Comprehensive Business Finance Foundations and Management Notes

Finance in Everyday Life

• The study of business finance begins with understanding its application in daily life, focusing on basic concepts such as budgeting, investments, and identifying sources of funds.

• Learning Objectives:

  • Understand the concept of finance and its application in everyday life.
  • Learn basic financial vocabulary: Finance, Budgeting, Investments, and Sources of Funds.
  • Develop an awareness of the importance of savings and financial planning.
  • Identify and analyze personal expenses to practice budgeting.

• 1.1 Daily Allowance Activity (Self-Reflective Exercise):

  • Individuals are encouraged to analyze their financial habits by asking the following:
    • How much is your daily allowance or average allowance per day?
    • Write down all items you spend money on (expenses) and the specific peso amount.
    • Calculation: Deduct daily allowance minus expenses (Allowance - Expenses).
    • Identify where additional money is sourced when allowances are insufficient.

• The Finance Decision:

  • Any activity involving decisions on where and how to use your allowance is classified as a finance decision.

Basic Financial Vocabulary and Concepts

• Finance (Definition):

  • According to Gitman & Zutter ($2012$), finance is defined as the science and art of managing money.
  • Finance is concerned with specific decisions regarding:
    • How much money to spend.
    • How much to spend specifically on needs.
    • How much to save for the future.
    • How to invest existing savings.
    • How to raise additional funds when required.

• Budgeting (Definition):

  • Budgeting is the act of estimating revenue and expenses over a specific period of time.

• Source of Funds (Definition):

  • When faced with financial difficulties or a lack of funds to meet current expenses, individuals or entities look for people or institutions to provide the necessary money. These origins are called Sources of Funds.

• Investment (Definition):

  • Investments come in many forms intended to generate income or appreciate in value in the future.
  • Investment is the act of allocating money with the expectation of achieving generating income or appreciation.

• Savings:

  • Savings are generated from excess allowance (Allowance > Expenses).

Forms of Business Organizations

• 1. Sole Proprietorship:

  • A business owned by exactly $1$ person.
  • It is operated for the owner's own profit.

• 2. Partnership:

  • A business owned by $2$ or more people.
  • It is operated for profit.

• 3. Corporation:

  • An entity created by law.
  • Owned by shareholders.
  • Types of Corporations:
    • Privately Owned Corporations: These are often owned by family members. Stocks in these corporations may not be offered to outsiders unless consent from the family members is secured.
    • Publicly Owned Corporations: These are publicly listed and owned by unrelated investors. Their shares are traded in organized exchanges, such as the Philippine Stock Exchange (PSE).

Profit Maximization vs. Wealth Maximization

• 1.3 Theoretical Comparison:

  • Profit Maximization:
    • Focuses primarily on increasing the total profit of the business.
    • Generally maintains a short-term perspective.
    • Serves as a means for the company to survive against immediate business challenges.
    • Profit is considered the basic building block for a company to accrue capital in the shareholder's equity.
  • Wealth Maximization:
    • Focuses on increasing the overall wealth of the shareholders.
    • Concerned directly with the market value of the company.
    • Takes a long-term perspective.
    • Considers a wide range of stakeholders, including shareholders, creditors, employees, and others.
    • Ensures the building of reserves for future growth and expansion.
    • Aims to maintain the market price of the company's shares and recognizes the value of regular dividends.

• Overall Shareholder Objective:

  • The fundamental objective of a shareholder is Wealth Maximization.

• Measuring Shareholders' Wealth:

  • Shareholders' wealth is measured based on the current market price of the corporation's stocks.

• Example Case: Globe Telecom:

  • Assume a learner purchased $10$ shares of Globe Telecom at $PHP\,2,510$ per share on September $9$, $2010$.
  • The initial investment is calculated as: $10 \times 2,510 = PHP\,25,100$.
  • If the price increases to $PHP\,2,600$ per share, the wealth increases.
  • If the price decreases to $PHP\,2,300$ per share, the wealth decreases.

Corporate Organizational Structure

• Financial Management (Definition):

  • According to Cayanan, financial management deals with decisions designed to maximize the value of shareholders' wealth.
  • The primary goal is to maximize the value of shares of stocks.

• Structure Hierarchy:

  • Shareholders (Owners):
    • They are the owners of the corporation.
    • They elect the Board of Directors (BOD).
    • Voting power is distributed such that each share held is equal to $1$ voting right.
  • Board of Directors (BOD):
    • The highest policy-making body in a corporation.
    • Key Functions:
      • Setting policies regarding investments, capital structure, and dividend policies.
      • Approving company strategies, goals, and budgets.
      • Appointing and removing members of top management, including the President.
      • Determining the compensation for top management.
      • Approving information and disclosures reported in financial statements.
  • President (Chief Executive Officer / CEO):
    • Responsible for overseeing company operations and ensuring strategies approved by the BOD are implemented.
    • Performs all management areas: Planning, Organizing, Leading, and Controlling.
    • Represents the company in professional, social, and civic activities.

Specific Vice President (VP) Roles and Functions

• VP for Marketing:

  • Formulates marketing strategies and plans.
  • Directs and coordinates company sales efforts.
  • Performs market and competitor analysis.
  • Evaluates the effectiveness and cost of applied marketing methods.
  • Conducts research to identify new marketing opportunities (e.g., variants of existing products).
  • Promotes relationships with customers and distributors.

• VP for Production:

  • Ensures production levels meet customer demands.
  • Identifies technologies or processes that minimize production costs to remain competitive.
  • Develops production plans that maximize the utilization of facilities.
  • Identifies adequate and cheap raw material suppliers.

• VP for Administration:

  • Coordinates functions between administration, finance, and marketing departments.
  • Assists other departments in hiring employees.
  • Assists in payroll preparation, vendor payments, and receivable collections.
  • Determines location and office space requirements.
  • Identifies systems to minimize operating costs.

Functions of the Financial Manager (Chief Financial Officer / CFO)

• The VP for Finance (CFO) has four core functions:

• 1. Financing:

  • Financing Decisions: Deciding how to fund long-term investments (like expansions) and working capital for day-to-day operations (inventory, expenses).
  • Capital Structure: Determines the appropriate mix of how much of the total assets is financed by debt versus how much is financed by equity.

• 2. Investing:

  • Short-Term Investment: Planning for excess cash using tools like budgeting and forecasting to secure the best profit.
  • Long-Term Investment: Evaluated through a Capital Budgeting Analysis, a process used to evaluate potential major projects or investments.

• 3. Operating:

  • Operating Decisions: Determine how to finance working capital accounts, such as accounts receivable and inventories, using either short-term or long-term sources.

• 4. Dividend Policies:

  • Determines when the company should declare cash dividends (returns paid to shareholders based on shareholdings).
  • Conditions for Declaring Dividends:
    • The company must have enough retained earnings (accumulated profits).
    • The company must have sufficient cash.
  • Residual Dividend Policy: Suggests that dividends can only be declared if there are funds remaining after all viable investment needs are met.

Financial Sourcing and Risk Trade-offs

• Financial Managers must choose between short-term and long-term sources of financing based on risk and return trade-offs.
• Short-Term Sources:
  • Feature lower interest rates and lower financing costs.
  • Pose a trade-off between higher profitability and high liquidity risk (the risk of not being able to pay obligations).
• Long-Term Sources (e.g., Suppliers' credit):
  • Mature over longer periods.
  • Feature higher interest rates.
  • Provide more time to accumulate cash to pay off future obligations.
• Factors Affecting Dividend Decisions:
  • Availability of viable long-term investments.
  • Access to long-term funds (creditors may not finance $100\%$ of an investment, necessitating equity financing).
  • Management's target capital structure.

Questions and Discussion

• Reflection Question: What is the importance of budgeting and managing money responsibly?
  • Answer contextualized by transcript: Budgeting is essential for estimating revenue, controlling expenses, and ensuring that financial goals—such as wealth maximization and future growth—are met while maintaining enough cash for dividends and operations.
• Guide Question: What do you think of a company that has a very large amount of cash?
  • This leads to discussions on whether the cash should be reinvested or distributed as dividends.
• Guide Question: Would you prefer a company that makes a lot of profit now or one that steadily increases in value over time?
  • This highlights the choice between short-term Profit Maximization and long-term Wealth Maximization.
• Guide Question: Why does a Financial Manager need to choose which source of financing a company should use?
  • They must consider the cost (interest rates) and the risk (liquidity) associated with different debt durations.