Managing the Finance

Function
 FINANCE
F- financing
I- investing
N- negotiating and deal making
A- administering
N- numbers generation, analysis and reporting
C- cash and treasury management
E- evaluating and planning
 The Finance Person is the harnesser, allocator, ang
provider of funds, the balancer of growth, profits and
sustainability the gatherer of information, and
reporter of information for presentation to the board
and the enterprise managers. The Finance Person is
the corporate planner who assesses where the funds
should go, and what action programs should be
undertaken.
 Figure 10.1. (A) The First Two Finance Functions:
Translating Corporate Goals and Operating Plans into Investment and Financing Plans

Corporate Goals

Vision
Mission
Objectives
Key Result Areas
Performance Indicators

Corporate Strategy

Operating Plans and Action Programs

Investments Financing

Fixed Assets Equity

Current Assets Long term Debt
Current Liabilities
 It is important to set the criteria by which the crucial
decision of Financing and Investing should be made. The
primary criterion is to achieve the financial objectives
and performance indicators set. These objectives
emanate from the overall corporate vision, mission, and
policies. What is needed is a well-articulated financial
plan that justifies the specific capital investment and
working capital needed to grow the enterprise. The
financial plan recommends the most advantageous
financing program to be followed.
 The Financial Plan brings the overall corporate
vision, mission, and policies and the corporate
financial objectives and performance indicators
together. These corporate financial objectives are
cascaded into divisional and departmental
measures of performance that seeks to influence
the behavior of people by tying up the reward,
recognition, and promotion schemes of the
corporation to their actual performance.
 Figure 10.1. (B) The First Two Finance Functions:
Translating Corporate Goals and Operating Plans Into Financing Plans

Corporate
Vision
Mission
Policies
Financing Decision Investment Decision

Financial Plan Usage of Funds

Sourcing of Funds
Corporate Financial
Objectives and Performance
Indicators
Asset Management
Liabilities Management
• Return on Equity
• Return on investment
• Market Price of Shares
• Meet Creditor’s
covenants

Common
Suppliers’ and Investment Current
Long Term Fixed Assets
Credit Short Preferred Portfolio Assets
Debt
Term Debt Stock
Divisional and Departmental Standards of
Performance and their Behavioral Implications on
Corporate Personnel
 The Investment Decision
There are five sub- objectives in the making investment decision.

1. The first sub- objective in the investment decision is to maximize returns on the
investments or the assets of the enterprise and the returns on the stockholders’ equity.
There may be other reasons for making investment decisions. These include growth in
asset size, market dominance, image, prestige, and a lot of other factors. Tools for gauging
these types of reasons are not precise. However, a benefit versus cost analysis can be done.

2. The second sub- objective in the investment decision is optimizing liquidity and the
solvency position of the company. Some companies want have very liquid assets like cash,
marketable securities, and other current assets so that they can remain liquid enough to
meet pressing short term financial obligations. Beyond
 that, the more entrepreneurial companies who growth- oriented want to remain
liquid so that can more readily seize attractive investment opportunities as they
come along. Solvency is the ability to sustain the operations of the company
with the proper financing mix that maximizes returns but minimizes costs risk
at the same time. The tools for assessing liquidity and solvency include current
ratios, debt/ equity ratios, funds flow analysis, and cash flow projections.

3. The third sub- objective in the investment decision is to achieve investment

flexibility. An enterprise with investment flexibility has the ability to grow,
diversify, and venture into many other investments. Investment flexibility can
be measured by the disposability or salability of its assets in order to acquire
new investments.
4. The fourth sub-objective in the investment decision is asset control. Do the
stockholders and managers of the enterprise have maximum control in
running the corporation, managing its assets, and investments and determining
their usage without encumbrances? Can they liquidate, exchange, and convert
these assets readily? The tools for analyzing this run along legal lines.

5. The fifth sub-objective in the investment decision is minimizing the investment

risk. This means avoiding being taken over by raiders, avoiding obsolescence in
the fixed assets and inventories, and avoiding asset losses due to bad debts,
pilferage, and damage. Good asset protection through insurance schemes can be
done. In acquiring assets or making investments, the enterprise must properly
assess their business risks and determine the downside consequences of the
investments being made.
 The Financing Decision
There are also five sub-objectives in making the financing decision.

1. The first sub-objective in the financing decision is to minimizing the cost of funds raised to finance
the investments made. On the liabilities side, there are three major sources of funds: stockholders’
equity, long-term liabilities, and short-term liabilities including suppliers’ credit. Tools in
determining these financing costs include computations on the cost of debt and the cost of equity
through discounted cash flow methods. A weighted average cost of capital (WACC) is then
calculated based on the relative weight of the debt and equity portions of the company’s
capitalization.

2. The second sub-objective in the financing decision is to remain financially liquid and solvent in
order to meet financial objectives and loan covenants imposed by the creditors. Liquidity measures
include the current and acid test ratios, net working capital
 levels, and short-term cash flow projections. Solvency measures include asset to
equity and debt to equity ratios and longer term cash flow projections. Creditors may ask
for other ratios.

3. The third sub-objective in the financing decision is to achieve financial flexibility. This
means avoiding onerous fixed financial obligations due to high levels of debt. A company
which enters into huge debts often meets a lot of constraints since the creditors will
definitely impose dos and don’ts on the company. Financial inflexibility can also be
caused by low market valuations of common stocks. This prevents the company from
raising funds from the equity market because selling too many stocks at a low price will
dilute earnings and ownership too much. Being financially flexible means having a large
elbow room (i.e., minimal barriers).

4. The fourth sub-objective in the financing decision is maintain financial control, which
means being able to fully determine how the firm’s capital structure should be configured
 and reconfigured without much difficulty and resistance from debt or
equity markets. This requires relative financial health and strength.
Financial control also means not having legal impediments when raising a
preferred source of funds.

5. The fifth sub-objective in the financing decision is minimizing financial

risk. This means that the firm is not in danger of defaulting on its loan
repayments and not under threat of foreclosure. It also means not having
contingent liabilities that may force the company into bankruptcy. These
include foreign exchange losses from debts denominated in foreign
currencies and monetary claims that can be made by customers, suppliers,
business partners, and other potential sources of court litigations.
 Table 10.1. Investment and Financing Decision Criteria and Sub-objectives

Financial Decision Investment

Sub-objectives Analytical Tools and Techniques Decision Sub-
objectives
Financing Both Investing
1. Minimize costs Cost of Debt ROI/ ROA/ ROS/ ROE/ 1. Maximize Returns
Cost of Equity IRR/ NPV/ EPS Market
WACC Price
Credit Ratings

2.Remain Liquid and Current Ratio Cash Flow Liquidity for 2. Optimize Liquidity
Solvent Quick Ratio Funds Flow Investment and Leverage Position
Net Working
Capital
Asset/ Equity
Debt/ Equity

3. Achieve Financial Coverage Ratios High Sustainable 3. Achieve Investment

Flexibility EBITDA Growth Rate Market Flexibility
Overage Valuation of Assets
Asset Salability/
Disposability
4. Maintain Capital Structure Legal Analysis Condition of 4. Maintain Asset
Financial Control Assets Control
Asset Liens
Asset Insurance

5. Minimize Solvency Ratios Cash Flows 5. Minimize

Financial Risks Assets/ Equity Funds Flow Investment Risk
Debt/ Equity Sensitivity
Analysis
Contingent
Liabilities
Fall Back
Positions
The Third Finance Function: Negotiating and Deal Making

Most business deals carry financial implications. How much funding is needed for the
deal? What are the business and financial risks? What will the company gain from the deal?
What will it have to give up? Will the interests of the different company stakeholders be
served well? Since the Finance Person is usually the most capable in assessing deals from a
financial standpoint, he or she is oftentimes made the primary deal-maker and negotiator by
the CEO, working closely with the legal officers and technical experts.

Terms and conditions are negotiated, debated and agreed upon with the blessings of the
Finance Person. External business deals include: joint ventures and partnership agreements;
mergers and acquisitions; franchising and licensing contract; supply and distributions
arrangements; subcontracting and networking; purchasing; real estate leases; and so on.
Internal business deals include internal budget deliberations, collective bargaining
agreements, research and development program, and others.
 The Finance Person may also be in charge of presenting proposals to the Board of
Directors or Trustees, especially if it involves large capital outlays. He or she also acts as the
balancer and arbiter in Management Committee meetings and sometimes plays the fine
toothcomb in order to keep everybody honest. To the rest of the company, the Finance
Person is the gatekeeper of deals, making sure that due diligence has been exercised by all.
 The Fourth Finance Function: Administering
The Finance Person often heads a formidable army of bean counters, paper chasers, credit
collectors, expense bashers, money keepers, and risk hedgers. He or she may be put in charge
of Treasury, Accounting, Management Information Systems, Financial Planning,
Comptrollership, and Budgeting.

Smaller organizations even entrust the entire corporate planning process to the Finance
Person and throw in a few administrative functions like Property Management, Purchasing,
and General Services Administration. Most of theses functions and tasks are the least
appreciated and the most thankless of jobs.

As Administrator, the Finance Person must master the art and science of managing people,
managing information, managing processes, managing systems, and managing policies.
 The Fifth Functions: Numbers Generation, Analysis, and Reporting

The Finance Person is in charge of collecting all corporate information and generating all the
numbers needed for translation into accounting entries, financial reports, and management
control and information systems.

The Finance Person records the numbers according to the needs of the company’s many
stakeholders starting from the government, which inspects the income for taxation purposes, and
the stockholders who are watching the bottom line and its effect on the market price of their
shares. Internally, managers and staff are given management reports on their divisional or group
performance. Budget reports complete with variance analysis are important to them.

All sorts of numbers like personnel compensation, properties and inventories held, assets and
supplies purchased, sales of each area or product unit, production statistics, and others are kept by
the Finance Person, the knowledge keeper. But more than gathering, processing, and storing
numbers, the Finance Person also disseminates numbers. He or she is the corporate crier who
announces monthly, quarterly, and yearly accomplishments and reports to the management, to the
Board of Directors, and periodically, to bankers and government regulators.

In interpreting past information and extrapolating them to the futures, the Finance Person
must do a historical analysis and compare this to the present. Patterns, trends, and cycles revealed
by the information in the form of “predictable ratios and consistent funds flows” can be used for
projection purposes. The Finance Person must watch out for seasonal, secular, and cyclical
movement sand must be able to discern normal versus abnormal patterns. Good financial
forecasting is entrusted to the Finance Person.
 The Sixth Finance Functions: Cash and Treasury Management

The sixth function of Finance is to manage Cash and Treasury operations by orchestrating
the flows of funds, starting from their sourcing and ending in their optimal usage.

The Finance of Person traffics the inflows and outflows of the corporate funds in their
various forms and oversees the treasury function of safekeeping the funds and releasing them to
meet corporate, marketing, production, people, and financial objectives.

What should the Finance Person be most vigilant and concerned about?

a. Raise funds with the lowest weighted average cost of capital without losing control and
flexibility and incurring high financial risks. This is liabilities management.
b. Invest funds in projects or assets with the highest possible returns at reasonable
business risks while maintaining a modicum of flexibility and control. This is assets
management.

c. Monitor the flow of funds and ensure that they keep on circulating. This means
preventing funds from “freezing”. Using human analogy, this means preventing blood
clots that may rupture veins and arteries. Aside from freezing or clotting, the Finance
Person must plug all possible holes where fund leakages may occur. In human terms,
stop all hemorrhage.

d. Assure uninterrupted and fast circulation of funds. This is hasten the high “turnover”
of funds . The faster the funds turnover, the greater the opportunity to make profits
since inventories are sold faster and sales/ receivables are collected faster, resulting in
many more business rounds of producing goods (or delivering services) and selling
them at handsome profits.
e. Keep the funds safe; place them in high-yielding marketable securities, if not
immediately needed, and release them for operations and for asset build-up as required
on a just-in-time basis.
 Graphically, the Finance Person carries these six trafficking and treasury
functions in the Funds Flow diagram as shown below.

Assure Low Cost of Funds Allocate and Invest Funds Achieve High
• Debt Fast Turnover of Funds Profits
• Equity Safekeep and Release Funds • Good Prices
Assure Repayments • Low Costs
Monitor and Control the Usage
of Funds

Liabilities Assets Income Statement

Operating and
Financing Investing and Controlling Managing

Figure 10.2. Graphical Presentation of Finance Functions

 The Seventh Finance Function: Evaluating and Planning

Oftentimes, the Finance Person orchestrates the entire corporate planning process and spearheads
the budgeting effort. This is because the Finance Person carries the weight of the first six finance
functions on his or her shoulders. The seventh finance function, which is evaluating and planning , is
logical continuation of the financing, investing, negotiating, administering, numbers generation, and
cash management functions.

It converges everything into a coherent and comprehensive enterprise evaluation process and a
corporate and financial plan that will guide the strategies and action programs of everyone in the
organization toward a unified vision and toward peak corporate performance.

The following figure (Figure 10.3) presents an Enterprise Evaluation and Planning model. The right-
most part of the model displays three very important performance indicators: customer satisfaction,
market performance, and financial performance. The first measure is concerned with delighting
customers by meeting their quality specifications, delivery time, and quantity requirements.
This leads to the second measure of attaining market targets such as sales levels, reach, and
efficiency. The third measure hopes to achieve the financial bottom line results such as
returns on sales, assets, and equity leading to increases in the market price of company
stocks.
 Figure 10.3. Evaluation and Planning Model

MARKET EVALUATION AND

OPERATIONS EVALUATION AND PLANNING
PLANNING
TRANSFORMATION
POSITIONING IN MARKET
INPUT PROCESS OUTPUT
THROUGHPUT
Technology
Money,
Application Volume of
Manpower,
Operating Flow, Products or
Machinery,
Systems and Services
Equipment,
Procedures,
Building,
Proficient and PACKAGED
Land,
Efficient Usage of PRODUCTS/
Materials,
Input, Services
Methods
Management
Management
Application
 To realize the three final performance outcomes or indicators, the enterprise must deliver the right
output to the customers; which output will come in the form of products produced or services
rendered. The output, depending on market acceptability, will dictate the final outcomes. It is with this
output in mind that the enterprise comes up with its product or service delivery system. This system
requires the proper input or resources and the best possible transforming unit, which will convert the
input into output.

While undergoing the conversion process, the input becomes throughput in the transformation
system. The input is composed of six Ms: Money, Materials. Machinery(including land, building, and
other fixed assets), Manpower, Methods, and Management. The input is processed in a transforming
unit, which is the factory or the service shop.

While in the factory or the shop, technology is applied, system and procedures are set in motion,
and work processes are operationalized. As the actual transformation of the six Ms into products and
services takes place, there is , hopefully, a proficient and efficient usage of the input and an excellent
application of management talents. Known as the transformation process, this called the operational
throughput. Finally, the enterprise comes up with the output and products and services in a certain
quantity and quality.

During the transformation process, the enterprise incurs product costs, which eventually make up
the enterprise’s Cost of Sales or Cost of Goods Sold. Operations performance measures are applied by
the enterprise to ensure efficiency, effectiveness, and economy. These measures include Input-Output,
Throughput Time, Wastage and Reject Levels, Capacity Utilization, and Quality Control Measures.

In the production of goods and services, the enterprise also incurs General and Administrative
Expenses that include head office salaries and wages, rental payments, travel, representation and
transport costs, maintenance, janitorial and security services, and other overhead costs. These become
part of the enterprise’s Operating Expenses.

Market Evaluation and Planning endeavors to bring the products or services to the marketplace
successfully. Of course, this starts with the first P or positioning of the enterprise and its products in the
marketplace. This generates the second P or the Product, which must be made presentable in an
attractive and appropriate Package (the third P). The enterprise then puts the right Price (the
fourth P) to the product. The product is then sold through sales People (the fifth P) in a well-
chosen Place or location and distribution system (the sixth P) with the proper Promotion and
advertising (the seventh P).

The seven Ps combined, work to penetrate the market and attain a certain sales level, a wide
enough market reach, and sizeable share of the market through efficient and effective sales efforts,
which are the Market Performance Measures. These can only happen if delivery time expectations
and volume requirements are met.

The Sales attained enter the top line of the Income Statement. The Selling Expenses, which
include the four Ps of marketing (excluding the Packaged Product), enter the Operating Expenses
along with the General and Administrative expenses.
 Since we have now assembled the Sales, Cost of Sales (Cost of Goods Sold), and Operating Expenses,
we can proceed with our Financial Evaluation and Planning exercise. The Sales, Cost of Sales, and
Operating Expenses enable us to come up with the Operating Profit.

Next, we must ensure that we have enough resources or Assets to produce the Sales, and support the
Cost of Sales and Operating Expenses. Then, we must determine what sort of financing we need, which
encompasses Liabilities Management or the determination of our Capital Structure (Short – Term Debt,
and Stockholder’s Equity). Doing so enables us to plan or forecast our Balance Sheet Composed of Current
Assets and Fixed Assets on one side, and the Short – Term Debt, the Long – Term Debt, and Stockholders’
Equity on the other side.

The Assets may produce Non – Operating Income, and Liabilities may incur Non – Operating
Expenses, both of which we must add to, or subtract from, the enterprise’s Operating Profit. The results
Net Profit before Taxes. We deduct the Taxes to produce Net Profit after Taxes, thereby completing the
Income Statement.
Depending on the operations, marketing and administrative performance, we can now measure the
Financial Performance. Hopefully, we are able to produce products or service with high profit margins
or Return on Sales (ROS). We also aspire to have a good Asset Turnover, which implies that we are
able to generate the most Sales out of our Assets. A high ROS combined with a good Asset Turnover
(Sales over Assets) will result in a high Return on Assets (ROA) or Profit over Assets. A high ROA
combined with good financial leverage (Assets over Equity) will results in a high Return on Equity
(ROE) or Profit Over Equity, which in turn, produces a high Earnings per Share (EPS) or Net Profit
after Taxes over the number of outstanding Equity Shares. A high EPS multiplied by a high Price –
Earnings multiple for the enterprise will result in a high Market Price per Share at the enterprise,
which is our ultimate enterprise performance measure. This completes the full cycle of the Enterprise
Evaluation and Planning Model.