12

Business Finance
(Quarter 1-Module 2/Week 2)

FINANCIAL INSTITUTIONS

Department of Education
SDO- City of San Fernando (LU)
Region 1
 12
Business Finance
(Quarter 1-Module 2/Week 2)

FINANCIAL INSTITUTIONS

MOST ESSENTIAL LEARNING COMPETENCY

 distinguish a financial institution from financial instrument and
financial market (ABM_BF12-IIIa-2)
 explain the flow of funds within an organization – through and from
the enterprise—and the role of the financial manager. (ABM_BF12-
IIIa-5)

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Guide to Parents:
Get the module from your child’s subject teacher.
2. Read and understand together with your child.
3. Guide your child in reading the module.
4. If there are questions regarding the lesson/module, feel free to call/text the teacher using
this cellphone numbers 09385918457.
5. The module shall be returned to the designated area/teacher every Friday of the week.
6. Place the checked answer sheets in your child’s portfolio.
7. Thank you parent partners. We’re hoping for your full support.

Guide to Learners:
1. Read and understand the module together with your parents.
2. Do not leave any activity sheets unanswered.
3. Work on the activity sheets independently and BE HONEST at all times for you to maximize
learning.
4. Write your answers clearly.
5. If you are done with the module, give it to your parents/guardian so they can give it back to
the designated area/teacher for checking.

Health Tips:
1. Always wear your face mask and face shield.
2. Wash your hands with soap and water regularly.
3. Use alcohol or hand sanitizer when needed.
4. Practice social distancing to stop the spread of COVID-19 virus.

ii
 Business Finance Self-Learning Module has been developed for you to be
equipped with the knowledge of business and finance. It prepares you to work in
corporate and government financial management, banking, and financial planning.
And because finance revolves around planning and analysis, studying finance and
becoming more financially literate enables you to make better personal financial
decisions in the future.

Business Finance Self-Learning Module attains all the competencies outlined in

the K to 12 curriculum guide. Each lesson is packed with varied strategies and
activities and applies different instructional approaches to ensure that lifelong
learning is achieved. Furthermore, this module includes the following components:

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 INTRODUCTION

This module has been developed for you to be equipped with the knowledge of
business and finance. It prepares you to work in corporate and government
financial management, banking, and financial planning. And because finance
revolves around planning and analysis, studying finance and becoming more
financially literate enables you to make better personal financial decisions.

Besides improving a person's chances, Finance can also help you hone your
critical-thinking and problem-solving skills, which you can then use to make sound
financial decisions.

Therefore, this module will help you to add value to your learning phase by
proper understanding of time value of money; taking better financing decision;
being aware of the valuation of financial resources; understanding the requirement
of evaluation of investment opportunities; able to analyze each and every
opportunity cost; putting efforts for maximization of wealth; acquiring maximum
return of your investment; increasing your analytical skills; managing their
personal and professional life in a better way; deep analysis of sources of funds;
understand the investors life cycle to choose right investment time; understand key
success factors of financing and know how to get their cost capital and analyze it.

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 What I Need To Know
Learning Competency:
 Distinguish a financial institution from financial instrument and financial
market.
ABM_BF12-IIIa-2

 Explain the flow of funds within an organization – through and from the
enterprise—and the role of the financial manager. ABM_BF12-IIIa-5

Learning objectives:
1. Prepare a diagram illustrating how the Financial System works.
2. Define Financial Markets, Financial Institutions and Financial Instruments.
3. Identify the types of Financial Markets, Financial Institutions and Financial
Instruments.

What I Know
Instructions: Read the following questions carefully and encircle the letter that
best
describes the answer.

1. One of the functions of a financial manager is financing and _____________ of

funds.
a.) Investing
b.) Budgeting
c.) Saving
2. Organized forums in which the suppliers and users of various types of funds
can make transactions directly.
a.) Financial business
b.) Financial institutions
c.) Financial markets
3. The sale of either bonds or stocks to the general public.
a.) Public offering
b.) Public bonding
c.) Public sale
4. The sale of a new security directly to an investor or group of investors.
a.) Public placements
b.) Public sale
c.) Public offering

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5. A Financial Asset is any asset that is
a.) Cash
b.) To exchange financial instruments with another entity under conditions
that are potentially unfavorable.
c.) Is any liability that is a contractual obligation:
6. A market that enables suppliers and users of long-term funds to make
transactions.
a.) Secondary market
b.) Capital market
c.) Money market
7. Banks which use the deposited funds to provide commercial loans to firms
and personal loans to individuals, and purchase debt securities issued by
firms or government agencies.
a.) Agricultural banks
b.) Industrial banks
c.) Commercial banks
8. Financial institutions that receive payments from retired employees and
invest the proceeds on their behalf
a.) Pension funds
b.) Insurance companies
c.) Mutual funds
9. Financial market in which securities are initially issued; the only market in
which the issuer is directly involved in the transaction.
a.) Tertiary market
b.) Secondary market
c.) Primary market
10.These companies pool these payments and invest the proceeds in various
securities until the funds are needed to pay off claims by policyholders.
a.) Pension funds
b.) Insurance companies
c.) Mutual funds

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 LESSON PROPER

What’s In

The Financial System

Financial
Institutions

(Learner A) (Learner B)
Savers/Suppliers Users/Demanders
of Funds Private Placement of Funds

Financial
Markets
Flow Flow of
of funds securities/notes/
bonds/debt/instruments
class is an illustration on how the Financial System works. Due to the increased need f
Above is an illustration on how the Financial System works. Due to the
increased need for security for the performance of obligations arising from these
transactions and due to the growing size of the financial system, the transfers of
funds from one party to another are made through Financial Instruments. On the
diagram above, the solid lines represent the flow of cash/funds, while the light blue
lines represent the flow of financial instruments which represent obligations to
transfer cash or other assets in the future. Transacntionsbetween suppliers and
users of funds take place through verval and written agreement.

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 What’s New
Financial Instruments
Let us discuss the composition of the Financial System and that we will identify the
types of Financial Markets, Financial Institutions and Financial Instruments.
A. Financial Instruments
 When a financial instrument is issued, it gives rise to a financial asset on
one hand and a financial liability or equity instrument on the other.
(Recall from ABM the following definitions)

 A Financial Asset is any asset that is:

• Cash
• An equity instrument of another entity
• A contractual right to receive cash or another financial asset from
another entity.
• A contractual right to exchange instruments with another entity
under conditions that are potentially favorable.
• Examples: Notes Receivable, Loans Receivable, Investment in
Stocks, Investment in Bonds
 A Financial Liability is any liability that is a contractual obligation:
• To deliver cash or other financial instrument to another entity.
• To exchange financial instruments with another entity under
conditions that are potentially unfavorable.
• Examples: Notes Payable, Loans Payable, Bonds Payable
 An Equity Instrument is any contract that evidences a residual
interest in the assets of an entity after deducting all liabilities.
• Examples: Ordinary Share Capital, Preference Share Capital
Who are the holders of Financial Assets? – (Answer: Suppliers of Funds)
Who are the makers of Financial Liabilities and Equity instruments?. – (Answer:
Users of Funds)
When companies are in need of funding, they either sell debt securities (or bonds)
or issue equity instruments. The proceeds from the sale of the debt securities and
issuance of bonds will be used to finance the company’s plans. On the other hand,
investors buy debt securities of equity instruments in hopes of receiving returns
through interest, dividend income or appreciation in the financial asset’s price.
Common examples of Debt and Equity Instruments:
 Debt Instruments generally have fixed returns due to fixed interest rates.
Examples of debt instruments are as follows:
• Treasury Bonds and Treasury Bills are issued by the Philippine
government.
These bonds and bills have usually low interest rates and have very low
risk
of default since the government assures that these will be paid.

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 • Corporate Bonds are issued by publicly listed companies. These bonds
usually have higher interest rates than Treasury bonds. However, these
bonds are not risk free. If the company which issued the bonds goes
bankrupt, the holder of the bonds will no longer receive any return from
their investment and even their principal investment can be wiped out.
 Equity Instruments generally have varied returns based on the performance
of the issuing company. Returns from equity instruments come from either
dividends or stock price appreciation.
The following are types of equity instruments:
• Preferred Stock has priority over a common stock in terms of claims over
the assets of a company. This means that if a company were to be
liquidated
and its assets have to be distributed, no asset will be distributed to
common
stockholders unless all the claims of the preferred stockholders have been
given.
Moreover, preferred stockholders have also priority over common
stockholders in cash
dividend declaration. Dividends to preferred stockholders are usually in a
fixed rate.
No cash dividends will be given to common stockholders unless all the
dividends due to preferred stockholders are paid first. (Cayanan, 2015)
• Holders of Common Stock on the other hand are the real owners of the
company. If the company’s growth is spurring, the common stockholders
will benefit on the
growth. Moreover, during a profitable period for which a company may
decide
to declare higher dividends, preferred stock will receive a fixed dividend rate
while common stockholders receive all the excess.

B. Financial Markets
-organized forums in which the suppliers and users of various types of funds
can make transactions directly.

Classify Financial Markets into comparative groups:

Primary vs. Secondary Markets
• To raise money, users of funds will go to a primary market to issue new
securities (either debt or equity) through a public offering or a private
placement.
• The sale of new securities to the general public is referred to as a public
offering and the first offering of stock is called an initial public offering.
The
sale of new securities to one investor or a group of investors (institutional
investors) is referred to as a private placement.
• However, suppliers of funds or the holders of the securities may decide to
sell the securities that have previously been purchased. The sale of
previously owned securities takes place in secondary markets.
• The Philippine Stock Exchange (PSE) is both a primary and secondary
market.

Money Markets vs. Capital Markets

  Money markets are a venue wherein securities with short-term maturities
(1 year or less) are sold. They are created because some individuals,
businesses, governments, and financial institutions have temporarily idle
funds that they wish to invest in a relatively safe, interest-bearing asset.
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 At the same time, other individuals, businesses, governments, and financial
institutions find themselves in need of seasonal or temporary financing.
 On the other hand, securities with longer-term maturities are sold in
Capital markets. The key capital market securities are bonds (long-term
debt) and both common stock and preferred stock (equity, or ownership)

C. Financial Institutions
– intermediaries that channel the savings of individuals, businesses, and
governments into
loans or investments.

Examples of financial institutions:

 Commercial Banks - Individuals deposit funds at commercial banks, which
use the deposited funds to provide commercial loans to firms and personal
loans to individuals, and purchase debt securities issued by firms or
government agencies. –
 Insurance Companies - Individuals purchase insurance (life, property and
casualty, and health) protection with insurance premiums. The insurance
companies pool these payments and invest the proceeds in various
securities until the funds are needed to pay off claims by policyholders.
Because they often own large blocks of a firm’s stocks or bonds, they
frequently attempt to 25 Terms Defined Public offering - The sale of either
bonds or stocks to the general public. Private placement - The sale of a new
security directly to an investor or group of investors. Secondary market -
Financial market in which preowned securities (those that are not new
issues) are traded. Money market - A financial relationship created between
suppliers and users of short-term funds. Capital market - A market that
enables suppliers and users of long-term funds to make transactions.
influence the management of the firm to improve the firm’s performance,
and ultimately, the performance of the securities they own.
 Mutual Funds - Mutual funds are owned by investment companies which
enable small investors to enjoy the benefits of investing in a diversified
portfolio of securities purchased on their behalf by professional investment
managers. When mutual funds use money from investors to invest in newly
issued debt or equity securities, they finance new investment by firms.
Conversely, when they invest in debt or equity securities already held by
investors, they are transferring ownership of the securities among
investors.
 Pension Funds - Financial institutions that receive payments from
employees and invest the proceeds on their behalf.
 Other financial institutions include pension funds like Government Service
Insurance System (GSIS) and Social Security System (SSS), unit investment
trust fund (UITF), investment banks, and credit unions, among others.
 7

What Is It

Functions of a Financial Manager

The four functions of a Financial Manager
 Financing
 Investing
 Operating
 Dividend Policies

1. Financing decisions include making decisions on how to fund long term

investments (such as company expansions) and working capital which deals with
the day to day operations of the company (i.e., purchase of inventory, payment of
operating expenses, etc.).
The role of the Financial Manager is to determine the appropriate capital
structure of the company. Capital structure refers to how much of your total
assets is financed by debt and how much is financed by equity.

Sample Capital Structure

Equity Liabilities Assets

100%

75%

50%

25%

0%
Total Assets Capital Structure
Recall that Assets = Liabilities + Owner’s Equity.
  To be able to acquire assets, our funds must have come somewhere. If it was
bought using cash from our pockets, it is financed by equity.
 On the other hand, if we used money from our borrowings, the asset bought
is financed by debt.

 In the figure above, the total assets is financed by 60% debt and 40% equity.
Accordingly, the capital structure is 60% debt and 40% equity.
Is there an ideal mix of debt and equity across corporations?
Answer: No. The mix of debt and equity varies in different corporations
depending on management’s strategies. It is the responsibility of the
Financial Manager to determine type of financing (debt or equity) is best
for the company.

2. Investing- as where to put your excess cash to make it more profitable. We

expand that definition by including cash held taken from funds as a result of
financing decisions.
Investments may either be short term or long term.
 Short term investment decisions are needed when the company is in an
excess cash position.
 To plan for this, the Financial Manager should be able to make use of
Financial Planning tools such as budgeting and forecasting
 Moreover, the company should choose which type of investment it
should invest in that would provide an most optimal risk and return
trade off.
 Long term investments should be supported by a capital budgeting
analysis which is among the responsibilities of a finance manager.
 Capital budgeting analysis is a tool to assess whether the investment will
be profitable in the long run.
 The lenders should have the confidence that the investments that
management will push through with will be profitable or else they would
not lend the company any money.

3. Operating Decisions
-deal with the daily operations of the company. The role of the VP for finance is
determining how to finance working capital accounts such as accounts
receivable and inventories. The company has a choice on whether to finance
working capital needs by long term or short term sources. Why does a
Financial
Manager need to choose which source of financing a company should use?
What do they need to consider in making this decision?
 Short Term sources are those that will be payable in at most 12
months. This includes short-term loans with banks and suppliers’
credit. For short-term bank loans, the interest rate is generally lower as
compared to that of long-term loans. Hence, this would lead to a lower
financing cost.
 Suppliers’ credit are the amounts owed to suppliers for the inventories
they delivered or services they provided. While suppliers’ credit is
generally free of interest charges, the obligations with them have to be
paid on time to maintain good supplier relationship. Such relationships
should be nurtured to ensure timely delivery of inventories.
 Short term sources pose a trade-off between profitability and liquidity
risk. Because this source matures in a short period, there is a
possibility that the company may not be able to obtain enough cash to
pay their obligation (i.e. liquidity risk).

 Long term sources, on the other hand, mature in longer periods. Since
this will be paid much later, the lenders expect more risk and place a
higher interest rate which makes the cost of long term sources higher
than short term sources.
 However, since long term sources have a longer time to mature, it gives
the company more time to accumulate cash to pay off the obligation in
the future. - Hence, the choice between short and long term sources
depends on the risk and return trade off that management is willing to
take.

What’s More

Dividend Policies
-Recall that cash dividends are paid by corporations to existing
shareholders
based on their shareholdings in the company as a return on their
investment. Some investors buy stocks because of the dividends they
expect
to receive from the company. Non-declaration of dividends may disappoint
these investors. Hence, it is the role of a financial manager to determine
when the company should declare cash dividends.
Before a company may be able to declare cash dividends, two conditions
must exist:
1. The company must have enough retained earnings (accumulated
profits) to support cash dividend declaration.
2. The company must have cash.
What will affect the decision of management in paying dividends?
Remember that dividends come from the company’s cash and availability
of unrestricted retained earnings.
 Availability of financially viable long-term investment
 Access to long term sources of funds
 Management’s Target Capital structure

Recall that one of the functions of a finance manager is investing and

its available cash may be used to invest in long term investments that
would increase the profitability of the company. Some small enterprises
which are undergoing expansion may have limited access to long term
financing (both long term debt and equity). This results to these small
 companies reinvesting their earnings into their business rather than
paying them out as dividends.

 On the other hand, a company which has access to long term sources of
funds may be able to declare dividends even if they are faced with
investment opportunities. However these investment opportunities are
generally financed by both debt and equity.

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What I have learned

To sum up our lesson we were able to learn about how the Financial system
works in a business. It shows how transactions between suppliers and users of
funds take place. We also identified the types of Financial Markets, Financial
Institutions and Financial Instruments. Moreover, we also discussed the role and
the four functions of a Financial Manager.
Now that you learned about these things I know you are now ready to take your
Post-Test following this page. Goodluck!

Assessment
Instructions: Read the following questions carefully and encircle the letter that
best describes the answer.

1. A Financial Asset is any asset that is

a.) Cash
b.) To exchange financial instruments with another entity under conditions
that are potentially unfavorable.
c.) Is any liability that is a contractual obligation.
2. These companies pool these payments and invest the proceeds in various
securities until the funds are needed to pay off claims by policyholders.
a.) Pension funds
b.) Insurance companies
c.) Mutual funds
3. One of the functions of a financial manager is financing and _____________ of
funds.
a.) Investing
b.) Budgeting
c.) Saving
4. Banks which use the deposited funds to provide commercial loans to firms
and personal loans to individuals, and purchase debt securities issued by
firms or government agencies.
a.) Agricultural banks
 b.) Industrial banks
c.) Commercial banks
5. The sale of either bonds or stocks to the general public.
a.) Public offering
b.) Public bonding
c.) Public sale

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6. Financial market in which securities are initially issued; the only market in
which the issuer is directly involved in the transaction.
a.) Tertiary market
b.) Secondary market
c.) Primary market
7. Organized forums in which the suppliers and users of various types of funds
can make transactions directly.
a.) Financial business
b.) Financial institutions
c.) Financial markets
8. Financial institutions that receive payments from retired employees and
invest the proceeds on their behalf
a.) Pension funds
b.) Insurance companies
c.) Mutual funds
9. A market that enables suppliers and users of long-term funds to make
transactions.
a.) Secondary market
b.) Capital market
c.) Money market
10. The sale of a new security directly to an investor or group of investors.
a.) Public placements
b.) Public sale
c.) Public offering

ADDITIONAL ACTIVITIES

TRUE OR FALSE TEST:

Directions: Write T if the staement is True and write F if otherwise. Write the
letter of your answer on the blank provided at the right side of the test paper.
(10 pts.)
1. To achieve the goal of profit maximization for each alternative
being considered, the financial manager would select the one
that is expected to result in the highest monetary return.
2. Dividend payments change directly with changes in earnings
per share.
3. The wealth of corporate owners is measured by the share price
of the stock.
 4. Financial markets are intermediaries that channel the savings
of individuals, businesses, and government into loans or
investments.
5. The money market involves trading of securities with
maturities of one year or less while the capital market involves
the buying and selling of securities with maturities of more
than one year.
6. High cash flow is generally associated with a higher share price
whereas higher risk tends to result in a lower share price.

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7. When considering each financial decision alternative or

possible action in terms of its impact on the share price of the
firm's stock, financial managers should accept only those
actions that are expected to increase the firm's profitability.
8. To achieve the goal of profit maximization for each alternative
being considered, the financial manager would select the one
that is expected to result in the highest monetary return.
9. Dividend payments change directly with changes in earnings
per share.
10.The wealth of corporate owners is measured by the share price
of the stock.

ESSAY:
In your own words, explain the flow of the Financial System. (10 pts.)
 13
How would you relate the role of financial managers, role of financial markets and
role of investors? (10 pts.)
Role of Financial Role of Financial Role of Investors
Managers Markets
Financial managers The financial markets Investors provide the
make financing decisions provide a forum in which funds that are to be used
that require funding from firms can issue securities by financial managers to
investors in the financial to obtain the funds that finance corporate growth.
markets. they need and in which
investors can purchase
securities to invest their
funds.
 14
Answer Key
Practice Exercise 1
True/False
1.T
2. F
3. T
4. F
5. T
6. F
7. F
8. T
9. T
10. F

Practice 2
1. A
2. A
3. B
4. B
5. A
6. C
7. A
8. D
9. D
10.B
 References

Image Sources:
1. https://www.flaticon.com/free-icon/megaphone_314441
2. https://www.flaticon.com/free-icon/objective_1632633
3. https://www.iconfinder.com/icons/1297845/
message_note_noted_notes_report_statement_write_icon
4. https://en.m.wikipedia.org/wiki/File:VisualEditor_-_Icon_-_Open-book-
2.svg
5. https://icon-library.com/tags/writing.html
6. https://freeiconshop.com/icon/edit-document-icon-flat/
7. https://commons.wikimedia.org/wiki/
File:Checklist_Noun_project_5166_yellow.svg
8. https://www.clipartmax.com/middle/m2H7H7m2d3K9K9N4_illustration-
of-a-hand-writing-on-paper-representing-things-to-do-icon/
9. https://slideplayer.com/slide/8171108/

Bibliography:
Bernstein, Leopold. Financial Statement Analysis, 4th Ed. Illinois: Irwin, 2014.
Brealey, Richard A., Myers, Stewart.C. and Marcus, Alan .J. Fundamentals of
Corporate Finance, 3rd Edition. New York: Mc-Graw Hill Co., 2014.
Cabrera, Elenita B. Management Advisory Services. Manila: Conanan, 2015.

Development Team of the Module

Writer: Jusie C. Apilado, Teacher II

EPS In-charge: Dr. Lorena C. Salvador
Management Team: Dr. Rowena C. Banzon, CESO V, SDS
Dr. Agnes B. Cacap, Chief- CID
Dr. Jose Mari P. Almeida, Chief- SGOD
Genevieve B. Ugay, EPS- LRMS
Hazel JaneB. Libatique, Librarian II
Aurelio C. Dayag, Jr. , PDO II