A study guide to business FInance

2. Risk may be defined in two ways.
First, it may be viewed as the variability
in possible outcomes of an event based
on chance.
Second, refers to uncertainty
associated with an exposure to loss.

3. 1. INTERNAL RISK
Risks arising from the events taking
place within the organization.
2. EXTERNAL RISKS
Risks arising from the events taking
place outside the organization.

4. 1. Strategic Risk: They are the risks associated with the
operations of that particular industry. These kind of
risks arise from:
a) Business Environment: Buyers and sellers
interacting to buy and sell goods and services,
changes in supply and demand, competitive
structures and introduction of new technologies.
b) Transaction: Assets relocation of mergers and
acquisitions, spin-offs, alliances and joint ventures.
c) Investor Relations: Strategy for communicating
with individuals who have invested in the business.

5. 2. Financial Risk: These are the risks associated
with the financial structure and transactions of the
particular industry.
3. Operational Risk: These are the risks associated
with the operational and administrative procedures
of the particular industry which are very common
in today's generation.
4. Compliance Risk(Legal Risk): These are risks
associated with the need to comply with the rules
and regulations of the government.
5. Other risks: There would be different risks like
natural disaster(floods) and others depend upon the
nature and scale of the industry.

6. 1. Risk may be avoided;
2. Risk may be retained;
3. Hazard may be reduced;
4. Loss may be reduced;
5. Risk may be shifted; and
6. Risk may be reduced

7. The most common device used in
handling risk is insurance. Most risks
that are related to business operations
may be covered by insurance policies
currently sold in the market. In spite of
this, however, the Filipino businessman
is not very keen in availing the services
provided by insurance firms.

8. Insurance may be defined in various ways.
From the legal viewpoint, a contract of insurance
is an agreement whereby one undertakes for a
consideration, to indemnify another against loss,
damage, or liability arising from an unknown or
contingent event.
From the viewpoint of business economics,
insurance is an economic device used to reducing
risk by combining a sufficient number of exposure
units to make their individual losses collectively
predictable.

9. The insurance policy is the written
instrument in which a contract of insurance is set
forth. It contains the following:
The nature of the risk is described in the
“declarations” which are usually found on the
first page of an insurance policy.

10. The insuring agreements is that part of the policy
which states what the insurer agrees to do and the
major conditions under which it agrees. The insurer
promises to compensate the insured if a loss under the
insured peril occurs and if the insured meets the
conditions of the contract. The insurer has no
obligation to pay if the conditions are not met.
The insuring agreements in a personal accident
policy, for instance, usually include the table of
benefits, provisos, and general conditions

11. An exclusions is a provision or part of
the insurance contract limiting the scope of
coverage. Exclusions comprise certain causes
and conditions listed in the policy which are
not covered. Death and disablement due to
war and invasion, for example, are excluded
in the risks covered by a personal accident
policy.

12. Conditions may be general or
specific. The general conditions usually
cover the following:
1. Conditions or payment of premium;
2. Notices required;
3. Evidence of loss;
4. Cancellation;
5. Short-period rate scale;

13. 6. Arbitration clause;
7. Agreement on the effect of legal
provision on extraordinary inflation;
8. Omnibus clause;
9. Important notice;
10. Action or suit clause; and
11. Settlement clause.

14. Insurance contracts may be classified as
either life or non-life.
Life coverages are those relating directly
to the individual. The risk covered is the
possibility that some peril may interrupt the
income that is earned by an individual.

15. The perils relating to life coverages
consist of the following:
1. Death;
2. Accidents and sickness;
3. Unemployment; and
4. Old age.
Insurance is written on each of the four perils.

16. A non-life coverage refers to insurance
other than life. Included in non-life coverage:
1. Fire and allied risks;
2. Marine;
3. Casualty;
4. Surety; and
5. Liability.

17. There a quite number of life insurance
policies which are offered for sale in the market to
meet the varying needs of individuals and business
firms. All are either whole life, term, or
endowment, or a combination of one or more of
these. Such combinations include annuities, since
they form part of the life insurance business. this
condition makes life insurance contracts into four
basic types:

18. Whole life insurance is a kind of life
insurance which is kept in force until death so
long as premiums are paid, regardless of age
and the time period. It is a permanent form of
insurance and covers the insured for life. The
phrase covers the insured for his whole life is
the basis for naming this particular kind of
insurance contract.

19. Classes of Whole Life Insurance Policies
Based on the method of premium
payment, there are three classes of whole life
insurance policies: (1) single-premium; (2)
continuous-premium; and (3) limited
payment policies.
Single-premium whole life polices are
those for which, in exchange for one
premium, the insurer promises to pay the
claim whenever death occurs.

20. Continuous-premium whole life policies
are those for which the insured pays the same
premium amount continuously as long as he is
alive.
Limited-payment whole life policies
belong to the type of insurance plan under which
the premiums are paid for limited period of
years, after which no further premium payments
need to be made.

21. A term insurance policies is a
contract between the insured and insurer
whereby the insurer promises to pay the
face amount of the policy to a third party
(the beneficiary) if the insured dies
within a specified time period.

22. Term insurance policies are classified as
follows:
1. Straight term policies which are written for a
specific number of years and then
automatically terminated.
2. Long-term policies written to terminate at
some specified age of the insured, commonly
65.
3. Renewable term insurance which may be
renewed by the insured before expiry date,
without again proving insurability.

23. 4. Convertible term policies which may be
converted into whole life or endowment
insurance within specified period, without
evidence of insurability.
5. Increasing term insurance, the policy
amount of which increases monthly or
yearly; and
6. Decreasing term insurance, the face value
of which reduces periodically, either
monthly or yearly.

24. Endowment insurance is a contract
under which the insurer promises to pay the
beneficiary a stated sum if the insured dies
during the policy term, or to the insured if
the policy term is survived. The policy term
is also referred to as the “endowment
period”.

25. Endowment insurance may be classified
according to the following:
1. The term for which they are written may vary
from 5 to 40 years.
2. The designed age of maturity to which they are
written, such as 60 to 65 years; and
3. The period of premium payment, such as the
limited payment endowment, where the
endowment is payable at death or at the end of
the endowment period.

26. An annuity is a series of payments
made at certain specified intervals.
Annuities are written either (1) as separate
contracts, on an individual or group basis;
or (2) as supplementary contracts, using
the proceeds of a life insurance contract to
purchase an annuity benefit.

27. The employees of a firm constitute a very
important investment. Possible liabilities of the
company may arise when employees are injured or
killed in work-related accidents. The moral
obligation of the employer is to provide for such type
of needs. If these are not provided for through
insurance, the funds of the firm which are earmarked
for other uses, may be jeopardized. The various types
of life insurance contracts available provide solution
to such possible difficulties.

28. Fire is one of the most destructive perils known to
man. It kills people and it destroys properties. As people
and properties are important business resources, some
device must be used to protect both. News reports
abound about properties and lives lost due to fire.
A fire insurance contract covers all direct losses
and damages by fire or lightning and by removal from
premises endangered by fire. In the attempt to rescue
property, losses due to theft may occur. Such losses are
also covered by a fire policy.

29. Other allied perils may be covered in a fire
insurance contract, provided they are specifically
named in the policy.
The allied perils refer to the following:
1. Earthquake fire;
2. Earthquake shock;
3. Windstorm, typhoons, and flood;
4. Riot and strike damage and riot fire; and
5. Explosions.
Fire insurance contracts are designed to cover
any of the following:

30. 1. building;
2. Contents of the building like machinery,
appliances, furniture and fixtures, stock-
in-trade, and others; or
3. Both building and contents.
Most business firms cannot avoid the
ownership of motor vehicles. Conveyances are
needed by the firm for transporting goods and

31. persons. Its executives will need cars in
the performance of their assigned jobs.
Products need to be delivered to
customers. Suppliers need to be fetched
from where there were brought.
Employees need to be transported from
their homes to their place of work and
vice versa. All these will require the firm
to own motor vehicles.

32. The types of insurance coverages applicable to
motor car are the following:
CTPL insurance covers loss or damage
inflicted upon third parties owing to the use of a
motor car. Loss or damage refers to pedestrians or
passengers of other vehicles who may be injured or
killed by a vehicle driven by a person.

33. The use of motor vehicles may also cause
damage to property of third parties. This type of loss
may be covered by a third party property damage
agreement. Depending on the insurer, maximum
coverage for TPPD could reach more than a hundred
thousand pesos.
Operators of public utility vehicles may
be held liable for death or injuries inflicted upon
passengers. Losses under this type of liability may be
covered by passenger liability insurance. Maximum
coverages differ depending on the type of vehicle.

34. The motor vehicle itself may also be the
subject of loss or damage. A brand new delivery
truck, for example, may be damaged by typhoon.
The firm needs protection from such unwanted
physical destruction of their vehicles. Such
protection is available through the purchase of own
damage policies. Losses due to theft are oftentimes
available in conjunction with the OD cover.
The driver and passenger of private and
commercial vehicles are oftentimes left without
protection against accidents. Policies may be bought
to cover them against such risks.

35. Business firms involved in transporting
commodities from one seaport to another require
protection from possible losses such commodities. The
type of insurance coverage applicable is called marine
insurance.
Business firms may at times be subjected to
liability claims by other parties. Damages paid to
claimants are sometimes enough to cause bankruptcy to
the firm. To protect the firm from such adverse financial
difficulties, some sort of insurance cover is required.

36. Generally liability exposures may be
classified into three broad areas: (1) business
liability; (2) professional liability; and (3) personal
liability. The first class concerns business and it may
be covered by business liability forms. These forms
consist of the following:
1. owners’, landlords’, and tenants’ form;
2. Manufacturers’ and contractors’ form;
3. Comprehensive general liability form;
4. Contractual liability form;

37. 5. owners’ and contractors’ protective
liability insurance;
6. Products and completed-operations
liability form;
7. Products recall insurance;
8. Personal injury liability policy;
9. Storekeeper liability policy; and
10. Dram shop liability policy.

38. A fidelity bond is one of that covers an
employee/s in position/s of probate trust and it
guarantees the employer against loss up to the
penalty of the bond should the employee/s
bonded be proven dishonest.

39. A surety bond guarantees to the obligee that
the principal named in the bond will perform a
certain obligation and if he fails to do so, the surety
will perform the obligation or pay the damages up to
the amount of the bond.
There are other types of insurance coverages
which may protect the firm from possible financial
losses. These are the following:

40. Crime insurance protects owners of property
against losses due to its being wrongfully taken by
someone else.
Glass set in display windows is particularly
susceptible to destruction. Riots, strikes, runaway
cars, and accidental or deliberate breakage by persons
are some of the common hazards.
The comprehensive glass policy insures against
breakage or damage to the glass.

41. The boiler and machinery insurance is a type of
insurance contract which provides protection against
loss resulting from the accidental bursting or breaking
of a great variety of apparatus.
Credit insurance is a contract whereby the
insurer promises, in consideration of a premium paid,
and subject to specified conditions as to the persons to
whom credit is to be extended, indemnify the insured,
wholly or in part, against loss that may result from the
term of insurance.

42. Business failure refers to the following:
1. All industrial and commercial enterprise that are
petitioned for bankruptcy in the courts;
2. Concerns which are forced out of business through
such actions in the courts as foreclosure, execution,
and attachments with insufficient assets to cover all
claims;
3. Concerns involved in actions in courts and other
government agencies such as receivership,
reorganization, or arrangement.
4. Voluntary discontinuance with known loss to creditors;
and
5. Voluntary compromises with creditors out of court.

43. ECONOMIC FAILURE. This happens when the
firm’s revenues no longer cover cost.
FINANCIAL FAILURE. This happens when the
firm becomes insolvent or is unable to pay its debts.
EXTERNAL CAUSES OF FAILURE
Failure may be due to any of the following
external causes:

44. 1. recession;
2. Changes in government regulations or contracts;
3. Burdensome taxes or tariffs;
4. Court decisions;
5. Legislation unfavorable to the specific type of
business or to business in general;
6. Strikes or boycotts;
7. Labor cost;
8. Dishonest employees; and
9. Disasters or “acts of God”.

45. INTERNAL CAUSES OF FAILURE
The internal causes of business failure consist of
the following:
1. Overcapitalization in debt;
2. Undercapitalization in equity;
3. Inefficient management of income;
4. Inferior merchandise;
5. Improper costing with excessive expenditures;
6. Errors of judgement concerning problems or
expansion;
7. Inefficient pricing decisions; and
8. Inability to improve a weak competitive position.

46. Statistical data are sometimes useful in
identifying indications of impending business
failure. In this regard, financial ratios play an
important role.
Viable firms have higher cash flow to total
debt ratio. When this ratio gets lower, the
financial standing of the firm weakens, and when
it gets even lower, failure approaches.

47. Approaching failure is also indicated by a
declining market price of the firm’s stock. This is
the result of the decreasing confidence of the
investors in the survival of the firm.
When this ratio declines, failure
approaches. The decline reflects the inadequacy
of working capital.

48. Retained earnings provide a source of
funding for unexpected costs, delays, or credit
crunches. A decline in this ratio indicates an
approaching failure.
The ratio reflects the adequacy of cash flow
in relation to the firm’s liabilities. A lower ratio
means lesser chance of settling debts.

49. When debts are used excessively, the market
value of the stock goes down because of increased
financial risk. This is indicated by a lowering down
of the ratio.
A decreasing sales to total assets ratio
reflects a shrinking market for the product. As the
ratio gets lower, the firm approaches failure.

50. Rehabilitation is an attempt to keep the firm
going. It may be achieved through any of the following:
1. Formal proceeding called reorganization; or
2. Voluntary agreement.
This term refers to a formal
proceeding under the supervision of a court,
including short-term liabilities, long-term debt and
stockholders’ equity, in order to correct gradually the
firm’s immediate inability to meet its current
payments.

51. 1. REFINANCING refers to the replacement of
outstanding securities by the sale of new
securities. Refinancing may be classified as:
a) Refunding;
b) Funding; or
c) Reverse funding.
2. RECAPITALIZATION is undertaken when a
group of existing security holders accepts a
new issue in voluntary exchange for the
issue it now holds.

52. When creditors
and stockholders agree to give the firm a chance to
get back on the right track under a mutually
accepted plan, the action referred to is called
voluntary agreement.
VOLUNTARYAGREEMENTS MAY FALL
UNDER ANY OF THE FOLLOWING:
1. Extension;
2. Composition; or
3. Creditor management.

53. Liquidation occurs when a firm dissolves
and ceases to exist and its assets are solid.
Liquidation may be accomplished through any
of the following:
1. A voluntary agreement called assignment;
or
2. a formal proceeding called liquidation
under bankruptcy.

54. . An assignment is an out-of-court
settlement where the creditors select a trustee to sell
the assets and distribute the proceeds.
It is a legal process by which a
person or business that is unable to meet financial
obligations is relieved of those debts by the court.
The court divides whatever is left of the assets of
the person or firm among creditors, allowing
creditors at least part of their money and freeing the
debtor to begin anew.