CONCEPCION CATHOLIC SCHOOL, INC.

Concepcion, Tarlac
S.Y. 2020-2021

Grade 12 Module
in
BUSINESS FINANCE
Content

Introduction to Financial Management

Content Standards
The learners demonstrate an understanding of the definition of finance, the activities of the financial
manager, and financial institutions and markets.
Performance Standards
The learners shall be able to…
1. define Finance
2. describe who are responsible for financial management within an organization
3. describe the primary activities of the financial manager
4. describe how the financial manager helps in achieving the goal of the organization
5. describe the role of financial institutions and markets

MODULE MAP
This will guide the learner understand the flow of discussion.

An Introduction to Financial Management

Financial Financial Financial Institutions The flow of money and

Institutions and Instruments and and financial services the role of the Financial
the Key Financial Markets manager
Individuals Who
Play Vital Roles

1. The important 1. Money market 1. Kinds of banks

role of the debt:  Thrift banks
Financial  Treasury Bills  Commercial
Institutions  Commercial banks
2. The key Papers  Universal banks
individual roles  Money market  Investment
 The Depositor funds banks
who has the  Consumer credit, 2. Kinds of non-
funds credit card debt banks
 The Borrower 2. Long-term debt:  Leasing
who needs the  Treasury notes companies
funds and bonds  Investment
 Federal agency companies
debt  Mutual funds
 Municipal bonds,  Insurance
local government companies
bonds  Private equity
 Corporate bonds funds
 CONCEPCION CATHOLIC SCHOOL, INC.
Concepcion, Tarlac
S.Y. 2020-2021

BUSINESS FINANCE 12
Name: __________________________________ Date: ______________________
Subject: __________________________ Grade & Section: __________________

MELC Grade 12 Quarter 1, Week 1 to 2– Introduction to Financial Management

1. Explain the major role of financial management and the different individuals involved.
2. Distinguish a financial institution from financial instrument and financial market.
3. Explain the flow of funds within an organization – through and from the enterprise—and the role of the
financial manager.

Remember: The learner may be assisted by an able member of the family in terms of explaining how the
activities will be done. After the learner has understood how to do the activities, he/she should independently
work on the activity.

LESSON PROPER
A. INTRODUCTION
Finance is the study of how individuals or businesses evaluate investment opportunities, business
proposals, and business projects, and raise capital to fund them. Evaluating an investment means
ensuring that the fund to be invested will create value to a business or an individual in the form of
profit. The main goal of finance is to maximize profit.

Financial Management on the other hand, means the efficient and effective management of
funds. To achieve this, it would be helpful to understand and apply financial management tools,
concepts, and theories.

Since funds are important to any business whether to start, sustain, or expand operations, it also
helps to understand how funds are raised.

B. DISCUSSION

The Role of the Financial Institution

FINANCIAL INSTITUTION
FINANCIAL INSTITUTION Evaluation of Investment
Lends Funds

BUSINESS
DEPOSITOR BORROWER PROJECT
4 3
FINANCIAL INSTITUTION FINANCIAL INSTITUTION
Pays Interest Return of investment

The flow of money begins with the individual who deposits in the bank, a financial institution.
The depositor opens up a bank account and earns an interest from this account. In turn, these funds
are lent by the banks to businesses, the borrowers, who either start-up a new project, a new line of
product, or merely expand operations. As the business earns profits, the borrower of the funds is able
to pay interest on the loan, and the depositor receives an interest on his bank accounts.

The Key Individual Roles

 The Depositor who has the funds
 The depositor is the person who has money and deposits it in a savings account with a
bank that pools this together with the savings from other depositors.
 The Borrower who needs the funds
The borrower is the party at the other end. He is the small business owner. He is the one
who needs the funds and borrows the funds through a bank. He needs the funds to start a project
or a business venture, or expand his ongoing business. He knows where the funds can be placed
or invested in so that the funds will grow.

Financial Instruments are the tools that help a business daily operations and eventually make it
grow.
 Money Market Instruments – are an inexpensive way for government and financial
institutions to raise funds. These funds are usually available for short periods of time;
therefore, their rates are generally lower than funds which are available for use over longer
periods of time.
 Stock – is a type of security that signifies ownership in a corporation and represents a claim
on part of the corporation’s assets and earnings. There are two main types of stocks:
preferred and common.
Preferred and common stocks are financial instruments businesses can use to raise funds
for their long-term requirements. Should your business expand, you can issue (sell) preferred
and common stock to potential investors.
 Commercial Papers- are mainly borrowings of corporations usually with good credit
standing. Funds raised through commercial paper borrowing are used to finance inventories
and receivables.
 Treasury Notes- are borrowings of governments. When governments embark on long-term
infrastructure projects, for example, to ensure the viability of businesses, building new roads
and bridges, they borrow by issuing notes.
 Government or Corporate bonds- Like notes, bonds are issued to finance very long-term
projects of governments or corporations. Bonds have a longer maturity compared to notes;
some may even take up to thirty of forty years to mature.
 Mutual Funds/Investment Funds – Financial markets are the platform where financial
instruments are offered, bought, and sold. In simple terms, it is where you can find the
financial instruments like money market, notes and bonds that you need to manage your
business daily and the financial instruments you need to grow your business exponentially.

Table 1. The Different Money Market Instruments and Their Characteristics

Financial Instrument
Financial Instrument Basic Characteristics
Money market debt:
Treasury bills  lssued by the treasury/government
 Matures within one year
 Is generally default-free as
government will exert all effort to
pay
Commercial papers  Issued by financially-sound
businesses to fund investments in
inventories and receivables
 Maturity is about nine months
 Generally low default risk as
businesses have good credit standing
Money market funds  Issued by banks or mutual fund
companies
 No specific maturity date
 The degree of default risk is low .
 These funds are usually invested in
money market instruments,
treasuries, and commercial papers
Consumer credit, credit card debt  Issued by banks, credit unions,
finance companies
 Maturity date varies
 Default risk varies
 Table 2. Financial instrument and Their Basic Characteristics Basic Characteristics
Financial Instrument Basic Characteristics
Long-term debt:
Treasury notes and bonds  lssued by the government
 Notes mature in two, five, or ten
years
 Bonds mature longer (ten years or
more)
 No default risk as governments exert
all efforts to pay
 The price of bonds usually fall,
becoming less attractive as interest
rates in the markets rise
Federal agency debt  This is a United States type of long-
term debt and not applicable in the
Philippine setting
 lssued by federal agencies and is
similar to treasuries
 Has long-term maturity (i.e., up to
thirty years)
 Has low default risk
Municipal bonds, local government  Issued by local governments
bonds  Matures longer (i.e., up to
thirty years)
 More risky than government
securities
Corporate bonds  Issued by corporations
 Matures in forty years, (some bonds
like Walt Disney and Coca-Cola
have issued 100-year bonds)
 More risky than government
securities and rely on the financial
soundness of the company

Table 3. Preferred and Common Stocks with Their Basic Characteristics

Financial Instruments Basic Characteristics
Preferred stock  lssued by corporations in exchange for units
of ownership
 Has no maturity date
 Pays dividends when declared
 More risky than corporate bonds
 Has no voting rights
 Has preference over common stocks in asset
liquidation, hence the term "preferred"
Common stock  Units of ownership in a public corporation
 Pays dividends when declared
 Owners are entitled to vote on the selection of
directors and other important matters
 In the event of a corporate liquidation claims
of preferred stockholders take precedence
over common stockholders
  For the most part, common stockholders
enjoy potential profits from the capital
appreciation of their stock

FINANCIAL INSTITUTIONS
The role of the financial institution is critical because economies have grown and
expanded from the simple communities that thrive in barter or exchange trading to large and modern
communities that experience the benefits of science, technology, and progress.
Financial institutions help in funding important government projects and extend advisory
services to help in nation building. A financial institution can be a bank or a nonbank.

Here are the different kinds of banks:

1. Thrift Banks
This are deposit taking financial institutions that also extend credit to the consumer market.
Thrift banks usually cater to the countryside or rural areas as compared to commercial banks
which focus mainly on the top companies located in the major cities.
2. Commercial Banks
This are mainly deposit taking financial institutions that extend credit to the retail and consumer
market. They deal with the “mom and pop stores” and their transactions are usually many but
small, denominated in the local currency.
3. Universal Banks
This lends to multinational companies or companies with global presence. Their transactions are
larger than commercial banking transactions and are denominated in multicurrencies and not just
limited to the local currency.

4. Investment Banks
This are known to successfully raise funds for big corporations and governments. They deal with
the “big ticket items” and are able to raise funds from the “investing public” through bond
issuances and initial public offerings.

The nonbanks that lend or raise funds for businesses are the following:
1. Leasing Companies
This are not banks and are not governed by the central banks. Yet leasing companies also extend
credit or financing to companies that need it for their projects.
2. Investment Companies
This are regulated by the Securities and Exchange Commission (SEC) and perform similar
functions as banks in the sense that they can provide funding to companies or raise funds through
bond issuances or initial public offerings.
3. Mutual Funds
This are collective investments or funds of small investors pooled together and managed to be
able to reach maximum returns. Mutual funds, though small individually, are big collectively.
4. Insurance Companies
This sell insurance coverage to provide guarantee of compensation for specified death, Illness,
accident, loss. Or damage to property in return for payment of a premium.
5. Private Equity Funds
This are not regulated by government or any regulatory body. They are funds managed by
private fund managers and private investors and hence, the owners are able to invest more in the
financial markets. This funds finance businesses and projects.

THE FLOW OF MONEY and THE ROLE OF THE FINANCIAL MANAGER

The flow of funds to businesses begin with the source of funds, the one who has the money to
lend, the one who saves and deposits with the bank or any financial institution. When money is
deposited to a bank, this same money looks for outlets so that it can grow. This same money finds itself
in the hands of businessmen who borrow the money lent through the banks or financial institutions. In
exchange for borrowing the money from the depositor, the borrower pays interest.

Where does the financial manager put this borrowed money?

Remember that the goal of finance is to maximize profit. Therefore, it is expected that the
financial manager invests this money in projects that are worthwhile. He invests it in a new business
venture, or a new manufacturing plant. Also, he can invest it to expand his already thriving business
because he has dreams of a bigger enterprise. Sometimes, he invest this money to train his people to
continue servicing his customers and to continue doing a good job.

What is the ultimate goal of all his endeavors?

He aims to make money work for him, to make money grow, and to make his business earn profits so
that,
 He can pay his employees and in turn, his employees can feed their families and send their
children to school
 He can pay the rent or amortization on his office property
 He can pay his creditors the interest from the borrowed money
 He can reinvest some of the profits to the business, thereby sustaining all who depend on it.

What is a worthwhile business?

A worthwhile business is a business worth giving your time and attention to because it achieves
the goal of financial soundness, liquidity, profitability, and nation building. The role of the financial
manager is to ensure that the entire flow of money happens and is completed up to the payments of
interest on the borrowed loan after money is invested in a worthwhile business.

C. PRACTICE

Critical Thinking

Financial institutions are intermediaries that play a vital role in nation building. They source funds for
businesses to engage in projects that are profitable, maximize shareholder wealth, and build communities.
Is there a project you have in mind that is worthwhile, has potential to earn profits, and will benefit your
community in the long-term? List down those projects. What financial institutions can help you achieve
your dream of a sustainable business for your shareholder or community?

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Activity 1
A. Multiple Choice

1. A ______ is one financial intermediary handling individual savings. It receives premium payments
that are placed in loans or investments to accumulate funds to cover future benefits.
A. life insurance company
B. commercial bank
C. savings bank
D. credit union

2. The key participants in financial transactions are individuals, businesses, and governments.
Individuals are net ______ of funds, and businesses are net ______ of funds.
A. suppliers; users
B. purchasers; sellers
C. users; suppliers
D. users; providers

3. Which of the following is not a financial institution?

A. A pension fund
B. A newspaper publisher
C. A commercial bank
D. An insurance company

4. A ______ is set up so that employees of corporations or governments can receive income after
retirement.
A. life insurance company
B. pension fund
C. savings bank
D. credit union

5. A ______ is a type of financial intermediary that pools savings of individuals and makes them
available to business and government users.
Funds are obtained through the sale of shares.
A. mutual fund
B. savings and loans
C. savings bank
D. credit union

6. Most businesses raise money by selling their securities in a.

A. a direct placement.
B. a stock exchange.
C. a public offering.
D. a private placement.

7. Which of the following is not a service provided by financial institutions?

A. Buying the businesses of customers
B. Investing customers’ savings in stocks and bonds
C. Paying savers’ interest on deposited funds
D. Lending money to customers

8. Government usually
A. borrows funds directly from financial institutions.
B. maintains permanent deposits with financial institutions.
C. is a net supplier of funds.
D. is a net demander of funds.

9. By definition, the money market involves the buying and selling of

A. funds that mature in more than one year.
B. flows of funds.
C. stocks and bonds.
D. short-term funds.

10. The ______ is created by a financial relationship between suppliers and users of short-term funds.
A. financial market
B. money market
C. stock market
D. capital market

11. Firms that require funds from external sources can obtain them from
A. financial markets.
B. private placement.
C. financial institutions.
D. All of the above.

12. The major securities traded in the capital markets are

A. stocks and bonds.
B. bonds and commercial paper.
C. commercial paper and Treasury bills.
D. Treasury bills and certificates of deposit.

13. Long-term debt instruments used by both government and business are known as
 A. bonds.
B. equities.
C. stocks.
D. bills.

B. True/False
______1. Primary and secondary markets are markets for short-term and long-term securities,
respectively.
______2. Financial markets are intermediaries that channel the savings of individuals, businesses,
and government into loans or investments.
______3. The money market involves trading of securities with maturities of one year or less while
the capital market involves the buying and selling of securities with maturities of more than one
year.
______4. Holders of equity have claims on both income and assets that are secondary to the claims
of creditors.
______5. Preferred stock is a special form of stock having a fixed periodic dividend that must be
paid prior to payment of any interest to outstanding bonds.
______6. Commercial banks obtain most of their funds from borrowing in the capital markets.
______7. Credit unions are the largest type of financial intermediary handling individual savings.
______8. A mutual fund is a type of financial intermediary that obtains funds through the sale of
shares and uses the proceeds to acquire bonds and stocks issued by various business and
governmental units.

Activity 2

Role of Financial Managers Role of Financial Markets Role of Investors

How would you relate the role of financial managers, role of financial markets and role of investors?

GENERALIZATION

Activity 3
I learned about…

Reflection Note

Prepared by:
Sir Argie R. Gomez

Content

Financial Planning Tools and Concepts

Content Standards
The learners demonstrate an understanding of the financial planning process, including budget
preparation, cash management, and working capital management
Performance Standards
The learners shall be able to…
1. illustrate the financial planning process
2. prepare budgets such as projected collection, sales budget, production budget, income projected
statement of comprehensive income, projected of financial position, and projected cash flow statement
3. describe concepts and tools in working capital management

MODULE MAP
This will guide the learner understand the flow of discussion.

Financial Planning

Steps in The Budget Tools in Managing

Financial Preparation Cash, Receivables,
Planning Process and Inventory

1. Long-term  Divided into three  Steps in

Financial plan parts: preparing the
a. Forecast your 1. Cash recipient cash budget
sales 2. Cash
b. Compute the disbursements
dividend payout 3. Excess cash
ratio and the balance/required
plowback ration total financing
c. Identify your
spontaneously-
generated funds
d. Use the percent
of sales approach
to prepare the pro
forma financial
statements
e. Calculate your
external
financing need
(EFN)
2. Short-term
financial plan
 CONCEPCION CATHOLIC SCHOOL, INC.
Concepcion, Tarlac
S.Y. 2020-2021

Name: __________________________________ Date: ______________________

Subject: __________________________ Grade & Section: __________________

MELC Grade 12 Quarter 1, Week 3 to 5 - Financial Planning Tools and Concepts

1. Identify the steps in the financial planning process

2. Illustrate the formula and format for the to 4 preparation of budgets and projected financial statement
3. Explain tools in managing cash, receivables, and inventory

Remember: The learner may be assisted by an able member of the family in terms of explaining how the
activities will be done. After the learner has understood how to do the activities, he/she should independently
work on the activity.

LESSON PROPER
A. INTRODUCTION

Generally speaking, the financial planning process is articulated in a document called the financial plan.
The financial plan is divided into:

1. The long-term financial plan, also known as strategic financial plan, and
2. The short-term financial plan, also known as the operating financial plan.

Financial planning is often defined as the forecasting of a business future financing requirements.

A long-term financial plan involves forecasting the financing requirements of a business three to
five years down the road. On the other hand, the short-term financial plan involves forecasting the
financing requirements of a business within a year or less, and as is expected is more detailed than the
former.

Developing the long-term financial plan takes precedence over the short-term financial plan as it will
set the overall direction in developing the latter.

B. DISCUSSION

Basically, developing the long term plan comes down to a few simple steps:

a. Forecast your sales.

In doing sales forecasting, it helps if it starts with an understanding of the industry your business
belongs to, knowing your target market segment from that industry, and ultimately, forecasting
your market share in terms of sales form that segment. It may increase based on the target
increase in the market share, or due to the increase of the market itself
b. Compute the dividend payout ratio and the plowback ratio.
If the business pays any cash dividend, then this dividend amount should be divided by net
income to get the dividend payout ratio. This ratio tells us the proportion of net income paid out
as dividends. If the business does not pay any dividend, then it is equal to zero. The plowback
ratio, also known as retention ratio is 100%. The plowback ratio is the proportion of net income
that does not get paid out in cash dividends.
c. Identify your spontaneously-generated funds
From the word “spontaneous”, which means “done naturally”, these funds come about as a result
of normal business operations. If a business wants to increase its sales, then it has to load up on
its inventory, otherwise it would have just very few items or units to sell.
d. Use the present of sales approach to prepare the pro forma financial statements.
This approach calls for dividing expenses, assets, and liabilities by the sales figure. This sales
figure can be based on the latest available financial statement, the average figure the past few
years, or a combination of both.
The derived percentages are then used as weights in preparing the pro forma income statement
and balance sheet. It is interesting to note that pro forma is a Latin word which means “as a
matter of form” and is used to emphasized projected figures.
 e. Calculate your External Financing Need (EFN).
EFN, also known as Additional Funds Needed (AFN) and Discretionary Financing Needs
(DFN), is the required additional financing, through the additional issuance of interest-bearing
debt and common stock, to acquire the needed assets.

Below is an example.

Let us say sales are forecasted to grow 20% next year. Obviously this translates to a 20% growth
in assets. Then, use the percent of sales approach to calculate the weights needed in preparing the
pro forma income statement. As you can see, costs and net income were 55% and 31.50% of
sales, respectively. Furthermore, the dividend payout ratio is 0%.
Income Statement Percent of Sales
Sales 9,268,315.00
Costs 5,097,573.25 55.00%
Taxable Income 4,170,741.75
Taxes (30%) 1,251,222.53
Net Income 2,919,519.23 31.50%
Dividends (0%) 0.00
Addition to 2,919,519.23
Retained Earnings

To prepare the pro forma income statement, simply increase sales by 20%. Then, multiply the
resulting figure by 55% to get the costs. To get the addition to retained earnings, simply subtract
dividends paid from net income.
Pro Forma Income Statement Percent of Sales
Projected Sales(20%) 11,121,978.00
Costs(55%) 6,117,087.90 55.00%
Taxable Income 5,004,890.10
Taxes (30%) 1,501,467.03
Net Income 3,503,423.07 31.50%
Dividends (0%) 0.00
Addition to Retained 3,503,423.07
Earnings

As you can see from the balance sheet below, your spontaneously generated funds are accounts payables
and accrued expenses. The capital intensity ratio is three, which means that it takes ₱3 to generate a peso
of sales. Just like what we did earlier, we use the percent of sales approach to calculate the weights
needed to prepare the pro forma balance sheet. As we have computed, cash and accounts receivables are
16% and 44% of sales, respectively. While on the liabilities side, accounts payable and accrued expenses
are 30% and 10% of sales, respectively.

Balance Sheet Percent of Sales

Cash and Cash Equivalents(20%) 1,482,930.40 16.00%
Accounts Receivable (44%) 4,078,058.60 44.00%
Inventory (60%) 5,560,989.10 60.00%
Current Assets 11,121,978.00 120.00%

PPE-net 16,682,967.00 180.00%

Total Assets 27,804,945.00

Account Payables (30%) 2,780,494.50 30.00%

Accrued Expenses 926,831.50 10.00%
Notes Payables 88,150.00 n/a
Current Liabilities 3,795,476.00 n/a
Noncurrent Liabilities 500,597.00 n/a
Liabilities 4,296,073.00 n/a

Common Stock 16,456,210.40 n/a

Retained Earnings 7,052,661.600 n/a
Owner’s Equity 23,508,872.00 n/a
Total Liabilities + Owner’s 27,804,945.00 n/a
Equity

Now, we are ready to prepare the pro forma balance sheet. Simply multiply the weights by the projected
sales figure. Cash increased to 1,779,516.48, which is computed by multiplying 16% by 11,121,978.
Note that cash still accounts for 16 % of the projected sales figure. We apply the same process to
accounts receivable, inventory, and PPE-net. Summing them up, we get 33,365,934, which marks a 20%
increase from the initial total asset figure of 27,804,945 and matches the projected increase in sales.

Balance Sheet Percent of % Increase

Sales
Cash and Cash Equivalents 1,779,516.48 16.00% 20.00%
Accounts Receivable 4,893,670.32 44.00% 20.00%
Inventory 6,673,186.80 60.00% 20.00%
Current Assets 13,346,373.00 120.00% 20.00%

PPE-net 20,019,560.40 180.00% 20.00%

Total Assets 33,365,934.00 20.00%

Account Payables 3,336,593.40 30.00% 20.00%

Accrued Expenses 1,112,197.80 10.00% 20.00%
Notes Payables 88,150.00 n/a
Current Liabilities 4,536,941.20 n/a
Noncurrent Liabilities 500,597.00 n/a
Liabilities 5,037,538.20 n/a

Common Stock 16,456,210.40 n/a

Retained Earnings 10,556,084.57 n/a
Owner’s Equity 27,012,295 n/a
Total Liabilities + Owner’s 32,049.833 n/a
Equity
External Financing Needed 1,316,101
 On the liabilities and equities side, we just retain the initial figures of all the other line items
except for the spontaneously generated funds--accounts payables and accrued expenses --and the
retained earnings. To get the new figures for accounts payables and accrued expenses, just multiply their
respective weights by the projected sales figure. In reference to the new figure for retained earnings,
simply add the pro forma net income (since dividend payout ratio is O%) to the initial retained earnings.

To complete the process, add total liabilities to total owner’s equity. As we can see, this amounts
to 32,049,833. This figure is what is known as External Financing Needed (EFN). This example is less
than the projected total asset figure, which means the business needs an additional financing of
1,316,101. This 1,316,101 can come in the form of additional borrowings or additional capital infusion.
A negative EFN, on the other hand, means that the business will have extra funds.

THE BUDGET PREPARATION

As mentioned earlier, the short-term financial plan involves forecasting the financing
requirements of a business within a year or less. This financing requirement comes in the form of cash.
Contrast this one with the financing requirement form a long-term financial plan.

The primary tool in short-term financial planning is the cash budget, also known as cast forecast.
It plots the business’ projected cash inflow and outflow and is typically done monthly and is used to
cover a year’s time. An example of a cash budget is shown below.

CASH BUDGET
Jan Feb Mar
Cash Receipts
Less: Cash Disbursements
Net Cash Flow
Add: Beginning Cash
Ending Cash
Less: Minimum Cash Balance
Required Total Financing
Excess Cash Balance

It is divided into three parts, which are as follows:

1. Cash Receipts
2. Cash Disbursements
3. Excess Cash Balance/ Required Total Financing

Just like the long-term plan, preparing the cash budget comes down to a few simple steps:

1. Forecast the business monthly sales. Again, this can be done using historical figures.
2. Forecast the cash sales and the credit sales from the projected monthly sales. Cash sales are more
preferable to credit sales. If sales are made on credit, then estimate when those receivables will be
collected.
3. Take into account other cash receipts. Other cash receipts are sources of cash other than sales such as
interest payment received, among others.
4. Sum up the total cash receipts.
5. Forecast the business’ monthly purchases.
6. Forecast the cash purchases and the credit purchases from the projected monthly purchase. If
purchases are made on credit, then forecast when those payable will be paid.
7. Take into account other cash disbursements. Other cash disbursements include wages and salaries,
taxes, capital, expenditures, rent, and interest payments.
8. Sum up the total cash disbursements.
9. Subtract the total cash disbursements from the total cash receipts to get the net cash flow.
10. Add the beginning cash balance to the net cash flow to get the ending cash balance. The ending cash
balance of the previous month is the beginning cash balance of the following month.
11. Subtract the minimum cash balance from the ending cash balance. The minimum cash balance also
known as target cash balance, is the minimum cash balance the business needs to have on hand, to
conduct its day to day operations. If the minimum cash balance is greater than the ending cash
balance then the short-term financing is required. If, on the other hand, the minimum cash balance is
less than the ending cash balance, then the business has excess cash.

Consider the situation that follows.

Sales in January and February were 150,000 and 220,000 respectively. Sales of 380,000,
340,000, and 295,000 have been forecasted for March, April, and May, respectively. Thus, we are
trying to develop a cash budget for March to May. Based on historical data 15% of the business sales
 are in cash form, 55% have generated accounts receivables collected after one month, and the
remaining 30% have generated accounts receivables collected after two months. It also receives a
monthly interest payment of 150.000 from a bank certificate of deposit.

Tools in Managing Cash, Receivables, and Inventory

A close relation of the current ratio which you learned in chapter 2 is the Net Working Capital
(NWC). This is computed by subtracting the business Current liabilities from its current assets. One
thing to remember is that an NWC of zero is equivalent to a current ratio of one. Just like the current
ratio, NWC is als0 a measure of liquidity and as such, a higher NWC means the business is more liquid.

Let us take liquidity analysis to the next level. A business purchases raw materials to
manufacture the products they sell. More often than not, these material purchases are acquired on credit.
Once those products are they are either paid in full immediately or are paid at a later date or a
Combination of the two. ldeally, you would want to receive the full payment for the sales right away and
use that money to pay your raw materials. However, the reality is that there is a mismatch in the timing
of the cash receipts (the cash inflows) and the cash payment for the raw materials. Therefore, we need to
know how long. on average, it takes for the business to pay its suppliers and to collect on its sales.

The time from raw material purchase to the cash receipt is called the Operating Cycle. This
cycle is composed of two periods. These are the Inventory Period, known as Age of Inventory taken up
in chapter 2, and the Accounts Receivable Period, known as Age of Receivables also in chapter 2. The
former refers to the time it takes for the business to sell its finished product from the time it purchased
its raw materials. On the other hand, the latter is the time it takes for the business to collect on the sale of
the finished product. Add the two periods together to get the operating cycle. Obviously, a shorter cycle
is much preferred.

Cash Conversion Cycle, also known as Cash Cycle, is the time it takes for the business to
collect on its accounts receivables after it has paid for its raw materials. It is calculated by subtracting
the Accounts Payable Period from the Operating Cycle. Accounts Payable Period is defined as the time
it takes for the business to pay for its raw materials from the time they are acquired. Just like the
Operating Cycle, a shorter cycle is much preferred.

Let us compute the Operating Cycle and the Cash Conversion Cycle of Good Food Snack House for
2014, first discussed in chapter 2 and reproduced in this chapter for your convenience. As we already
know, the Inventory Period is 91 days, while the Accounts Receivable Period is days. Therefore, the
Operating Cycle is 132 days (9 1 days+41 days). This means that the business gets to collect the cash
from its sales 132 day after it buys the raw materials.

Good Food Snack House

Balance Sheets
December 31,2013 and December 31, 2014
2014 2013 Change Percentage
in
Amount
Cash 91,626 7,792 83,835 10.76%
Accounts Receivable, net 939,460 676,411 263,049 39%
Inventories 1,836,634 1,377,475 459,158 33%
Prepaid Rent 180,000 360,000 -180,000 -50%
Total Current Assets 3,047,720 2,421,678 626,042 26%

Equipment and Fixtures 1,280,961 1,287,157 -6,195 0%

Less Accumulated Depreciation 406,728 281,581 125,147 44%
Total Fixed Assets 874,233 1,005,575 -131,343 -13%
TOTAL ASSETS 3,921,953 3,427,253 494,699 14%

Accounts Payable 467,376 560,851 -93,475 -17%

Notes Payable 312,000 681,385 -360,385 -53%
Accruals 436,560 523,872 -87,312 -17%
Total Current Liabilities 1,224,936 1,766,108 -541,172 -31%
Long-term debt 608,000 1,134,072 -526,072 -46%
Owner’s Capital 2,089,017 527,073 1,561,943 2.96%
TOTAL LIABILITIES AND 3,921,953 3,427,253 494,699 14%
 CAPITAL

Good Food Snack House

Income Statement
December 31,2013 and December 31, 2014

2014 2013 Change Percentage

in
Amount
Net Sales 7,457,736 6,396,040 1,061,69 17%
6
Less: Cost of Goods Sold 6,228,552 5,859,680 368,872 6%
Gross Profit 1,229,184 536,360 692,824 129%
Less: Other Expenses 886,177 561,974 324,203 58%
Operating Income 343,008 -25,614 368,621 14.39%
Less: Interest Expense 74,208 144,173 -69,964 -49%
Net Income 268,799 -169,787 438,586 2.58%

Let us now go to the Accounts Payable Period. Just like the Accounts Receivable Period, it is
computed by dividing 365 days by the Accounts Payable Turnover Ratio, which in turn is calculated by
dividing Cost of Goods Sold by the Average Payables. The Cost of Goods Sold is 6,228,552 while the
Average Payables is 514,114 and therefore the Accounts Payable Turnover is twelve days. To compute
the Accounts Payable Period, simply divide 365 days by twelve days, which yields thirty days. This
figure means that the business pays for its raw materials thirty days after purchasing them.

To compute the Cash Conversion Cycle, simply subtract the Accounts Payable Period from the
Operating Cycle. This computation yields 103 days, which means there is a 103-day gap between the
time the business pays for its raw materials and the time it collects the payment on its sales. To tide over
this 103-day gap, it can either borrow money or hold liquid reserves in the form of cash.

As mentioned earlier, you want a shorter Operating and Cash Conversion Cycle. To achieve this, ideally
you would want to collect the cash that is owed to you right away and pay your obligations at the latest
possible time. However, the reality is that you need to extend some sort of credit to your Customers to
grow your sales and you need to pay your obligations a bit earlier to make your creditors happy.

To manage the two cycles-actually, to shorten them, you need to manage their individual component
periods. First, we have the inventories The objective of inventory management is to shorten the time
your products stay in your inventory. In other words, you want to sell your goods as fast as you can. But
if you cannot speed up sales, then you reduce your inventory of products without losing sales due to
stockouts.

Second, we have accounts receivables. The objective of accounts receivables management is to collect
your accounts receivables in full as soon as possible without resorting to intimidation and high-pressure
collection tactics. To achieve this, you need to carefully choose which Customer to give credit to.

The 5Cs of Credit is a set of guidelines of carefully selecting your customers.

1. Character. This refers to the customer's track record of settling its obligations on time. More often
than not, customers without a track record should not be given credit.

2. Capacity. This refers to the capacity of the customer to repay you. This is typically done through
financial statement analysis discussed in Chapter 2.

3. Capital. This refers to the customer's level of capital in relation to its debt level.

4. Collateral. This refers to the value of the assets that the customer has and plans to use to secure the
credit.

5. Conditions. This refers to the general global and home country macroeconomic conditions and the
industry-specific conditions.

While liquidity is important, there is a price to pay for too much liquidity. A business that is very liquid
as evidenced by high liquidity ratios might be considered not at risk of going bankrupt, but is not being
profitable. It should be noted that current assets are less profitable than fixed assets. Think about it. If all
a business has are its current assets, would it be able to manufacture its products to sell? The answer is
clear. A business cannot manufacture its products without fixed assets.

Therefore, holding other things constant, a business having more current assets, is predisposed to being
less profitable though more liquid.

This trade-off between profitability and risk is also evident in current liabilities. Having more current
liabilities, holding other things constant, will provide a big boost to its profitability as current liabilities
are cheaper than long-term debt. However, the drawback in having more current liabilities is that it
exposes the business to liquidity risk.

C. PRACTICE
Answer the following questions.

1. Retell briefly the steps in Planning.

______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________

2. What is the difference between long term and short term goals?
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________

Activity 1

A. Multiple Choice
1. The _________ inventory consists of all items currently in the production process.
(a) raw materials
(b) work-in-process
(c) finished goods
(d) capital goods

2. The _________ inventory consists of items that have been produced but not yet sold.
(a) raw materials
(b) work-in-process
(c) finished goods
(d) capital goods

3. The three basic types of inventory are all of the following EXCEPT
(a) raw materials
(b) work-in-process
(c) finished goods
(d) capital goods

4. The _________ inventory contains the basic components of the production process.
(a) raw materials
(b) work-in-process
(c) finished goods
 (d) capital goods

5. The credit applicant’s _________ is the amount of assets the applicant has available for use in
securing the credit.
(a) character
(b) capacity
(c) capital
(d) collateral

B. Philippine Products Company is concerned about managing cash efficiently. On the average,
inventories have an age of 90 days and accounts receivable are collected in 60 days. Accounts payable
are paid approximately 30 days after they arise. The firm has annual sales of about PHP30 million.
Assume there is no difference in the investment per peso of sales in inventory, receivables, and payables
and that there is a 360-day
year.
1. Calculate the firm’s operating cycle.
2. Calculate the firm’s cash conversion cycle.
3. Discuss how management might be able to reduce the cash conversion cycle.

Activity 2
Problem Solving:
Gerry Jacobs, a financial analyst for Best Value Supermarkets, has prepared the following sales and
cash disbursement estimates for the period of August through December of the current year.

Month Sales Cash Month Sales Cash Month Sales Cash

Disbursements Disbursements Disbursements
August $400 $300
September 500 500
October 500 700
November 600 400
December 700 500

90% of sales are for cash, the remaining 10% are collected one month later. All disbursements are on
a cash basis. The firm wishes to maintain a minimum cash balance of $50. The beginning cash
balance in September is $25. Prepare a cash budget for the months of October, November, and
December, noting any needed financing or excess cash available.

GENERALIZATION

Reflection Note
 Activity 3
I learned about…

Prepared by:

Sir Argie R. Gomez

Content

Sources and uses of short-term and long-term funds.

Content Standards
The learners demonstrate an understanding of the sources and uses of short-term and long-term funds ,
and the requirements , procedure , obligation to creditor, and reportorial necessities
Performance Standards
The learners shall be able to…
1. distinguish debt and equity financing
2. identify the bank and nonbank institutions in the vicinity that are possible sources of funds, and
enumerate their requirements and process for loan application

MODULE MAP
This will guide the learner understand the flow of discussion.

Sources and uses of Short-term and Long-term Funds

Banks and Non- Requirements of Loan Amortization

banks applying for a and The Loan
personal loan Application process
 CONCEPCION CATHOLIC SCHOOL, INC.
Concepcion, Tarlac
S.Y. 2020-2021

Name: __________________________________ Date: ______________________

Subject: __________________________ Grade & Section: __________________

MELC Grade 12 Quarter 1, Week 6 to 7– Sources and uses of short-term and long-term funds.

1. Compare and contrast the loan requirements of the different banks and nonbank institutions and cite
these institutions in the locality.

Remember: The learner may be assisted by an able member of the family in terms of explaining how the
activities will be done. After the learner has understood how to do the activities, he/she should independently
work on the activity.

LESSON PROPER
A. INTRODUCTION

 BANKS
A bank is a financial intermediary that brings together depositors and borrowers.

Banks are a major source of funding for our working capital requirements. A business can deal with
different types of banks. These are enumerated below.

COMMERCIAL BANKS
Commercial bank clients are mostly retail customers. They are the moms and dads in the neighborhood
who are either employed, self-employed, or who have small businesses to operate. Its main business is
lending.

Transactions of commercial banks are many and usually not very large in size. To be able to reach more
clientele, the commercial bank puts up many branches in different locations. The objective is to be
closer to their market so that they may service them better and faster.

In the Philippines, the larger commercial banks include Banco De Oro (BDO), Union Bank,
Metrobank, and Bank of the Philippine Islands (BPI). Each of these banks has more than a hundred
branches located all over the country to lend better service to their customers. This brings the bank
closer to the customers.

Other services of commercial banks include:

 loans for vehicles or home improvement;

 requiring collateral, security, and credit history for loans;
 personal installment loans and credit card loans; and
 offering passbook, loans, and second mortgages.

UNIVERSAL BANKS

Universal banks are also commercial banks but are licensed to do more sophisticated banking services
than commercial banks. Their clientele comprises of the top corporations of the country and global
businesses. Universal banks have business dealings with top business corporations locally and globally,
and lend to these top business conglomerates, manage their corporate funds, invest their portfolio, and
advise these companies on financial market movements and directions. Their transactions are usually
bigger in size than commercial bank transactions, multicurrency, and global in nature.

INVESTMENT BANKS

Investment banks are similar to universal banks in terms of sophisticated banking services. Unlike
commercial banks, they do not have branches all around the country. They are more specialized and deal
with top corporations, global businesses, and governments. They perform market making activities such
as trading, fund management, and portfolio management.

 NONBANKS

Nonbanks are financial intermediaries as well but are supervised and regulated by another government
body, the Securities and Exchange Commission (SEC). Banks, on the other hand, are regulated by its
Central Bank. In the Philippines, it is the Bangko Sentral ng Pilipinas (BSP).

Life insurance companies, investment companies, finance companies, and mortgage companies are
examples of nonbank financial intermediaries.

INVESTMENT COMPANIES

Investment companies pool your money together with the money of other investors and invest these in
financial instruments-stocks, bonds, currencies, commodities, financial derivatives. They manage this
pool of funds which are called mutual funds. These accounts are not covered by deposit insurance.
Mutual funds are sold based on a net asset value per unit. Investors may come in and out of mutual
funds. There are different types ranging from aggressive mutual funds invested in stocks, to conservative
mutual funds invested in money-market instruments and fixed-income securities.

INSURANCE COMPANIES

Insurance compahies sell coverage or protection from events such as (1) a death of a loved one, (2) fire,
or (3) accident. Insurance premiums are paid by the owner/buyer over a time period such as from five to
ten years, in exchange for coverage for the events mentioned. In return, the insurance companies manage
the premiums by investing the same in Financial instruments that offer good returns-i.e., stocks, bonds,
currencies, Commodities, financial derivatives, or real estate. In the event that any of the above occurs,
the insurance owner is compensated through the insurance claim.
Other services that an insurance company offers include:

 lend on cash value of the insurance policy;and

 offer single payment or partial payment loans.

PRIVATE EQUITY FUNDS

Private equity funds are funds of private investors used to finance lucrative projects that are projected to
give good returns. They are big in Europe because the market has grown and investors have become
more 80phisticated, more knowledgeable, and are trying to move away from regulated investments and
funds.

B. DISCUSSION

REQUIREMENTS OF APPLYING FOR A PERSONAL LOAN

Lending happens when the owner of a property or money allows another party the use of the property or
money. The borrower promises to return the property or money after an agreed period of time. The
payment for the use of the property or money is called interest. The agreement is usually documented
through a promissory note, connoting a promise to pay back the owner for the use of the property or
cash.

Debt is the obligation to pay back property or cash borrowed in accordance to an agreement, and this
may be in the form of notes, bonds, or mortgages.

A credit is a loan or money extended to a person or business in exchange for a return. Once issued, it
becomes a debt of the borrower. When this money is extended, there is a pre-agreed covenant, such as
how long the credit payment is extended, for how much, how much will be returned (above the original
price), how frequent the payments, and at what interest rate.

The credit analyst holds the important role of analyzing the financial track record of the person or the
business that borrows, as well as its financial transactions. He determines the credit rating of the
borrower by looking at trends and forecasting potential payback on the loan.

What affects credit ratings?

 Ability to repay the loan. This mainly focuses on the security of the person's job, business
and/or the security of the company that employs you. This takes a look at the condition of the
borrower Does he have the ability to pay back the loan borrowed?
 Character of borrower. Are you trustworthy? Do you have a history of trouble with the law?
How long have you lived in your present address? These are the questions asked to establish the
character of the borrower and his attitude, priorities with regard to debt payments. Will he
prioritize debt payments or will he delay them? Will he exhaust all efforts to be able to make
good his promise to pay or will he relax and dillydally and not take his debts seriously?
 Capacity to pay the loan. Does he hold a stable job or have a stable source of income if he is in
business? What are the other sources of income and what are the current debts? These will
determine the borrower's capacity to pay his credit card debts. Is he in a situation wherein he can
afford to pay his debts?
 Capital and personal assets. Determine the value of cash, property and other investments. Do
assets exceed liabilities? Will savings and the value of property be able to pay for all debts?
 Collateral and size of business assets. If payments to credit card debts are delayed and/or
irregular, this may be an early indication of cash flow and liquidity problems, which could
eventually escalate to major problems such as bankruptcy. When this situation happens, the
creditor will look at real assets or property that can be liquidated and sold. Such proceeds will be
used to pay off the loan.

The credit bureau is the agency that gathers information about the credit history of the borrower and
sells this information for a fee. In the Philippines, the banks keep credit information private and
confidential. This is for security reasons. Unlike in the US where credit bureaus have been recognized
and existed for quite some time, the credit information in the Philippines is more limited.

 What is insolvency?
Insolvency is the inability to pay debts on time when they are due. It 1S not the same as bankruptcy.
Insolvency is insufficiency of cash flow and is temporary. It is a matter of timing. Why is it important to
know between the two? Insolvency or illiquidity is already an indication of trouble. The
acknowledgement of insolvency is a step toward managing your credit better.

 What is bankruptcy?

f you suffer from debt problems, the last remedy is to declare bankruptcy. Bankruptcy is a legal process
wherein assets of a debtor are distributed to creditors to be able to pay his debts. Bankruptcy also
includes a plan to repay creditors on an installment basis. Declaring bankruptcy severely damages one's
credit rating.

 What is your personal net worth?

Your net worth is the value of your assets, cash, savings, real estate, cars, stock, bonds, jewelry
collection, insurance, and art collection. The net worth value is deducted from your debt including credit
card debts, monthly bills, auto loans, home loans, and medical bills.

LOAN AMORTIZATION AND THE LOAN APPLICATION PROCESS

Lending is the commercial bank's bread and butter. This is where banking earns and pays its employees,
whose salaries, in turn, are reserved for several purposes. What are the mechanics of lending, credit, and
how does the loan application process work?

When a borrower visits the bank to borrow for a housing loan, for example, he talks to a bank officer
and fills out a housing loan application form.
What information will he put that the banks needs to know before he is granted a loan?
Because his loan is a Personal Loan, he will be assessed on the basis of his personal financial capacity.

 What is his age?

 What is his occupation?
 Where does he live?
 How many cars does he have?
 How many children does he have?
 What is his business?

If it is a Business Loan, the application will ask for information to be able to determine the capacity of
the business to repay the loan.

 What is the nature of the business?

 How long has the business been in operation?
 How much revenues accrued in the last three years?
 How much were profits for the last three years?
 What is the size and value of the business?
 What is the size and value of the properties of the business?

As soon as all pertinent information is available, the Loan Officer will forward the application form to
his manager who will forward the same to the Credit Officer, who will assess the credit paying ability
and request for loan approval from the Credit Committee.

CREDIT COMMITTEE

This group of officers represents the financial institutions, creditors and/ or investors that have claims on
a company that is in financial difficulty or bankruptcy. Their role begins with approving the credit line
and credit terms for a business, monitoring the payments schedule as agreed on, and filing for
bankruptcy or initiating the claims procedures if the business operations fail.

CREDIT RATINGS

Credit ratings are a way to formally evaluate the credit history of a person or company and includes a
forecast of the capability to repay obligations. It will normally begin with the company's three- to five-
year financial statements, a review of its business operations, a review of the economic conditions the
company operates in, the stability and credibility of the business owners and management, and a forecast
on revenues and the bottomline.

What Is a Credit Analyst?

The credit analyst evaluates the borrower's financial standing by reviewing his financial statements. The
borrower here is usually a company or corporation. The credit analyst evaluates statistics and analyzes
corporate records including (1) payment plans, (2) savings data, (3) payment history, and (4) purchase
activity. Based on these records, the credit analyst makes a recommendation to his lending officer
whether to extend credit to the borrower or not, after determining his credit worthiness and/or credit
limit.

The credit analyst's job involves a lot of critical thinking, judgment, and decision-making.

The Very Important Cs of Credit

 Character. Who is the borrower? The credit analyst establishes his Identity and character, and
his willingness to pay his loans. This enables the lender (banks) extending credit to determine
whether the borrower will remain committed to his promise to pay the loan or money borrowed.
Character is something in the attitude or discipline in the borrower, which is beyond the numbers
in his business statements or the capability to pay. Its in the character of the person who, despite
financial difficulties, would be able to find a way to pay back money he owes the banks and his
creditors because it is in his value system that whatever he borrows must be paid back.
 How long has Credit been used before?
 How long has the borrower lived in the present address?
 How long has he held the same job?
 Capacity. This is establishing the income and debts that the borrower already has. This will
affect his capacity to afford any additional debts. If the amount is already big relative to income,
lenders would probably no longer extend the additional credit, as his ability to pay now
diminishes. Establishing the sources of income, employment stability, cash flow of the business,
and stability of business operations involves answering the following:
 Who is the current employer and how much is the current salary?
 What are other sources of income?
 What are the current debts?
 Capital. This is establishing the borrower's assets, cash, property, personal possessions, and
investments in stocks or bonds. The lender will look into the borrower's total assets if these
exceed his liabilities or total debts. They will establish if there is enough to pay for all debts, so
even if income is lost, selling these assets would be able to pay for all the debts.
 What are his/her assets?
 What are his/her liabilities?
 Are the assets enough to pay for the debts?
 Collateral. If the loan extended to the borrower is not paid, the creditor will look at real estate
owned, or any other savings. as these can be offered to secure a loan.
 What assets do you have to secure the loan (a vehicle, your home, furniture)?
 What investments or savings do you have (stocks or bonds)?
 Conditions. General economic conditions such as unemployment and recession can affect the
ability to pay a loan. This important C focuses on the security of your job and the company that
employs you.

Improving Your Credit Score

 Pay your bills on time.

 Lower your balances.
 Set a monthly date wherein you can pay a certain amount regularly if you are not able to pay the
entire balance.
 Target paying the entire balance all the time.
 Delay or forgo unimportant purchase like luxury items.
 Use credit wisely.

SOLE PROPRIETORSHIP AND THE BUSINESS DOCUMENTATION REQUIREMENTS

Starting up your own small business would be a very interesting project to start with your group of
friends. Usually, it starts with a need. For example, are you dissatisfied with the taste of certain food that
you would rather create your own food instead? Perhaps you should go into the food business. Or are
you frustrated with the choice of clothing or shoes you find in the market? Are the choices either always
too big or always too small for you because you are not quite adult but already past your teens? Maybe,
joining the clothing or shoe business is for you. It all starts from something small.

How do you begin?

As discussed during the early pats of the book, where to look for financing is a critical part of any start-
up project. For bigger projects, it is usually referred to as capital ventures possibly financed by private
venture capitalists. For this book's discussion, we are limiting it to small business projects, sole
proprietorship, and financing support for these business ventures.

Business Loan Requirements

 Copy of Valid identification

 Bureau of Internal Revenue Registration Certificate
 Department of Trade and Industry Certificate
 Business Permit or Mayor's Permit
 Settlement Procedures and Details

REQUIREMENTS

Identification

Because the type of business being discussed is a sole proprietorship, the valid identification will be
that of the business owner. This means that his ID is required as part of the submission of requirements.
The following may be accepted:

 Passport ID
 Any government-issued ID
 School ID Voter's ID
 Picture in the ID must be clear
 The ID must have a recent signature
Bureau of Internal Revenue (BIR) Registration Certificate.
Department of Trade and Industry (DTI) Certificate.

Another requirement for business loan documentation is the Bureau of Internal Revenue (BIR)
registration certificate and the Department of Trade and Industry (DTI) certificate. Both ensure
that the business had gone through the proper procedures and compliance with the Bureau of Internal
Revenue and the Department of Trade and Industry. Certificates must be updated and not expired.

Business Permit

The business permit must be current and updated. If the business is undergoing renewal, a clear copy of
the business permit application for renewal must also be submitted as part of the requirements for a
business loan. If the application for renewal is just awaiting for its release, the official receipt or proof of
payment must be submitted. Once the updated and current business permit has been released, this too
must be submitted as part of the requirements of the loan.

Settlement Bank Account

This facilitates the more efficient payment of interest on the loan. If this will involve electronic or
mobile or internet funds transfer to the bank account, this procedure must be indicated. The business
owner may also opt for payment through bank checks. Passbooks with complete name and account
number may be included as part of the submission of requirements as proof of regular loan payments.

What is bad credit? How does bad credit happen?

Bad credit happens when companies are unlikely to pay their debts. They are either illiquid, meaning
that their debts are not paid on time, or could go bankrupt, which means that their assets even if sold,
would not be enough to pay for their debts.
 Bad credit happens when company sales do not grow over time and when company expenses increase
faster than sales. This is why growing companies are always on the lookout for new products and new
business opportunities.

C. PRACTICE

1. Have them identify whether the following are short-term or long-term sources of financing.

2. Provide scenarios and let them decide whether long-term or short-term financing is needed.

Need/Activity
Acquisition of equipment
Franchise of a fast-food outlet
Purchase of inventory for a clothing shop
Loan for agricultural needs (i.e. palay
production,mango, etc.)
Loan for purchase of a commercial space
Development of a subdivision
Auto-loan
Loan for sari-sari store supplies
Housing Loan
Emergency loans (advances)

2. Provide a time limit for them to write their answers on a piece of paper.

4. After the activity, ask this question, ‘Why is it important to distinguish between long-term or short term
financing?’

Activity 1

Answer the following questions.

1. What are the advantages and disadvantages of long term debt financing? Give at least 3. Explain.
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
2. What are the advantages and disadvantages of equity financing? Give at least 3. Explain.
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
3. Identify the different sources of short-term funds and long-term funds. Give at least 3 and define.
 ____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
4. Discuss when to use short-term funds in business.
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
5. Discuss when to use long-term funds in business.
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________

Activity 2
A. Self-Test Questions:

1. Enumerate the 5C’s of credit

____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________

2. What do you think is the most important consideration of banks in approving a loan?
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
3. Why is it important for banks to collect all the loan requirements? Which requirements are meant to
be used to evaluate each of the 5C’s of credit?
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________

B. Critical Thinking

1. When you are in a credit bind, what is the best way to address your problem to immediately get back
to your feet?
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________

2.When your business is going through financial difficulty like declining sales and declining profits,
what steps should you take to slowly recover and get back on track?
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________

3. What types of funding can you access to support your road to recovery?
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
GENERALIZATION

Reflection Note
Activity 3
I learned about…

Prepared by:

Sir Argie R. Gomez

Content

Basic Long-term Financial Concepts

Content Standards
The learners demonstrate an understanding of basic concepts of risk and return, and the time value of
money.
Performance Standards
The learners shall be able to…
1. distinguish simple and compound interest
2. solve exercises and problems in computing for time value of money with the aid of present and future
value tables
3. prepare loan amortization tables
4. compute for the net present value of a project with a conventional cash-flow pattern
5. describe the risk-return trade-off

MODULE MAP
This will guide the learner understand the flow of discussion.

Basic Long-term Financial Concepts

 Loan
Future Value Nominal and Amortization/ Applying The Risk-return
and Present Effective Interest Installment business concepts Tradeoff
Value Rate Loan in financial
management and
investment

CONCEPCION CATHOLIC SCHOOL, INC.

Concepcion, Tarlac
S.Y. 2020-2021

Name: __________________________________ Date: ______________________

Subject: __________________________ Grade & Section: __________________

MELC Grade 12 Quarter 1, Week 8 to 10– Basic Long-term Financial Concepts

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

Remember: The learner may be assisted by an able member of the family in terms of explaining how the
activities will be done. After the learner has understood how to do the activities, he/she should independently
work on the activity.

LESSON PROPER
A. INTRODUCTION

Time Value of Money and Opportunity Cost

The concept of time value of money states that a peso today, all things being equal, has greater value
than a peso in the future because of the opportunity to invest that peso today and earn interest.

In making decisions, for example, choosing between a European or an Asian trip. you must carefully
weigh all considerations including the costs. Choosing one option means letting go of the other option.
So the cost of choosing the European trip means losing the opportunity to go on an Asian trip, or vice
versa.

This concept holds true when spending your money. Because money is a limited resource, you cannot
spend money and save that money at the same time. If you decide to save, then the opportunity for you
to spend has just been given up. As what was stated earlier, the money that you save can earn interest.

Therefore, opportunity cost is anything given up after choosing an option. In finance, it is the possible
income from one option or investment opportunity given up.

Good money management is a decision to invest either in money market, fixed-income securities,
stocks, bonds, real estate, or in small business venture. If you decide to spend the money instead of
investing it, you are foregoing the opportunity to earn interest from investing this money. If you decide
to invest in financial instruments-fixed-income securities, bonds, or stocks-you are saying no to
investment in real estate and a start-up business.

How do you determine the amount of interest that you will earn?

The annual interest is the additional money earned from money in an account.

To ilustrate:

You deposited ₱10,000 in a savings account The bank pays an interest of 3%

annually.

How much interest will this account earn in one year?

Formula: Principal × annual interest rate × time = Interest earned for one year

Solution: ₱10,000 × 0.03 × 1 = ₱300

Answer: The account will earn ₱300 for one year.

B. DISCUSSION

FUTURE VALUE AND PRESENT VALUE

What Is Future Value?

How would you know, given that you have choices, and will reject one investment avenue by going with
another, if your choice was a good choice?

The future value of money is the amount your original funds will be worth in the future, based on
earning an interest rate over a time period.

Compute how much your savings will earn by multiplying the principal and the interest rate. Then, add
this interest amount. This new amount will also earn interest, which will again be added to the new
principal which will again earn interest the following year. This is the reason why future value is also
known as compounding. Compounding makes money increase over time, given a certain interest rate.

The formula to compute for future value of money is

F V n =PV ¿

where:

FV= Future value in n period

PV= Present value or the money invested today

i=interest rate

n= number of periods

To illustrate:
You deposit ₱10,000 in a savings account
The account pays 390 annual interest.
The account earned ₱300 in interest after the first year.
How much will the account earn after two years?

Solution:
Year 1: (₱10,000x0.03) ₱300.00
Year 2:(₱10,000 ₱300)0.03 P309.00
Using the formula, FVn¿ PV(1+i ¿n
FVn = ₱10,000 (1 + 0.03)2 = ₱10,609.00

Explanation:
You will earn ₱300.00 in interest on the first year.
You will earn ₱309.00 in interest on the second year.
The future value of your original money at the end of the second year is ₱10,609.00.

Rate 3.00%
Year Principal Interest
1 10,000,00 300.00 10,300.00
2 10,300.00 309.00 10,609.00
3 10,609.00 318.27 10,927.27
4 10,927.27 327.82 11,255.099
5 11,255.09 337.65 11,592.74
6 11,592.74 347.78 11,940.52
7 11,940.52 358.22 12,298.74
8 12,298.74 368.96 12,667.70
9 12,667.70 380.03 13,047.73
10 10,000,00 1 391.43 13,439.16

What Is Present Value?

Present value is today's worth of future money. An investor puts his money in stocks, bonds, or any
other investment with an objective of earning income. The investment plus the earned income is the
future value of money. Present value is determining today's worth of this future value (investment +
earned income). It is also known as discounting.

Using the previous illustration on future value, the ₱10,609.00 worth of money in two years at 3%
interest rate has a present value of ₱10,000.00. Refer to the timeline below:

Today Year1 Year2

₱ 10,000.00 ₱ 10,609.00
Present value Future value

The formula to compute for the present value of money is

PV =F V n /¿

where:

PV = Present value

FN = Future value in n period

n = number of period

i= interest rate

Why Do We Need to Compute for Present Value?

Various investment options have different required capital and expected rate of return. Most of the time,
you have the information about an investment's future value. However, it does not always mean that an
investment with a greater future absolute value is a better investment. You also need to consider the
initial capital required. If you know the present value of an investment as well as the present value of the
other investments, you can compare with their respective value today. Present value will tell you the
initial amount of money required to achieve your target return at a given interest rate at a certain number
of periods. Therefore, you consider the investment with a lower present value but with a higher possible
return.

Returns on investments will be received in the future and you want to buy that investment now. Being
able to compute for the various investment returns based on an interest rate and an initial required
investment will help an investor decide which investment to choose from.

Factors that determine the present value of an investment include:

1. The rate that the market gives

2. The cash flows expected

3. Number of periods these cash flows will continue

NOMINAL AND EFFECTIVE INTEREST RATES

Having Fun with the Math of It

Unfortunately, we cannot escape the math that comes with business and finance. Fortunately, the math
need not be confusing or complicated. Let us introduce and discuss in this chapter the math that you will
most likely need and meet along the way. We can assure you that the discussion will be light, fun, and
enjoyable.

Nominal interest rate or sometimes called annual percentage rate or quoted rate indicates the interest rate
paid or earned in one year without compounding. It is commonly known as simple interest rate.

On the other hand, the effective annual rate which is also known as effective interest rate indicates the
compound interest rate paid or earned in one year. This is the true amount of interest you pay or earn in
one year.

Below illustrates the nominal and effective interest rates in action.

If you deposit ₱100 in a savings account, how much interest will you a. using 4% annual percentage rate
earn in two years?

a. Using 4% annual percentage rate

b. using 4% interest rate compounded monthly
Annual percentage rate:
 Principal x rate x period= interest earned

Year 1: ₱100 x 0.04 x 1 year ₱4.00

Year 2: ₱100 x O.04 x 1 year = ₱ 4.00

The total interest earned for two years is ₱8.00

Effective annual rate:

i. Principal x annual interest rate ¿ interest earned for the

12 1st month

ii. (Principal + Previously Earned Interest) × Annual Interest rate/12= Interest earned for a given
month

Illustration for One Year

MONTHLY CALCULATION
1 100.00 4.00% 0.33
2 100.33 4.00% 0.33
3 100.67 4.00% 0.34
4 101.00 4.00% 0.34
5 101.34 4.00% 0.34
6 101.68 4.00% 0.34
7 102.02 4.00% 0.34
8 102.36 4.00% 0.34
9 102.70 4.00% 0.34
10 103.04 4.00% 0.34
11 103.38 4.00% 0.34
12 103.73 4.00% 0.35
13 104.07 4.00% 0.35
14 104.42 4.00% 0.35
15 104.77 4.00% 0.35
16 105.12 4.00% 0.35
17 105.47 4.00% 0.35
18 105.82 4.00% 0.35
19 106.17 4.00% 0.35
20 106.53 4.00% 0.36
21 106.88 4.00% 0.36
22 107.24 4.00% 0.36
23 107.60 4.00% 0.36
24 107.95 4.00% 0.36
8.31

At the end of the two years, you will have ₱108.31(₱100 + 8.31). You earned ₱8.31 in compounded
interest for the two years.

FV =PV ¿
where:

FV = Future value in n period

PV = Present value or the money invested today

i = interest rate m number of compounding periods per year

n = number of years

LOAN AMORTIZATION/INSTALLMENT LOAN

Charmaine Reyes is a single working mom. She has been employed by a retail mall for a little over a
year and wants to purchase an appliance through a bank loan available to her. How much should she
budget for the loan amortization of this purchase? How will she know how much to pay?

llustration:

Installment loan amount: ₱10,000

Installment term: 12 months

Monthly add-on rate: 1.50%

Monthly effective interest rate: 2.643%

Monthly factor rate: 0.0983333

Installment Loan Payment

Loan Amount ₱10,000 (1.50%x 12)+1=1.18

Installment Term 12 months 1.18/12-9.83%

Monthly Rate 1.50%

Monthly Effective 2.643%

Monthly Factor Rate 0.0983333

TOTAL PRINCIP INTERE OUTSTANDI
PAYMEN AL ST NG
T
10,000.00
1 983.33 719.03 264.30 9,280.97
2 983.33 738.03 245.30 8,542.94
3 983.33 757.54 225.79 7,785.40
4 983.33 777.56 205.77 7,007.84
5 983.33 798.11 185.22 6,209.73
6 983.33 819.21 164.12 5,390.52
7 983.33 840.86 142.47 4,549.66
8 983.33 863.08 120.25 3,686.58
9 983.33 885.89 97.44 2,800.70
10 983.33 909.31 74.02 1,891.39
11 983.3 933.34 49.99 958.05
12 983.33 958.05 25.32 0.00
The monthly factor rate is used to determine the amount of payment for the loan on a monthly basis
(principal plus interest). Every month, the amount below is paid.

₱10,000 x 0.0983333 = ₱983.33 (a)

The amount of interest paid on the loan is determined by using the monthly effective interest rate. Of the
total amount paid monthly above, the monthly interest is computed as follows:

₱10,000 x 0.02643 = ₱264.30 (b)

The amount of principal is determined by subtracting the interest payment (b) from the principal
payment (a). This bank product will vary from bank to bank and your credit standing.

₱983.33 - ₱264.30 = ₱719.03

The amount above is used to compute for the new outstanding principal which becomes smaller each
month until the entire loan is fully paid.

The illustration above helps you understand and make full use of credit opportunities available to you. A
necessary purchase can in time be fully paid with discipline and perseverance. The amount can be
computed as explained above.

APPLYING BUSINESS CONCEPTS IN FINANCIAL AND INVESTMENT PROBLEMS

One of the most effective ways to understand the basic concepts of finance is through personal finance.
How does one source his funding, create a budget, monitor a budget and control his costs, to ultimately
maximize his revenues and reduce his expenses.

Plan Your Budget Now

The Teenager's Personal Budget

Budget for the Month ₱4,000
Daily allowance ₱200
Daily cost for lunch ₱ 75 ₱1,500
Others 900
Savings monthly ₱1600
Savings yearly ₱19,200
Savings, three years ₱57,600

If invested in the stock market, how much will ₱50,000 grow?

Assuming that in a period of 10 years, the stock market will grow 3.5x, from an index of 2,000 to an
index of 7,000, your ₱50,000 investment could potentially reach ₱175,000 in the same time frame.

That amount is no small feat and especially if you compare that to the returns that a fixed-income
investment will give you.

Personal Investments

The Various Investment Portfolio Types: Which One Are You?

Before an investment portfolio is setup or designed, it is critical to define the risk appetite of the
investor. The process is a must preparation without which the investment portfolio will likely fail to
achieve its objectives. A good analogy we can offer would be preparing and/or dressing up for a special
occasion. One would have to know certain information so as not to look inappropriate.

 What is the occasion? a baptism, a wedding, or a dinner party?

 The occasion will help determine what you will wear.
 What will be the weather?
 How long will the event be held and where?
  Who will be hosting and who will be the guests?

Understanding the risk appetite of the investor will likewise require certain knowledge and information
about the investor.

 What is the age of the investor?

If he is in his 20s-30s, he can afford to take more risks with his investments, going for more percentage
allotted to stock investments or real estate property where the investment returns tend to be higher
although longer-term.

If he is in his 30s-40s, married, with perhaps two kids, he will have to temper his risk taking as he now
will have monthly requirements given that he is keeping house with a growing family. Hence, he will
need to allot more to fixed income securities that give regular cash flows, money market placements,
bonds to cover monthly expenses in, including food for the family, tuition and fees, rent, water, and
electricity. He may however, still keep some of his stock investments, albeit with a lower exposure.

If he is in his 40s-60s, he becomes more conservative with his investments and becomes more risk
averse. That would mean less stock investments exp0sure (maybe 10%), with the rest of his investments
in money market instruments, fixed income securities, bonds-both corporate and government.

If he is in his 60s onward, he may want to keep his entire investments in fixed income and shorter to
medium-term duration (maturity). This is because at this stage of his life, he may need more monthly
income requirements, usually food, medicine, water, and electricity.

 Other considerations include:

 Gender: ls the investor male or female?
 Civil status: Is the investor single or married?
 Does he have children, dependents?
 Where does his income come from?
 What is his objective for investing?
-to afford luxury vacations
- to be able to send his children to school
-to start saving up for retirement

Money market, fixed-income securities, and bonds

An investment portfolio that consists of money market instruments, Tied-income securities, and bonds
are for investors that are conservative. Conservative investors are usually older, more mature, and have
dependents a family to take care of. He would likely be looking for a fixed amount of income to
generate regularly because he has regular monthly bills to pay for, such as house rent, car amortization,
groceries, medicines, transportation costs, electricity, and children's education.

Stocks

Stock investors are more aggressive investors. They are younger and usually do not have dependents
yet. Their investment horizon or timetable for expecting investment returns is longer and, hence, stock
investors have the luxury of time to wait for stock markets to recover in case they have gone down
temporarily. Unlike the conservative investor, stock market investors do not necessarily need a monthly
income. Their long-term view on investment returns afford them to ride out bear markets which will
temporarily suspend income to them.

A combination of fixed-income and stocks

Investors who will design a more balanced investment portfolio will have another set of investment
profit and investment risk appetite. He will most likely be middle aged, with a small family depending
on him, hence, his need for a regular and fixed income stream. Being young however, he can afford to
be partially aggressive, time on his side, and hence capable of investing in the stock market and riding
the waves that go up and down.

Real Estate
Investors who like real estate may be categorized under "old school" or traditional. Wealthy families
hold on to more tangible assets like real estate, and in the Philippines many still consider real estate as
reliable and stable

There are several advantages and disadvantages to investing in real estate.

Advantages

1. Hedge against inflation. Real estate investments can be used to hedge against inflation. This means
that when the prices of goods and commodities move up, the purchasing power of the consumer goes
down, or he can afford less now than before. If he has real estate investments, he can be assured that its
value over time will increase and, therefore, his real estate proceeds. When he sells them, he can cover
expenses that he has consumed over time.

2. Rent income. Real estate investments may provide you with regular rent income, or cash flows. Your
property can be leased or rented out to an investor who has use for it. The property can either to put up
as commercial business, to rent it out, or to use it to warehouse his business inventory.

3. They are real and tangible properties, assets owned by the investor or by the business. Assets that can
be sold to pay off the debts of the investor or the debts of the business.

Disadvantages

1. Real estate investments are illiquid investments. They cannot easily be converted into cash. It may
take months or years to sell a property, and hence, their conversion to cash or cash flows may limit the
investor. Meantime, while these assets are not yet liquidated, the owner's debts are increasing due to
interest rates.

2. Although they offer some protection against inflation, real estate investments may also experience a
decline in value. When inflation goes down, the price of everything else goes down, the value of real
estate investments may also go down and, therefore, the owner may have to experience selling his
property for less than he initially acquired it for. This can be very dangerous to the real estate investor
because if he is depending on his real estate's value to increase and cover his debts, what will happen if
the value of his real estate goes down?

3. Lack of diversification. Because real estate investments are expensive, one can only invest in one or
two properties. This means that the investor loses his opportunity to invest in other types of investments
or securities that offer better features like liquidity.

4. Management and operating expense issues come with real estate investments. This pertains to looking
for reliable tenants, incurring operating expenses in maintaining the property like replacing worn Out
carpeting or keeping the garden in order, or fixing the bathroom tiles. Other investment outlets do not
carry this burden.

The Entrepreneur

A start-up project is another investment option. It is not a financial product or a marketable security such
as a stock or a bond that will give you a Certificate as evidence of your investment in the company's
stock or bond.

A business has real assets such as inventories, plant, and equipment. Business also incurs debts and
obligations to finance its operations. Business uses financial instruments to finance its expansion and
uses to increase its revenues and finance its operations.

To journal what is happening to the business and monitor its growth, and report its health to the owners,
the business prepares regular financial statements. These financial statements will regularly tell if the
assets of the business is growing and if the debts and obligations of this business is being paid. The
financial statements are the report card of the business. The statements of a business include:

 the balance sheet that shows the assets of the business and its liabilities and the value of
the owner's equity.
 the income statement that shows if the business is earning. It reports the revenues and
costs and expenses of a business during a period. It is also called the Profit and Loss
Statement.
Refer to the financial statements of Good Food Snack House in chapter 2.

Setting up a business as another investment option is the most risky choice for an investor who
wants to grow his money. Why? This is because unlike a marketable security, a business entails so much
more than giving money in exchange for a certificate and waiting for regular cash flows or capital
appreciation to happen. It means:

 knowing why you are in business and what you are in business for;
 setting goals and targets and achieving them on time;
 knowing the right people to hire and knowing how to motivate them to achieve your targets as a
business;
 delivering the goods and services to your customer;
 keeping costs down; and keeping the company profitable so that there is money to pay the
business' debts, the salaries of the employees, and having some left for improving the business
further, to keep it growing and sustain all those who depend on it.

THE RISK-RETURN TRADEOFF

Current events and updates are especially important discussions for business landscape (whether in the
Philippines or outside) as they affect the latter.

The concept of risk-return tradeoff explains that there is a commensurate return for every risk a business
owner or investor takes, and that the return expected is usually greater for more risk taken. Hence, the
common business term "the greater the risk, the greater the potential return or "no pain, no gain"

An example of a situation for a risk-return tradeoff:

1. A business can enhance its profitability by carrying less cash and marketable securities since these
earn very low rates in the market;

2. The funds, instead, are put into more risk, such as a higher investment in inventories that can generate
more sales for the company:

3. If the company is able to sell more from this inventory, then it is able to generate more return for the
risk it entered into;

4. However, the tradeoff can be complex: if the additional investment in inventory does not generate
more sales, perhaps because of a slowdown in the economy or the quality of the product being sold; or
for some other reason, when the business has carried less stable cash and marketable securities to pay for
the short-term loans it used to finance this additional inventory; and

5. The higher the risk the business takes, the higher the potential to earn, as well as the potential to lose
which can lead to delayed payments on short-term debts that financed the inventories in the first place.

Knowledge, technology, and changing markets have made competing for customers tougher. On top of
this, there are many more challenges that a business owner is faced with today, compared to ten years
ago. Some of these challenges include:

 international conflicts/events
 extreme weather events
 failure of national governance
 state collapse or crises
 unemployment and underemployment
 natural catastrophes
 failure of climate change adaptation
 water crises
 data fraud or theft
 cyber attacks, computer hackers
 C. PRACTICE

Answer the following questions.

1. You deposited PHP1,500 in a bank with an interest rate of 5% for 1 year. What is the future value of
your deposit?

Answer:

2. You need to save up for P1,500 in 1 year. How much should you save now if the bank offers a rate of
5%? (Find the present value)

Answer:

3. FNB pays 6% interest compounded semi-annually. SNB pays 6% compounded monthly. Which bank
offers the higher effective annual rate?

Answer:

4. Compute the present value and future value of P100 cash flow for the following combination of discount
rates and times:
A. r = 8%, t = 5 years
B. r = 8%, t = 10years
C. r = 5%, t = 5years
D. r = 5%, t = 10 years

Answer:

Activity 1
Answer the following questions.

1. Explain the risk and return trade-off.

______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
2. Ask learners on how the risk and return trade-off can be applied in real life.
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________

Activity 2
 Read and discuss the following case.

• You are the investment manager of an appliance company. The industry is currently in the expansion
face and the CEO would like to capture as much of the market share as possible. You asked your
analysts to submit project proposals as summarized below.

Project Discount Rate Investment Annual Cash Flow Project Life

(Years)
A 10 3M 1M 5
B 12 4M 1M 8
C 8 5M 2M 4
D 8 3M 1.5M 3
E 12 3M 1M 6

Which projects should the manager choose? If you were given unlimited capital, which projects should be
implemented?

GENERALIZATION
Reflection Note

Activity 3
I learned about…

Prepared by:
Sir Argie R. Gomez