Business Finance — Lesson 1: Introduction to Financial Management

Topic Learning Outcomes

  • By the end of Lesson 1 learners should be able to:
    • Explain the significant role of financial management and the different individuals involved.
    • Distinguish a financial institution from a financial instrument and financial market.
    • Describe the flow of funds within an organization and the role of the financial manager.
    • Identify key roles / responsibilities of finance personnel inside an organization.
    • Recognize the ethical implications of financial decisions and the need for ethical conduct.

Finance and Business

  • Finance is both broad and dynamic—it influences every business decision from hiring to plant expansion.
  • Knowing finance makes one a smarter consumer & investor, even if they pursue a non-finance career path.
  • Two umbrella career tracks:
    • Financial Services (banks, insurance, brokerage, etc.)
    • Managerial Finance (internal corporate decision making)

Definitions of Finance

  • Aduana (2017):

Finance is both a science and an art of correct application of the economic and accounting concepts and principles that define the system, structure, and process of management, allocation, and utilization of financial resources, investments, and expenditures.

  • Gitman & Zutter (2013):
    Finance = the science and art of managing money.
  • Gitman, Joehnk, Billingsley, Besley & Brigham (2017):
    Finance also covers the creation of money and the administration/operations of institutions (banks, investment companies, cooperatives, etc.) that facilitate credit.
  • Five key take-aways embedded in the definitions:
    1. Both science and art
    2. Applies economics & accounting concepts
    3. Focuses on systems, structure, processes
    4. Centers on management, allocation, utilization
    5. Deals with resources, investments, expenditures

Career Opportunities in Finance

  • Financial Analyst
  • Fund/Portfolio Manager
  • Stock Broker
  • Banker & Bond Dealer
  • Treasury / Trust Manager
  • Investment Researcher
  • Business Consultant, Forex Trader, Risk-Management Associate
  • Finance Officer, Credit Appraiser

Financial Management: Major Roles & Objectives

  • Concerned with procurement, allocation, and control of funds.
  • Primary objectives:
    1. Ensure a regular & adequate supply of funds.
    2. Provide adequate returns to shareholders (capital gains & market-price appreciation).
    3. Achieve optimum utilization of funds at the least cost.
    4. Invest in safe ventures that still deliver adequate returns.
    5. Design a sound capital structure balancing debt & equity.

Three Branches of Finance

  1. Personal Finance – individuals’ spending, saving, and investing decisions.
  2. Public Finance – efficient management of government funds.
  3. Corporate Finance – management of company resources.

Key Individuals in Financial Management

  • Senior Leaders (ultimate accountability):
    • Chief Executive Officer (CEO)
    • Chief Financial Officer (CFO)
    • Chief Operating Officer (COO)
    • President (where applicable)
  • Unit Heads (internal, day-to-day fiscal oversight):
    • Division Heads
    • Department Managers
    • Project Managers
  • Responsibility themes:
    • Budgeting, financial reporting, risk management, resource allocation
    • Avoidance of unintended deficits & stewardship of entrusted resources

The Business & Societal Environment

  • Business operates within overlapping systems:
    • Technological, Economic, Political, Financial, Socio-Cultural, Legal → collectively shape strategy.
  • Example influences:
    • Technological: e-commerce, AI, robotics
    • Economic: inflation or recession alters consumer spending
    • Political: tax policy, trade regulations
    • Financial: interest-rate levels, venture-capital availability
    • Socio-Cultural: sustainability values affect branding & HR
    • Legal: data-privacy rules constrain tech firms

The Financial System: Structure & Elements

  • Purpose: channel funds from lenders (savers) to borrowers (users).
  • Components (Figure 2 reference):
    1. Financial Institutions
    2. Financial Markets
    3. Financial Instruments
    4. Lenders & Borrowers
  • In the Philippines, the Bangko Sentral ng Pilipinas (BSP) regulates institutions & intermediaries.

Financial Institutions

  • Provide services such as deposits, loans, funds transfer, asset management.
  • Sub-categories:
    • Depository Institutions – accept deposits, extend loans (e.g., Commercial Banks)
    • Financial Intermediaries – pool investors’ money, lend/invest to deficit entities
    • Investment Institutions – buy securities for investment (e.g., mutual funds)
  • Illustrative examples & roles:
    • Commercial Banks: transform deposits into business/consumer loans & debt-security purchases.
    • Insurance Companies: pool premiums, invest until claims arise; often influence corporate governance.
    • Mutual Funds: aggregate small investors; buy equity/debt → provide firms with fresh capital or facilitate secondary trading.
    • Pension Funds (e.g., GSIS, SSS): receive employee contributions, invest for retirement payouts.
    • Other: UITFs, investment banks, credit unions, trust departments.

Financial Markets

  • A market = mechanism/place where buyers & sellers of financial instruments meet.
  • Two broad categories:
    1. Money Market – trades short-term securities (≤ 1 year); satisfies temporary surplus/deficit needs.
    2. Capital Market – issues & trades medium- to long-term securities (stocks & bonds).
    • In PH: Philippine Stock Exchange (PSE) (est. 1994, merger of Manila & Makati exchanges).
    • Globally largest: NYSE & NASDAQ (USA, > 25\text{ trillion} in market cap).
    • Table highlights top markets: US, China, Japan, UK, EU with respective caps & traits.
  • Note: A platform can serve both functions when highly liquid, short-term instruments are also traded (PSE example).

Financial Instruments

  • Contractual claims resulting in a financial asset for one party and a financial liability or equity for another.
  • Common forms: Cash, Check, Loan Agreements, Bonds, Stocks.

Bonds (Debt Securities)

  • Evidence of a contractual debt; issuer promises to repay principal at maturity plus periodic interest.
  • Parties: Issuer (debtor) & Holder (creditor).
  • Certificate = bond indenture.
  • Typical types:
    • Term, Serial, Secured, Debenture (unsecured), Convertible, Callable.

Stocks (Equity Securities)

  • Signify ownership in a corporation; only corporations registered with SEC may issue.
  • Shareholder’s percentage ownership:
    \text{Ownership \%} = \frac{\text{Shares Held}}{\text{Total Outstanding Shares}} \times 100\%
    Example: \frac{2{,}500}{10{,}000}=25\% → 25 % control over net assets & voting power.
  • Two major classes:
    1. Common Stock (Ordinary Shares)
    • Voting rights: 1 share = 1 vote.
    • Residual claim on dividends & liquidation proceeds (last in line → higher risk, higher upside).
    1. Preferred Stock (Preference Shares)
    • Priority over common in dividends & liquidation, usually fixed dividend rate.
    • Normally no voting rights.
  • Quick comparison:
    • Risk/Return: Common > Preferred (riskier but larger growth potential).
    • Dividend priority: Preferred first.

Flow of Funds Within an Organization

  • Cash Outflows
    • Payments to employees (salaries, benefits)
    • Supplier & creditor settlements
    • Capital expenditures (plant, equipment)
    • Legal expenses, lawsuit settlements
  • Cash Inflows
    • Customer receipts (core operating revenue)
    • Borrowings (bank loans, bond issuance)
    • Equity financing (sale of shares)
    • Asset disposals, legal settlements, miscellaneous gains
  • Visualize as a continuous cycle—healthy operations require long-term inflows ≥ long-term outflows.

Other Goals of the Firm & Ethical Responsibility

  • Social Responsibility: Active concern for societal welfare.
  • Ethical Responsibility:
    • Honest, fair treatment of employees, customers, community, stockholders.
    • Ethical finance involves:
    • Truthful reporting (no earnings manipulation)
    • Integrity in budgeting/investing/borrowing choices
    • Fairness to all stakeholders (avoid insider trading, conflicts of interest)
    • Compliance with laws & regulations
  • Consequences of unethical acts: legal penalties, loss of trust, reputational damage.

Point to Ponder / Daily Life Relevance

  • Studying Business Finance helps everyday life by:
    • Enhancing personal budgeting & saving decisions.
    • Guiding investment choices for retirement or wealth-building.
    • Sharpening awareness of interest-rate movements, inflation, and risk.
    • Cultivating ethical judgment in personal & professional financial dealings.
    • Empowering informed participation in societal discussions on economic policy, corporate behavior, and sustainability.