San Pablo Diocesan Catholic Schools System

Diocese of San Pablo

Liceo de Calauan
Calauan, Laguna
2021-2022

BUSINESS FINANCE
MODULE 1
FUNDAMENTALS OF FINANCE AND FINANCIAL MANAGEMENT

MOST ESSENTIAL LEARNING COMPETENCIES

At the end of this module, the learner will be able to:
● Explain the major role of financial management and the different individuals
involved
● Distinguish a financial institution from financial instrument and financial
market.
● Explain the flow of funds within an organization – through and from the
enterprise—and the role of the financial manager.

LEARNING
CONTENT
The rapid growth in the world of business has increased the demand for a parallel advancement
in different fields such as accounting, marketing, human resource management, operations management,
finance, and financial management. Moreover, increasing customer demand heightened competition, and
technological advancement has pushed business practitioners from different fields to connect with one
another and make sure that systems and processes are well-coordinated.

Our lives are, in one way or another, touched by finance ---

in our households, for instance, and in the jobs that we will have in
the future. An understanding of finance and financial management is
essential both in our personal lives and careers. Now, as learner, and
for the rest of your life, you will be both working and living in a world
where the choices that you will make will have financial
consequence. The companies you will work for will make money as
a result of introducing products, expanding market coverage, hiring
the right people, improving productivity, and investing money today
with the hope of increasing wealth.

FINANCE AND FINANCIAL MANAGEMENT

The definition of finance may be presented in two different ways depending on the
perspectives on its use. “To finance” would mean to provide funding, for example, in the form of a loan
or borrowed money with the intent of collecting the money back after a specified period of time. In this
kind of arrangement, the money that was loaned will earn interest --- the charge for borrowing money
which is usually a percentage of the principal or the loaned amount --- over a specified period of time.
 Finance is also a field in business and economics. From the perspective of an economist,
finance is the allocation of scarce resources which includes money.
There are three basic questions that are addressed by the study of finance:
1. What types of investments (short-term and/or long-term) should the firm undertake?
2. What sources of funds (short-term and long-term) should the firm tap in order to fund these
investments?
3. How can the firm ensure that its cash flows will suffice to support its day-to-day operations?

Financial Management, on the other hand, has broader meaning as its cover the planning,
organizing, leading, and controlling of all financial activities of an organization. Financial management
puts emphasis on managing the funds of an organization which includes day-to-day operations,
investment decisions, and financing those investments. The focus of this module, however, is on finance
and financial management as a function in business.

BRANCHES OF FINANCE
The broad field of finance may be separated into three subcategories: personal, corporate, and
public.
A. Public finance is the field of finance which deals with the collection of taxes and budget
allocation for programs designed to benefit the general public and the production and distribution
of public goods. An example of a person practicing public finance is the person in charge of the
budget of a local municipality. The dynamics of a public finance of public finance can be
observed in the budget allocation for the construction of roads in a municipality, improvements
made on a public market, and the building of other infrastructure projects that are intended for
public use.
B. Personal finance is a field of finance which gained popularity especially among the younger
generation of income earners. It encompasses everything that pertains to personal financial
planning including coming up with a budget that matches one’s short- and long-term needs,
creating a savings plan for contingencies, investing in financial products which are often intended
for retirement, and investing for the purpose of maximizing wealth. Your parents budgeting for
the needs of your household while at the same time saving for your college education is a good
example of personal finance.
C. Corporate finance is primarily concerned with the management of all the financial activities of
an enterprise or a business organization. The ultimate goal of corporate finance is to maximize
the shareholder value through sound financial planning. A detailed plan for an organization
includes areas of decision that are meant to ensure the financial well-being of the firm. There is
a good chance that someone from your neighborhood or even a relative works in a field that is in
one way or another related to corporate finance – a bank employee, a financial analyst, or the
head of the accounting department in your school. The following are all examples of how
corporate finance is practiced in organizations:
1. The accounting supervisor is tasked to prepare a cost and benefit analysis on whether it is
more costly (or cheaper) to purchase or rent a piece of equipment.
2. The marketing manager meets with the finance officer to discuss how a new product should
be priced before it is launched in the market.
 3. The Human Resource manager shows the other members of the management team how the
hiring of additional manpower will help with productivity but may also impact cost and
profitability.
4. Logistics requested a new vehicle that will be used for delivery. However, the finance officer
stated that the benefits of purchasing a new vehicle will not be enough to justify the amount
to be spent.
5. The marketing officer was advised that the budget for advertising and promotion is not enough
to include billboard advertising.

FINANCIAL MANAGEMENT IN BUSINESS

Decision makers rely heavily on financial information prepared, processed, and analyzed by
financial managers. The key to the effective use of such information is how finance is applied in other
business functions within the organization such as production, marketing, human resource, procurement,
and operations.
Financial managers are involved in planning wherein they contribute in identifying goals and
objectives, setting targets, and establishing control measures in order to monitor performance. However,
it is not just the finance manager who should possess financial knowledge. In most cases, managers from
different levels are required to have an understanding of how the different functions affect or can be
affected by the overall financial condition of the organization.
Financial information is generated by the different departments. At times, other department heads
also prepare financial reports. For instance, the production manager prepares a periodic report on the
amount of rejects as a percentage of total production or the human resource supervisor monitors the
number of overtime hours. It is up to the person in charge in the Finance Department to gather all these
data and put them together in a format that is easily understood.
Figures 1 and 2 provide two examples of organizational charts which show how finance is
positioned in an organization. They also show who reports to whom and who has authority over certain
people or groups of people often referred to as departments.
 In figure 1, the CFO is tasked to oversee the different finance functions. Typically, a manager
or an officer will be in charge of each function. For instance, a credit and collection officer will be
assigned to oversee all activities that are related to the extension of credit to customers and the collection
of receivables.

The organizational structure in figure is not that different from that figure 1. Instead of a CFO,
a vice president for finance is tasked to manage all the functions of the CFO. In some cases, an accounting
and finance manager will oversee the unit. Individual employees will be in charge of handling taxes,
receivables and payables, and record sales, respectively.

FINANCIAL INSTITUTIONS, FINANCIAL INSTRUMENTS, AND FINANCIAL MARKET

A financial institution is an organization that handles financial transactions for individuals,
groups, and other organizations --- profit, non-profit, private, or government-owned. Financial
institutions can either be depository institution or nondepository institutions. A depository institution
manage money that is deposited by individuals and organizations. A nondepository institution does not
handle deposits.
Financial institutions are also referred to as financial intermediaries while financial products
are called financial instruments. Financial intermediaries are called as such because at times, they
facilitate the flow of funds between the savers and demanders of funds in an economy or a financial
system.
Financial products are signified by instruments when individuals and organizations alike deal
with each other in completing financial transactions, thus, the term financial instruments. Other sources
define financial instrument as a document which signifies a legal or binding agreement between two
parties.
The most common types of financial institutions are as follows:
1. Commercial Banks – Commercial bank accepts deposits from individuals and organizations that
have excess funds and provide loans to those who need or want to borrow money.
2. Savings and Loans – They are also referred to S & L or thrift banks. Unlike commercial banks,
the bulk of the financial transactions in S&Ls are dedicated to residential mortgages.
 3. Credit Unions – Credit unions are normally associated with or are an offshoot of cooperatives.
The way they operate is similar to an S&L. The interest rates offered by credit unions on savings
accounts are generally higher or lower on certain types of loans compared to what most banks
will offer.
4. Investments Banks – Operations of investment banks are different from that of commercial
banks. Generally, they do not have any dealings with general public.
5. Insurance Companies – Insurance companies provide individuals and organizations a way to
manage risk. They operate on the principle of pooling of risks wherein premiums are collected
from clients.
6. Brokerage – A brokerage is a financial institution that earns through commissions. Brokerage
firms facilitate the buying and selling of securities.
7. Investments Companies – Investment companies are corporations wherein individuals and
other organizations invest in investment portfolios that are managed by professionals who are
tasked to keep track of market trends and the performance of different financial products or
instruments.

THE FINANCIAL MARKET

Financial institutions operate in the financial markets. A financial market is a means for the
buying and selling of stocks, bonds, and other financial instruments. Stocks are shares of a corporation
sold to investors while bonds are, in essence, money loaned. The financial market is also a means where
individuals and organizations who need funds find investors and lenders.
The exchange of funds between people and organizations with surplus funds and those who
want to borrow or need money take place in the financial markets. Such transactions are called financial
transactions, and they facilitated by safeguard the efficient functioning of the financial markets.
A. Money Markets
Money markets are the markets where transactions involving short-term debt securities take
place. A short-term debt, just like in accounting, is one that is due and/or demandable within one year or
less. The following are some examples of money market securities:
● Treasury bills
● Commercial paper
● Negotiable certificates of deposit issued by government, businesses, and other financial
institutions.

B. Capital Markets
Capital markets are where transactions involving long-term debt, or those maturing in more
than one year, take place. The buying and selling of stocks issued by corporations also take place in
capital markets.
MOST COMMON FINANCIAL INSTRUMENTS
There are several kinds of financial instruments offered by various financial institutions as
discussed previously.
1. Savings – a saving account in a bank is by far the most common type of financial product that is
offered to customers. Savings could either be just a regular account, one where the depositor is
issued a passbook, or a more long-term basis such as time deposit where the depositor is issued
a time deposit certificate.
2. Loans – What do banks do with the deposits? They loan them to individuals and organizations
who need funds. The interest rate that they charge on the loans is higher than what they pay to
the depositors. Short-term loans are payable within one-year or less while long-term are those
that are due beyond one year or more. There are also collateralized and uncollateralized loans. A
collateral is an asset, like a piece of real estate property or a vehicle that is attached to a loan.
3. Bonds – Bonds is a loan granted to other organizations by individuals and organizations with
excess funds.
4. Security – When an investor has a security, this means that he or she has a financial instrument
signifying ownership of stocks of a publicly traded company, or a bond issued by a government
agency. A publicly traded company is a stock corporation that has opened the selling of shares
of stocks to the general investing public.
5. Treasury Bills – The government may also issue financial instruments or securities to the public.
Often referred to as T-bills, they yield no interest but are sold at a discount. The earning of T-
bills is minimal as the risk level is very low.
6. Insurance Products – People also buy insurance coverage for illnesses, injuries, accidents, and
physical disabilities. Life insurance gives benefits to those who were left behind by the deceased
policyholder. The policyholder is referred to as the insured while the insurance company is the
insurer.
7. Mutual Funds – The funds are invested into different financial products such as securities,
stocks, and bonds. The fund is managed by a fund manager employed by the mutual fund
company.

FLOW OF FUNDS IN A BUSINESS ORGANIZATION

The flow of funds through and from a business organization is best illustrated in the following
flowchart:

Individuals, households, organizations, and government agencies with surpluses or excess

money are the supplier of funds. On the other hand, there are also individuals, households, organizations,
and government agencies who are in need of money for a variety of reasons --- for personal use, to
support family needs, for expansion, and to support public programs or infrastructure building, among
others. Those in need of funds are the demanders of funds. These needed funds are provided by the
suppliers in the form of loans or investments.

MODULE 2
PLANNING AND WORKING CAPITAL MANAGEMENT

MOST ESSENTIAL LEARNING COMPETENCIES

At the end of this module, the learner will be able to:
● Identify the steps in the financial planning process
● Illustrate the formula and format for the top 4 preparation of budgets and projected
financial statements.
● Explain tools in managing cash, receivables, and inventory

LEARNING
CONTENT
PLANNING
Planning is very much related to another management function, controlling. These two
management functions reinforce each other, and both are very important for the success of an
organization.
Management planning is about setting the goals of the organization and identifying ways to
achieve them. This may be broken down into long-term plans and short-term plans. Long-term plans are
reflected in a company's business strategy. In the process of planning, resources have to be identified.
These resources include manpower resources, production capacity, and financial resources.

Once a plan is set, it has to be quantified. A plan that is not quantified is useless because there
will be no basis for monitoring performance and hence, no way of gauging success. Quantified plans are
in the form of budgets and projected financial statements. These budgets and projected financial
statements are then compared with the actual performance. This is where the controlling function comes
into play. It does not mean that if the actual performance falls short of the budgets or of the projections,
the management is not doing its function. Reasons have to be identified for the shortfall so that corrective
measures can be made. Also, the analysis will show whether the reasons for not meeting the projections
are due to management incompetence or factors outside its control.
Controlling goes beyond comparing plans with actual performance, but it takes off from
planning. To be effective, controlling must include a reward system for those who deliver and a penalty
for those who do not deliver whose reasons for failing to meet objectives are within their control.
Managers should not be penalized if failure is caused by fortuitous events.
STEPS IN PLANNING
The following steps can be followed in planning.
1. Set goals or objectives. The goals of a company can be divided into short-term, medium-term
and long-term goals. Short-term goals can be for a year medium term goals can be between one
to three years, and long-term goals can be five or 10 years or even longer Management can
actually define their timeframes for short-term, medium-term, and long-term goals. Long-term
and medium-term plans are generally established during strategic planning where the vision and
mission of a company are formulated or revisited. Strategic planning sessions or workshops are
not necessarily conducted every year.
2. Identify resources. Resources include production capacity, human resources who will man the
operations and financial resources.
3. Identify goal-related tasks. In this step management must figure out how to achieve an
objective. For example, if the target for this year is to increase sales by 15%, tasks should be
considered to achieve this goal. One task is to hire more sales agents if the management believes
that number of sales agents it has is not enough to support this 15% increase in sales. It is also
possible that the number of sales agents it has is already enough but many of them have to
improve their selling skills. So, the task that needs to be done soon is to provide training that will
improve the skills of the sales agents.
4. Establish responsibility centers for accountability and timeline. If tasks are already identified
to achieve goals, the next important step to do is to identify which department should be held
accountable for this task. For example, if the goal is to achieve a 15% increase in sales you may
immediately jump into the conclusion that this should be the responsibility of the head of sales
and marketing department. While the sales figures may have to be delivered by the sales and
marketing department, there should be other departments who take responsibility in achieving
this goal. The production department must ensure that there are enough units to sell and are of
good quality. Otherwise, if the products are defective, the sales and marketing department will
have a more difficult time selling the products. Also, the credit committee which approves credit
 terms to customers must be efficient in evaluating customer’s applications so that sales
transactions can be processed immediately. There must also be a timeline for the activities,
especially for those activities which are not normally done on a daily basis such providing
training to sales agents or hiring, additional agents if that is one of the tasks that needs to be
performed.
5. Establish an evaluation system for monitoring and controlling. The management must
establish a mechanism which will allow plans to be monitored. This can be done through
quantified plans such as budgets and projected financial statements.
6. Determine contingency plans. In planning, contingencies must be considered as well. Budgets
and projected financial statements are anchored on assumptions. If these assumptions do not
become realities, management must have alternative plans to minimize the adverse effects on the
company.
BUDGET PREPARATION
For this module, the following budgets will be prepared:
1. Sales budget
The most important financial statement account in forecasting is sales because almost all
other accounts in the financial statements are affected by sales. If you analyze the statement
of profit or loss, the accounts such as cost of sales, gross profit, and variable operating
expenses are based on the sales figure. To a large extent, depreciation expense and income tax
expense are also based on sales. The decision of management to expand production capacity
is based on projected increase in sales. With the expansion in capacity comes higher
depreciation expense. Higher income tax expense is expected with higher sales, assuming that
most of the operating expenses and cost of sales will remain unchanged as a percentage of
sales.
Looking at the accounts in the statement of financial position, almost all of them are also
correlated with sales. The amount of cash that a company maintains, its accounts receivable
and inventories, property, plant, and equipment, and trade payables are affected by sales.
Given the importance of sales forecast, attention must be given to it and must be supported
by reasonable assumptions. To have a set of reasonable assumptions on sales there must be a
good understanding of the industry where the company operates, enough historical financial
data to establish trend, and knowledge about corporate plans such as expansion of product
offerings or expansion into other geographical areas.
 2. Production Budget
Production budget is a schedule which provides information regarding the number of
units that should be produced over a given accounting period based on expected sales and
targeted level of ending inventories.
Required Production in Units = Expected Sales + Target Ending Inventories – Beginning
Inventories

Projected Financial Statements

The financial statement method will be used in projecting financial statements. Based on this
approach, the following steps will be followed:
1. Forecast soles. In making financial projections, always start with the statement of profit
or loss and the most important account to forecast first is sales.
2. Forecast cost of sales and operating expenses. For the cost of sales, the average cost of
sales over the historical data analyzed can be used. If there are plans to improve cost
efficiency, then such improved cost efficiency can also be considered. For example, if the
average cost of sales for the past five years is 60% but the management feels that given their
plans to improve production efficiency, cost of sales can be reduced to 58% In the projection,
this 58% cost of sales percentage can be used.
For the operating expenses, try to figure out which are variable and which are fixed.
Variable operating expenses include commissions. Fixed operating expenses include
depreciation office building salaries, and some maintenance expenses.
3. Forecast net income and retained earnings. To forecast net income, there should be
information on income taxes and how much financing cost a company will have. Financing
costs will be based on the amount of loans the company has and the payment terms for these
loans. There should also be assumptions on the interest rates for the projection period.
4. Determine balance sheet items that will vary with sales or whose balances will be
highly correlated with sales. Balance sheet items that may vary with sales or will be highly
correlated with sales are cash, accounts receivable, inventories, accounts payable, and
accrued expenses payable.
5. Determine payment schedule for loans. The payment schedule for loans can be based
on the disclosures provided in the notes to financial statements or the plans of management
 on how to pay the loans if no details about payment terms are provided in the notes to
financial statements.
6. Determine external funds needed (EFN). This amount is more of a balancing figure or
a squeeze figure. The balance sheet has to balance. Therefore, after assumptions are made to
project different balance sheet accounts, the projected statement of financial position has to
balance. The formula for this EFN IN shown below
EFN Change in Total Assets – (Change in Total Liabilities + Total Change in Stockholders
Equity)
7. Determine how external funds needed will be financed. Once EFN is computed, the
management decides how to finance. It can all be through debt or equity or combination of
debt and equity.

WORKING CAPITAL MANAGEMENT

Working capital refers to the current assets used in the operations of the business. This
includes cash, accounts receivables, inventories, and prepaid expenses. The amount of resources that a
company sets aside to these working capital accounts can be reduced by current liabilities such as trade
accounts payable and accrued expenses payable. The difference between these current assets and current
liabilities used in the operations of the business is net working capital.
The management of these accounts, both the current assets and the current liabilities is
important because these accounts deal with the day-to-day operations of the business. If the company
fails in the management of these accounts, there will be no expansion to talk about or this can lead to the
closure of the company.
Good management of working capital accounts allows the company to pay maturing
obligations on time. This helps in developing good business relationships with suppliers and other
vendors such as utility companies. Good management of working capital accounts also relieves managers
of unnecessary stress and gives them more executive time to improve the business operations.
Efficient management of working capital accounts can improve the earnings of the company.
This improvement in earnings can come from savings in financing costs and minimizing possible
impairment losses from inventories.

Working Capital Financing Policies

There are three types of working capital financing policies management can choose from.
These are:
A. Maturity Matching Working Capital Financing Policy
Based on the maturity-matching working capital financing policy, permanent working capital
requirements should be financed by long-term sources while temporary working capital requirements
should be financed by short-term sources of financing. Long-term sources of financing include long-
term debt and equity such as common stocks and preferred stocks. Short-term sources include short-term
loans from a bank. These short-term loans from banks are called working capital loans which perfectly
describe the reasons why these loans are incurred.

B. Aggressive Working Capital Financing Policy

Under the aggressive working capital financing policy, some of the permanent working capital
requirements are financed by short-term
sources of financing. Why do managers of
some companies adopt this policy? It is
because long-term sources of funds have
higher cost as compared to short-term sources
of financing. By financing some of the
permanent working capital requirements with
short-term sources of financing, financing cost
is minimized which in turn, improves net
income. By having this financing policy, the
company is increasing the probability that it
will not be able to meet maturing obligations.
In finance, we call this default risk. Embracing
this policy increases default risk.

C. Conservative Working Capital Financing Policy

Based on the conservative working capital financing policy, some of the temporary working
capital requirements are financed by long-term sources of financing.
Why do managers of some companies adopt this working capital financing policy? There are
many possible reasons but it can also be management style. Top management does not probably want to
be stressed too much so that they can concentrate their efforts on other important concerns that will
benefit the company. Maybe the management would also like to preserve their financial flexibility. This
means that if the company is conservatively financed and good investment opportunities come along the
way, it will be easier for the company to raise additional funds, be it in the form of debt financing or
equity financing.
Management of Working Capital Accounts
Cash
Cash is the most liquid asset of a company but it is also the asset most vulnerable to the theft.
Because of this, there must be proper internal controls over cash that need to be observed to safeguard
the asset. The following internal controls over cash are suggested.
1. Separating cashiering function from the recording or accounting function. A basic
internal control system should not allow the assignment of custodial function and
recording function to one person, unless you are the owner.
2. Issuing official receipts for collections and summarizing collections in a daily
collection report. It is important to know the collections from business every day as these
collections reflect the health of the company. The daily collection report is going to be
useful for the next control measure for cash--- depositing collections.
3. Depositing collections. A good internal control over cash is by depositing all collections
intact. The daily collection reports are now compared with the deposit slips to find out if
all collections are indeed deposited.
4. Adopting the check voucher system for payments. If all collections need to be
deposited, then payments must be made through a check voucher system. There must also
be two signatories in the check to provide check and balance.
Cash Budget
To find out if the company will be in need of cash in the coming accounting period and to
have an estimate of how much is needed and at what particular period that need will arise, a cash budget
must be prepared. A cash budget shows the expected cash receipts and disbursements for an accounting
period. It can be prepared on a monthly or a quarterly basis for a year.
The cash budget has the following parts:
1. Cash receipts. This includes collections from receivables, proceeds from loans or issuance of
new shares of stocks and advances from stockholders.
2. Cash disbursements. This section includes payments to suppliers and other service providers,
payments for loans and cash dividends.
3. Net cash flow for the period. This is computed by deducting cash disbursements from the
collections for the period. This provides information regarding the amount of excess cash or cash
deficit for the period.
 4. Target cash balance. No business can operate without cash. This target cash balance is the
amount of cash that management wants to maintain at all times given its present level of
operations, stability of cash flows, and the macroeconomic and political conditions. There are
primary and secondary reasons for holding cash which will be discussed in the next section.
5. Cumulative excess cash or funding requirements. This is the most important part of the cash
budget where the possible funding requirements are shown on a cumulative basis. This part of
the cash budget is very important in planning because if the management can estimate the amount
of cash they will need in the future and when it will possibly arise, this early, management can
identify the possible sources of cash. Planning the possible sources of cash in advance will save
the company financing costs and the unnecessary stress for managers.

MODULE 3
SOURCES AND USES OF SHORT-TERM AND LONG-TERM FUNDS

MOST ESSENTIAL LEARNING COMPETENCIES

At the end of this module, the learner will be able to:
● Compare and contrast the loan requirements of the different banks and nonbank
institutions and cite these institutions in the locality.

LEARNING
CONTENT
DEBT AND EQUITY FINANCING
Sources of financing are divided into two major categories: debt financing and equity
financing. The following section describes the features of each source.
Debt Financing
Debt financing can be in the form of borrowing from banks or other lending institutions or
issuance of debt securities like commercial papers and bonds. For some companies, it can also be in the
form of advances from stockholders to expedite the process of raising funds.
Debt financing creates a contractual obligation for the borrower to pay the interest and the
principal. Payments have to be made on time because unpaid interest and principal lead to penalties and
more interest. Despite these advantages, companies still resort to borrowing to fund their working capital
requirements and expansions. If managed properly and if taken in reasonable amounts, debt financing
can help the company grow. Among the benefits of debt financing are as follows:
1. Interest expense is tax-deductible.
2. Debt financing allows the company to grow without diluting the interest of the controlling
stockholders.
3. Creditors generally do not intervene in the decisions of the management.
 These benefits from debt financing can be realized if the level of debt incurred by the company
is manageable. Too much debt can expose the company to a bankruptcy risk and this may disrupt the
operations of the company.

Equity Financing
Equity financing refers to issuance of new shares of stocks and retained earnings plowed back
into the operations of the company. The latter is also called internally generated funds. Equity financing
is the safest source of financing for a company because it does not require any mandatory payment of
the dividends. If you own enough shares of a company, you can end up controlling its operating and
financing decisions. Controlling stockholders defines the direction of the company because they can
choose who will manage the company.
Disadvantages of Equity Financing
1. Cash dividends are not tax-deductible.
2. Offering new shares to other investors may dilute the ownership stake in terms of percentage of
the existing stockholders.
3. It is the most expensive source of financing. At the onset, it does not appear to be expensive
because there are no mandatory payments for dividends.
Pecking Order Hypothesis
The pecking order hypothesis in corporate finance was developed based on repeated
observations of how companies fund their financing requirements. According to this hypothesis, this is
how companies fund their requirements:
1. Internally generated funds. These are the funds that come from operating cash flows.
2. Debt. When internally generated funds have been exhausted, debt financing is the next
alternative.
3. Equity. The last in the priority list of financing is equity financing. This is not surprising given
it is more difficult to issue new shares of stocks.
SOURCES AND USES OF SHORT-TERM FUNDS
Short-term funds are normally used to finance the day-to-day operations of the company. It is
used for working capital requirements such as accounts receivables and inventories. It can also be used
for bridge financing where a company has some maturing obligations and does not have enough cash to
pay such maturing obligations. There are occasions when the management of a company decides to
borrow short-term loan to address this problem.
The following can be source of short-term funds:
1. Supplier’s credit. Suppliers of raw materials and merchandise are the best sources of short-term
working capital. This is the reason why a good relationship has to be nurtured with suppliers. As
much as possible, honor the credit terms. If you want the credit terms negotiated, the chances of
the suppliers agreeing to the request increase when your company has been a very good customer,
which is, paying the obligations on time. Some suppliers charge a small interest rate on their
deliveries to their customers if not paid on a certain date. They can also ask their customers to
sign promissory notes under certain circumstances.
2. Advances from stockholders. If you have enough personal assets and you control the company,
advancing funds to the company when there are financial requirements is an easy way for the
company to raise funds. Interest on these advances can be charged by the stockholder.
3. Credit cooperatives. To borrow from credit cooperatives, you have to be a member. Credit
cooperatives can lend as much as five times of your equity or contributions. If you own a
company which is in need of funds and you are at the same time a member of this credit
cooperative, then you can borrow in your personal capacity from the cooperative and advance
the proceeds from the loan to your company. This practice, however, should not be encouraged
because your company must be able to raise money on its own merits.
4. Bank loans. Banks can provide both short-term and long-term loans. Some banks also provide
credit facilities, not just to big corporations, but also to small and medium enterprises.
Government banks, the Development Bank of the Philippines (DBP) and Land Bank of the
Philippines (LBP), offer short-term credit facilities to small and medium enterprises. Private
banks such as BPI and BDO also provide working capital loans to small and medium enterprises.
Securing loans from these credit institutions may take some time as they have to do credit
investigation. They also have to evaluate the loanable values of the collateral that may be
mortgaged to support a loan. Among the collaterals that can be acceptable to banks include real
estate, transportation vehicles, and even inventories. The mortgaged properties like house and lot
may have to be insured as well. Thus, the transaction costs involved in bank lending may be high.
5. Lending companies. These are small lending companies which cater normally to small and
medium enterprises. The lending process is much faster as compared to banks but they charge
higher interests, higher than the banks but lower compared to a more informal lending, popularly
known as "5-6." These lending companies can finance working capital requirements. Some of
them may require some documents such as purchase order to support a loan application. This
purchase order may become the basis of a loan release.
 6. Informal lending sources such as "5-6." This is a very expensive source of financing and
should be avoided. It is called such because for every P5 that you borrow, you have to return P6.
This 20% interest is just for a month. Without interest compounding, this translates into an annual
interest rate of 240%. Therefore, this source of financing should never be considered because
you will end up working for the creditor.
SOURCES AND USES OF LONG-TERM FUNDS
Long-term funds are used for long-term investments or sometimes called capital investments.
This includes expansion, buying new equipment, or buying a piece of land which will be the site of
future expansion. Long-term funds can also be used to finance permanent working capital requirements.
Long-term investments have to be financed by long-term sources of funds to minimize default
risk or the risk that you may not be able to pay maturing obligations. The returns on long-term
investments may not be realized immediately, and therefore require more patient sources of financing.
For example, if a new branch of restaurant is going to be opened in a mall and an investment of P2
million is made which includes permanent working capital requirements. This investment may not be
recovered in a year or worse, there is no assurance that customers will patronize the restaurant
immediately and may take some time before potential customers will get to know it. If the source of
financing is a short-term loan, say a six-month loan, and one does not have enough personal funds to
shell out in case of emergency, the new outlet may end up defaulting with its obligations when the loan
matures. Therefore, for this kind of expenditure, a more patient source of financing is needed.
The following are the different sources of long-term funds:
1. Equity investors. Equity investors can be issued common stocks. This is the most patient source
of capital. As far as the company is concerned, this is the safest source of financing.
Unfortunately, it is not always available when the company needs it. Even big corporations have
to identify a correct timing or opportunity for them to issue more shares. Big companies normally
wait for a bullish market in issuing new shares of stock. During bull market, companies can afford
to set a higher price for each share allowing them to maximize the amount that they can generate
from public offering.
2. Internally generated funds. Instead of declaring cash dividends, the company can use internally
generated funds for expansion or to finance other types of capital investments. Based on the
Corporation Code of the Philippines, there is a limit regarding the amount of retained earnings
that the company can keep in its statement of financial position. Retained earnings cannot exceed
100% of the value of common stocks or sometimes called paid-in capital. However, if the board
can make a resolution, setting aside a specific amount of retained earnings for expansion, then
 this is acceptable. There are other approaches on how to go about this provision in the law, but
this topic may be reserved for a more advanced subject in finance.
3. Banks. Banks are sources of different types of financing from short-term to long-term. They
provide lower interest rates as compared to other financial.
4. Bond market. This market is gaining more popularity among our big publicly listed companies
for their fundraising activities. Philippine bonds are now traded through the electronic platform
provided by the Philippine Dealing System Holdings Corporation (PDS Group). To issue bonds,
the services of an investment bank are also needed to underwrite the issue. The bonds that will
be issued have to be registered with the Securities and Exchange Commission and they have to
be credit rated. Moody's and PhilRatings are among the credit rating agencies in the Philippines.
The credit rating given by these credit rating agencies is important because it will dictate the
interest rate that the issuer can charge to the buyers of the bonds. A high credit rating means that
the bond issuer can afford to charge lower interest rates which in turn will minimize its financing
cost. Just like in an IPO, roadshows are also conducted in a bond offering to have a feel of the
market's perception of the issue and the interest rate bond investors are willing to take.
5. Lending companies. These are the same lending companies previously discussed. Some of them
also provide long-term loans ranging from two to five years. These lending companies can
process loans faster but they charge higher interest rates. When companies have identified good
investment opportunities they want to pursue, financing is generally a combination of debt and
equity. It is just a question of how much of the funding requirement will come from debt and
how much will come from equity. Again, this decision depends on many factors: access to
different forms of financing. existing capital structure, size of the capital investment, bullishness
or bearishness of the stock market and the bond market, interest rates, economic conditions and
management style
DUTIES OF THE BORROWER TO CREDITORS
This section lists down the duties of a borrower to its creditors:
1. Pay the creditors based on the payment schedule agreed upon. One way of establishing
credibility is paying obligations on time. If you cannot pay on time, notify the creditors ahead of
time. But as much as possible, pay on time. Coming up with different reasons for not paying on
time creates bad impression.
2. Provide the collaterals as agreed upon in the loan negotiation with proper documentation,
if necessary and if applicable (eg, annotation of the Transfer Certificate of Title (TCT) or
Condominium Certificate of Title (CCT). Ensure that these collaterals are in the physical
 condition perceived by the creditors during the determination of the loanable value of the loans.
It pays to be in good faith.
3. Comply with the provisions of the loan covenant such as maintaining certain liquidity and
leverage ratios. These conditions are supposed to benefit the borrower so that his company will
not be over-exposed to borrowing and he will be tasked to monitor the liquidity position of the
company on a more regular basis.
4. Notify the creditor if the company is acquiring another company or the company is now
the subject of acquisition. The interest of creditors may be jeopardized if new owners take over
the company or if the company is going to acquire another company.
5. Do not default on the loans as much as possible. Aside from the creditors, there may be other
parties such as the guarantors of the loan who will be put at a disadvantage if the borrower
defaults.

MODULE 4
BASIC LONG-TERM FINANCIAL CONCEPT

MOST ESSENTIAL LEARNING COMPETENCIES

At the end of this module, the learner will be able to:

● Calculate future value and present value of money.

● Compute loan amortization using mathematical concepts and the present value tables.
● Apply mathematical concepts and tools in computing for finance and investment
problems.
● Explain the risk-return trade-off.

LEARNING
CONTENT
TIME VALUE OF MONEY
"A peso today is worth more than a peso tomorrow". All individuals and businesses face the
same two basic finance-related problems:
1. Where to put the money?
2. Where to get the money?
The first problem is called the "investment" decision; the second, the "financing" decision. In
addressing the investment problem, individuals and companies choose from a wide range of real and
financial assets. They can opt to put their funds in real assets that represent their various projects. Real
asset investments include purchasing equipment and machinery with the purpose of generating revenues
across the useful lives of these assets. This could also take the form of adding a new wing to their office
building or factory. The acquisition of license brands is also considered a real asset investment. Financial
assets include investing in the shares of another company. Lending money to others and purchasing fixed
income instruments such as government-issued Treasury securities and corporate bonds are also
considered financial investments.

THE CONCEPT OF INTEREST

The most basic finance-related formula is the computation of interest. It is computed as
follows:
I=PxRxT
I = interest R = Interest Rate
P = Principal T = Time Period
Interest is earned or incurred for the use of the principal amount over the relevant time
period. For example, an individual borrowed P1 000 from a local bank at an interest rate of 9% over a
one-year period. In this example, the P1 000 amount borrowed is the principal of the loan; 9% is the
applicable interest rate; and the relevant time period is one year. The interest on the loan is computed as:
I=PxRxT
₱90 = ₱ 1000 x 9% x 1year
Thus, the interest on the loan is ₱90. This ₱90 is the cost of using the ₱1000 borrowed for one year.

Exercise 1
Identify the (a) principal, (b) interest rate, and (c) time period in the examples below:
1. Your mother invested ₱18 000 in government securities that yields 6% annually for two years.
2. Your father obtained a car loan for ₱800 000 with an annual rate of 15% for 5 years.
3. Your sister placed her graduation gifts amounting to ₱25 000 in a special savings account that
provides an interest of 29% for 8 months. Your brother borrowed from your neighbor ₱17 000 to
buy a new mobile phone.
4. The neighbor charged 11% for the borrowed amount payable after three years.
5. You deposited ₱5 000 from the savings of your daily allowance in a time deposit account with
your savings bank at a rate of 1.5% per annum. This will mature in 6 months.
SIMPLE INTEREST
If the interest earned or incurred is always based on the original principal, then simple interest
is assumed. For example, you invested ₱10 000 for 3 years at 9% and the proceeds from the investment
will all be collected at the end of 3 years. Using a simple interest assumption, interest will be computed
as follows:
Year Principal Rate Time Interest Cumulative Total
Interest

1 ₱10 000 9% 1 ₱900 ₱900 ₱10900

2 ₱10 000 9% 1 ₱900 ₱1800 ₱11800

3 ₱10 000 9% 1 ₱900 ₱2700 ₱12700

COMPOUND INTEREST
The usual assumption in most business transactions is to use compound interest. Compound
interest is simply earning interest on interest. This means that the basis for the computation of the
applicable interest for a certain period is not only the original principal but also any interest earned in the
previous period assuming all cash flows would be paid or received in lump sum upon maturity.
Using the previous example where you invested P10 000 for 3 years at 9% and the proceeds from
the investment will all be collected at the end of 3 years, we illustrate the computation of compound
interest. Using a compound interest assumption, interest will be computed as follows:

Year Principal Rate Time Interest Cumulative Total

Interest

1 ₱10 000 9% 1 ₱900 ₱900 ₱10 900

2 ₱10 900 9% 1 ₱981 ₱1 881 ₱11 881

3 ₱11 881 9% 1 ₱1 069.29 ₱2 950.29 ₱12 950.29

FUTURE VALUE OF MONEY
In the previous example, the value of the investments at the end of the year 1 is equal to ₱10 900
computed as follows:
Value at the end of the year 1 = ₱10 000 + (₱10 000 x 9% x 1 year)
₱10 900 = ₱10 000 x (9% x 1)
We, therefore, say that given an interest rate of 9% the future value of ₱10 000 after one year is
₱10 900.
Similarly, the future value of the ₱10 000 at the end of year 2 will be equal to the value at the
end of year 1 plus the compound interest in year 2 as shown below:
Value at the end of year 2 = ₱10 900 + (₱10 900 x 9% x 1 year)
₱ 11 881 = ₱10 900 x (1 + 9%)
₱ 11 881 = ₱10 000 x (1 + 9%) x (1 + 9%)
₱ 11 881 = ₱ 10 00 x (1 + 9%)2
The future value then at the end of year 3 is determined as follows:
Value at the end of year 3 = ₱11 881 + (₱11 881 x 9% x 1 year)
₱12, 950.29 = ₱11 881 x (1 + 9%)
₱ 12 950.29 = ₱10 000 x (1 + 9%) x (1 + 9%) x (1 + 9%)
₱ 12 950.29 = ₱10 000 x (1 + 9%)2
The future value of ₱10 000 invested for 3 years at a rate of 9% is equal to ₱ 12 950.29.
Therefore, we use the general formula to determine the future value:
Future Value = Initial Value x (1 + R)T
To get the future value, we multiply the initial value by (1 + R) T which is referred to as the
future value interest factor (FVIF)

PRESENT VALUE OF MONEY

To make cash flows comparable, we either determine their future value at a common future date
or compute their present value today. Most decision makers choose to get the present values since the
decisions are made today.
To get the present value of a lump-sum amount, we go back to equation:
Future Value = Initial Value x (1 + R)T
 The future value in the formula is the expected lump-sum amount while the initial value is actually
the present value. Rearranging equation gives us the formula for the present value of money.
𝑓𝑢𝑡𝑢𝑟𝑒 𝑣𝑎𝑙𝑢𝑒
Present Value =
(1+𝑅)𝑇
1
Present Value = Future Value x
(1+𝑅)𝑇
To get the present value, we multiply the future lump-sum amount by 1 / (1 + R) which is referred
to as the present value interest factor (PVIF) The PVIF is also called the discount factor and the whole
process of determining the present value is referred to as discounting. The interest rate used to get the
present value is denoted as the discount rate.
For example, your father told you that he will entrust you with the funds for your graduate program
education. He gave you two options: (1) receive the money now in the amount of P200 000 or (2) receive
P500 000 ten years from now. The available investment opportunities to you provide a 10% rate of return.
Which option would you prefer?
To address this dilemma, you either determine the future value of the P200 000 and compare it with the
expected cash flow of P500 000 ten years from now, or compute the present value of the P500 000 and
compare it to the P200 000 which you can receive today.
Choosing the second method will require you to get the present value of the P500 000 as shown below:

𝑓𝑢𝑡𝑢𝑟𝑒 𝑣𝑎𝑙𝑢𝑒
Present Value =
(1+𝑅)𝑇

500 000
= = ₱192 771.64
(1+10%)10

Since the P200 000 is greater than P192 771.64 (the present value of the P500 000), you will
choose to receive the P200 000 today instead of waiting for it in ten years' time. Getting it now will give
you the opportunity to grow the investment at the rate of 10% and the related future value is expected to
be greater than the P500 000. To validate this, we compute for the future value of the P200 000:
Future Value = Present Value x (1 + R)T
= ₱200 000 x (1 + 10%)10
Future Value = ₱ 518 748. 50
₱518 748.50 > ₱ 500 000
 MODULE 5
INTRODUCTION TO INVESTMENTS

MOST ESSENTIAL LEARNING COMPETENCIES

At the end of this module, the learner will be able to:
● Explain the risk-return trade-off.
● Compare and contrast the different types of investments.
● Measure and list ways to minimize or reduce investment risks in simple case
problems.

LEARNING CONTENT

RISK-RETURN TRADE-OFF

Risk Preference

The choices we make when faced with simple life decisions such as eating in a restaurant,
purchasing an airline ticket, choosing which theme park ride to ride on exhibit our risk preference.

Answer these questions. Choose only one answer from the choices

1. You were assigned to arrange the Christmas party of your class and you were looking for a venue
outside the school. How would you go about searching for this location?
a. Call the mobile or landline number of the venue to ask for the details of the place
b. Visit the location two weeks before the party to personally talk to the administrative staff.
c. Search the Internet then select a venue. Go to the venue together with your classmates on the
day of the party itself
d. Send an email message to the administrative office inquiring about the availability and rates?
2. You are planning to spend the holidays out of town and have chosen Boracay as your preferred
destination. How would you purchase your airline tickets?
a. Purchase it online for P12 000 round-trip with a possibility of refund and rebooking.
b. Make a reservation and pay between P5 000 to P15 000 before the date of departure.
c. Immediately purchase it online for P7 000 round-trip with no refund.no rebooking clause.
d. Purchase it online for P10 000 round-trip with a no-refund clause but with a possibility of
rebooking.
3. You were given a chance to ride only one amusement ride at Enchanted Kingdom. Which one will
you choose?
a. Anchor's Away c. Space Shuttle
b. EKstreme Tower d. Wheel of Fate
 Which options did you choose? Are your choices the same as your classmates? Which ones
were the most preferred responses?

You will probably observe that different individuals have different answers to the given
questions. Each individual's choice exhibits a different risk preference. Other Individuals may be
considered more aggressive or conservative than the others.

RISK AVERSION

In finance, we assume that individuals are risk averse but have different levels of risk
aversion. The figure below explains what risk aversion means Risk aversion means that individuals
maximize returns for a given level of risk or minimize risk if the returns are the same. Risk-averse
individuals would require a higher return if the risk level increases.

INVESTMENTS AND THE RISK PREMIUM

Brown and Reilly (2014) defined investment as the current commitment of dollars for a
period of time in order to derive future payments that will compensate the investor for.
• the time the funds are committed;
● the expected rate of inflation during this time period
● the uncertainty of future payments."

Investments do not have to be in dollars but may be denominated in any other currency.
Simply, money which is committed with an intention to earn a return over a period of time may be
considered as an investment.

The required return of any investment is dependent on the risks faced by the investor as the
risk-return trade-off suggests. The riskier the investment, the higher is the required rate of return by the
investor.

This means that all investments are faced with the same nominal risk-free rate consisting
of the real risk-free rate (time value of money) and the same expected rate of inflation. The required rates
of return of various investment instruments differ because of their risk premium. The riskier the
investment, the greater is the risk premium added to the nominal risk-free rate in order to determine the
required rate of return.
Brown and Reilly (2014) identified the major sources of risk as follows:

1. Business risk 4. Exchange rate risk

2. Financial risk 5. Country risk
3. Liquidity risk
Business risk is related to the nature of the company's products and its operating strategy.
Companies with stable sources of sales and earnings have relatively low business risk. These companies'
products are patronized even during times of recession. Business risk is also associated with the cost
structure of the issuing company. If the issuing company chooses to incur higher fixed operating costs
then its business risk increases Higher fixed operating costs result in greater variability in the operating
income (loss) as the sales of the company fluctuate. Business risk is usually measured by the degree of
operating leverage

Financial risk refers to the risk created by the choice of capital structure-the financing mix of the
issuing company. A company usually funds its operation through debt and equity financing. As the debt
portion increases, financial risk increases. Incurring debt creates a fixed financial obligation. Just like
fixed operating costs, these fixed financial costs create more variability in the returns of the issuing
company. Financial risk is usually measured by the degree of financial leverage.

Liquidity risk is the uncertainty that an investment can be converted to cash at a known price. The
existence of exchanges facilitates ease in liquidating an investment. If there is no ready market for the
investment, it is considered illiquid and a higher liquidity premium is required by investors. The presence
of many ready buyers and sellers reduces liquidity risk.

Exchange rate risk exists if the investment is denominated in another currency different from that
of the local currency of the Investor. An additional uncertainty exists if the investor needs to liquidate the
foreign currency-denominated investment and convert it to Philippine Peso, for example. The investor
then must consider the direction and variability of the exchange rate between the local currency and the
various foreign currencies.

Country risk is associated with political and economic uncertainty of a particular business
environment. You can only entice investors to invest in countries with political instability if a higher rate
of return is expected. Country risk also increases if natural disturbances usually occur such as typhoons
and earthquakes. Investments in countries prone to changes in government through coup d' etat, rebellion,
or revolutions have higher country risk premium.
TYPES OF INVESTMENTS AND THE RELATED RISKS

To describe the basic types of investments and identify the related risks, ask following questions:

1. Is the return provided by the investment fixed or variable?

2. Who is the issuer of the investment?

3. Can the investment be liquidated immediately at a known price?

4. How long is the term to maturity of the investment? These questions represent the various risks
involved with each type of the investment.

DEPOSITS

Deposit instruments are provided by financial institutions, mostly banks. The major deposit
instruments include the following:

1. Savings account 2. Checking account 3. Time deposit account

A typical savings account provides a low fixed rate of return but provides the convenience of
availability. The depositor can easily deposit and withdraw from the account at any banking day.

Previously, a depositor with a checking account does not earn interest but now most, if not all, banks
provide a rate of return although the fixed rate is very low. Clearly, the depositor can issue checks from
his account to pay for various expenditures Instead of delivering bills or coins as payment Banks charge
a certain fee for the printing costs of check booklets. Checks issued are subject to a clearing float (usually
3 days) when deposited by the payee.

A time deposit account usually requires a minimum amount of deposit with a fixed term to
maturity. This type of account provides a higher fixed rate of return compared to a savings and checking
account. The depositor cannot withdraw from his account before the fixed maturity date.

Although banks are monitored by the Bangko Sentral ng Pilipinas (BSP), there is the possibility
that these financial institutions may face the risk of bankruptcy. If this scenario arises, the bank would not
be able to pay for all their deposit liabilities. Deposits with banks are insured with the Philippine Deposit
Insurance Corporation (PDIC) up to P500 000 per depositor for every bank. Depositors need to determine
the bank's overall financial position and performance before transacting with them. A comprehensive
rating system was developed in assessing the overall condition of the bank. This CAMELS rating system
is based on the following components:
 1. Capital adequacy 4. Earnings quality
2. Asset quality 5. Liquidity
3. Management indicators 6. Sensitivity to risk factors

CORPORATE DEBT SECURITIES

Corporations issue debt instruments in the form of commercial papers and corporate bonds.
Commercial papers are short-term instruments issued by corporation for their immediate needs. Corporate
bonds are long-term debt instruments issued by corporations. Most corporate bonds provide fixed coupon
payments although there are already variable-rate corporate securities. Fixed rate bonds pay coupon
payments at regular intervals usually semi-annually.

Corporate bonds are also traded like government securities using the PDEx platform Investors
would need to transact with their dealer banks in order to invest in these securities.

EQUITY SECURITIES

Stocks are financial instruments that represent ownership in a corporation. Equity securities are
classified under two main categories: common stocks and preferred stocks. Let us summarize the features
of a common stock investment by answering our guide questions earlier and then we differentiate this
from a preferred share.

1. Is the return provided by the investment fixed or variable?

Investors earn from an equity investment through dividends and capital gains. Dividends
issued by corporations may vary from year to year since the earnings of the company also fluctuate
from period to period. Companies are not required to declare annual dividends. Since owners of
common shares only have a residual interest in the earnings of the business, dividends are only
declared if there are enough available funds after the payment of commitments to creditors. Thus,
equity investors are exposed to greater variability of returns. Being exposed to greater variability
also means that if the fixed obligations have been settled, then the excess earnings would all go to
the common stockholder.
2. Who is the issuer of the investment?
Only corporations issue common shares. The credit standing of these corporations
influences the protection of capital of their shareholders. If corporations default on their debt
obligations, more so that they cannot provide sufficient returns or even repay the capital of
shareholders since creditors have seniority over claims to the assets of the corporation.
3. Can the investment be liquidated immediately at a known price?
 If the equity investment represents ownership in a listed company, then the Instrument is
considered liquid since the stock exchange would facilitate the availability of known bid and ask
prices for the shares and access to a wide base of buyers and sellers as well. Investors would only
need to look for a stockbroker in order for the individual to purchase and sell shares in the stock
market.
4. How long is the term to maturity of the investment?
Common shares do not have a term to maturity. The shareholder may hold the stock
indefinitely.

Aside from these features, the common stockholders also have voting rights. Also, because of its
residual interest, the potential upside of equity returns is essentially limitless. Yet, the risk lies in the
variability of the returns with a maximum loss equal to the initial investment of the stockholder Equity
investments have higher required rates of return compared to fixed income instruments because of this
variability.

Preferred stocks differ from common shares in terms of preference as to dividends, seniority over
claims to assets, and the absence of voting rights Corporations are not required to pay dividends annually
to preferred stockholders but when they do, they declare dividends, preferred shareholders are paid first
before common shareholders In case of liquidation, preferred shareholders also have preference over
claims to the assets relative to common shareholders but not over creditors. Preferred shareholders also
do not have voting rights in stockholders' meetings. Dividends paid to preferred shareholders are computed
as a percentage of the par value of the shares and thus may be considered as a fixed income instrument
because of the similarity in the cash flow pattern.

ALTERNATIVE INVESTMENTS

Investors can also put their funds in tangible assets such as real estate, antiques, artwork, horses,
etc. Higher risk premium is associated with these investments since the future cash flows associated with
owning these assets are unclear and the absence of a ready market increases the liquidity risk of these
assets. For example, a piece of artwork may be bought from art dealers but these dealers may provide a
different estimate of the value of these assets. Some of these assets are also susceptible to theft and
physical deterioration.

34
 MODULE 6
MANAGING PERSONAL FINANCE

MOST ESSENTIAL LEARNING COMPETENCIES

At the end of this module, the learner will be able to:
● Enumerate money management philosophies.
● Illustrate the money management cycle and give 4 examples of sound practices in
earning, spending, saving, and investing money.

LEARNING
CONTENT
FINANCIAL PLANNING AND THE INDIVIDUAL'S LIFE CYCLE

The financial plans of an individual depend on his financial objectives that are very much affected
by the stage he is at in an individual life cycle. Brown and Reilly (2014) identified the four life cycle
phases as follows:

1. Accumulation phase. Those who have just started working or in the early part of their respective
careers. Since they are relatively young, they can afford to take on high-risk investments for they
can simply start again if they fail in some of their business ventures and investments. In this phase,
they are still "accumulating" assets that will satisfy their individual goals. Typical assets that any
individual or household acquires at this stage include their own car or house. It is also at this stage
that individuals start living separately from their parents. Individuals may start by first renting a
condominium unit or house then eventually buying one of their own.
2. Consolidation phase. Those in this phase already have the necessary assets required of a typical
household and have settled most of their outstanding liabilities. Major concerns at this stage
include the ability to pay for the education of their children (from grade school to college).
3. Spending phase Retired individuals belong to this stage. Their main source of income comes from
their pension although they also benefit from the returns of their existing investments. Capital
preservation is their main return objective with the intention of earning more than inflation to
protect the value of their investments in real terms. Capital preservation objectives require the
individual to put his money in very safe investments.
4. Gifting phase. Not everyone is expected to reach this phase and most of the time this stage is
concurrent with the consolidation phase. This stage focuses on how the individual provides support
to the family members, friends, or any charitable institution. The focus of the individual is

35
 consistent on how he wants to allocate his funds to these beneficiaries in case of his death or even
during his remaining years.

BASIC PRINCIPLES OF PERSONAL FINANCE

Keown (2010) summarized the basic principles of personal finance management in the following
points:

1. The Best Protection Is Knowledge.

The chapters of this worktext provide the financial literacy to understand basic finance
concepts applicable to both businesses and individuals. We have discussed essential finance
concepts such as the time value of money and the risk-return trade-off. These concepts also apply
to personal finance and should be the guiding principles in assessing potential investment schemes
and the related returns promised by these schemes. Individuals should be cautious when reading
and understanding the advertisements and leaflets disseminated.

2. Nothing Happens. Without a Plan Financial planning is not restricted to companies alone.
Individuals also prepare their financial plans to order to meet their set objectives and goals
Basic financial plans include the preparation of annual, monthly, weekly, or even daily budgets.
Adults prepare the household budget to determine if the sources of funds (earnings, etc.) of the
family will be able to meet the required living expenditures and if there will be an excess available
for savings and investment. If this is not enough, the creation of a budget will also trigger the
family to seek potential sources of financing (bank borrowings, credit cards, etc.). Even at an early
age, individuals should practice financial planning/budget preparation. This can be applied when
determining the potential uses of the daily or weekly allowances children get from their parents.
They should be able to establish the basic expenditures such as food, transportation, school
supplies, etc. and determine whether there is money left that they can spend on entertainment toys,
or leisure outside school days.

3. The Time Value of Money.

Remember the power of compound interest. Albert Einstein acknowledged its importance
and individuals must use it to their advantage by investing wisely and avoiding its dangers by
borrowing judiciously. Do not forget to select the best investment alternative by determining first
a common valuation date, today for example, then comparing its (present) value before deciding

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 which offers the most attractive proposition Financing or borrowing options (whether home or car
loans) should also be compared based on the (present) values The time value of money is also the
basis in computing the return promised by an investment scheme and whether this is realistic given
the applicable investment time horizon.
4. Taxes Affect Personal Finance Decisions.
Almost all transactions involve taxes. Analyze the returns of potential investments on an
after tax basis. Even in determining the earnings of an individual, just like a company, almost 1/3
of the income will go to taxes. Passive Income is also subject to taxes and this must be incorporated
in the analysis before making any investment decisions.
5. Stuff Happens, or the Importance of Liquidity.
Remember to provide enough leeway for liquidity in the form of cash or any assets easily
convertible to cash or with a ready market. This will allow the individual to cover for any
unexpected needs and take advantage of unexpected opportunities. Illiquidity may lead the
individual to seek funds haphazardly and be subjected to onerous terms by creditors.
6. Waste Not, Want Not - Smart Spending Matters
Individuals must identify priority goals--both near term and long-term. This should be the
basis in ranking potential purchases whether staples or capital expenditures. Only when the
necessities are taken care of should an individual indulge in more luxurious items. Impulsive
buying should be minimized and a specific budget should be set for these lower priority items.
7. Protect Yourself Against Major Catastrophes
Risk management involves protecting the individual and his property from event risks such
as natural calamities. This is more urgent in calamity-prone countries such as the Philippines.
Insurance policies should include provisions that will cover for these events. These clauses are
sometimes referred to as "Acts of God" riders. In this case, the individual must not forget payments
for insurance premiums as necessary fixed obligations just like principal and interest payments of
his mortgages.

8. Risk and Return Go Hand in Hand

If you desire to achieve higher returns, you must understand that investments that will
provide this involve higher risk Asset classes being considered by the individual should fall within
his risk tolerance level. Risk minimization is also achieved by remembering the adage, "Do not
put all your eggs in one basket."

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 9. Mind Games and Your Money
Achieving financial proficiency does not solely involve formulae and computations
Finance is a much broader field that includes the study of behavioral traits and reactions of
individuals. Behavioral finance is an interesting field to study and seek applications to personal
finance problems.
10. Just Do It!
Now that you have covered the basic concepts in financial management as provided by this
worktext, it is up to you to apply these concepts now and in the future regardless of the field or
career you will specialize in. We have covered a wide range of topics including financial statement
analysis, planning and forecasting, working capital management, short-term and long-term sources
of financing and evaluation of long-term investment. The risk-return trade-off of different
investments such as those related to stocks, government securities, and corporate bonds were also
discussed.

REFERENCES:
Books:
Business Finance ; Rex Book Store: Arthur S. Cayanan and Daniel Vincent H. Borja
Exploring Small Business and Personal Finance: Phoenix Publishing House; Kenneth Yumang
Business Finance in the Philippine Setting; Nick L. Aduana
Websites:
https://www.investopedia.com/terms/w/workingcapital.asp
https://www.investopedia.com/terms/w/workingcapitalmanagement.asp
https://www.pse.com.ph/stockMarket/home.html
https://www.accountancyknowledge.com/future-value-of-a-single-amount-problems-and-
solutions/

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