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CEBU INSTITUTE OF TECHNOLOGY - UNIVERSITY

N. Bacalso Avenue, Cebu City
College of Management, Business & Accountancy
FINANCIAL MANAGEMENT
Jonas B. Abellar, CPA, MBA * jbabusinessacctg@gmail.com

Topic: FINANCIAL MANAGEMENT, An Introduction

Learning Objectives
Module 1 - Introduction to financial management: Discuss objectives of financial management, its scope and importance.

Module 2 - Financial Statement Analysis: Discuss various types of financial statement analysis, explain various methods
and the types of ratio analysis.

Module 3 - Working Capital Management: Discuss working capital management including cash, receivables and
inventory management.

Module 4 - Risk and Company Goal: Discuss the different types of risks and the goal of the business.

Module 1 – Introduction to Financial Management

1. Meaning of Finance – defined as the art and science of managing money. It includes financial service and
instruments. Finance also is referred as the provision of money at the time when it is needed. Finance function is
the procurement of funds and their effective utilization in business concerns.

2. Financial management – integral part of overall management. It is concerned with the duties of the financial
managers in the business firm.

3. Scope of financial management – financial management is one of the important parts of overall management
directly related to various functional departments as follows:

3.1 Financial management and Economics. Economic concepts like micro and macroeconomics are directly
applied with the financial management approaches. Investment decisions, micro and macro environmental
factors are closely associated with the functions of financial manager. The use of the economic equations
like money value discount, economic order quantity etc.
3.2 Financial management and Accounting – Accounting records includes financial information of the business
concern which financial management uses.
3.3 Financial management or Mathematics – modern approaches of financial management applied large number
of mathematical and statistical tool and techniques called econometrics. EOQ, discount factor, time value of
money, present value of money, cost of capital, capital structure theories, etc.
3.4 Financial management and production management – Production management is the operational part of the
business concern, which helps to multiple the money in profit. Profit of the concern depends upon the
production performance. Production performance needs finance, because production performance
requirements raw material, machinery, wages, operating expenses etc. These expenditures are decided and
estimated by the financial department and the finance manager allocates the appropriate finance to
production department. The financial manager must be aware of the operational process and finance
required for each process of production activities.
3.5 Financial management and marketing – Produced goods are sold in the market with innovative and modern
approaches. For this, the marketing department needs finance to meet their requirements.
3.6 Financial management and Human resource – Financial management is also related with human resource
department, which provides manpower to all functional areas of the management.

4. Objectives of Financial Management: a. Profit maximization and b. wealth maximization

4.1 Profit maximization – main aim of any kind of economic activity is earning profit. Profit is the measuring
technique to understand the business efficiency of the concern.

4.1.1 Favorable arguments for profit maximization

a. Main aim is earning profit.
b. Profit is parameter of the business operation.
c. Profit reduces risk of the business concern.
d. Profit is the main source of finance.
e. Profitability meets the social needs also.
4.1.2 Unfavorable arguments for profit maximization
a. Leads to exploiting workers and consumers.
b. Creates immoral practices such as corrupt practice, unfair trade practice, etc.
c. Leads to inequalities among the stakeholders such as customers, suppliers, shareholders, etc.

4.2 Wealth Maximization – one of the modern approaches, which involves latest innovations and improvements
in the field of the business concern. The term wealth means shareholder wealth or the wealth of the persons
those who are involved in the business concern.

4.2.1 Favorable arguments for wealth maximization

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a. Wealth maximization is superior to profit maximization because the main aim of the business
concern under this concept is to improve the value or wealth of the shareholders.
b. Wealth maximization considers the comparison of the value to cost associated with the business
concern.
c. Considers both time and risk of the business concern.
d. Provides efficient allocation of resources.
e. Ensures the economic interest of the society.
4.2.2 Unfavorable arguments
a. Leads to perspective idea of the business concern but it may not be suitable to present day
business activities.
b. Indirect name of the profit maximization.
c. Creates ownership-management controversy.
d. Management alone enjoy certain benefits.
e. Ultimate aim is to maximize the profit.
f. Can be activated only with the help of the profitable position of the business concern.

5. Importance of Financial Management – finance is the lifeblood of business organization. It needs to meet the
requirement of the business concern. Each and every business concern must maintain adequate amount of
finance for their smooth running of the business concern and also maintain the business carefully to achieve the
goal of the business concern.

a. Financial planning. It helps to determine financial requirement of the business concern and leads to take
financial planning.
b. Acquisition of funds. Involves the acquisition of required finance to the business concern. Acquiring needed
funds play a major part of the financial management, which involve possible source of finance at minimum
cost.
c. Proper use of funds. Proper use and allocation of funds leads to improve the operational efficiency of the
business which leads to a reduction of cost of capital and increase in value of the firm.
d. Financial decision – helps to take sound financial decision in the business concern which affect the entire
business operation of the concern.
e. Improve profitability – depends on the effectiveness and proper utilization of funds. FM helps to improve the
profitability position of the concern with the help of strong financial control devices such as budgetary control,
ratio analysis and cost volume profit analysis.
f. Increase the value of the firm – FM is very important in the field of increasing the wealth of the investors and
the business concern.
g. Promoting savings – helps promote to promoting and mobilizing individual and corporate savings.

Module 2 – Financial Statement Analysis

6. Types of Financial statements analysis – analysis of financial statements is also necessary to understand
financial position during a particular period. It is a study of the relationship among the various financial factors in
a business as disclosed by a single set of statements and study of the trend of these factors.

6.1 Based on material used, financial statement analysis may be classified into two major types such as External
analysis and internal analysis:
a. External analysis – mainly depends on the published financial statement of the concern and provides only
limited information about the business concern.
b. Internal analysis – disclose some of the valuable information. This is used to understand the operational
performances of each and every department and unit of business concern.

6.2 Based on method of operation, financial statement analysis may be classified into two major types: horizontal
and vertical analysis.
a. Horizontal analysis – financial statements are compared with several years and based on that, a firm may
take decisions. Normally, the current year’s figures are compared with the base year (base year is
consider as 100) and how the financial information are changed from one year to another.
b. Vertical analysis – financial statements measure the quantities relationship of the various items in the
financial statement on a particular period. It is also called a static analysis which help determine the
relationship with the various items in the financial statements.

7. Techniques of financial statement analysis – is interpreted mainly to determine the financial and operational
performance of the business concern.
7.1 Comparative Statement Analysis
a. Comparative income statement analysis – helps to understand the operational performance of the
business concern in a given period. (horizontal or vertical)
b. Comparative position statement analysis – helps to understand real financial position of the concern as
well as how the assets, liability and capitals are placed during a period.
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Exercise 1. Comparative statement analysis. The following are the balance sheets of XYZ Company as at December
31, 2018 and 2017. Perform a comparative balance sheet and discuss the operational performance of the business
concern.

2019 2018 Increased Increased

(Amount in (Amount in ‘000) (decreased) (decreased) in
‘000) in PhP %
Assets
Current Assets
Cash 8,978 5,121
Accounts receivable 32,751 24,767
Inventories 1,197 910
Other current assets 7,661 6,629
Total current assets 50,587 37,427

Non-current Assets
Property and equipment 5,706 5,680
Other assets 108 108
Total Non-current Assets 5,814 5,788

Total Assets 56,401 43,215

Liability and Equity

Current liabilities
Accounts payable 40,474 30,863
Income tax payable 411 374
Short-term loans - 32
Other liabilities 219 258
Total current liabilities 41,104 31,527

Equity
Capital stock 1,200 1,200
Retained earnings 14,097 10,488
Total equity 15,297 11,688

Total liability and equity 56,401 43,215

Comparative income statement. Perform horizontal and vertical analysis.

2019 2018 Increased Increased

(Amount in (Amount in ‘000) (decreased) (decreased) in
‘000) in PhP %
Revenues 111,970 129,425
Less: Cost of sales (89,647) (107,183)
Gross Income 22,323 22,242

Distribution expenses (2,927) (4,468)

General and administrative (11,924) (12,471)
Other income 13 11
Other expenses (1,634) (49)

Earnings before tax 5,851 5,265

Less Income tax expense (2,242) (1,577)
Net income 3,609 3,688

7.2 Trend analysis – It may be upward or downward directions which involve the percentage relationship of each
and every item of the statement with the common value of 100%. It helps to understand the trend
relationship with various items, which appear in the financial statements.

7.3 Common size analysis – Figures reported are converted into percentage to some common base. In the
balance sheet figures is assumed to be 100 and all figures are expressed as a percentage of this total.
7.4 Fund flow statement – one of the important tools, which is used in many ways. It helps to understand the
changes in the financial position of a business enterprise between the beginning and ending financial
statement dates. It is also called a statement of sources and uses of funds.
7.5 Cash flow statement – shows the sources of the cash inflow and uses of cash out-flow of the business
concern during a particular period of time. It provides a summary of operating, investing, and financing cash
flows.

7.6 Ratio analysis – commonly used tool to financial statement analysis. Ratio is a mathematical relationship
between one number to another number. Classification from the point of view of financial management is as
follows (Liquidity ratio; activity ratio; solvency ratio and profitability ratio)
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A. Liquidity ratio – which is called a short-term ratio which helps to understand the liquidity in a business
which is the potential ability to meet current obligations.

No. Ratio Formula Significant Ratio

1. Current ratio = Current Assets 2:1
Current Liability
2. Quick ratio = Quick Assets 1:1
Quick liability

B. Activity ratio – also called as turnover ratio measures efficiency of the current assets and liabilities in
the business concern during a particular period. It is helpful to understand the performance of the
business concern.

No. Ratio Formula

1. Stock Turnover Ratio = Cost of sales
Average Inventory
2. Accounts Receivable Turnover Ratio = Credit Sales
Average A/R
3. Accounts Payable Turnover Ratio = Credit Purchases
Average A/P

4. Working capital turnover ratio = Sales

Net working Capital

C. Solvency Ratio – also called leverage ratio, which measures the long-term obligation of the business
concern. This ratio helps to understand, how the long-term funds are used in the business concern.

No. Ratio Formula

1. Debt-Equity Ratio = Total Liability
Total Equity
2. Proprietary Ratio = Shareholder’s Fund
Total Assets
3. Interest Coverage Ratio = EBIT*
Fixed Interest Charges

* EBIT – Earnings before income taxes

D. Profitability Ratio – helps to measure the profitability position of the business concern.

No. Ratio Formula

1. Gross Profit Ratio = Gross Profit X 100
Net sales
2. Net Profit Ratio = Net Income X 100
Net Sales
3. Operating Profit Ratio = Operating profit X 100
Sales

4. Return in Investment = Net income X 100

Shareholder Fund

MODULE 3: Working Capital Management

8. Working capital comprises current assets less current liabilities.

8.1 Working capital policy involves two basic questions: (a) What is the appropriate level for current assets, both
in total and by specific accounts? (b) How should current assets be financed?

8.2 Working capital decisions – involved managing the relationship between firm’s short term assets and its
short-term liabilities. Its goal is to ensure that the firm is able to continue its operations and that it has
sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses.
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8.3 Advantages of adequate working capital

 Settle debt promptly maintaining good credit standing

 Extension of credit may increase sales volume
 Inventories readily replenished
 Current operating expenses paid promptly
 Management employee morale enhanced
 Profitable opportunities

8.4 Disadvantages of inadequate working capital:

 Increased risk of business failure.

 May not pursue its objectives.

8.5 Disadvantages of Excessive working capital

 Inefficient and complacent management

 Management to speculate
 Unnecessary expenses
 Unutilized resources

9. Cash management
9.1 Objectives
 To meet cash disbursement needs
 To minimize funds committed to transactions, and
 To avoid misappropriation and handling losses in the normal course of business.

9.2 Cash budget computation

Cash balance, required end balance P100,000
Add: Estimated expenditures 50,000
Total cash required 150,000
Less: Cash balance, beginning 80,000
Required cash to be collected 70,000

10. Receivable management

10.1 Objectives
 To encourage sales
 To gain additional customers by extending credit

10.2 Factors in Accounts Receivable Policy

10.2.1 Credit standards – Significant influence upon sales.
10.2.2 Credit terms – length of credit period and discount given, 2/10, net 30
10.2.3 Collection program – amount of credit risk to be accepted.
10.2.4 Delinquency and default policy

11. Inventory management

11.1 Objectives
11.1.1 To maintain a sufficient amount of inventory to insure the smooth operation of the firm’s production
11.1.2 To ensure effective marketing functions to avoid tying up funds in excessive and slow-moving
inventory.

11.2 Inventory management – functions of inventories

11.2.1 Pipeline or transit inventories – moved or transported to other location.
11.2.2 Organizational or decoupling – provide each link in the production – distribution chain.
11.2.3 Batch or lot size inventories – maintained whenever user makes or buys material in larger lots
11.2.4 Safety or buffer stock – maintained to protect the Company from unexpected customer demand,
delay in delivery.

Module 4: Risk and Company Goal

12. Financial Risk – risk is the threat that an event or action will adversely affect an entity’s ability to achieve its
objectives and/or execute its strategies successfully.

12.1 Types of risk

a. Strategic risks – doing the wrong things
b. Operating risks – doing the right things the wrong way
c. Financial risks – losing financial resources or incurring unacceptable liabilities.
d. Informational risk – inaccurate or non-relevant information, unreliable systems and inaccurate or
misleading reports.
e. Physical risks – loss of computer data, fire, earthquake, degradation of the environment, injury to people
and/or things.

12.2 Quantitative factors for risks

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a. Cash (monetary loss) e.g. loss of future cash flows
b. Cost of property, equipment, or inventory
c. Cost of defending lawsuit

12.3 Qualitative factors for risks

a. Increased legislation
b. Loss of public trust
c. Injury to the unit’s and or entity’s reputation

12.4 How to deal with Risk?

a. Ignore risk
b. Accept the risk
c. Transfer the risk (insurance) or
d. Mitigate the risk or risk reduction

13. The Common Stockholders are the owners of the corporation. Stockholders elect board of directors who in turn
hire managers to maximize the stockholders’ well being.

When stockholders perceive that management is not doing this, they might attempt to remove and replace the
management, but this can be very difficult in a large corporation with many stockholders.

14. Dissatisfied stockholders – more likely, when stockholders are dissatisfied they will simply sell their stock shares.
This action by the stockholders will cause the market price of the Company’s stock to fall.

When stock price falls relative to the rest of the market (or relative to the rest of the industry)… management is
filing in their job to increase the welfare (or wealth) of the stockholders (the owners). Conversely, when stock
price is rising relative to the rest of the market (or industry)… management is accomplishing their goal of
increasing the welfare (or wealth) of the stockholders (the owners).

15. The Goal of the Firm should be to maximize stock price!

This is equivalent to saying the goal is to maximize owner’s wealth. Note that that stock price is affected by
management’s decisions affecting both risk and profit.
Stock price can be maintained or increased only when stockholders perceive that they are receiving profits that
fully compensate them for bearing the risk they perceive.

* * *

JONAS B. ABELLAR
CPA, MBA
Managing Director
JBA Business & Accounting Solutions
jbabusinessacctg@gmail.com
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CEBU INSTITUTE OF TECHNOLOGY - UNIVERSITY
N. Bacalso Avenue, Cebu City
College of Management, Business & Accountancy

FINANCIAL MANAGEMENT
Instructor: Jonas B. Abellar, CPA, MBA

Name: _______________________________________________ Course __________________ Score ___________

Comparative Statement of Financial Position and Income Statement: Exercises

2019 2018 Increased Increased

(decreased) (decreased) in
in PhP %
Assets
Current Assets
Cash 358,782 127,672
Accounts receivable 157,962 209,625
Inventories 290,523 160,335
Other current assets 58,905 58,905
Total current assets 866,172 556,537

Non-current Assets
Property and equipment 1,192,596 792,880
Other assets 98,326 56,326
Total Non-current Assets 1,290,922 849,206

Total Assets 2,157,094 1,405,743

Liability and Equity

Current liabilities
Accounts payable 402,716 328,772
Income tax payable 176,720 145,087
Short-term loans 100,000 200,000
Other liabilities 57,835 76,091
Total current liabilities 737,271 749,950

Equity
Capital stock 250,000 250,000
Retained earnings 1,170,823 405,793
Total equity 1,420,823 655,793

Total liability and equity 2,157,094 1,405,743

2019 2018 Increased Increased

(Amount in (Amount in ‘000) (decreased) (decreased) in
‘000) in PhP %
Revenues 7,276,262 5,237,081
Less: Cost of sales 4,392,000 2,804,435
Gross Income 2,884,262 2,432,646

Distribution expenses 582,261 386,362

General and administrative 1,189,101 836,710
Other expenses 20,000 289,015
1,791,362 1,512,087
Earnings before tax 1,092,900 920,559
Less Income tax expense 327,870 276,168
Net income 765,030 644,391