INTRODUCTION

Financial Management

- Preparing, directing and managing the money activities of a company to maximize wealth or produce best value for money.
- Means applying general management concepts to the cash of the company.

Key objectives of financial management

- To create wealth for the business

- Generate cash
- Provide an adequate return on investment

Personal Finance

- Deals with an individual’s decisions concerning the spending and investing of income.
- How much of their earnings should they spend, save and invest

Business Finance

- Focusing on how the firms raise money from investors, how to invest money to earn a profit
- How to reinvest profits or distribute them back to investors.

Key elements to the process of financial management

1. Financial Planning – to ensure that enough funding is available at the right time to meet the needs of the business.
2. Financial control (monitoring) – ensure that the objectives are being met. It determines if assets are secured and being used
efficiently. It identifies if the management acct in the best interest of shareholders and in accordance with business rules.
3. Financial decision making – include investment, financing and dividends. The key objective of this is whether the profit earned
by the business should be retained instead of distributing to shareholders via dividends. Dividends that are too high may
cause the business to starve of funding to reinvest in growing revenues and profits further.

Scope of financial management (FIVE A’s as stated by Dr. S.C. Saxena)

1. Anticipation – finds out how much finance is required by the company.

2. Acquisition – collects finance (fund raising)
3. Allocation – acquired finance to purchase fixed and current assets
4. Appropriation – distributes part of the company
5. Assessment - means controlling all the financial activities of the company. checks if the objectives are being met.

Finance Areas and Career Opportunities

Major areas in the field of finance;

1. Financial Service (client based) – one concerned with the design and delivery of advice and financial product
2. Managerial Finance (employee of a company) – concerned with the duties of the financial manager working in a business.
Encompasses financial planning or budgeting. The management of the firm’s funds within the firm.

---- Increasing globalization has increased demand for financial experts who can manage cash flows in different currencies and protect
against the risks that naturally arise from international transactions.—

Professional certification in finance

1. Chartered Financial Analyst (CFA) – focused largely on the investments side of finance.
 2. Certified Treasury Professional (CTP) – focused on the knowledge and skills needed for those working in corporate treasury
department (cash management)
3. Certified Financial Planner (CFP) – related to personal financial planning
4. American Academy of Financial Management (AAFM) – administers certification programs for financial professional in wide
range of fields.
5. Professional Certifications in Accounting – include CPA, CMA , CIA and many other programs.

Legal Forms of Business Organization

 Sole Proprietorship – business owned by one person and operated for own profit.
 Partnership – business owned by two or more people and form with the intention of dividing the profit.
 Corporation – an entity created by law. It has legal powers of an individual. Governed by the Board of Directors, in case of a
profit organization, or Board of Trustees in case of non-for-profit organization.

Economics

- Study of choice
- Social science that deals with individual or collective economic activities.
- Based on the fact that our resources are scarce and need to deliberately and systematically allocated.

Finance

- Study of financial allocation

- Often considered a form of applied economics.
- Financial manager focuses on the actual inflows and outflows of cash, recognizing revenues when cash is collected and
expenses when actually paid.

Marginal cost-benefit analysis

- Primary economic principle that is being used in managerial finance.

- Reminds the decision makers to choose and take actions only when the firm will have a net advantage which means that the
added benefits exceed the added costs.
- Difference in accounting is that accountants generally use the accrual method while finance emphasis is on cash flows.

Goals of the Firm and the Role of the Finance Manager

- To maximize shareholder’s wealth. This can measure by share price, an increasing price per share of common stock relative
to the stock market as a whole indicates achievement of this goal.

Decision rule for managers: “Only take actions that are expected to increase the share price”

- It means that whenever the financial manager decides or choose between among alternatives, after assessing the risks and
returns, only actions that would be increase share price shall be accepted. Otherwise, the alternative/s shall be rejected.

Profit maximization is not consistent with wealth maximization. It may not lead to the highest possible share due to the following
reasons:

1. Timing is important – receipt of funds sooner rather than later is preferred.

2. Profits do not necessarily result in cash flows available to stockholders – cash is king in finance, the firm must arrange short-
term financing to meet its debt obligations before the revenue arrives.
3. Profit maximization fails to account for risk – risk is the chance that actual outcomes may differ from expected outcomes.
Increased risk may decrease the share price, while the increased return is likely to increase the share price.
2 key activities that the financial manager does as related to a firm’s balance sheet

1. Investment decisions – deals with the items that appear on the asset section of the balance sheet.
2. Financing decisions - refers to the items that appear on the liability and equity section of the balance sheet

Corporate Governance Ethics and Agency Issues

Corporate Governance

- Policies of the company

- System of organizational control that defines and establishes the responsibility and accountability of the major participants in
an organization.
o Organizational chart – example of a broad agreement of corporate governance

Business Ethics

- Standards of conduct or moral judgment that apply to persons engaged in industry or commerce.

Shareholders – the owners of the corporation.

Agency costs – costs borne by shareholders due to the occurrence and avoidance of agency problems.

Agency problem and the associated agency costs can be reduced with the following:

o Properly constructed and implemented corporate governance structure.

o Structured expenditures thru compensation plans
 Incentive plans tie management performance to share price.
 Performance plans, compensation is based on performance measures such as earnings per share.
o Market forces such as shareholder crusading from large institutional investors.
o Threat of hostile takeovers

FINANCIAL STATEMENT ANALYSIS

Financial statements - provides the basic source of information by managers and other interested parties (specifically the external
users)

- Managers find it equally useful for their making decisions such as performance evaluation.
- A potential lender or investor could assess the company’s overall financial strength, income and growth potential as well as
the financial effects on some matters that required future decisions.
- Company’s ability to repay obligations and distribution of returns on investments are the primary concerns of the potential
lenders and investors.

Four key financial statements

1. Statement of Financial Position or Balance Sheet – to present a summary of the assets owned by a firm, its liabilities and its
net financial position at a given point in time. assets (investments) and liabilities and equity (financing). ASSETS =
LIABILIITIES + EQUITY OR CAPITAL
2. Statement of Comprehensive Income or Income Statement – a financial summary of a company’s operating results during a
specified period. REVENUES EARNED/GAINS – EXPENSES/LOSSES = NET INCOME OR LOSS
3. Statement of Cash Flow or Cash Flow Statement – a summary of the firm’s operating, investing and financing cash flows and
reconciles them with changes in its cash and marketable securities during the period. CASH BALANCE BEG. + CASH
INFLOW – CASH OUTFLOW = CASH BALANCE ENDING
 4. Statement of Retained Earnings – reconciles the net income earned during a given year and any cash dividends paid, with the
change in retained earnings between the start and the end of that year.

Techniques in financial statement analysis

1. Comparative analysis
a. Horizontal analysis – comparing two periods (changes), technique for evaluating a series of data over a period time
to determine the increase or decrease that has taken place, expressed as either an amount or a percentage.
 Current year – previous year = peso change
 Peso change / previous year = percentage changes
 Current year / previous year = ratio presentation
b. Trend analysis – an extended horizontal analysis, trend percentages state several years’ financial data in terms of a
base year, which equal 100 percent.
 Current sales / previous sales = changes in percentage
 Current net income / previous net income = changes in percentage
c. Vertical analysis (specific account to total base account) – technique that expresses each item within a financial
statement as a percentage of a relevant total or a base amount. Focuses on the relationship between various
financial items in a given financial statements in a single period. The FS then will be presented in percentages
commonly called “common-size statements”
 Current year / total assets of the current year
 Previous year / total assets of the previous year
2. Ratio or component analysis including turnovers
a. Liquidity ratios – ratios that show the relationship of the company’s cash and other current assets to its current
liabilities. Liquidity is the number one concern of most financial analysts.
i. Working capital = current assets minus current liabilities. Excess of current assets over current liabilities.
Used to designate current assets only as the amount intended for day to day operations of the business.
Bigger the net working capital, the better.
ii. Current Asset ratio = current assets divided by current liabilities. Basic test of liquidity of the firm. Determine
the adequacy of working capital or the ability to meet current obligations. Higher current asset ratio, the
better.
iii. Quick (Acid) Test ratio = Quick Assets (most liquid assets) divided by current liabilities. Test of ability to pay
current obligations as they come due. Quick assets are cash and cash equivalents, accounts receivable,
marketable securities, short-term notes receivable.
b. Asset Management ratios – set of ratios which measures how effectively a firm is managing its assets. Also called
asset utilization ratio which pertains to how effectively the firm utilized its assets to earn profits.
i. Accounts receivable turnover = net sales on account (net credit sales) divided by average accounts
receivable (beg + end / 2). Measures the efficiency of collections, how fast collections are being made. The
higher the turnover, the better.
ii. No. of days in Accounts receivable or Average collection period = 365 days (in a year) divided by AR
turnover or Average Accounts receivable divided by the Average daily sales. Measure the number of days
the firm invests in accounts receivable. The shorter the collection, the better.
iii. Inventory turnover or Average selling period = 365 days (in a year) divided by Inventory turnover.
Determines the number of days in inventory is held as stock before it will be sold. The shorter the number of
days it is held on stock, the better.
1. Finished goods turnover = cost of sales / average finished goods inventory
2. Work in process turnover = cost of goods manufactured / average work in process
3. Raw materials turnover = raw materials used / average raw materials inventory
iv. Fixed assets turnover or Fixed assets utilization ratio = sales / net fixed assets
v. Total assets turnover = sales / total assets.
 1. These two measures determine the number of times investments in assets are reinvested in sales.
The more the number of times it turnover, means the higher profit utilized its assets.
c. Debt management ratios or financial leverage – ratios that will measure the extent to which firm uses its debt
financing or the so-called financial leverage.
i. Important implications could be raised in managing financial leverage;
1. By raising funds through debt, the owners can maintain control of the firm limited investment.
2. Creditors look to the equity, or owner-supplied funds, to provide a margin of safety.

Debt to Total Asset ratio = total debt / total assets. Ratio of total liabilities to total assets, measures what extent that portion of
the total assets provided by the creditors.

Debt to Equity ratio = total liabilities / total stockholder’s equity. Measures the resources provided by the owners in the
business. Provides information on the equivalent mount provided by creditors for every P1 provided by the owners.

Times-interest-earned ratio = EBIT / interest charges. EBIT (Earnings before interest and taxes) – net of all operating
expenses

Fixed charge coverage = EBIT + Fixed charges / (interest charges + fixed charges)

Cash flow coverage ratio = EBIT + Fixed charges + depreciation / [interest charges + fixed charges + (preferred stock
dividends/ (1-tax rate) + (debt repayment/ 1-tax rate)

Book value of securities = value of each security / each number of shares outstanding (bonds, preferred stocks and common
stocks)

Capitalization ratio = proportion of the face value of a particular type of security to the company’s total equity (creditors’ and
owners’ equities). Applicable only to long-term debts

d. Profitability ratios – show the net result of the policies and decisions the management did in the current period.
i. Profit margin = net income available to common stock / sales
ii. Return on sales = net income / net sales
iii. Return on total assets (ROA) = net income available to common stock / average total assets or Net income
+ interest exp. Net of its tax effect / average total assets (TA beg + TA end / 2)
iv. Return on common equity (ROE) = net income available to common stock / average common stock equity
v. Basic earning power = EBIT / average total assets
vi. Earnings per share (EPS) or basic EPS = net income avail. To common stock before extraordinary items net
of its tax effect) / weighted average number of shares outstanding
vii. Dividends per share = dividends paid to common stock / common shares outstanding
viii. Dividend pay-out ratio = dividends per share of common stock / earnings per share.
e. Market value ratios – set of ratios that relate the firm’s stock price to its earnings and book value per share.
i. Price earnings ratio = market price per share of common stock / EPS. Ratio shows the peso amount
investors will pay for every P1 of current earnings.
ii. Market-book ratio = market price per share / book value per share.
iii. Dividend yield ratio = dividends per share of common stock / market price per share.

Cautions about financial statement analysis

 Managers should look beyond the ratios.

 Cautions about using financial ratios;
o Ratios that reveal large deviations from the norm merely indicate the possibility of a problem
o A single ratio does not generally provide enough information from which to judge the overall performance of
the firm.
 o The ratios being compared should be calculated using FS dated at the same point in time during the year.
o It is preferable to use audited FS.
o The financial data being compared should have been developed in the same way.
o Results can be distorted by inflation.

Three major areas that concern the users of financial statements;

1. Stability
2. Solvency or liquidity
3. Profitability