stock have no par value (but with an arbitrary stated
value):
Capital Stock (stated value at
₱10 per share) ₱20,000,000
Paid-in surplus ₱30,000,000
Total Net Worth ₱50,000,000

24. Exhibit 1
A SAMPLE BALANCE SHEET
ANDRES NICOLAS CORPORATION
Balance sheet
December 31, 2006
ASSETS
Cash ₱ 38,130,000
Accounts Receivable 97,943,000
Inventory 161,351,000
Total Current Assets ₱ 297,424,000
Fixed Assets 131,067,000
Prepaid Expenses 9,239,000
Cash Value, Life Insurance 22,431,000
Total Assets ₱ 460, 161,000
LIABILITIES
Due Banks ₱ 45,000,000
Notes Payable 24,000,000
Accounts Payable 40,203,000
Accruals 15,332,000
Taxes 5,906,000
Undistributed Earnings 2,109,000
Total Current Liabilities ₱ 132,604,000
OWNERS’ EQUITY
Common Stock ₱ 104,500,000
Capital Surplus 0
Earned Surplus 223,057,000
Total Liabilities and Net Worth ` ₱ 460,161,000
3. When there is a special class of ownership:
Capital Stock
Preferred (₱500 par, 8% 100,000 shares) ₱ 50,000,000
Common (₱500 par, 200,000 shares) ₱ 100,000,000
Total Net Worth ₱ 150,000,000
The Income Statement
The income statement represents the revenues realized from the sale of
commodities and services produced by the company, as well as the costs and expenses
incurred in connection with the realization of said revenues. The income statement also
referred to as profit and loss statement, as two possibilities are presented, i.e., net profit
or net loss. Unlike the balance sheet which shows the financial condition of the firm on a
given date, the income statement presents a summary of the transactions for a given
period.
The income statement is characterized by four distinct items: (1) revenues; (2)
expenses; (3) other income; and (4) net profit or loss.
Revenues. This term refers to the gross income from the production and sale of a
firm’s product or service. Revenues include cash collections and receivable or unpaid sale.
This item does not include trade discounts allowed to distributors of other middleman.
To obtain net income or net sales, returns and allowances are deducted from the gross
revenues.
Expenses. This refers to the monetary values of goods and services used in the
production and delivery process in order to obtain revenues. Expenses consist of three

25. items: (1) the cost of goods manufactured and sold; (2) operating expenses; and (3) other
expenses.
1. Cost of Goods Manufactured and Sold. This item presents a summary of
the cost of raw materials, labor, and various overhead costs directly
involved in the manufacturing process and which represent the
manufacturing cost of goods sold during the period under consideration.
Overhead costs include expenditures like salaries of supervisors,
depreciation, light and water, supplies, and factory rent.
The cost of direct materials is computed by deducting the raw materials inventory
at the end of the period from the total raw materials available for use. In turn, the
raw materials available for use are computed by getting the sum of raw materials
inventory at the beginning of the period and purchases during the period. The
formula for determining the cost of raw materials used is as follows:
Raw Materials Inventory, Beginning of the Period
+ Purchases during the period _____
= Raw Materials Available for Use
- Raw Materials Inventory, End of the Period
= Cost of Raw Materials Used
The cost of goods manufactured is computed by deducting the work-in-
process, end of the period, form the cost of goods processed. In turn, the cost of
goods processed is the sum of the cost of raw materials used, the direct labor,
overhead, and if applicable, the work-in-process at the beginning of the period.
When the cost of goods manufactured is determined, the formula will appear as
follows:
Cos or Raw Materials
+ Direct Labor
+ Overhead
+ Work-in-Process, beginning
= Cost of Goods Processed
- Work-in-Process, end
= Cost of goods Manufactured
As some of the goods manufactured may have been added to inventory, the cost
of goods sold may be computed by deducting the finished goods inventory (end) from the
total amount of goods available for sale. The cost of goods manufactured and the finished
goods inventory (beginning) comprises the total amount of goods available for sale. Thus,
the following formula is used in determining the cost of goods manufactured and sold:
Cost of Goods Manufactured
+ Finished Goods, Beginning
= Total Goods Available for Sale
- Finished Goods, End
= Cost of Goods Manufactured and Sold

26. Exhibit 2
A SAMPLE INCOME STATEMENT
VIRGILIO ILIAGAN COMPANY
Income Statement
12 Months to December 31, 2006
Sales ₱ 150,817,000
Less: Royalties 8,853,000
Net ₱ 141,964,000
Cost of Goods Sold:
Beginning Inventory 17,161,000
Purchases 79,600,000
Freight 1,179,000
Labor 12,970,000
Indirect Manufacturing Expenses 4,847,000
₱ 115,757,000
Less: Ending Inventory 53,400,000
₱ 62,357,000
Gross Profit ₱ 79,607,000
Operating Expenses:
Salaries-administrative ₱ 27,090,000
Salaries-secretarial 5,625,000
General Office 2,120,000
Travel and Entertainment 7,650,000
Auto Expenses 4,374,000
Depreciation and Amortization 1,016,000
Legal and Accounting 4,366,000
Payroll Taxes 4,753,000
Business Taxes 1,749,000
Telephone 1,749,000
Insurance 1,515,000
Management Fee 9,895,000
Research and Development 2,996,000
Miscellaneous 4,990,000
Contributions 2,508,000
Advertising 509,000
Literature 808,000
Interest 2,447,000
Bad Debts 2,580,000
Commission -
₱ 88,740,000
Net Loss - ₱ 9,133,000
2. Operating Expenses. These represent marketing, general, and
administrative expenses. Examples are advertising, salaries, and wages.
3. Other Expenses. These include interest expense and sales discounts.
Other Income. This item refers to non-operating income such as interest income
and purchase discounts.
Net Profit or Net Loss. Net profit or net income refers to the difference between
revenues less period expenses and product costs. When expenses and costs are greater
than the revenues, the result is a net loss.

27. SIGNIFICANCE OF FINANCIAL STATEMENTS
There are five distinct groups interested in knowing the financial standing of the
firm. These are: (1) the owners, (2) the management, (3) the creditors, (4) the
government, and (5) prospective investors. In some cases, customers and employees
require financial data about the firm. Financial statements and budgets provide most of
the information required by interested parties.
The owners are primarily concerned with receiving information on the anticipated
financial benefits that will be generated by the firm. They also need to know whether it
wise or not to continue their relationship with the firm owners. These information
requirements are provided by the financial statements.
The management is concerned with effective planning and control of the activities
of the firm. As various financial information is provided by the financial statements and
budgets, they are particularly useful to management.
The creditors will be interested to know if the firm is credit worthy. The use of the
firm’s financial statements will help them find out the answer.
Financial statements are required by the government for tax and regulatory
purposes. Examples of the areas of concern are income tax assessment and the regulation
of the issuance of securities like stocks and bonds.
Financial statements are also especially important to prospective investors. They
are mainly interested in the protection of their investments and the earnings they require
over a period of years. The balance sheet and the income statement will be very useful in
this regard.
THE BUDGET
Concerning the finance function of the manager, one of the useful tools he could
use is the budget.
The budget is defined as an estimate of income and expenditures for a future
period. The budget is contrasted with the income statement, which is the summary of the
performance of the firm for a past period, and with the balance sheet which presents the
financial condition of the firm at a given date, past or present. The budget completes the
financial picture by referring to the future.
Budgets are essential elements in the planning and control of the financial affairs
of the business. Large corporation place so much emphasis in the annual budget which is
normally broken down into monthly and weekly periods, and which may take several
months to prepare.
In preparing the budget, an estimate of sales and income for the period is made,
followed by estimates of expenditures in purchasing, administration, production,
distribution, and research. Detailed budgets of cash flow and capital expenditures are also
included.
The Sales Budget
The sales budget is the starting point of company budgets. It shows an estimate
of sales in units and dollars or pesos for each major subdivision of sales.
The Material and Purchases Budget
This portion of company budget refers to the estimate of the materials required
by the firm, specified in quantities, costs, timing of purchase, the required delivery dates,
and other requirements.
The Production Budget
The production budget is an estimate of the quantity of products that should be
produced in accordance with the sales budget. It also shows the monthly breakdown of
quantities to be produced for each product depending upon the firm’s seasonal sales
index. The total units to be produced could be derived using the folloqing equation:
TOPIC 4: The Budget and Its Significance

28. Budget Sales
- Starting Finished Goods Inventory (Expected)
+ Ending Finished Goods Inventory (Planned)
= Total Units to be Produced
SIGNIFICANCE OF BUDGETS
Budgets are especially important to management because they are able to do the
following:
1. Anticipate asset needs;
2. Plan for necessary financing; and
3. Established standards by which to test current operating performance.
Customers who would want to established long-term relationship with the firm
would be particularly interested to know how stable the firm is. Financial statements
could provide them with initial information.
Employees who would want to consider long-term employment with the firm
would also want to know the long-term prospects of the firm. Financial statements would
be useful in this regard.
THE ANNUAL REPORT
The report sent out each year by the company to its stockholders or members is
called the annual report. It normally contains the following:
1. The balance sheet;
2. The profit and loss statement;
3. The auditor’s report; and
4. The chairman’s report.
In case the firm is part of a group, the report must also contain a consolidated
balance sheet and a consolidated profit and loss statement.
LBJ Company manufactures staplers. At the beginning of November, the following information
was supplied by its accountant:
Direct materials inventory P 68,000
Work in process inventory 12,000
Finished goods inventory 11,750
During November, direct labor cost was P 35,000, direct materials purchase were P 90,000, and
the total overhead cost was P 223,000. The inventories at the end of November were:
Direct materials inventory 20,000
Work in process inventory 7,650
Finished goods inventory 8.620
Solve the following:
1. Total manufacturing cost.
2. Cost of goods manufactured.
3. Cost of goods sold.
TOPIC 5: The Annual Reports
ASSESSMENT: PROBLEM SOLVING

29. WHAT ARE THE FINANCIAL MARKETS
There are lots of individuals and firms with surplus funds. This actually means that
their current expenditures are smaller than their current incomes. To many of them, the
surplus funds need to be invested.
At the same time, there are people and firm whose needs for funds are greater
than their current incomes. They need a reliable source of loanable funds.
Individuals and firms who want to borrow money are brought together with those
who want to lend in the financial markets. These markets provide a permanent venue for
savers and borrowers, and which render financial services whenever required by their
customers. These services are made possible by the financial markets through expediting
the creation and trading of financial instruments.
Figure 4 shows an illustration of how funds and financial instruments are
channeled to and from the surplus spending units (SSUs) and the deficit spending units
(DSUs) in the financial markets.
BENEFITS OF FINANCIAL MARKETS
The operation of financial markets offer advantages which covers the following:
1. Funds are directed to DSUs which can use them most efficiently; and
2. Liquidity is provided to savers.
LESSON 4
Financial And Capital Markets
TOPICS
1. Financial and Capital Markets Defined
2. Benefits and Components of Financial and Capital Markets
3. Classification of Financial Markets
4. Methods of Fund Transfer
5. Under Writing and Selling the Firm’s Securities in the Capital Market
LEARNING OUTCOMES
At the end of the lesson, you should be able to classify savings and
investment. Identify the environment where the business operates provides
better perspective in decision making.
TOPIC 1: Financial and Capital Markets Defined
TOPIC 2: Benefits and Components of Financial and Capital Markets

30. Direct Credit
Market
Primary Securities
Funds
Funds
Primary Securities
Secondary Securities
Primary Securities
Funds
Funds
Intermediation
Direct
Market Market
Figure 4. Channels for Funds and Financial Instruments in the Financial Market
Financial markets, just like any market, operate under the influence of the demand
and supply of funds. DSUs that can use borrowed funds in the most productive manner
can afford to pay higher interest rates. Because of this, they have an edge in the bidding
for loanable funds. As such, business firms, big and small, compete for the use of the funds
made available by the financial market. The competition will push interest rates higher
and this will motivate savers to save more so they will have more funds for lending.
An additional benefit provided by financial markets is liquidity. Without the
intervention of financial markets, savers will directly lend to borrowers. This arrangement
DIRECT FINANCING
Private placements
Brokers
Dealers
Investment bankers
SURPLUS SPENDING
UNITS
Households
Business firms
Government
DEFICIT SPENDING
UNITS
Households
Business firms
Government
INDIRECT FINANCING BY
FINANCIAL INTERMEDIARIES
Commercial banks
Savings and loans Associations
Mutual Savings banks
Credit unions
Insurance companies
Pension funds
Finance companies
Mutual funds
Money market funds

31. forces the lender to wait for the maturity date of the loan before he gets his money back.
The lender will be at a great disadvantage if he finds out later that he needs the loaned
amount before maturity. This problem is eliminated when financial markets are tapped.
This happens because financial instruments are issued to lenders, which in turn, can be
converted to cash even before maturity, by endorsement or sale.
WHY FIRMS INVEST AND BORROWS
Firms, at one time or another, are confronted by capital deficiency. This happens
when opportunities for investment come by. Additional investment may bring additional
income or economies in operation. An electronics-retailing firm, for instance, may expand
by opening branches in various places. The immediate advantages that may be derived
are as follows:
1. Quantity discounts for bulk purchases granted by suppliers; and
2. Additional revenues from sales.
When the owners of the firm cannot provide additional capital, they will resort to
borrowing. This situation happens not only to small firms but to big firms as well.
A system must be able to address that particular economic need. The answer lies
in the operation and maintenance of a financial system, which includes financial markets.
CLASSIFICATION OF FINANCIAL MARKETS
Financial markets may be classified as follows:
1. Primary market
2. Secondary market
3. Money market
4. Capital market
5. Bond market
6. Stock market
7. Mortgage market
8. Consumer credit market
9. Auction market
10. Negotiation market
11. Organized market
12. Over-the-counter market
13. Spot market
14. Futures market
15. Options market
16. Foreign exchange market
Primary Market
A financial market in which newly issued primary and secondary securities are
traded for the first time is called primary market. Investors who buy these new issues are
supplying funds to DSUs which issue the securities.
Secondary Market
A secondary market is that financial market through which existing financial
securities are traded. SSUs which bought new securities from the primary market may sell
the same to the secondary market anytime they wish to change their portfolios before
TOPIC 3: Classification of Financial Markets

32. maturity dates. As such, the secondary market provides liquidity to the SSUs with
securities held.
When banks buy Treasury bills (T-bills) from the Bangko Sentral, they do so in
consideration of their clients who buy the T-bills from them and which forms a solid
secondary market. Figure 6 shows the flow of funds and securities in the primary and
secondary markets.
Money Market
The money market is that financial Market on which debt securities with an
original maturity of one year or less are traded. Long-term securities may also be traded
in the money market if they have six months or less left to maturity.
Banks like the Land Bank of the Philippines perform money market functions:
PRIMARY MARKET: New Issues
N
ew Funds
New Common Stock and New Stock and
Bond Certificates Bond Certificates
Money
Common Stock and
Bond Certificates
Common Stock and
Bond Certificates
Money
SECONDARY MARKETS: Seasoned or Existing Issues
Figure 6. The flow of Funds and Securities in Primary and Secondary Markets
Capital Market
The capital market is that portion of the financial market where trading is
undertaken for securities with maturity of more than one year. Banks that bid for two-
year Treasury bonds are considered part of the capital market.
The capital market is subdivided into three parts:
1. The bond market;
2. The stock market; and
3. The mortgage market.
Investment Bankers and Private
Placement
Household
Sector Business
Sector
Stock Exchanges and Over-the-
Counter Market

33. Bond Market
The market for debt instruments of any kind is called the bond market. It operates
through a system of dealers using a telecommunications network, rather than in a single
physical location for trading. Dealers include giant banking firms located around the
world.
Stock Market
The stock market is that financial market where the common and preferred stocks
issued by corporations are traded. It has two components: (1) the organized exchanges;
and (2) the less formal over-the-counter markets.
There are many organized exchanges throughout the world like the New York and
London Stock Exchanges. In the Philippines, stocks are openly traded in the Philippine
Stock Exchange. The companies whose stocks are traded in the Philippines Stock
Exchange are classified into the following categories:
1. Banks
2. Financial service
3. Communication
4. Power and energy
5. Transportation services
6. Construction and other related products
7. Food, beverages, and tobacco
8. Holding firms
9. Manufacturing, distribution, and trading
10. Hotel, recreation, and other services
11. Bonds, preferred stocks, and warrants
12. Others
Mortgage Market
The mortgage market is that portion of the financial market which deals with loans
on residential, commercial, and industrial real estate, and on farmland.
Various financial institution comprise the mortgage market. This may be derived
from a review of advertisements in newspapers where financial institutions are inviting
interested parties to buy foreclosed properties. Aside from banks, the National Home
Mortgage Finance Corporation, the Government Service Insurance System, and the Social
Security System grant mortgage loans, secure by house and lot as collateral.
Consumer Credit Market
The market involved in loans of autos, appliances, education, and travel is referred
to as consumer credit market. As there are millions of consumers tapping the credit
market, it is expected that there will be a number of financing institutions extending auto,
salary, and various personal loans to consumers.
Auction Market
The auction market is one where trading is conducted by an independent third
party according to a matching of prices on orders received to buy and sell particular
security. Stocks are sold to the highest bidder on the trading floors.
At the Philippine Stock Exchange, buyers of securities make their bids and
prospective sellers make their offer. Bids and offers stipulate both price and volume and
are handled by the trader, an agent of the auction market.

34. Offers are ranked from the lowest price up; bids from the highest price down. Bids
and offers are matched with one another. If there is a match, Trade is consummated.
Buyers and sellers do not directly trade with one another, but though the trader.
The Philippine Stock Exchange is an example of an auction market.
Negotiation Market
When buyers and sellers of securities negotiate with each other regarding price
and volume, either directly or through a broker or dealer, they are engaged in the financial
market called negotiation market.
Securities that are not frequently traded and which are in large volume may not
be readily accommodated in the auction market for lack of time to receive sufficient
orders. This situation is remedied by the negotiation market where the buyers and sellers
are given sufficient time to locate one another and to revise either price or volume in
order to clear the market.
Once in a while, the Philippine government negotiates with institutions like the
World Bank for loans intended for various projects.
Organized Market
The organized market is that financial market with fixed trading rules. It is situated
at a central location in the financial district in which trading is generally conducted by
auction. Another name for organized markets are exchanges like the Philippines Stock
Exchange and the Australian Stock Exchange. Common and preferred stocks, bonds, and
warrants are sold at the Philippine Stock Exchange.
Stock exchanges have specifically designated members, and have an elected
governing body – the board. Members have seats in the exchange, which are bought and
sold. The seat gives the holder Philippine Stock Exchange is composed of 15 members.
Over-the-Counter Market
The over-the-counter market is that market consisting of large collection of
brokers and dealers, connected to electronically by telephones and computers that
provide for trading in unlisted securities. All securities not traded in the stock exchange,
for one reason or another, are traded over the counter.
The over-the-counter market consists of facilities, namely:
1. Relatively few dealers who hold inventories or over-the-counter securities and
act as a securities market;
2. The many brokers who act as agents in bringing these dealers together with
investors;
3. The computers, terminals, and electronic networks that provide a
communications link between dealers and brokers.
Spot Market
When securities are traded for immediate delivery and payment, the market type
referred to is spot market. The spot price is the feature of the spot market and which is
actually the price paid for a security that will be delivered on the spot immediately. The
term immediately may actually mean one or two days to one week depending on the
facilities used or the tradition in the area.
The spot market is an alternative to the future market.

35. Futures Market
The futures market is that market where contracts are originated and traded that
give the holder the right to buy something in the future at a price specified by the
contract.
For some time in the past, there was a futures market operating in the Philippines,
but I was dissolved because of some difficulties. As its importance cannot be discounted,
The Bankers Association of the Philippines has recommended key reforms in government
regulations that will pave the way for the resumption of futures trading in the country.
Options Market
The options market is one where stock options are traded. A stock option is a
contract giving the owner the right to either buy or sell a fixed number of shares of a stock
(usually 100) at any time before the expiration date at a price specified in the option.
Options contract may cover items like gold and Treasury bonds. Options are
traded in organized securities exchanges like the Philippine Stock Exchange.
One purpose of the option market is to make possible investors who wish to
reduce the risk of losing money due to price changes in the future. For instance, an
importer purchasing goods to be paid in foreign currency may avoid the risk of a sharp
rise in the foreign exchange rate by buying an options contract.
Foreign Exchange Market
The foreign exchange market is the market where people buy and sell foreign
currencies. This market is composed of the following:
1. Banks located throughout the world buying and selling monies, in the form of
foreign currencies and deposits in foreign banks;
2. Foreign exchange dealers; and
3. Currency exchanges catering mostly to tourists and are found in the
downtown areas, airports, and railroad stations in major tourist centers.
METHODS BY WHICH FINANCIAL MARKETS TRANSFER FUNDS
When firms need funds, the financial markets provide two methods by which
funds could be transferred to them. The methods consist of direct and indirect finance.
Direct Finance
Direct finance refers to lending by ultimate borrowers with no intermediary.
Under this method, the SSU gives money to the DSU in exchange for financial claims on
the DSU. The claims issued by the DSU are called direct claims and are typically sold in
direct credit markets such as the money or capital markets.
Direct financing provides SSUs with a venue for savings with expected returns. The
DSUs as a result, are provided with a source of funds for consumption or investment. This
arrangement increases the efficiency of the financial market.
Direct financing, however, has some disadvantages. These are as follows:
1. There are few DSUs which can transact in the direct market because the
denominations of securities sold are very large (usually millions of pesos).
2. It is difficult to match the requirements of SSUs and DSUs in terms of
denomination, maturity, and other factors.
TOPIC 4: Methods of Fund Transfer

36. Methods of Direct Financing. There are various means used in direct financing.
These are as follows:
1. Private placements;
2. Brokers and dealers; and
3. Investment brokers.
Private placement refers to the selling of securities by private negotiation directly
to insurance companies, commercial banks, pension funds, large-scale corporate
investors, and wealthy individual investors.
A broker is one who acts as an intermediary between buyers and sellers but does
not take title to the securities traded.
INDIRECT FINANCE
Funds Funds
Funds
FINANCIAL
MARKETS
Funds Funds
DIRECT FINANCE
Figure 5. Transfer of Funds From Lenders to Borrowers
A dealer is one who is in the security business acting as a principal rather than an
agent. The dealer buys for his account and sells to customers from inventory. He makes
profits by selling his inventory of securities at a price higher than the acquisition cost.
The investment banker is a person who provides financial advice and who
underwrites and distributes new investment securities.
Indirect Finance
Indirect finance (also called financial intermediation) refers to lending by an
ultimate lender to a financial intermediary that then relends to ultimate borrowers.
Financial intermediaries includes commercial banks, mutual savings banks, credit unions,
life insurance companies, and pension funds.
The beneficiaries of direct financing brought to the fore the services of financial
intermediaries. Direct claims with one set of characteristics are purchased from
borrowers, then transformation into indirect claims with a different set of characteristics
and then sold to lenders.
FINANCIAL INTERMEDIARIES
Lender-Savers
1. Households
2. Business Firms
3. Government
4. Foreigners
Borrowers-Savers
1. Households
2. Business Firms
3. Government
4. Foreigners

37. The underwriting of securities may be done using any of the following methods:
1. negotiated underwriting;
2. competitive underwriting;
3. commission sales;
4. direct sales; and
5. firm commitment basis.
Negotiated Underwriting
When the issuing firm and the investment banker meet and agree on the terms and
conditions of the underwriting, this method is referred to as negotiated underwriting.
Several steps are required in the use of this method. These are the following: 1. The firm
decides that additional funds are needed and a
suitable investment banker is identified.
A pre-underwriting conference is made between the firm and the investment banker.
The following items are discussed:
a. The appropriate amount of funds to be raised;
b. The receptiveness of the capital market to different
types of long-term securities;
c. The appropriate timing of such an issue; and
d. The terms of the underwriting agreement between
the investment banker and the firm.
3. An underwriting syndicate is formed by the one who initiates the underwriting. The
syndicate is a temporary association of several investment bankers, with the number of
participants varying from one, when the initiating underwriter handles the whole issue,
to a few dozens if the amount to be raised is large. The initiating underwriter often
becomes the manager of the syndicate and forms an agreement with the other
underwriters in the syndicate which defines the responsibilities, liabilities, and fees of
each and specifies the proportional amount of the issue each must purchase.
Competitive Underwriting
competitive underwriting is similar to the negotiated underwriting except that
the underwriting group bids against other underwriting groups for the initial purchase of
the securities at a public auction.
Commission-Best Efforts Basis
When the investment banker acts as a selling agent for the issuer and not as an
underwriter, he is paid a commission. The investment banker agrees to try his “best
efforts" to sell the security
is made on the successful sale of the entire amount. Whatever is left over is returned to
the issuing corporation.
Direct Sale
There are instances when the issuer sells directly to the public, bypassing the
underwriter entirely.
Firm Commitment Basis
The firm commitment basis is an underwriting agreement wherein the
investment house agrees to purchase the issue from the issuing corporation.
TOPIC 4: Under Writing and Selling the Firm’s Securities in the Capital Market

38. Test I. Enumerate the following
1-3 The classification of SSU’s or Surplus Spending Units
4-6 Methods of Direct Financing
7-9 Parts of Capital Market
10-11 Two components of Stock Market
12-15 Give at least four classifications of financial market
Test II Essay (5 Points)
Discuss logically and comprehensively in a paragraph form the advantages and
disadvantages of indirect financing?
ASSESSMENT: ENUMERATION
ASSESSMENT: ESSAY

39. Working Capital
To obtain revenues, the firm strives to provide customers with products or
services. To achieve this, various inputs are required, all in need of adequate funding.
What is needed is a portion of the total capital which will take care of financing the day-
to-day activities of the firm. The funding requirement is covered by the firm’s working
capital.
MEANING AND COMPOSITION OF WORKING CAPITAL
Working capital refers to that part of the capital of the company which is
continually circulating. It is circulating in the sense that the initial cash funds of the firm
are converted into inventories, which in turn are converted into cash or accounts
receivable and ultimately into cash again.
Working capital may be described in two ways: (1) gross working capital, which is
the total amount of the firm’s current assets; and (2) working capital, which is the total
amount of current assets minus current liabilities.
The gross working capital of the firm is usually composed of the following:
1. cash in the firm’s safe;
2. checks to be cashed;
LESSON 5
Working Capital Management
TOPICS
1. Meaning and Composition of Working Capital
2. The Need for Working Capital
3. Management of Working Capital
LEARNING OUTCOMES
At the end of the lesson, you should be able to Identify the
composition, the need and the management of the working capital
TOPIC 1: Meaning and Composition of Working Capital

40. 3. balances in the bank accounts;
4. marketable securities (not including stocks in subsidiaries);
5. notes and accounts receivable;
6. supplies;
7. inventories;
8. prepaid expenses; and
9. deferred items.
THE NEED FOR WORKING CAPITAL
Working capital is required for the following purposes:
1. Replenishment of Inventory. A sufficient stock of inventory is required to support
the sales target of the firm. This requirement, however, will depend on the
availability of resources. An unserved portion of demand may mean lost revenues
for the firm.
2. Provision for Operating Expenses. To maintain the operations of the firm on a
day-to-day basis, a working capital is required. This will be needed to take care of
salaries and wages, advertising, taxes and license, insurance premium, and
interest payments.
3. Support for Credit Sales. At times, conditions require that credit sales be extended
to the firm’s clients. This will need sufficient working capital to enable the firm to
maintain its operations until receivables are converted into cash.
4. Provision of a Safety Margin. The firm should have sufficient amount of capital to
provide for unexpected expenditures, delays in the expected inflow of cash, and
possible decline in revenue.
Cash Requirements
The firm needs cash to pay for expenditures that arise from time to time. Even if
the anticipated cash receipts is equal to the anticipated cash expenditures, it is still
necessary to maintain a sufficient cash fund for the firm to meet its cash commitments.
This is needed because of the difficulty in synchronizing cash receipts with cash
disbursements. It is, therefore, required that a positive cash balance be maintained so
that the firm’s obligations are settled as they become due.
TOPIC 2: The Need for Working Capital

41. The amount of cash needed depends upon the following:
1. the amount of the firm’s purchases and cash sales;
2. the time period for which the firm receives and grants credit;
3. the time period from the dates of purchase of raw materials and payment of
wages to the dates of cash receipts from sales;
4. the amount of cash to be used for investment in inventories; and
5. the amount of cash needed for other purposes such as cash dividends.
Accounts Receivable Requirements
Since liquidity is a primary concern of sound business finance, firms prefer cash
sales over credit sales. Many companies, however, cannot avoid the extension of credit
to customers for various reasons. Credit is used to sustain and to promote production,
distribution and consumption of goods and services.
The unpaid portion of credit sales is represented by accounts receivables in the
firm’s records. The collection of accounts receivable from customers contribute to cash
inflow requirements of the firm.
Credit terms vary according to the degree of competition within individual
industries, the availability of bank credit, and pressures for increased sales in periods of
increasing plant capacities.
Inventory Requirements
The production of large stocks inventory generate savings as a result of lower
production cost. It will also provide the firm with large quantity of stocks to meet
increasing unusually large orders from customers. The maintenance of large stocks of
inventory, however, may unnecessary tie up funds which could have been made available
for other uses. Outside financing may even be required. In addition, storage and
warehousing costs may also increase.
The ideal set-up is for the firm to make sales as soon as finished products come
out of the production line, or to acquire raw materials and supplies as soon as they are
needed. Since these are not possible, economist have devised a method of knowing the
inventory level that will optimize results considering both of the above-mentioned
requirements.

42. MANAGEMENT OF WORKING CAPITAL
Working capital must always be able to cover fund requirements of the company
as they are needed. There are times when unusual pressures on working capital makes
the job of the finance manager very difficult. To overcome this, a system should be
adapted considering the following objectives:
1. Working capital must be adequate to cover all current financial requirements. It
must be allocated among various needs in sufficient amounts. The quantity of
inventory stocks to be carried and the maximum allowable amount of receivables
must be decided in advance.
2. The working capital structure must be liquid enough to meet current obligations
as they fall due. Salaries and wages must be paid on time. Raw materials and
supplies must be acquired on days they are needed.
3. Working capital must be conserved through proper allocation and economical
use. It must be protected against losses arising out of natural calamities,
malversation, or pilferage.
4. Working capital must be used in the attainment of the profit objectives of the
firm. Measures to contribute to increased profits through avoidance of loss must
be instituted.
LIQUIDITY MANAGEMENT
Liquidity refers to the ability of the firm to pay its bill on time or otherwise meet
its current obligations. Activities geared towards achieving the liquidity objectives of the
firm is called liquidity management.
The objective of management is to acquire sufficient amounts of funds to cover
the cash requirements of the firm. The cash inflows of the firm come from various sources
which are briefly described as follows:
1. Cash Sales. The percentages of cash derived from sales vary from company to
company and from industry to industry.
2. Collection of Accounts Receivables. The credit policies and the pattern of
company sales determine the frequency and volume of collections from
receivables.
3. Loans. Loans from banks and other creditors may be availed of by management
mostly on its own initiative. The timing and amount of cash receipts derived from
loans depend largely on the borrowing firm.
TOPIC 2: Management of Working Capital

43. 4. Sales of Assets. Assets are sometimes sold by the company for various reasons.
Obsolescence is one of those.
5. Ownership Contribution. Additional contributions from the owners are
sometimes tapped to improve the liquidity posture of the firm.
6. Advances from Customers. Manufacturers, at times, require cash advances from
customers as soon as an order is made and before production is started. This is
not unusual especially if the objects of sale are capital goods like airplanes and
ships. The number o years required in the manufacturing process justifies
whatever cash advances are required from customers.
Cash Management
Idle cash earns nothing and even if it is kept in a bank, the interest it earns is
minimal. If sufficient amounts of profits must be attained, cash should be invested.
Sufficient cash must be maintained, however, to cover the firm’s cash expenditures. The
activity involved in achieving these two opposite goals is called cash management.
To effectively manage cash, five major approaches are suggested. These are as
follows:
1. Exploit techniques of money mobilization to reduce operating requirements for
cash;
2. Expend major efforts to increase the precision and reliability of cash flow
forecasting;
3. Use maximum efforts to define and quantify the liquidity reserve needs of the
firm;
4. Develop explicit alternative sources of liquidity; and
5. Search aggressively for more productive uses of surplus money assets.
Money Mobilization. Some companies maintain branches and agencies in distant
places. Those that serve customers directly may find that they are also serving customers
from far-flung areas. These two conditions are characterized by remittances which take
several days before they are converted into usable cash balances. Check payments, for
instance, are sent through the email. When these checks are received, they are deposited
in the bank. These checks will only be cleared for the company’s use after several days.
Checks issued by customers from distant areas require longer clearing period. This time
lag stated briefly, consists of two identifiable periods: (1) the mail traveling time of the
check payment; and (2) the check clearing time.
Various solutions are offered to improve the set-up. To shorten the time lag, some
companies open accounts with banks located in the far-flung areas where the company’s
branches are located. These banks serve as the collecting arm of the companies. In most

44. cases, this improvement reduces to half the number of days spent between actual
payment made by the client and the availability of such payment for use by the firm.
Improved Cash Flow Forecasting. A cash flow forecast with a high degree of
precision and reliability provides the firm with realistic approaches to planning and
budgeting. The disadvantages of cash excess and cash shortages are eliminated if not
minimized.
The advantages brought by an improved cash flow forecast are the following:
1. Surplus funds are more fully invested;
2. Alternative methods of meeting the outflows can be explored; and
3. The creation of special reserves for major future outlays will be minimized.
Defining and Quantifying the Liquidity Reserve Needs of the Firm. Firs are faced
with a number of uncertainties and contingencies which may require cash reserves. To be
protected against the worst possibilities, a very large reserve cash will be needed. The
idea is to avoid unnecessary losses or expenditures brought about by liquidity problems.
The holding of cash reserves, however, entails cost. The management is left with striking
a reasonable balance between the two requirements. Several steps are necessary to
accomplish this objective. These are the following:
1. Identification of contingencies requiring protection;
2. Assessment of the probabilities of the contingencies occurring;
3. Assessment of the probabilities of the contingencies occurring at the same time;
and
4. Assessment of the probable amount of cash required if each of the
contingencies happens.
If reserves for certain contingencies will not be provided, the amount of possible
losses must be ascertained. If reserves will be provided, the cost of carrying the reserves
must also be determined. The expected value of the losses and cost must be computed.
This may be arrived at by multiplying the losses or cost with probability estimates of
occurrence.
To illustrate, assume that a labor strike happening in the premises of the company
will paralyze operations. Borrowing funds to cover the necessary expenditures of the firm
will penalize the firm with interest charges amounting to one million pesos. It has also
been ascertained that if a reserve fund has to be carried for the contingency, the firm will
be penalized with eight thousand pesos in the form of lost income which could have been
otherwise earned by the idle cash reserve.

45. If the probability of the strike happening is placed at 50%, the expected values of
the options may be computed as follows:
Option Penalty Probability ExpectedValue
No reserve ₱1,000,000 50% ₱500,000
With cash reserve ₱ 800,000 50% ₱400,000
Carrying a cash reserve in this case is more economical to the firm because it carries a
lower penalty expected value.
Development of Alternative Sources of Liquidity. Once the liquidity reserve needs
of the firm have been defined and quantified, alternative sources of meeting these needs
should be identified and evaluated.
One possible alternative is the exploitation of the unused borrowing capacity of
the firm. Borrowings, oftentimes, provide the funds necessary for liquidity. Not all
companies, however, may avail of this option. During recession, when small companies
are unable to borrow money from lending institutions, interbusiness financing may
provide the answer to liquidity problems. Interbusiness financing refers to credit flowing
from a large business to small business.
Search for More Productive Uses of Cash Surplus. Cash surplus may be utilized by
the firm to earn higher returns. A gap may exist, however, between the time when cash
starts coming in and the time it is actually made more productive. As various investment
opportunities may be available, it is important that sufficient effort is expended in the
determination of the best alternative. Planning activities must also be geared towards
eliminating the unproductive or less productive gap.
Inasmuch as new investment opportunities may be made available from time to
time, a continuous search and evaluation activity must be done.
Accounts Receivable Management
As sales on account cannot be avoided most of the time, management must face
difficulty squarely and make it work to the advantage of the firm. This is important
because when accounts receivables are not properly managed, the financial viability of
the firm may be impaired.
Objectives. One of the goals of business finance is to maximize sales. Thus, if more
sales is required by the firm, more credit is extended. Increased sales, however, is not an
end in itself. Any advantage gained in extending credit to customers may be offset or even
surpassed by problems brought about by bad-debt losses and the consequent tie-up of
funds in receivables.

46. The objective of accounts receivable management is to determine the cost and
profitability of credit sales. There is no point in extending credit to customers if this will
cause a lowering of the firm’s return on investment.
The second objective of accounts receivable management is the projection of cash
flows from receivables. This will provide an essential input in the preparation of the firm’s
financial plan. The third objective relates to the direction and control of activities involved
in the extension of credit to customers.
Elements of the Cost of Credit. The cost of credit is composed of three elements:
(1) bad debts cost; (2) cost of invested funds; and (3) administrative costs.
Bad debts cost refers to accounts receivable uncollected and subsequently written
off. The cost of invested funds refers to the rate at which the firm could borrow funds to
finance credit sales. These include form letters, individually written letters, telephone
charges, clerical and administrative time spent on an account, and credit and investigation
expenses.
Functions of the Credit Department. The credit department performs the
following functions:
1. Gathering and organizing of information necessary for decisions on the granting
of credit to particular customers;
2. Assuring that efforts are made to collect receivables when they become due; and
3. Determining and carrying out appropriate efforts to collect accounts of customers
who cannot or do not intend to pay.
Sources of Credit Information. A variety of sources may be used to obtain credit
information concerning customers. The sources most commonly used are the following:
1. Personal interviews;
2. References;
3. Credit Bureaus;
4. credit-reporting agencies; and
5. Banks.
Personal interviews provide basic information concerning an applicant for credit.
The applicant is usually required to fill up a credit application blank. The credit application
contains the following items:
1. The name of the applicant;
2. Residence and former address;
3. Occupation or business;
4. Business address;
5. Bank where the applicant maintains an account; and

47. 6. Property owned.
More information is usually required if the credit applicant is a company.
References also provide a valuable source of information. The credit applicant is usually
required to furnish names of at least three credit references. These references, in turn,
may provide valuable insights into the character and ability of the applicant.
Credit bureaus are institutions organized for the exchange of ledger information
among associated creditors. Among the services rendered by credit bureaus are the
following:
1. reports;
2. bulletins;
3. credit guides; and
4. special services.
Credit reporting agencies consist of more specialized forms of credit bureaus.
Banks constitute a valuable source of credit information. This is largely due to their
involvement in lending activities.
Evaluation of Credit Risk. Before credit is granted, the risk involved is evaluated. This is
done after information regarding the credit risk has been gathered. In the evaluation of a
credit risk, the basic criteria used refer to the following:
1. Capital;
2. Capacity;
3. Character; and
4. Conditions.
Capital refers to the financial resources of the credit applicant. The balance sheet
is a very useful tool in determining the resources of the applicant. Capacity refers to the
ability of the applicant to operate successfully. This is indicated in the profit and loss
statement of the applicant. Character refers to the reputation for honesty and fair dealing
of the applicant or the owners of the firm applying for credit. Conditions refer to the
environment required for the extension of credit.
Inventory Management
Inventory management refers to the activity that keeps track of how many of the
procured items needed to create a product or service are on hand, where each item is,
and who has responsibility for each item.
Inventory management consists of two aspects: liquidity, and profitability. The
liquidity aspects is usually measured in terms of inventory turnover. The profitability
aspect is measured in terms of inventory level at a given level of sales and profit.