LESSON 1: Introduction to Financial Management

Target:
At the end of this lesson, you should be able to:

 Explain the major role of financial management and the different individuals
involved
 Distinguish a financial institution from financial instrument and financial market
 Enumerate the varied financial institution and their corresponding services
 Compare and contrast the varied financial instrument
 Explain the flow of funds within an organization – through the form of enterprise-
and the role of the financial manager

Explore:
Present a scenario in everyday life by asking the learners how much allowance they
are given to and how often they receive it. Inside the box identify the expenses they
incurred until the end of the day.

Expenses

Examine:
• Define Finance as follows:
- Finance can be defined as the science and art of managing money. (Gitman & Zutter, 2012)
- Budgeting is the act of estimating revenue (in the form of their allowance) and expenses over
a period of
- sources of funds people or institutions that will give us the money we need.
- Investment comes in many forms that will generate income or appreciate in the future.

FORMS OF BUSINESS ORGANIZATIONS:

- Sole Proprietorship - A business owned by one person and operated for his or her own profit.
- Partnership - A business owned by two or more people and operated for profit.
- Corporation – An entity created by law owned by shareholders. Corporations may either be
privately owned or publicly owned. Privately owned corporations are often owned by family
members whose stocks may not be offered to outsiders unless consent by the family members
is secured. Companies which are publicly listed are owned by unrelated investors and
are traded in organized exchanges like the Philippine Stock Exchange. While there are
many stockholders, there is generally a group of investors or a family which controls
each listed company. Prices of stocks of listed corporations are driven by several
factors such as the earnings of the companies, the prospects of the industry where
these companies operate, the general market sentiment, and the economic prospects of
the country, among others.

What defines a shareholder’s wealth?

 Shareholder should be wealth maximization
 Conclude that shareholders’ wealth is measured based on the current market
price of the corporation’s stocks. The market price changes across different
periods. Hence, the value of your investment changes in different points on time
based on the market value at that time.

Factors that Influence Market Price

• Group the factors into two: Factors that the Management can control and external
factors that
cannot be controlled by management.

- Examples: Suppose the following Income Statements and Cash Flow Statements of
companies A, B and C were presented to you. Which
do you think is a more attractive company?

7
Controllable by Management Uncontrollable External Factors
• profitability
• having a good liquidity and reasonable
leverage position
• dividends
• competent management which affects the
company’s operating efficiency
• coming up with corporate plans that improve
the business prospects of the company

• macroeconomic conditions
• political stability
• prospects of the industry where the
company operates
• general market sentiment
• flow of foreign funds invested in the
Philippine stock market

COMPANY A
Income Statement Cash Flows
Sales P 100,000 Collection from Customers P 0
Less: Costs 50,000 Payment of Expenses 50,000
Profits P 50,000 Net Cash Flow (P 50,000)

COMPANY B
Income Statement Cash Flows
Sales P 100,000 Collection from Customers P 100,000
Less: Costs 150,000 Payment of Expenses 50,000
Profits (P 50,000) Net Cash Flow P 50,000

COMPANY C
Income Statement Cash Flows
Sales P 100,000 Collection from Customers P 100,000
Less: Costs 70,000 Payment of Expenses 70,000
Profits P 30,000 Net Cash Flow P 30,000

• Company A is profitable but generated negative cash flows which resulted from the
uncollected accounts receivable of PHP100,000.
Without adequate cash inflows to meet its obligations, the company will face liquidity
problems, regardless of its level of profits.
• Company B on the other hand has a positive cash flow but is unprofitable. This is a
result of the company’s delay in payment of its costs.
Accordingly, the Company will soon have to pay the remaining PHP100,000 liability and
its cash will no longer be sufficient. Again, without
adequate cash inflows to meet its obligations, the company will face liquidity problems.
• Company C is profitable and has a positive cash flow. Based on the information
provided, Company C seems to be the best.
- Good liquidity and reasonable leverage position.
• Liquidity and leverage refers to the company’s management of the type and amount of
assets and liabilities that it will hold in the course
of its operations. This will further be discussed in Lesson 2.
- Dividends.
• Holders of shares receive dividends from a corporation as returns on their investments
in form of cash or other properties. Companies
which have better dividend policies are generally more attractive than companies who
do not pay out dividends.
• Note that there may be times that companies do not pay out dividends because of
future expansions. Same with the other factors
affecting share price, dividend policies should go hand in hand with other factors in
determining market price.
- Competent management.
• Competent managers may have any of the following attributes: 1) visionary 2) decisive
3) people-oriented, 4) inspiring, 5) innovative, 6)
respected and 7) experienced/seasoned manager.
- Corporate plans that improve the business prospects.
• Example: Company A which is in the business of selling Halo-halo in the Dapitan area
(or any other area) for 5 years. Company A is
consistently earning profits and has a positive cash flow. When asked how Company A
sees itself after 5 more years, Company A answered
that it would continue to sell Halo-halo in Dapitan (or any other area).
• On the other hand, Company B sells Buko Juice in Katipunan area (or any other area
different from Company A’s area) for 5 years.
Company B is consistently earning profits and has a positive cash flow. When asked
how Company B sees itself after 5 more years,
Company B answered that it has generated enough cash to expand its business to
Cubao area (or any other area) to take advantage of
the growing demand of Buko Juice in Cubao.
• Between Company A and Company B, which would be a better investment? Company
B. Since it has more concrete future prospects
allowing investors to hope for better revenues and net income.
• External Factors
- These factors influences the general reaction of investors in making an investment
decision.

- Its effect is not only to a specific company but on all companies or a group of
companies under
similar circumstances.
- Such factors are a result of the environment a company operates in rather than the
decisions of the
company’s management.
3. Role of Financial Management
• Ask the learners, given the factors that influence market price, how will the company
ensure that
such objectives will be achieved? Reveal the answer that this is achieved through
financial
management.
• Financial management deals with decisions that are supposed to maximize the value
of
shareholders’ wealth. (Cayanan)
- These decisions will ultimately affect the markets perception of the company and
influence the
share price.
- The goal of financial management is to maximize the value of shares of stocks.
- Managers of a corporation are responsible for making the decisions for the company
that
would lead towards shareholders’ wealth maximization.
• Tell the learners that for the next parts of this course, they will fill in the shoes of a
Chief Financial
Officer (CFO) and every problem that they will encounter for this course should be dealt
with having
shareholders wealth maximization in mind.

ENRICHMENT (5 MINS)
1. Integration of Learning
• Ask the learners the following:
- Aside from the factors mentioned during class, what other factors can influence the
investor’s
perception on the company’s performance which would ultimately affect share price?
- Why is the study of finance important to you?
2. Homework
• Go to a business in your locality. Ask who is in charge of the finances of the business.
Interview the
“Chief Financial Officer (“CFO”) or the Vice-President for Finance” and ask them to
report about their
roles and functions within the organization.

Teacher Tips:
Possible answers: Ethics, Corporate Social
Responsibilities, Employee Relationships.

Business'Finance
Introduction to Financial Management
Content Standards
The learners demonstrate an understanding of the definition of finance, the
activities of the financial manager, and the financial institutions and markets.
Performance Standards
The learners will be able to:
• Describe who are responsible for financial management within an
organization.
• Describe the primary activities of the financial manager.
• Describe how the financial manager helps in achieving the goal of the
organization.
Learning Competencies
The learners shall be able to:
• Explain the major role of financial management and the different individuals
involved. (ABM_BF12-IIIa-1)
• Explain the flow of funds within an organization – through and from the
enterprise—and the role of the financial manager. (ABM_BF12-IIIa-5)
Specific Learning Outcomes
At the end of this lesson, the learners will be able to:
• Understand the key positions in a corporate organization and identify the roles of each.
• Identify the primary activities of the financial manager.

10

60 MINS

LESSON OUTLINE
Introduction Identifying the roles in a Corporate

Organization

25
Motivation Message from the CFOs 5
Instruction Identifying the functions of a Financial

Manager

25
Enrichment Integration of learning 5
Materials Board Notes
Resources
(1) Cayanan, A. & Borja (forthcoming). Business Finance. Quezon
City. Rex Bookstore.
(2) Gitman, L. J. & Zutter C. J. (2012), Principles of Managerial
Finance (13th Ed), USA: Prentice-Hall

INTRODUCTION (25 MINS)

1. Discussion of Homework
• Begin by asking at least five learners to share in class the result of their interview with
a Chief
Financial Officer (CFO) or Vice-President for Finance.
• Write on the board the roles and functions that the students identified from their
interview.
• Take note of functions that are not roles of a Financial Manager but are roles of other
managerial
positions.
• Discuss that these functions are done by people in the company who are holding other
managerial
positions. A Financial Manager is part of a management team whose ultimate goal is to
maximize
shareholders wealth.
2. The Corporate organization Structure
• Illustrate the corporate organization structure and inform them that this particular set of
people
each play a role in the decision making of the company.

Figure 1: Illustration of the Corporate Organization Structure

• From the diagram presented, emphasize that each line is working for the interest of
the person on
the line above them. Since the managers of the company are making decisions for the
interest of

11

Teacher Tips:
The various types of functions are expected
if the person they interviewed is a small
business owner who makes decisions on
various aspects of the business.

SHAREHOLDERS

BOARD OF DIRECTORS

PRESIDENT (CEO)

VP FOR
MARKETING

VP FOR
FINANCE

VP FOR
PRODUCTION

VP FOR
ADMINISTRATION

elects

appoints

OWNERS
MANAGERS

the board of directors and the board of directors does the same for the interest of the
shareholders, it follows that the goal of each
individual in a corporate organization should have an objective of shareholders’ wealth
maximization.
• Discuss briefly the roles of each position identified.
• Shareholders: The shareholders elect the Board of Directors (BOD). Each share held
is equal to one voting right. Since the BOD is elected
by the shareholders, their responsibility is to carry out the objectives of the shareholders
otherwise, they would not have been elected in
that position. Ask the learners again what the objective of the shareholders is just to
refresh.
• Board of Directors: The board of directors is the highest policy making body in a
corporation. The board’s primary responsibility is to
ensure that the corporation is operating to serve the best interest of the stockholders.
The following are among the responsibilities of the
board of directors:
- Setting policies on investments, capital structure and dividend policies.
- Approving company’s strategies, goals and budgets.
- Appointing and removing members of the top management including the president.
- Determining top management’s compensation.
- Approving the information and other disclosures reported in the financial statements
(Cayanan, 2015)
• President (Chief Executive Officer): The roles of a president in a corporation may vary
from one company to another. Among the
responsibilities of a president are the following:
- Overseeing the operations of a company and ensuring that the strategies as approved
by the board are implemented as planned.
- Performing all areas of management: planning, organizing, staffing, directing and
controlling.
- Representing the company in professional, social, and civic activities.
• Tell the learners that although the president carries out the decision making for all
functions, it would be difficult for him/her to do this
alone. The president cannot manage the company on his own, especially when the
corporation has become too big. To assist him are the
vice presidents of different functional areas: finance, marketing, production and
administration.
• Determine from the list of roles written on the board the functions that pertain to the
respective VPs. Add the following functions if needed:
• VP for Marketing: The following are among the responsibilities of VP for Marketing
- Formulating marketing strategies and plans.
- Directing and coordinating company sales.
- Performing market and competitor analysis.
- Analyzing and evaluating the effectiveness and cost of marketing methods applied.
- Conducting or directing research that will allow the company identify new marketing
opportunities, e.g. variants of the existing
products/services already offered in the market.
- Promoting good relationships with customers and distributors. (Cayanan, 2015)

12

• VP for Production: The following are among the responsibilities of VP for Production:
- Ensuring production meets customer demands.
- Identifying production technology/process that minimizes production cost and make
the company cost competitive.
- Coming up with a production plan that maximizes the utilization of the company’s
production facilities.
- Identifying adequate and cheap raw material suppliers. (Cayanan, 2015)
• VP for Administration: The following are among the responsibilities of VP for
Administration:
- Coordinating the functions of administration, finance, and marketing departments.
- Assisting other departments in hiring employees.
- Providing assistance in payroll preparation, payment of vendors, and collection of
receivables.
- Determining the location and the maximum amount of office space needed by the
company.Identifying means, processes, or systems
that will minimize the operating costs of the company. (Cayanan, 2015)
• Finally, focus the learners’ attention to the role of the VP for finance as this is where
the rest of the topics for this course will revolve.

MOTIVATION (5 MINS)
Message from the CFOs
• Share the following quotes from the Chief Financial Officers (CFOs) of the respective
corporations:
- Unilever: “Finance plays a critical role across every aspect of our business. We enable
the business to turn our ambition and strategy into
sustainable, consistent and superior performance” - Jean-Marc Huët (Unilever)
- Jollibee: “It’s very exciting because you are not just thinking of today but what the
company will need in the future” - Ysmael V. Baysa
(Morales, 2013)
- Globe Telecom: “Yesterday’s solutions are never adequate for the future” - Albert De
Larrazabal (Klobucher, 2015)
- SM Corporation: “Now, we don’t go out because we need funds. We go out because
it’s an opportunity.” – Jose T. Sio (Montealegre, 2015)
• Reflect on the quotes cited and mention how critical and dynamic working in the
finance field is.

13

INSTRUCTION (45 MINS)

1. Functions of a Financial Manager
• Identify the four functions of a VP for finance (CFO) as follows:
- Financing
- Investing
- Operating
- Dividend Policies
• Recall from the previous session that there are situations when we are faced with lack
of funds.
Financing decisions include making decisions on how to fund long term investments
(such as
company expansions) and working capital which deals with the day to day operations of
the
company (i.e., purchase of inventory, payment of operating expenses, etc.).
• The role of the VP for Finance of the Financial Manager is to determine the
appropriate capital
structure of the company. Capital structure refers to how much of your total assets is
financed by
debt and how much is financed by equity. To illustrate, show/draw the figure below:

Table 1: Sample Capital Structure

14

Teacher Tips:
Write the four functions on the board and
identify what is the role of the Financial
Manager in each function.

Teacher Tips:
Financing – to determine the appropriate
capital structure of the company and to
raise funds from debt and equity.

0%
25%
50%
75%
100%

Total Assets Capital Structure

Equity Liabilities Assets

• Recall that Assets = Liabilities + Owner’s Equity.

- To be able to acquire assets, our funds must have come somewhere. If it was bought
using cash
from our pockets, it is financed by equity.
- On the other hand, if we used money from our borrowings, the asset bought is
financed by
debt.
- In the figure above, the total assets is financed by 60% debt and 40% equity.
Accordingly, the
capital structure is 60% debt and 40% equity.
• Ask the learners if they think there is an ideal mix of debt and equity across
corporations?
- Answer: No. The mix of debt and equity varies in different corporations depending on
management’s strategies. It is the responsibility of the Financial Manager to determine
which
type of financing (debt or equity) is best for the company.
• The advantages of debt and equity financing will be discussed in Lesson 5: Sources
and Uses of
Funds.
• Recall that, previously, you discussed investing as where to put your excess cash to
make it more
profitable. We expand that definition by including cash held taken from funds as a result
of
financing decisions.
• Investments may either be short term or long term.
- Short term investment decisions are needed when the company is in an excess cash
position.
• To plan for this, the Financial Manager should be able to make use of Financial
Planning tools
such as budgeting and forecasting which will be discussed in Lesson 3: Financial
Planning
Tools and Concepts.
• Moreover, the company should choose which type of investment it should invest in that
would
provide an most optimal risk and return trade off. We will learn more about this on
Lesson 6:
Introduction to investments.
- Long term investments should be supported by a capital budgeting analysis which is
among
the responsibilities of a finance manager.
• Capital budgeting analysis is a tool to assess whether the investment will be profitable
in the

15

Teacher Tips:
A. Investing
• Short term investments:
1. Plan for expected excess in cash using
Financial Planning tools such as
budgeting and forecasting
2. Choose which type of investment should
it invest in that would secure the best
profits
• Long term investments:
Prepare a capital budgeting analysis to
determine if the long term investment will
be profitable
B. Operating - determine how to finance
working capital accounts such as
accounts receivable and inventories
(short term vs. long term)

long run and will be further discussed in Lesson 5: Basic Long Term Financial
Concepts. This is
a crucial function of management especially if this investment would be financed by
debt.
• The lenders should have the confidence that the investments that management will
push
through with will be profitable or else they would not lend the company any money.
• Operating decisions deal with the daily operations of the company. The role of the VP
for finance
is determining how to finance working capital accounts such as accounts receivable and
inventories.
The company has a choice on whether to finance working capital needs by long term or
short term
sources. Why does a Financial Manager need to choose which source of financing a
company
should use? What do they need to consider in making this decision?
- Short Term sources are those that will be payable in at most 12 months. This includes
short-term
loans with banks and suppliers’ credit. For short-term bank loans, the interest rate is
generally
lower as compared to that of long-term loans. Hence, this would lead to a lower
financing cost.
- Suppliers’ credit are the amounts owed to suppliers for the inventories they delivered
or
services they provided. While suppliers’ credit is generally free of interest charges, the
obligations with them have to be paid on time to maintain good supplier relationship.
Such
relationships should be nurtured to ensure timely delivery of inventories.
- Short term sources pose a trade-off between profitability and liquidity risk. Because
this source
matures in a short period, there is a possibility that the company may not be able to
obtain
enough cash to pay their obligation (i.e. liquidity risk).
- Long term sources, on the other hand, mature in longer periods. Since this will be paid
much
later, the lenders expect more risk and place a higher interest rate which makes the cost
of long
term sources higher than short term sources. However, since long term sources have a
longer
time to mature, it gives the company more time to accumulate cash to pay off the
obligation in
the future.
- Hence, the choice between short and long term sources depends on the risk and
return trade
off that management is willing to take. The learners will learn more about this on
Chapter 4:
Sources and uses of funds.
• Dividend Policies. Recall that cash dividends are paid by corporations to existing
shareholders
based on their shareholdings in the company as a return on their investment. Some
investors buy
stocks because of the dividends they expect to receive from the company. Non-
declaration of
dividends may disappoint these investors. Hence, it is the role of a financial manager to
determine
when the company should declare cash dividends.

16

Teacher Tips:
There are two types of liquidity risk:
A. Risk that the company will fail to pay its
short term obligations.
B. Risk that you will not be able to sell
investments in financial assets
immediately.

- Before a company may be able to declare cash dividends, two conditions must exist:
1. The company must have enough retained earnings (accumulated profits) to support
cash
dividend declaration.
2. The company must have cash.
• Ask the learners what they think will affect the decision of management in paying
dividends.
Remind them that dividends come from the company’s cash and availability of
unrestricted retained
earnings.
- Answer Key:
• Availability of financially viable long-term investment
• Access to long term sources of funds
• Management’s Target Capital structure
• Recall that one of the functions of a finance manager is investing and its available
cash may be used
to invest in long term investments that would increase the profitability of the company.
Some small
enterprises which are undergoing expansion may have limited access to long term
financing (both
long term debt and equity). This results to these small companies reinvesting their
earnings into
their business rather than paying them out as dividends.
• On the other hand, a company which has access to long term sources of funds may be
able to
declare dividends even if they are faced with investment opportunities. However these
investment
opportunities are generally financed by both debt and equity.
- The management usually appropriates a portion of retained earnings for investment
undertakings and this may limit the amount of retained earnings available for dividend
declaration.
- Creditors are not willing to finance entirely the cost of a company’s long term
investment.
Hence, the need for equity financing (e.g. internally generated funds or issuance of new
shares).
- Examples of these companies are publicly listed companies such as PLDT, Globe
Telecom, and
Petron. PLDT and Globe are two of the Philippine listed companies which have
generously
distributed cash dividends for the last five years (information as of 2014).
• For companies which have limited access to capital and have target capital structure,
they may end
up with a residual dividend policy. This means that when companies are faced with
investment
opportunities, internally generated funds will be used first to finance these investments
and

17

Teacher Tips:
Dividend Policies - These determine when
the company should declare cash dividends.

dividends can only be declared if there are excess funds.

ENRICHMENT (5 MINS)
Integration of Learning
• Ask the learners the following:
- Explain why shareholder wealth maximization should be the overriding objective of
management.
- What other positions can you think of that are related to financial management?
Answer: Treasurer, Controller. These are positions under the CFO)

18

Business'Finance
Introduction to Financial Management
Content Standards
The learners demonstrate an understanding of the definition of finance, the
activities of the financial manager, and the financial institutions and markets.
Performance Standards
The learners will be able to describe the role of financial institutions and
markets.
Learning Competencies
The learners shall be able to:
• Distinguish a financial institution from financial instrument and financial
market. (ABM_BF12-IIIa-2)
• Enumerate the varied financial institutions and their corresponding services.
(ABM_BF12-IIIa-3)
• Compare and contrast the varied financial instruments. (ABM_BF12-IIIa-4)
• Explain the flow of funds within an organization – through and from the
enterprise—and the role of the financial manager. (ABM_BF12-IIIa-5)
Specific Learning Outcomes
The learners will be able to:
• Prepare a diagram illustrating how the Financial System works.
• Define Financial Markets, Financial Institutions and Financial Instruments.
• Identify the types of Financial Markets, Financial Institutions and Financial
Instruments.

19

90 MINS

LESSON OUTLINE

Introduction Introduce the concept of a Financial System 30

Instruction Identify the types of Financial Markets,
Financial Institutions, and Financial
Instruments

45

Enrichment Integration of learning 5

Evaluation Short Quiz on Financial Institutions, Markets,

and Instruments

10
Materials Board Notes
Resources
(1) Cayanan, A. & Borja (forthcoming). Business Finance. Quezon
City. Rex Bookstore.
(2) Gitman, L. J. & Zutter C. J. (2012), Principles of Managerial
Finance (13th Ed), USA: Prentice-Hall

INTRODUCTION/MOTIVATION (30 MINS)

1. Savings and Shortages
• Recall from the previous discussions that one of the functions of a financial manager is
financing and
investing of funds.
• Pick a random learner (A) and present a scenario that during his/her management of
money, some
cash will remain. Ask him/her what he/she should do with that cash.
- Expected answer: Save or Invest
• Ask your students if they are going to save their money, where would they keep it.
- Expected answers: Banks, Piggy bank, Investments – stocks, mutual funds, insurance
• Pick another learner (B) and ask B what business he/she would like to try. Now,
suppose that he/she
had the business running and is profitable for some time. B then decides to expand
his/her business
but does not have enough cash to pay for the expansion. Ask the students where can B
get the
additional funding?
- Expected answers: Ask from parents, ask from friends, banks, lending institutions.
• Suppose B knew that A had excess money and approached A to lend him/her the
capital he/she
needs to expand his/her business for a 20% interest. Since A observed that B’s
business has been
profitable, A is willing to lend B the money since he/she is confident that B can repay his
loan. A is
now expecting to be 20% richer from his lending to B and B can now expand his
operations to gain
more profit from his business.
• Emphasize that this scenario where the lender and the borrower are present at the
right time and at
the right place may not happen all the time. In fact, it seldom happens. What happens if
they did
not meet? A will not be able to find someone to invest his money to and B cannot get
funds to start
his expansion. Here is where the Financial System comes in.
2. Role playing to introduce the concept of saving and investing
• Draw two boxes and label with names of learners A and B. Below [A], write “Saver”,
and below [B],
write “users of funds”.

20

Terms Defined:
Financial Markets – organized forums in
which the suppliers and users of various
types of funds can make transactions
directly

• Continue discussion as follows:

- If A knows that B is in need of funds, or if B knows that A is willing to invest funds, A
and B may
agree to make a Private Placement. (Draw the box for Private Placement between A
and B and
link the boxes as shown in Figure 1.)
- However, if these facts are unknown to them, A and B can go to a Financial Market
which is an
organized forum that lets A, along with other suppliers of funds, and B, along with other
users of
funds, meet and make transactions. Once A and B have met in the Financial Market,
they can now
agree to make a private placement. (Draw the box for Financial Markets and link this to
A and B as
shown in Figure 1.)
- If A and B do not want to make an effort to find a counterparty in the Financial
Markets, A and B
may go to a Financial Institution. A Financial Institution will receive A’s supply of funds
and match
it with B’s demand of funds. Unlike the Financial Markets were A and B knows to whom
the fund
went and from whom the funds came, Financial Institutions serve as an intermediary to
the
suppliers and users of funds. (Draw the box for Financial Institutions and link this to A
and B as
shown in Figure 1.)
- Moreover, Financial institutions actively participate in the financial markets as both
suppliers and
users of funds. (Draw the link between Financial Institutions and Financial Markets as
shown in
Figure 1.)
• Mention that the resulting diagram illustrates the Financial System.

21

Terms Defined:
Financial Institutions – intermediaries that
channel the savings of individuals,
businesses, and governments into loans or
investments.
Private Placements - the sale of a new
security directly to an investor or group of
investors.
Public Offering - The sale of either bonds or
stocks to the general public.
Financial Instruments – is a real or a virtual
document representing a legal agreement
involving some sort-of monetary value
(Source: Investopedia - Sharper Insight.
Smarter Investing. | Investopedia. (2016).
Investopedia. Retrieved 8 May 2016, from
http://investopedia.com). These can be
debt securities like corporate bonds or
equity like shares of stock.

Financial System

Figure 1: The Financial System

• Post the question of how transactions between suppliers and users of funds take
place. How would they prove that there was a transaction
so that the demander will be able to repay the supplier on time and at the right amount?
- Answers:
- Verbal agreement
- Written agreement
• Discuss that due to the increased need for security for the performance of obligations
arising from these transactions and due to the
growing size of the financial system, the transfers of funds from one party to another are
made through Financial Instruments.
• Note that on the diagram presented, the solid lines represent the flow of cash/funds,
while the broken lines represent the flow of financial
instruments which represent obligations to transfer cash or other assets in the future.

22
Financial
Institutions

[Learner A]
Savers/Suppliers
of Funds

[Learner B]
Users/Demanders
of Funds

Private Placement

Financial Markets

Flow of funds Flow of securities/notes/bonds/debt instruments

INSTRUCTION (45 MINS)

Tell the learners that you will further discuss the composition of the Financial System
and that you will identify the types of Financial Markets,
Financial Institutions and Financial Instruments.
1. Financial Instruments
• When a financial instrument is issued, it gives rise to a financial asset on one hand
and a financial liability or equity instrument on the other.
• Recall from ABM the following definitions:
- A Financial Asset is any asset that is:
• Cash
• An equity instrument of another entity
• A contractual right to receive cash or another financial asset from another entity.
• A contractual right to exchange instruments with another entity under conditions that
are potentially favorable. (IAS 32.11)
• Examples: Notes Receivable, Loans Receivable, Investment in Stocks, Investment in
Bonds
- A Financial Liability is any liability that is a contractual obligation:
• To deliver cash or other financial instrument to another entity.
• To exchange financial instruments with another entity under conditions that are
potentially unfavorable. (IAS 32)
• Examples: Notes Payable, Loans Payable, Bonds Payable
- An Equity Instrument is any contract that evidences a residual interest in the assets of
an entity after deducting all liabilities. (IAS 32)
• Examples: Ordinary Share Capital, Preference Share Capital
• Ask the learners who are the holders of Financial Assets.
- Answer: Suppliers of Funds
• Ask who the makers of Financial Liabilities and Equity instruments are.
- Answer: Users of Funds
• Continue discussing that when companies are in need of funding, they either sell debt
securities (or bonds) or issue equity instruments. The
proceeds from the sale of the debt securities and issuance of bonds will be used to
finance the company’s plans. On the other hand, investors
buy debt securities of equity instruments in hopes of receiving returns through interest,
dividend income or appreciation in the financial
asset’s price.
23

• Identify common examples of Debt and Equity Instruments.

- Debt Instruments generally have fixed returns due to fixed interest rates. Examples of
debt
instruments are as follows:
• Treasury Bonds and Treasury Bills are issued by the Philippine government. These
bonds and bills
have usually low interest rates and have very low risk of default since the government
assures that
these will be paid.
• Corporate Bonds are issued by publicly listed companies. These bonds usually have
higher interest
rates than Treasury bonds. However, these bonds are not risk free. If the company
which issued the
bonds goes bankrupt, the holder of the bonds will no longer receive any return from
their
investment and even their principal investment can be wiped out.
- Equity Instruments generally have varied returns based on the performance of the
issuing company.
Returns from equity instruments come from either dividends or stock price appreciation.
The
following are types of equity instruments:
• Preferred Stock has priority over a common stock in terms of claims over the assets of
a company.
This means that if a company were to be liquidated and its assets have to be
distributed, no asset
will be distributed to common stockholders unless all the claims of the preferred
stockholders have
been given. Moreover, preferred stockholders have also priority over common
stockholders in cash
dividend declaration. Dividends to preferred stockholders are usually in a fixed rate. No
cash
dividends will be given to common stockholders unless all the dividends due to
preferred
stockholders are paid first. (Cayanan, 2015)
• Holders of Common Stock on the other hand are the real owners of the company. If
the company’s
growth is spurring, the common stockholders will benefit on the growth. Moreover,
during a
profitable period for which a company may decide to declare higher dividends, preferred
stock will
receive a fixed dividend rate while common stockholders receive all the excess.
• Ask the learners which of the financial instruments presented they find most appealing.
• Inform them that they will learn more about the advantages and disadvantages of debt
and equity
instruments in Lesson 4: Sources and Uses of Funds and Lesson 5: Introduction to
Investments.
2. Financial Markets
• Recall the definition of financial markets from earlier discussion.
24

Terms Defined
Primary Market - Financial market in which
securities are initially issued; the only
market in which the issuer is directly
involved in the transaction.

• Classify Financial Markets into comparative groups:

- Primary vs. Secondary Markets
• To raise money, users of funds will go to a primary market to issue new securities
(either debt or
equity) through a public offering or a private placement.
• The sale of new securities to the general public is referred to as a public offering and
the first
offering of stock is called an initial public offering. The sale of new securities to one
investor or a
group of investors (institutional investors) is referred to as a private placement.
• However, suppliers of funds or the holders of the securities may decide to sell the
securities that
have previously been purchased. The sale of previously owned securities takes place in
secondary
markets.
• The Philippine Stock Exchange (PSE) is both a primary and secondary market.
- Money Markets vs. Capital Markets
• Money markets are a venue wherein securities with short-term maturities (1 year or
less) are sold.
They are created because some individuals, businesses, governments, and financial
institutions
have temporarily idle funds that they wish to invest in a relatively safe, interest-bearing
asset. At the
same time, other individuals, businesses, governments, and financial institutions find
themselves in
need of seasonal or temporary financing.
• On the other hand, securities with longer-term maturities are sold in Capital markets.
The key
capital market securities are bonds (long-term debt) and both common stock and
preferred stock
(equity, or ownership).
3. Financial Institutions
• Recall the definition of Financial institutions from the earlier discussion.
• Identify examples of financial institutions:
- Commercial Banks - Individuals deposit funds at commercial banks, which use the
deposited
funds to provide commercial loans to firms and personal loans to individuals, and
purchase debt
securities issued by firms or government agencies.
- Insurance Companies - Individuals purchase insurance (life, property and casualty,
and health)
protection with insurance premiums. The insurance companies pool these payments
and invest the
proceeds in various securities until the funds are needed to pay off claims by
policyholders.
Because they often own large blocks of a firm’s stocks or bonds, they frequently attempt
to

25

Terms Defined
Public offering - The sale of either bonds or
stocks to the general public.
Private placement - The sale of a new
security directly to an investor or group of
investors.
Secondary market - Financial market in
which preowned securities (those that are
not new issues) are traded.
Money market - A financial relationship
created between suppliers and users of
short-term funds.
Capital market - A market that enables
suppliers and users of long-term funds to
make transactions.
influence the management of the firm to improve the firm’s performance, and ultimately,
the performance of the securities they own.
- Mutual Funds - Mutual funds are owned by investment companies which enable small
investors to enjoy the benefits of investing in a
diversified portfolio of securities purchased on their behalf by professional investment
managers. When mutual funds use money from
investors to invest in newly issued debt or equity securities, they finance new
investment by firms. Conversely, when they invest in debt or
equity securities already held by investors, they are transferring ownership of the
securities among investors.
- Pension Funds - Financial institutions that receive payments from employees and
invest the proceeds on their behalf.
- Other financial institutions include pension funds like Government Service Insurance
System (GSIS) and Social Security System (SSS), unit
investment trust fund (UITF), investment banks, and credit unions, among others.

Figure 2: How Financial Institutions Provide Financing for Firms (Gitman & Zutter, 2012)
• The figure above illustrates how the key financial institutions serve as intermediaries
for suppliers and users of funds.
• Ask the learners which type of financial institution do they think is most critical for
firms?

26

ENRICHMENT (5 MINS)
Integration of Learning
• Question for reflection: How would you relate the role of financial managers, role of
financial markets
and role of investors?

EVALUATION (10 MINS)

Quiz:
Part 1: True/False
1. To achieve the goal of profit maximization for each alternative being considered, the
financial
manager would select the one that is expected to result in the highest monetary return.
2. Dividend payments change directly with changes in earnings per share.
3. The wealth of corporate owners is measured by the share price of the stock.
4. Financial markets are intermediaries that channel the savings of individuals,
businesses, and
government into loans or investments.
5. 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.

27

Role of Financial Managers Role of Financial Markets Role of Investors

Financial managers make financing
decisions that require funding from
investors in the financial markets.

The financial markets provide a

forum in which firms can issue
securities to obtain the funds that
they need and in which investors can
purchase securities to invest their
funds.

Investors provide the funds that are

to be used by financial managers to
finance corporate growth.

Teacher Tips
You may use suggested format or take
questions
Matter is made up of tiny particles
Matter makes up everything around you, including you. Matter is the air we breathe, the
water we drink and bathe in, and the chair you are sitting on. But when formally defined,
matter is any physical substance that possesses mass and occupies space (volume).
These are the critical characteristics of matter and what sets it apart from other
fundamental concepts in science, such as energy. In contrast with matter, energy may
not have mass, although it can occupy space. 
Scan this image for a copy of the slides of the lesson

Mass is the amount of matter in an object. An object may contain more matter than
another. In this case, you can describe matter as “heavy” or “light.” A device called a
weighing scale measures the “heaviness” or “lightness” of matter in kilograms (kg).
Although mass and weight may look similar, they are two different things.
While mass refers to the amount of matter an object has, weight refers to the amount
of the Earth’s gravitational pull on that object. For example, a book has uniform mass,
regardless of where it is found. But it may weigh differently on the Earth than the moon,
as the two bodies differ in gravitational pull. But more massive objects experience more
gravitational pull, which makes them feel heavier.
Volume is the amount of space an object occupies. Some everyday words we use to
describe it are big and small. Several devices and techniques can be used to quantify the
amount of space an object occupies. A measuring cup is one object you can use to
measure the volume of matter, particularly that of ingredients in the kitchen. Volume is
measured in terms of liters or cubic meters (m3).
 

Figure 1.1. Matter has both mass (can be measured by electronic balance) and
volume (can be measured by a graduated cylinder).
 

What makes up matter?

These fundamental properties of matter are direct consequences of another
fundamental characteristic of matter, as described by the Kinetic Theory of
Matter(Particle Theory).  This theory states that all matter consists of many tiny
particles which are always moving. Essentially, the Particle Theory can be broken down
into five key components:

1. All matter is made up of tiny particles.

2. All particles of one substance are the same.
3. Different pure substances are made of different particles.
 4. Particles are always moving.
5. There are attractive forces between particles.

AR-enabled. Scan this image with your app and compare the behavior of the particles.

Figure 1.2. Particle theory of matter states that all matter is made up of tiny
particles, which are always moving and interacting with each other. Themovement
speed, the distance between the particles and strength of interactions between the
particles dictate the state.
 

The distance between particles also affects the strength of the interactive forces that
each one of them experiences. When you separate refrigerator magnets further from
each other, you will feel less pull between them. This also happens when vast distances
separate particles.

The different phases of matter

Since the Particle Theory states that matter is made of tiny particles, the behavior of
these small particles and the distance between them can affect the state of the object as a
whole. These states or phases of matter are solids, liquids, gases, plasmas, and
Bose-Einsteincondensates.
 
 Figure 1.3. Matter can be classified into five states: Bose-Einstein (BE) condensates,
solids, liquids, gases, and plasmas. BE condensates and plasmas occur only in
exceptional situations and are uncommon. The most common states of matter we
observe every day are solids, liquids, and gases.
 

Solids are made of densely-packed particles of matter. In this state, the particles are
very close to each other, which makes the attractive forces between them strong. Often,
the particles in a solid are in fixed positions and do not move around as much, although
they still vibrate. Examples of solids are ice water (H2O) and steel rods.
Liquids, on the other hand, have particles that are not as densely packed as that of
solids. However, the particles are still quite close to each other, and still exert attractive
forces. Since the particles have some distance between them, they have more freedom of
movement than the particles solids have. This additional freedom gives liquids the
ability to flow. Examples of liquids are water (H2O) and milk.
Gases are a state of matter that exists when the distance between the particles is very
high. Consequently, particles in a gas have less attractive forces between them compared
to solids and liquids. Since the distance between gas particles is larger than those
between particles in solids and liquids, they have the highest freedom to move. Common
examples of gases are steam and air.
 

Solid Liquid Gas

Assumes the
Assumes the
Has a fixed shape of the
shape and volume
volume and shape container, but has
of the container.
a fixed volume
Not easily Not easily
Compressible
compressible compressible
Does not flow
Flows easily Flows easily
easily
Table 1.1. Some characteristics comparing gases, liquids, and solids
 

Plasma is a state of matter not commonly found here on Earth but is relatively
abundant everywhere else in the universe. Up until 1879, scientists thought that there
were only three states of matter. But a British chemist named William Crookes observed
how gas particles behave under higher temperatures. Gas particles tend to look like
glowing jelly at high temperatures, hence its name, plasma, a Greek word that describes
a creature-like form. The word also reflected Crookes’ superstitious beliefs. Today, we
have lamps containing neon that glow because the neon gas particles are ionized
(supercharged) by electricity. The ionization process gives the gas particles their high
energy, which makes this state of matter appear like a radiant gelatinous mass. Stars like
our Sun also contain lots of plasma. 
 
 A prominence erupting from the sun is an example of plasma. Photo courtesy
of NASA/GSFC/Solar Dynamics
 

In contrast with plasma, Bose-Einstein condensates (BECs) are produced when

matter is cooled to extremely low temperatures. While heating excites and adds energy
to particles of matter, cooling removes most of the energies in a particle. This is achieved
by cooling an object, close to absolute zero (0 K or -273.15 °C).
 
 Wolfgang Ketterle, Eric Cornell amd Carl Weiman, the discoverers of the Bose-Einstein condensate.
Although a BEC has already been produced, an actual BEC has yet to be photographed
 

Adding or removing energy from the particles of one state of matter could transform
that matter into a different state. When this process happens, matter undergoes physical
change, since the addition or removal of energy affects the movement and distance
between the particles. There are several transition processes for this type of change.
 

Integrate
How does the existence of BE condensates and plasma affect the
way the world lives?

How does matter change from one

phase to another?
Melting is one kind of physical change. It involves the conversion of a solidto a liquid.
When heat is added, the solid’s particles acquire energy and will have more freedom to
move. When particles have more freedom to move, solid may turn to liquid. The
temperature at which this change of state occurs is called the melting point.  Ice melts
to liquid water when the temperature exceeds water’s freezing point, which is 0 °C. 
If melting can occur, the opposite can also happen. Freezing  is the process when a
liquid turns to a solid. When liquids freeze, their particles cool down until they reach
the freezing point, the temperature where the particles lose energy. Because the
particles lose energy, they move slower and closer to each other, forming solids. 
Vaporization (Boiling) is the conversion of a liquid into a gas. The particles of a
liquid transfer energy to each other when they collide. Heating increases the energy of
each particle, making them move faster. The increase in speed also makes the collisions
between particles more powerful, contributing to larger distances between particles. The
distances become so high that the liquid turns into a gas. The temperature at which a
liquid boils or turns to gas is called the boiling point. When water is heated until it
reaches 100 °C, the liquid turns to steam or water vapor, its gaseous state. 
The reverse process of vaporization is condensation.  Condensation involves the
cooling of gas particles, which slows down their speed. The gas particles also move
closer to one another when they cool. The formation of water droplets on the surface of
eyeglasses is one instance where condensation occurs. 
 
 Dry IcePhoto by APN MJM - Own work, CC BY-SA 3.0
 

While it is common for solids to turn to liquid before becoming a gas, there are some
instances where solids can directly turn into gases. Sublimation happens when solids
are converted to gases directly, without having to go through the liquid state. 
Sublimation occurs when the energy of the particles in a solid are much higher than
atmospheric pressure. One way for this to happen is to rapidly raise the temperature of
the solid beyond its boiling point. Another way to achieve sublimation is by freeze-
drying – where the liquid is cooled under vacuum, and then the solidified liquid turns
to gas quickly. This is typically used to sublimate water to remove it from perishable
products, such as fruits.
Some substances can sublimate at room temperature and atmospheric pressure. Solid
carbon dioxide, dry ice is one example of a solid that can do this. Another example are
the mothballs used in cabinets.
The opposite of sublimation, deposition,  happens when the gas transforms directly
into a solid without having to go through the liquid state. This occurs when the
temperature of the gas is lower than the freezing point. For example, frost outlines the
surfaces of vegetables growing in the highlands during cold season, even if the
vegetables were dry. Ice deposits form directly from the water vapor surrounding the
leaves.
 
 Figure 1.4. Phase changes are shown, using water (H2O) as an example.
 

Pure substances and Mixtures

Matter can be classified into different categories, depending on their chemical
composition. In the broadest sense, matter can be classified as either pure substances
or mixtures.

Classification of Matter
 
 Figure 1.5. Classifications of matter.
 

Pure substannces have a homogeneous chemical composition and a fixed set of

properties. These substances can no longer be broken down into separate components
through physical processes such as melting and boiling. Nevertheless, pure substances
can still occur in any state – solid, liquid or gas – and can transition between them.
One common example of a pure substance is water. It will always have the same ratio of
hydrogen to oxygen – two hydrogens for one oxygen, regardless if it is solid ice, liquid
water, or water vapor. The hydrogen and oxygen components of water cannot be
separated by boiling or freezing alone. Yet pure substances such as water are made of
constituents called elements.
Elements are the components of pure substances that are made up of only one specific
atom. So despite its name, a pure substance can be made of one element or a
combination of elements. Elements can also combine to form compounds. Water is
one example of a pure substance made of a compound. On the other hand, a gold bar is a
pure substance made up only of one element. An element can no longer be broken down
into other kinds of elements. 
In contrast, compounds form from the reaction and combination of two or more
elements. Each distinct compound may have the same elements as other compounds but
differ in ratio. For example, water (H2O) is different from hydrogen peroxide (H2O2)
since water has a 2:1 ratio of hydrogen to oxygen, while hydrogen peroxide has a 1:1
hydrogen-oxygen ratio. The elements in these compounds can be joined together by
different force.
Mixtures are a type of matter that forms from the physical combination of elements
and compounds. But unlike compounds, there are no chemical bonds that hold the
components of a mixture. There are two general types of mixtures: heterogeneous
mixtures or homogeneous mixtures.
 
 Oil and water is an example of heterogeneous mixture.
 

Heterogeneous mixtures are those wherein the individual components can still be

visually distinguished from one another. The individual components of heterogeneous
mixtures can be separated using physical means, such as evaporation, filtration, and
simple sorting. Common examples of heterogeneous mixtures are salads and clothes in
the laundry basket.
There is also a type of heterogeneous mixture called a suspension wherein some of the
particles dispersed in a liquid would settle out of the mixture when left standing. Since
the size of the particles is larger than those of the medium that holds them, gravity can
pull them down and out of the medium.
 

A fruit shake is an example of a homogenous mixture. Can you see the sugar and crushed fruit solids
mixed in the shake?
  

On the other hand, homogeneous mixtures are those that have a uniform

consistency, which makes it difficult for its individual components to be distinguished
visually. The components of homogeneous mixtures are also harder to separate.
Examples of homogeneous mixtures are salt solutions and fruit shakes.
Solutions are homogeneous mixtures made up of at least two components:
the solvent and the solute. The solvent particles outnumber and dissolve the solute
particles. Additionally, the mixture is combined in such a way that the soluteparticles
(which can be ions, molecules, or atoms) are interspersed uniformly throughout the
solvent. Solutions can occur in every possible state of the solute and solvent. For
example, the air we breathe is a solution containing gas solutes (carbon dioxide, oxygen,
water vapor, argon) and gas solvent (nitrogen).
 

Milk is an example of a colloid.

  

There is another type of mixture that is a cross between homogeneous and

heterogeneous mixtures are the colloids. Colloids form when the dispersed particles
are intermediate in size between those of solutions and suspensions. The particles in
colloids are spread evenly and uniformly just like in a solution. However, the individual
particles are smaller than the particles compared to a suspension. One example of a
colloid is milk, which is made up of water (the dispersing liquid) and fat globules (the
particles). 

Matter has both physical and

chemical properties
All matter has both physical and chemical properties, as well as extensive and intensive
properties. Physical properties are those that can be measured without having to
change the identity of the substance through chemical change. Examples of matter’s
measurable physical properties are volume, mass, and density (ratio of mass and
volume). 
Physical properties can also be subdivided into extensive or intensive properties. The
value of the extensive properties depends on the amount of the matter or substance that
is being measured. Mass, volume, and length are examples of extensive properties of
matter. 
On the other hand, the intensive properties are inherent in the substance itself
regardless of its quantity. Density is one example of an intensive property. For example,
gold has the same density whether the density of a hundred bars or of just one bar is
being measured. Color, boiling point, and conductivity are other examples of intensive
properties of matter. 
 
 Figure 1.6. Diagram showing the extensive and intensive properties of gold
 

In contrast with physical properties, the chemical properties of matter are those that
can only be determined by making a substance react with another. Matter’s chemical
property is the “potential” of a substance to undergo a chemical reaction. This property
is dependent on the chemical identity and composition of the substance. An example of
a chemical property is flammability, which measures a substance’s ability to burn.
That ability to burn depends on the composition of the substance that makes it easier or
harder to combust into flames. Burning is a chemical reaction that occurs at high
temperatures in the presence of oxygen.
Matter can change physically or
chemically
As matter has physical and chemical properties, so can it
undergo physical and chemical changes. When matter undergoes physical change,
its physical properties such as size, color, density, and mass become different, but its
chemical properties remain the same. The chopping of wood and cutting of paper
involves changes in physical properties but not chemical properties. Transformation of
matter from one state to another only changes the form of matter but not its chemical
composition.
Chemical changes, on the other hand, are those that transform the chemical identity of
matter through chemical reactions. Burning, rotting, and cooking are some of the
common chemical changes. These changes transform the reactants (starting matter)
into products (resulting matter). The products have different intensive physical and
chemical properties than the reactants from where they formed. Some products cannot
be reverted into reactants while some can be broken down into their reactant
components through another chemical reaction. 

Figure 1.9. Example of a physical change is the freezing of liquid water into ice, while an example of a
chemical change is the conversion of hydrogen peroxide (H2O2) into water (H2O
VISUALIZE
CHECK

A. Identification

1. Determine whether the following quantities are physical or chemical properties. If you answered
‘physical property,’ specify if it is an intensive or extensive property.

Intensive or Extensive
  Physical or Chemical?
property?
i. Mass    
ii. Weight    
iii. Density    
iv. Color    
v. Odor    
vi. Hardness    
vii. Reactivity    
viii. Flammability    
ix. Toxicity    
x. Acidity    
2. Determine whether the following processes are physical or chemical properties. If you answered
‘physical property,’ specify if it is an intensive or extensive property.

Intensive or Extensive
  Physical or Chemical?
property?
i. Milk turning sour    
ii. Meat being boiled in
   
water
iii. Ice melting into water    
iv. Sugar caramelizing    
v. Cutting meat into cubes    
B. Enumeration
1. Enumerate and describe the different states of matter. Give one example for each.

 
2. Enumerate and describe the different classifications of matter. Give one example for each.

 
C. Essay
Describe the Particle theory of matter. What does it mean when we say that matter is made up of tiny
particles? What are its implications?

 
EQUIP
Equip
You can learn more about the other states of
matter in this video:

BUILD
Form groups of four or five members. This will be your group until you submit your research
proposal, which you should start thinking about as early as now. For this lesson’s portfolio task,
you will collect a sample of tap water from your home and iron nail from your local hardware
store. Take a picture of your samples showing their respective scales and attach them on your
data sheet which you can download from your Learning Management System (LMS). Also, list
down their respective physical properties (extensive and intensive). Store your water and nail
samples, which you will use again for the next lesson.