Chapter 1 In doing so, the market forces favor the company

and create value by increasing the demands for its

Introduction to Financial Management shares of stock. As the demand for their shares of
stock increases, and with limited authorized capital
Financial Management stock to issue, the price of its stock increases as well.
Finance Manager – plays a vital role in in Generally accepted goal of a company is to
company’s success such as they come up with ways maximize the wealth of its common stockholders
on how to use cash flows daily and how it can help through value of its common stock (Kolb & Demong,
the company sustain its future generations. 1988)
- has to be aware of all operations, marketing Intrinsic Value
strategies, and overall strategic plans of the
company. Intrinsic value refers to the estimate true value of a
stock. On the other hand, its market value is the
- find ways to control and improve a company’s estimate resulting from a security analysis by a
financial position. marginal investor.
- determine the best course of action a company Marginal investor - determines if a stock is
should take to maximize financial opportunities undervalued or overvalued.
such as investing in short-term marketable
securities, paying company debts, or paying dividends A stock is:
to stockholders. Overvalued = actual market price > intrinsic value
Undervalued = actual market price < intrinsic value
- able to suggest what dividend policy a company
should adopt. Profit Maximization

Financial management – goes beyond accounting. Primary objective of conducting a business:

More concerned with raising, allocating, and Finance: always tend to recommend the
controlling a company’s funds. maximization of the stockholders’ wealth.
Accounting professionals: recommend the
Dividend policy /decision – significant aspect of
maximization of profits
financial management.
Financial experts – need accounting to have
- it is used to attract investors; it determines the
necessary financial information for making quality
kind of investors the company will have, as well as
decisions. Financial and non-financial data are
the kind of company it will be in the future.
examined to make a decision.
The Company’s Goal Accounting experts - preparation of financial
Utilities – useful objects that provide satisfaction reports for both internal and external users, and
and pleasure. To maximize utilities, people should be their manner of reporting is based on certain
able to produce savings out of them for whatever accounting standards.
purpose. People who save money for investment The following arguments raised about profit
could have a better chance of satisfying their maximization not being the main objective in
wants and maximizing their money’s utility. financial management:
The primary objective of a company’s finance 1. A change in profit is also a change in risk.
manager is to maximize the return money could 2. It fails to determine the timing of benefits.
offer to the people who trust the company. 3. Measurements of accounting profits can be
Finance managers are tasked with handling inaccurate.
company operations, they accomplish this task by
increasing the market price or the current price of
the stock.
Profit Maximization versus Stockholders’ Wealth that will contribute to the overall profitability of
Maximization the firm and lead to the creation of wealth.

2. Financing decision
• Finds ways to fund the activities of a
company
• Must know where to outsource funds &
consider the best possible financing mix or
capital structure for a company.
• Capital structure – combination of long-
term liabilities and equity that finances a
company’s resources.
• The main goal is to look for resources that
will give a company the lowest weighted
average cost of capital (WACC).
• WACC – the minimum required rate of
return on investment. (Theory) In order to
maximize the company’s stock prize, must be
The Role of Financial Managers
able to determine lowest WACC.
The responsibilities of a financial manager include
The financing decisions assert that the mix of debt
the following:
and equity chosen to finance investments should
1. Investment decision maximize the value of investments made. The
• Entails an outflow of resources w/ finance decisions should consider the cost of
expectation of benefiting in the form of finance available in different forms and risks
cash inflows in the near future. attached to it.
• Most important of the three types of 3. Dividend policy decision
decisions in terms of value creation.
• Dividend policy – a good financial signal to
• A company’s life support in continuing its the market that continually assesses the
existence. company.
• Have to be evaluated in terms of their • Company’s board of directors w/ the
expected returns and corresponding risks. guidance & recommendations of a financial
Two kinds of capital budgeting techniques to manager, decides if the company will pay
accept/reject an investment proposal: dividends or not.

a. Those that consider the time value of money Treasurer – handles external financing matters.
(discounted payback period, internal rate of Responsible for managing corporate assets, &
return, net present value, and profitability liabilities, planning the finances, budgeting the
index) capital, financing the business, formulating a credit
b. Those that do not consider the time value policy, & managing the investment portfolio
of money (payback period and accounting - Common functions: acquisition of financial
rate of return). resources, financial & investment planning;
The investment decisions are those which determine capital budgeting, management of cash, risk,
how scarce or limited resources in terms of funds of baking relationships, & investor relations; &
the business firms are committed to projects. credit & collection.
Generally, the firm should select only those capital Controller – in charge of internal matters, involves
investment proposals whose net present value is finance and cost accounting, taxes, budgeting, and
positive and the rate of return exceeding the control functions.
marginal cost of capital. It should also consider
the profitability of each individual project proposal - Common functions: accounting & financial
reporting, internal audit, cost accounting, tax
 accounting, planning for control, evaluation & Sole Proprietorship
consultation, government reporting, protection of
• Business owned by a single person
assets, & economic appraisal.
• Finances the company by using his/her personal
Chief Financial Officer (CFO) – oversees the entire savings, supplemented by bank or government
financial activity of a company & serves as the loans.
adviser in financial matters to the board of
directors. Advantages:

The role of finance in a typical corporate business 1. Ease of formation. Sole proprietorship is simple
organization is illustrated as follows: established. It does not require tedious
documents similar to that of a partnership or
corporation.
2. Control over operations. There are no co-owners,
the owner has complete control over daily
operations, thereby speeding up the decision
making process.
3. No sharing of profits. All profits of the business
belong to the owner.
4. Simplicity. A sole proprietorship is subject to less
government regulation than a partnership or
corporation.
5. No taxation. The business itself is not subject to
Financial Decisions and Risk-Return Trade off the tax. However, the income or loss generated
from the business should be included and form
• increase in return is coupled by a corresponding
part of the income generated by the owner,
increase in risk.
which is subject to tax. The tax is graduated
• Finance manager’s obligation is to ascertain
based on the total income of the taxpayer.
risks are tolerable.
• Risks are common and ubiquitous. Be in the Disadvantages:
form of credit, interest, financial, political, &
1. Limited life. The death or bankruptcy of the
social instability.
owner results in the dissolution of the business.
• Decision-makers must remember the aphorism 2. Unlimited liability. The owner is personally
“the higher the return, the higher the risk.” liable for the company's debt and actions.
• Investment in stocks – way to use excess cash as 3. Difficulty in raising capital. The rapid
a means to get higher returns. expansion of a sole proprietorship operation is
• An investor demands for higher return from very difficult to achieve because it has limited
investing in stocks has to compensate or a access to borrowing large amounts of money.
higher level of risk. 4. Limitation skills. A proprietor, as compared to a
• A company that maintains a low level of partnership and corporation, has limitations in
inventory can expect a higher return, such terms of skill application. It is quite rare to see
company also faces a greater risk of running a proprietor who has all the skills involving
out of stocks, thereby losing potential sales of finance, marketing, & operations.
even clients.
Partnership
Types of Business Organizations
• Composed of two or more persons who agree to
The three major forms of business organizations: contribute money, property, or services for the
purpose of dividing the profits between or
1. Sole proprietorship
among themselves.
2. Partnership
• More formal legal organizations than a sole
3. Corporation
proprietorship but much less formal than a
corporation.
(SEC) Securities and Exchange Commission – is limited by each partner's personal wealth and
government body that supervises the affairs of borrowing power.
partnership & corporations. Also, requires the filling
Corporation
of the Articles of Partnership for the registration
of a partnership. • An artificial being created by operation of law
that had the right of succession & the powers,
The following information is needed in the Articles
attributes, & properties authorized by law or
of Partnership:
incidental to its existence, Section 2 of the
1. Name of the partnership Revised Corporation Code of the Philippines.
2. Principal place of business • Owned by several people that is recognized as a
3. Date of effectivity & life of the partnership separate legal entity by law.
4. purpose of the partnership • Owners are called shareholders/stockholders
5. names, addresses, & contributions of the • Ownership interest is evidenced by its readily
partners
transferable shares of stock issued or sold.
6. agreement regarding the manner of
management of the partnership Advantages:
7. manner of dividing the profits between or
1. Limited liability. The special legal status enjoyed
among the partners
by a corporation acts as a barrier to protect
8. manner of liquidating the partnership with the
the owners/shareholders from losses beyond the
rights & duties of the partners
amount of their investment.
9. arbitration of disputes
2. Indefinite life. Unlike in a sole proprietorship
Advantages: and partnership, the life of a corporation is
unaffected by the withdrawal of shareholders
1. Convenient organization. A partnership is
in any way because the corporation is treated
relatively easy to organize, as it is subject to
legally as if it were a person separate from its
only a few government regulations. owners.
2. Manageability. It is easy to handle because a 3. No mutual agency. Shareholders who are nor
group of people who shares common expertise is legal agents or officers cannot bind a
running the business. corporation by their actions. If they own many
3. Good capitalization. The combined capital shares, they may bear a strong influence on its
resources of partners offer better capitalization management team, but they cannot
as compared to that of a sole proprietorship. unilaterally bind the corporation legally
Disadvantages: without the specific authorization of the
corporation itself.
1. Limited life. The withdrawal, death, or 4. Ease of obtaining additional capital.
bankruptcy of a partner will result in the Corporations are aptly structured for borrowing
dissolution of a partnership. Likewise, the large sums of money. They also have a legal
admission of a new partner ends a previously structure that enables them to sell small
existing partnership. ownership interests or shares to the general
2. Unlimited liability. Each partner is personally public.
liable to creditors for debts incurred by other 5. Ease of transfer of ownership interest. As the
partners acting for a partnership. ownership of a corporation is done through the
3. Mutual agency. Each partner is an agent of the purchase of shares of stock, it is simple to
company and can bind the partnership through transfer ownership interest. Shareholders can
his/her acts within the scope of the partnership ordinarily sell their shares to others without
business. obtaining the company's approval, whereas a
4. Difficulty in raising capital. Although it is sole proprietorship cannot sell partial interests
relatively easier for a partnership to obtain the in business, nor can a partner sell a partnership
capital required for expanding operations, it is interest without dissolving the partnership.
still difficult to raise large amounts of 6. Separate legal entity. By virtue of its special
partnership capital because the ability to do so legal status, a corporation has the power to buy,
 own, or sell property. Furthermore, it can enter Some of the incentives that may be offered for
into contracts and can sue or be sued. good performance are as follows:

Disadvantages of a Corporation: Attractive compensation package. A company

should offer an attractive compensation Package to
1. Double taxation. Corporate income is initially
its managers. In doing so, the managers will be
subject to the payment of income taxes by the
recognized for their exemplary Performance by
corporate entity itself. In addition, the
increasing their salary or promoting them. The
shareholders are required to pay income taxes
failure to maintain sufficient compensation
on the portion of corporate earnings
packages for managers is a common cause of losing
distributed to them in the form of dividends.
them to competitors.
2. More government control. Corporations are
Bonus. Giving bonuses should be tied to a company's
governed and influenced largely by national
profit. This approach helps the managers find ways
government regulations.
to increase profit by reducing unnecessary expenses.
3. More costly to organize. The establishment of a
Stock options. The managers are given the chance
corporation entails the payment of legal fees.
to exercise their right to buy company stock when
4. More involved decision-making process. In
its market price is higher than the exercise price on
corporations, making important business
the exercise date. However, this incentive needs
decisions may be time-consuming. Decision-
further study because stock options should be
making is usually referred up to the chain of
offered when their price increase in the long-run,
command, often necessitating the agreement
not just high on the exercise date.\
and final approval of a corporation's board of
directors. On the other hand, the punishment for poor
5. Dilution of earnings and control. A typical performance are as follows:
corporation has a large number of shareholders
No bonus. The managers who are not able to meet
who must share the earnings and control of the
their objectives will not receive any bonus.
corporation with many other owners.
Threat of termination. The managers who do not
Agency Theory perform well for a specific period should be held
accountable. Although this may involve labor
• Poses a potential conflict of interest between problems, companies always have jurisdiction over
stockholders & managers, such as when the their managers who do not contribute to the
stockholders entrust the managers the sustainability of the company.
authority to make decisions. No increase in salary. Salary increases should be
• This theory exists due to the creation of an regulated properly based on the employees
agency relationship. This relationship created as performances. The managers who perform wall
soon as principal hire the service of an agent to should be entitled to a salary increase, whereas
perform a service & exercise decision-making for those with poor performances should not be
the capital. granted this benefit.
The primary agency relationship are those between: Threat of takeovers. A company may employ
threats of a takeover or shutdown to force the
1. Stockholders and managers managers to act competently in accordance with
- Potential agency conflicts are noted especially the interest of stockholders.
when managers do not own even a small
percentage of a company’s stocks. 2. Stockholders and creditors
- Mere employees who look at the company as - Stockholders’ claims over the assets of a
mere providers of employment. company are just a residue after the deduction
- Managers may be encouraged to act in of creditors’ claims. Creditors also have a claim
maximizing stockholders’ wealth by giving them over a company’s earnings through interests
incentives for good performance & punishment and principal payments.
for poor performance. - The conflict between the stockholders & the
creditors is more evident when stockholders,
through the managements, undertake a huge
 project that is too risky for a company, which Financial Management, also referred to as
has been overlooked by the creditors upon Managerial Finance, Corporate Finance, and
granting of a loan. Business Finance,
- Increased in risk, creditors increase their
- is a decision-making process concerned with
interest rate & provide a smaller amount for
planning, acquiring, and utilizing funds, in a
loan.
manner that achieves the firm’s desired goals.
- Project succeeds, all benefits will go to the
stockholders at the disadvantage of the - as cash flows into the company, the finance
creditor receiving small interest rate on the manager should be able to ensure the company
loans. has sufficient liquidity to meet its current
Misconceptions about Financial Management obligations, make informed investment
decisions, identify potential financial risks, and
1. Financial Management is accounting optimize the company’s overall financial health
• Most common misconceptions, FinMan is similar by effectively managing the inflow and outflow
to accounting because it utilizes financial of cash
statements to arrive at certain decisions.
Key Points About Focusing on Cash Flows:
• Financial acctg has acctg standards to be
followed, FinMan must conform with some 1. Liquidity Management - A primary function of
traditional finance theories. a financial manager is to ensure the company
2. Financial Management is a review of has enough cash on hand to cover immediate
mathematics. expenses like payroll and supplier payments
• Multiple formulas are used before arriving at a 2. Investment Decisions - Analyzing cash flows
decision. helps in determining which projects to invest in,
• Computation of present value, future values, as those with strong potential cash inflows are
annuities, etc. more attractive
• FinMan also uses calculus, math investments, & 3. Risk Mitigation - Monitoring cash flows can
algebra. reveal potential financial risks like upcoming
debt payments or large upcoming expenses,
• Similar to acctg, mathematics is one of the
allowing for proactive planning
tools used in decision-making.
4. Operational Efficiency - By tracking cash flow,
3. Financial Management is a branch of statistics.
a manager can identify areas where costs can
• Used to ascertain the risks involved in decision-
be reduced and operational efficiency improved
making.
5. Financial Forecasting - Cash flows analysis
• Standard deviations, correlation coefficient,
enables a company to better predict future
coefficient of determinations, & forecasting
financial performance and make informed
tools & techniques are used to measure risks
decisions about capital needs
Social Responsibility It is also described as the process for and the
• Primary responsibility, to maximize stockholder’s analysis of making financial decisions in the
wealth through the market price of the stock. business context. Financial Management is part of a
• Implies additional costs to a company. Not all larger discipline called FINANCE.
companies are willing to take that extra cost in FINANCE is a body of facts, principles, and theories
order to follow the rules & regulations set forth relating to raising and using money by individuals,
by good standards. businesses, and governments.
• Social responsibility has to be mandatory
FINANCE is the system that includes the circulation
rather than voluntary to ensure that a burden
of money, the granting of credit, the making of
will not be shouldered by a single company;
investments, and the provision of banking facilities
instead, it will be distributed uniformly among
businesses.
THREE AREAS OF FINANCE: STOCKHOLDER WEALTH MAXIMIZATION IS A LONG-
RUN GOAL
1. Financial Management, also called corporate
finance, focuses on decisions relating to how The stated goal considers the fact that the
much and what types of assets to acquire, how shareholders in a firm are the residual owners. By
to raise the capital needed to purchase the this, we mean that they are entitled only to what is
assets, and on how to run the firm so as to left after employees, supplier, creditors and anyone
maximize its value. else with a legitimate claim are paid their due. If
any of these groups go unpaid, the shareholders or
2. Capital Markets, relate to the markets where
owners get nothing.
interest rates, along with stock and bond prices,
are determined. It also includes the study of So, if the shareholders are benefiting in the sense
financial institutions that supply capital to that that the residual portion is growing, it must be
businesses. Banks, investment banks, true that everyone else is being benefited too.
stockbrokers, mutual funds, and insurance
Because the goal of financial management is to
companies. Also, the government institutions,
maximize the value of the share(s), there is a need
such as Bangko Sentral ng Pilipinas, which
to learn how to identify investments, arrangements
regulates banks and controls the supply of
and distribute satisfactory amount of dividends or
money; and the Securities and Exchange
share in the profits that favorably impact the value
Commission (SEC), which regulates the trading
of the share(s).
of stocks, traded in Philippine Stock Exchange;
and bonds in public market issued by the Finally, our goal does not imply that the financial
government or any corporations. manager should take illegal or unethical actions in
the hope of increasing the value of the equity in the
3. Investments, relate to decisions concerning
firm. The financial manager should best serve the
stocks and bonds. The activities may include –
owners of the business by identifying goods and
a) security analysis; b) portfolio theory; and, c)
services that add value to the firm because they are
market analysis
desired and valued in the free market place.
This concerns both financial management of
ADDING VALUE – BY CREATING A GOOD NAME IN
profit-oriented business organizations particularly
TERMS OF PROFITABILITY, LIQUIDITY,
the corporate form of business, as well as, concepts
EFFECTIVENESS OF MANAGEMENT, AND
and techniques that are applicable to individuals
SUSTAINABILITY OF THE OPERATIONS
and to governments.
- Commitment to employees
FINANCE prepares students for jobs in banking,
investments, insurance, corporations, and - Commitment to customers
government. - Commitment to suppliers
- Commitment to the community
Accounting students need to know marketing, - Commitment to the environment
management, and human resources; they also need
to understand finance, for it affects decisions in SCOPE OF FINANCIAL MANAGEMENT
all those areas. For example, marketing people 1. Procurement (acquisition) of short-term as well
propose advertising programs, but those programs as long-term funds from financial institutions
are examined by finance people to judge the effects (banking and non-banking institutions)
of the advertising on the firm’s profitability. 2. Mobilization (utilization or investing) of funds
THE GOAL OF FINANCIAL MANAGEMENT IS TO through financial instruments such as equity
MAXIMIZE THE SHAREHOLDERS’ WEALTH, WHICH shares, preference shares, debentures, bonds,
MEANS, MAXIMIZING THE VALUE OF THE STOCK notes, and so forth
3. Compliance with legal and regulatory provisions
MAXIMIZING THE VALUE OF THE STOCK = “TRUE, relating to funds procurement, use and
LONG-RUN VALUE” distribution as well as coordination of the
finance function with the accounting function.