Polytechnic University of the

Philippines
College of Business Administration
Department of Management
Sta. Mesa, Manila

FINANCIAL POLICY
ALLOCATING AND SOURCES
OF CAPITAL
Business Policy and Strategy
BSBA-HRDM 4-2N

Submitted by:
Nonifara, Andrea Faye
Ong, Christine Cindy
Pacanor, Ethel
Perez, Trixia Mae
Pineda, Mark Angelo
Rallonza, Alexandrea Nicole
Raya, Nicole
Regalado, Jamie
Sebastian, Pinky

Financial Policy Allocating Capital

A. Regulating Investments in Fixed Assets

In all business organizations, a number of proposals are made for the addition of facilities to increase
profitability. The managers concerned with product planning or production place emphasis on the deployment of a
better technology with a view to achieving higher production at lower cost. One important way to regulate such
proposal is to lay down a policy pertaining to investment in fixed assets. Here, we give some samples relating to
such proposals.

What is a 'Fixed Asset'?

A fixed asset is a long-term tangible piece of property that a firm owns and uses in the production of
its income and is not expected to be consumed or converted into cash any sooner than at least one year's
time. Fixed assets are sometimes collectively referred to as "plant."

What are Long-term Investments?

Long-term investments are non-current assets that are not used in operating activities to generate
revenues. In other words, LT investments are assets that are held for more than one year or accounting
period and are used to create other income outside of the normal operations of the company.

Long-Term Outlook of Investment in fixed asset

The policy relating to the investment in fixed assets should be administered with great caution. A
change in government policies and uncertainty of technology often tempt the management to give serious
thoughts to the varied problems of investment in fixed assets. If a company deals in wide variety of
production lines with a view to increase its profitability, heavy investment in fixed capital may be justified.
Example:
A plywood-making industry became worried about the increasing cost of production of one of its
plants located in Tamil Nadu. A cost analysis revealed that the plants located in North India were getting raw
material at a lower cost than that in Tamil Nadu.
It was, therefore, decided that no further investment in fixed assets should be made at the plants in
Tamil Nadu; that only the purchase of miscellaneous equipment and spare parts will be allowed; that
attempts will be made to ensure that the existing capacities of the plants located in North India are gradually
increased; and that the plant located in Tamil Nadu will be discounted.

Minimum Rate of Return of Investment in fixed assets

Most firms concentrate on the minimum rate of return that must be anticipated, if capital is employed
in a specific proposal. For example, a company may decide that the investment in new assets must earn at
least 5% on the initial investment after making the necessary provision for depreciation and taxes. All those
proposals which yield less than the desired return will then have to be dropped in the very first instance. This
sort of policy is quite useful, for the method of estimating the return is quite well defined. The depreciation
interest, taxes, net investment and other items can be treated in quite a different manner.

It is largely believed that the permissible rate of return should be the average cost of capital to the
company. The minimum rate of return can be properly estimated if due consideration is given to such factors
as the desire for expansion, the size of existing funds, plans about future procurement of funds, and
assessment of risk. As most executives, who make proposals for investment in fixed assets tend to be quite
optimistic in assessing the benefits that are likely to flow from the products, it is desirable that the
management should get a high rate of return.

Capital Budgeting in regulating fixed assets investment

In regulating investment of fixed assets, a company quite often has a variety of plans that can be
effectively financed. The technique which is widely utilized to screen various investment proposals is
commonly known as capital budgeting. The screening of a proposal calls for the identification of alternatives,
feasibility studies, cash flow forecasts, assessments of economic worth vis-a-vis the degree of risk involved,
and expected rate of return. Because of its crucial importance, an analysis of various proposals must be
done with great caution, for the effective functioning of subsequent plans will depend on the thoroughness
with which proposals have been screened. The whole task will be simplified by screening those proposals
which are not in conformity with purchase, production, personnel and finance policies.
Reporter: Ethel Pacanor
Effective investment criteria should have the following features:
1) It should clearly screen the projects which are to be accepted or dropped;
2) It should provide a logical base for the ranking of projects in the order of their priority;
3) It should furnish a scientific basis for choice from among alternatives.
Techniques of Screening Investment Proposals
There are number of appraisal methods which may be recommended for evaluating capital investment
proposals.

I. Traditional Methods
1. Payback Period method

Also termed as pay-out period or Pay-off period.

Defined as the number of years required to recover the initial investment in full with the help of the
stream of annual cash flows generated by the project.

In the Case of Constant Annual Cash inflow:

In the case of Uneven or Unequal Cash inflow, Pay-back period is determined with the help of cumulative
cash inflow. It can be calculated by adding up the cash inflows until the total is equal to the initial investment.
2. Accounting rate of return method;

Also termed as Accounting rate of return (ARR)

This method focuses on the average net income generated in a project in relation to the projects
average investment outlay. It involves accounting profits not cash flows.

ARR can be determined by this formula:

Where:

II. Time Adjusted Method or Discounted Cash Flow Method

1. Net present value method (NVP)

Technique which explicitly recognizes the time value of money. In this method all cash inflows and
outflows are converted into present value applying an appropriate rate of interest.

Equation for computing NVP:

In the case of conventional cash flows, NVP may be represented as follows:

In the case of non-conventional cash flows, the equation for calculating NVP is as:
Where:
NVP= Net Present Value
R= Future Cash Inflows at different times
K= Cost of Capital or Cut-Off Rate or Discount Rate
l= Cash outflows at different times.
2. Internal rate of return (IRR) method

Also known as Time Adjusted Rate of return Method

Defined as the rate which equates the present value of cash outflows of an investment. In other
words, it is the rate at which the net present value of the investment is Zero.

The Interpolation formula can be used to measure the IRR as follows:

3. Profitability index.

Also known as Benefit Cost Ratio

It gives the present value of future benefits, computed at the required rate of return on the initial
investment.

The Profitability Index can be calculated by the following equation:

Reporter: Nicole Raya

B. Policy Restraints on Current Assets

Current Assets
Are cash and any other assets that a company plans to either turn into cash or consume within one
year or in the operating cycle of the asset, whichever is longer. The operating cycle is the time between the
purchases of raw materials needed to produce a product and the sale of the actual product.
Currents Assets Includes:

Cash and Cash Equivalents- cash are actual currency that is available for use and Cash
equivalents are short term investments that will mature or become cash within no more than 3

months.
Short-term Investments- is a debt or equity security that is expected to be sold or converted into

cash in the next 3 to 12 months.

Receivables- are anything that a company is owed by a customer and has not been paid. An

example of a receivable is a sale on an account to a consumer.

Inventories- are any raw materials, completed products, and products that are still works in process.
Reporter: Trixia Mae Perez

Two Classes of Assets:

Fixed Assets- are assumed to grow at a constant rate which reflects the secular rate of growth in

sales.
Current Assets- are expected to display the same long term rate of growth. However, they exhibit
substantial variation around the trend line, thanks to seasonal (or even cyclical) patterns in sales
and/or purchases.

Two Parts of Investment in Current Assets:

Permanent Current Assets- what the firm requires even at the bottom of its sales cycle.
Temporary Current Assets- reflects a variable component that moves in line with seasonal
fluctuations.

Several strategies are available to a firm for financing its capital requirements. Three strategies are
illustrated by lines A, B, and C below.
Strategy A:
Long term financing is used to meet fixed asset requirement as well as peak working capital
requirement. When the working capital requirement is less than its peak level, the surplus is invested in
liquid assets (cash and marketable securities).
Strategy B:
Long term financing is used to meet fixed assets requirement, permanent working capital
requirement, and a portion of fluctuating working capital requirement. During seasonal swings, short-term
financing is used during seasonal down swing surplus is invested in liquid assets.
Strategy C:
Long term financing is used to meet fixed asset requirement and permanent working capital
requirement. Short term financing is used to meet fluctuating working capital requirement.

The Matching Principle

According to this principle, the maturity of the sources of financing should match the maturity of the
assets being financed. This means that fixed assets and permanent current assets should be supported by
long term sources of finance whereas fluctuating current assets must be supported by short term sources of
finance.
The rationale for the matching principle is fairly straightforward. If a firm finances a long term asset
(say, machinery) with a short term debt (say, commercial paper), it will have to periodically refinance the
asset. Whenever the short term debt falls due, the firm has to re-finance the assets. This is risky as well as

inconvenient. Hence, it makes sense to ensure that the maturity of the assets and the sources of financing
are properly matched.
Operating cycle and cash cycle:
The investment in working capital is influenced by four key events in the production and sales cycle
of the firm:
1.
2.
3.
4.

Purchase of raw materials

Payment of raw materials
Sale of finished goods
Collection of cash for sales

The firm begins with the purchase of raw materials which are paid for after a delay which represents
the cost payable period. The firm converts the raw material to finished goods and then sells the same. The
time lag between the purchase of raw materials and the sale of finished goods is the inventory period.
Customers pay their bills sometimes after the sales. The period that elapses between the date of sales and
the date of collection of receivables is the accounts payable period (debtors period).
The time that elapses between the purchase of raw materials and the collection of cash for sales is
referred to as the operating cycle, whereas the time between the payment for raw materials purchases and
the collection of cash for sales is referred to as the cash cycle. The operating cycle is the sum of the
inventory period and the accounts receivable period, whereas the cash cycle is equal to the operating cycle
less, the accounts payable period. From the financial statements of the firm, we can estimate the inventory
period, the accounts receivable period, and the accounts payable period.
Reporter: Christine Cindy Ong

C. Calculation of Profits

1. Start with a value for your business's total income.

Sold last month - $20,000

Rights sold to the intellectual properties - $7,000
Promotional materials - $3,000
$20,000 + $7,000 + $3,000 = $30,000 total income

2. Calculate your business's total expenses for the accounting period.

3. Subtract the total expenses from the total income.

Total income - $30,000

Total expenses for the month - $13,000
$30,000 - $13,000 = $17,000 profit

4. Note that a negative value for profit is called a "net loss"

5. Consult a business's income statement for revenues and expenses.
6. Start with the value of your business's net sales.

Sneakers sold for the quarter - $350,000

Refunds - $10,000
Returns and discounts - $2,000
$350,000 - $10,000 - $2,000 = $338,000 net sales

7. Subtract the cost of goods sold (COGS) to obtain gross income.

Direct materials (raw materials) - $30,000

Direct labor (factory worker) - $35,000
$338,000 - $30,000 - $35,000 = $273,000 Gross Income

8. Subtract all operating expenses

Indirect labor (non-factory worker) - $120,000

Rent and utilities - $10,000
Advertisements - $5,000
$273,000 - $120,000 - $10,000 - $5,000 = $138,000.

9. Subtract depreciation/amortization expenses.

Machinery - $100,000 and has a 10 year lifespan

Machinery depreciates by $10,000 per year, or $2,500 per quarter.
$138,000 - $2,500 = $135,500 operating income

10. Subtract any other expenses.

Loan expense - $10,000

New shoe-machinery - $20,000
$135,500 - $10,000 - $20,000 = $105,500

11. Add any one-time revenues.

Sold old shoe-machinery - $5,000

Licensed logo for other company - $10,000
$105,500 + $5,000 + $10,000 = $120,500

12. Subtract taxes to find your net income.

Taxed - $30,000
$120,500 - $30,000 = $90,500 profit for the quarter
Reporter: Jamie Regalado

D. Distribution of Earnings

Stockholders and Equity

Stockholders in corporations typically contribute cash although a stockholder may contribute business
assets in lieu of cash. Initially, cash is used to capitalize the business and later contributions are used to
fund growth. The number of shares a stockholder owns denotes the ownership interest. Stockholder
contributions are reflected in stockholder's equity on the balance sheet. In addition to contributed capital,

stockholder's equity also includes retained earnings, which are net profits or losses retained by the
company.

Distributions of Cash
Distributions paid to shareholders reduce stockholder's equity and its component, retained earnings.
Distributions of cash, or cash dividends, are typically called "dividends." These distributions are reflected on
your corporation's balance sheet and in the financing section of the cash-flow statement. Companies
typically reinvest earnings to maintain operations and fund growth. Rapidly expanding companies generally
pay no dividends and instead use all of their earnings to fund expansion. Conversely, mature, stable
companies often distribute a high percentage of earnings as dividends.

Dividend Declaration
Before a corporation can distribute dividends, its board must first declare the dividend. Laws require
corporations to show a positive number in retained earnings that exceeds the amount of the dividend to be
declared. In practical terms, a corporation also needs sufficient cash on its balance sheet to pay a dividend
while still being able to meet any financing or operating obligations.

Asset Distributions
Companies use their assets to support operations. Corporations sell assets they no longer need to generate
cash to purchase other assets, pay off debt or support operations. Therefore, healthy corporations rarely
distribute non-cash assets to shareholders. Corporations generally only distribute assets when the company
has partially or wholly failed and is in the midst of shutting down a portion or all of its business.

Business Failure
When a corporation fails, it distributes to shareholders only those assets that remain after it has paid all of its
outstanding creditors. It is usually easier for a corporation to sell its assets and distribute the proceeds.
However, if the corporation has few assets, finds it too time consuming to find buyers or has only one or two
shareholders, it will parse out the assets according to the assets' value and the shareholder's ownership
interest.
Reporter: Mark Angelo Pineda

Financial Policy Sources of Capital

A. Instruments to Obtain Capital

Equity Financing- Equity financing is the method of raising capital by selling company stock to investors. In
return for the investment, the shareholders receive ownership interests in the company.
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.
Kinds of Stocks:
o

Common Stocks- type of security that serves as an evidence of proportionate ownership, imparts
proportionate voting rights, and gives its holder unlimited proportionate claim on the assets and

income of the firm.

Preferred Stocks- a preferred stock is a class of ownership in a corporation that has a higher claim
on its assets and earnings than common stock. Preferred shares generally have a dividend that must
be paid out before dividends to common shareholders, and the shares usually do not carry voting
rights.
Reporter: Alexandrea Nicole Rallonza

Debt Financing- Debt financing means borrowing money from an outside source with the promise of paying
back the borrowed amount, plus the agreed-upon interest, at a later date.
Bonds- is a certificate of indebtedness whereby the borrower agrees to pay a sum of money at a specified
future date plus periodic interest payments at the stated rate.
Kinds of Bonds:
o
o
o

Term bonds- Bonds that mature on a single date

Serial bonds- bonds that mature in installments
Secured bonds- provide security and protection to investors in the form of specific assets of the
issuer, such as real estate or other collateral.
Real estate mortgage bond- secured by a lien against real estate
Collateral trust bond- secured by shares of stock and bonds held by the issuer as

investment
Chattel mortgage bond- secured by a lien against movable property like motor vehicles
Unsecured bonds- (frequently termed as debentures), are not protected by the pledge of any
specific asset of the issuing corporation. The issuance of the debenture bonds is generally based on
the credit rating of the company, as these bonds are backed only by the issuers general favorable

credit standing.
Registered bonds- are bonds whose owners names are registered in the books of the issuing
corporation

Notes Payable- the amount of principal due on a formal written promise to pay.

Kinds of Notes Payable:

o
o

Interest Bearing
Non-Interest Bearing
Reporter: Pinky Sebastian

B. Selecting Capital Sources

Business lenders
Reputable banks and business lending institutions offer debt financing charged with interest.
Instead of ceding any control or share of your business, as you would to an investor, a lender will negotiate a
timetable of repayments for your business to pay off the debt plus a percentage of interest that accrues
annually.
While different banks and lenders offer various incentives and fee structures for business loans, it is the
interest on the loans you should compare most keenly because that is the area where you can make the
most savings.

Family and friends

Borrowing capital or accepting investment from a family member or friend is often the easiest option.
Theyre more likely to place trust in you and be more accepting of your business case than other types of
lenders or investors.
However, tapping family and friends for capital is not always the best option.
Introducing money into a personal relationship can strain ties and damage trust, while the critical business
acumen provided by a professional investor will also be missing.
Select who you approach carefully and make sure you formalize the arrangement with a signed contract that
sets out the terms and conditions in writing so later disputes cant arise.

Angel investors
An angel investor is by definition a successful entrepreneur in their own right who is looking to invest funds
in an innovative start-up business they can also contribute their skills to.
The entrepreneurs who feature in TV shows such as Dragons Den, for example, are all acting as angel
investors.
Angel investors typically pick investment opportunities in their fields of expertise so they can apply their
experience to helping the business succeed.

They also tend to look for investment opportunities at earlier stages in the life of a business than other types
of investors or lenders. If they can see the potential of an idea, they are more likely to invest in a young startup business they can nurture.
In return for capital investment and their expertise, angel investors typically take equity in the business and
expect a healthy short-term ROI.

Venture capital firms

A venture capitalist manages the funds for investors looking for good short to medium term returns.
They do this by setting up a fund in a firm that specifically targets certain types of businesses aiming to be
bought out by a larger company or floated on the stock exchange.
Both growth strategies are often used as a short cut to achieve large returns on start-up businesses.
Like angel investors, venture capital firms also often get involved in the running of a business by offering
expertise and support. However, venture capital firms also typically require a significant degree of control in
a business to protect their investment as well as a share of the business itself.
Venture capital funding is received in rounds known as seed rounds with the amounts invested often
directly related to the businesss recent performance.

Crowd funding
Crowd funding is the newest trend in raising capital and is most appropriate for high-risk creative and artistic
projects that wouldnt typically receive funding from a bank, angel investor or venture capital firm.
Instead of seeking capital in its entirety from one source, crowd funding sees businesses seek capital in
small amounts online from as many investors as they can.
Crowd funding websites post online pitches from their member businesses that offer rewards, discounts and
special privileges (such as receiving a pre-release or beta version of a product) in return for small
investments.
Each crowd funding website operates to different rules, so make sure you research your options carefully
before choosing one as a platform to seek investment.
Reporter: Andrea Faye Nonifara

BOSTON CONSULTING GROUP MATRIX

A planning tool that uses graphical representations of a companys products and services in an effort to help
the company decide what it should keep, sell or invest more in. The BCG growth share matrix plots a
companys offerings in a four square matrix, with the y-axis representing rate of market growth and the xaxis representing market share. The BCG growth share matrix was developed by the Boston Consulting
Group (BCG) in the 1970s.

Bruce Doolin Henderson (April 30, 1915 July 20, 1992) was an

American

entrepreneur, the founder of the Boston Consulting Group (BCG).

Henderson

founded BCG in 1963 in Boston, Massachusetts. He headed the

firm

President and CEO until 1980 and stayed on as Chairman until

1985.

It was created for the Boston Consulting Group in 1970 to

as

help

corporations to analyze their business units, that is, their product

lines. This

helps the company allocate resources and is used as an analytical

tool

brand marketing, product management, strategic management, and

portfolio

analysis. Some analysis of market performance by firms using its

principles

in

has called its usefulness into question.

"To be successful, a company should have a portfolio of products with different growth rates and different
market shares. The portfolio composition is a function of the balance between cash flows."Bruce D. Henderson
(1970)
The combinations of high and low market share and high and low business growth provide four categories for a
corporate portfolio:

Business Growth Rate- pertains to how rapidly the entire industry is increasing.
Market Share- defines whether a business unit has a large or smaller share than competitors.

Star- has a large market share in rapidly growing industry. The star is important because it has additional growth
potential, and profits should be plowed into this business as investment for future growth and profits. The star is
visible and attractive and will generate profits and a positive cash flow even as the industry matures and market
growth slows.
Cash Cow- exists in a mature, slow-growth industry but is a dominant business in the industry, with large market
share. Because heavy investments in advertising and plant expansion are no longer required, the corporation earns
a positive cash flow. It can milk the cash cow to invest in other, riskier business.

Question Mark- exists in a new, rapidly growing industry, but

had only a small market share. The question mark business is
risky: it could become a star, or it could fail. The corporation
can invest the cash earned from cash cows in question marks
with the goal of nurturing them into future stars.
Dog- is a poor performer. It has only a small share of a slowgrowth market. The dog provides little profit for the
corporation and may be targeted for divestment or liquidation
if

turnaround is not possible.

Reporter: Alexandrea Nicole Rallonza

References:

https://en.wikipedia.org/wiki/Growth%E2%80%93share_matrix
http://www.netmba.com/strategy/matrix/bcg/