Module 01: Introduction to Financial Management - The Definition of Finance,

The Activities of the Financial Manager

I. LEARNING COMPETENCIES
1. Explain the major role of financial management and the different individuals involved.
2. Describe how the financial manager helps in achieving the goal of the organization.
3. Explain the flow of funds within an organization – through and from the enterprise
and the role of the financial manager.

II. LESSON PRESENTATION

Motivation
How much was your allowance last year when times were still normal?
How often did you receive your allowance (daily, weekly, etc.)?
List the expenses you incurred and its corresponding cost below:

Was there any amount left for savings (Yes/No)?

If there was for savings, how much?
What factors did you consider on deciding where to use your allowance? Answer briefly.

Most of the activities you did involving decisions on where to use your allowance is a
finance decision. Finance can be defined as the science and art of managing money. (Gitman &
Zutter, 2012)
Another coexisting activity to this is budgeting. Budgeting is the act of estimating
revenue (in the form of your allowance) and expenses over a period of time (in this case, on a
daily basis). Budgeting will be further discussed in the next module – Financial Planning Tools.
Let’s go back to your savings, if there is any. What do you do or where do you keep your
savings? Coin savers, hidden under their beds, deposit in banks, invest in stocks?
Excess money presents an opportunity for investments. Investments come in many
forms that will generate income or appreciate in the future. Between hiding your cash under
your bed and depositing it in the bank, it would be better to keep your money in bank deposits
because these earn interest. Investments will be discussed further in the later module –
Introduction to investments.
 Now, what if you are short of cash? What would you do? Where will you get extra cash?
What sources of cash do you know? Possible answers are ask from parents, borrow from a
friend, fund raising activities, pawnshops, 5/6, banks. All of these are called sources of funds.
When faced with financial difficulties (in this case, the lack of funds to meet the current
expenses) we look for people or institutions that will give us the money we need. We will know
more about where to get funds on the later module - Sources of short term and long term
funding.
In summary, finance is concerned with decisions about:
How much of their earnings they spend.
How much they save or how much they need.
How they invest their savings.
How they raise additional funds they need. (Gitman)

Review
Forms of business organizations:
Sole Proprietorship - A business owned by one person and operated for his or her own profit.
Partnership - A business owned by two or more people and operated for profit.
Corporation - An entity created by law owned by shareholders.

Knowing the Shareholder

How can you be a shareholder of a corporation? You can be a shareholder by buying
stocks. Where can you buy stocks?
Corporations may either be privately owned or publicly owned. Privately owned
corporations are often owned by family members whose stocks may not be offered to outsiders
unless consent by the family members is secured. Companies which are publicly listed are
owned by unrelated investors and are traded in organized exchanges like the Philippine Stock
Exchange. While there are many stockholders, there is generally a group of investors or a family
which controls each listed company. For example, in the case of BPI, the biggest stockholder is
Ayala Corporation and in the case of Banco De Oro, it is SM Investment Corporation. Prices of
stocks of listed corporations are driven by several factors such as the earnings of the
companies, the prospects of the industry where these companies operate, the general market
sentiment, and the economic prospects of the country, among others.

Objective of the Shareholder

Can success of a company be attributed to profitability only? Recall that the
determination of profit is based on the accrual method. A company can have profits but still
does not have enough cash to pay its obligations.
What do you think of a company who has very large amount of cash? Does it mean the
company is successful? Though having a lot of cash has its advantages, it also signals unhealthy
company practices. It may tell them that management has not been putting the company’s
resources into good use. Also, keeping too much cash in the books is like hiding extra allowance
under their bed. They will be missing out on investment opportunities.
Take note that the overall objective of a shareholder is wealth maximization.
Review
Measurement of the Shareholder’s Wealth
Shareholders’ wealth is measured based on the current market price of the
corporation’s stocks. The market price changes across different periods. Hence, the value of
your investment changes in different points on time based on the market value at that time.
Let's say you bought 10 shares of Globe Telecom at PHP2,510 each on September 1,
2020. This brings your investments to PHP25,100. What happens to the value of your
investment if the price goes up to PHP2,600 per share or it goes down to PHP2,300 per share?
An increase of the share price to PHP2,600 per share means that people are willing to buy the
shares for that amount. If you were to sell their shares at this point, it will result to a profit of
PHP90 per share or PHP900 on your whole investment. Hence, the value of your investment
increased from PHP25,100 to PHP26,000. Therefore, there is an increase in shareholder’s
wealth.
On the other hand, a decrease in the share price to PHP2,300 per share means that
people are only willing to buy shares for PHP2,300. If you were to sell their investment at this
point, you will receive PHP23,000 which would result to a loss of PHP2,100. The decrease in
value of your investment leads to a decrease in shareholder’s wealth.

Factors that Influence Market Price

The factors that influence market price can be grouped into two - factors that the
Management can control and external factors that cannot be controlled by management.
Give specific account titles for each of the terms below:

Image 1.1. Factors that Influence Market Price (Source: DepEd Business Finance Teaching Guide)
Controllable by Management
Profitability
- Profit is a measure of the financial performance of a company for a period of time.
- Although it is a major driver for increasing the value of stock, an investor should not rely on
profits alone. As discussed earlier, it is possible that the company has profits but its cash flow is
negative.
Examples: Suppose the following Income Statements and Cash Flow Statements of companies
A, B and C were presented to you. Which do you think is a more attractive company?
 Image 1.2. Income Statements and CFS of companies A, B and C (Source: DepEd Business Finance Teaching Guide)
*Company A is profitable but generated negative cash flows which resulted from the
uncollected accounts receivable of PHP100,000. Without adequate cash inflows to meet its
obligations, the company will face liquidity problems, regardless of its level of profits.
*Company B on the other hand has a positive cash flow but is unprofitable. This is a result of
the company’s delay in payment of its costs. Accordingly, the Company will soon have to pay
the remaining PHP100,000 liability and its cash will no longer be sufficient. Again, without
adequate cash inflows to meet its obligations, the company will face liquidity problems.
*Company C is profitable and has a positive cash flow. Based on the information provided,
Company C seems to be the best.
Good liquidity and reasonable leverage position
- Liquidity and leverage refers to the company’s management of the type and amount of assets
and liabilities that it will hold in the course of its operations. This will further be discussed in the
next module.
Dividends
- Holders of shares receive dividends from a corporation as returns on their investments in form
of cash or other properties. Companies which have better dividend policies are generally more
attractive than companies who do not pay out dividends.
- Note that there may be times that companies do not pay out dividends because of future
expansions. Same with the other factors affecting share price, dividend policies should go hand
in hand with other factors in determining market price.
Competent management
- Competent managers may have any of the following attributes: 1) visionary 2) decisive 3)
people-oriented, 4) inspiring, 5) innovative, 6) respected and 7) experienced/seasoned
manager.
Corporate plans that improve the business prospects
- Example: Company A which is in the business of selling Halo-halo in the Dapitan area (or any
other area) for 5 years. Company A is consistently earning profits and has a positive cash flow.
When asked how Company A sees itself after 5 more years, Company A answered that it would
continue to sell Halo-halo in Dapitan (or any other area).
- On the other hand, Company B sells Buko Juice in Katipunan area (or any other area different
from Company A’s area) for 5 years. Company B is consistently earning profits and has a
positive cash flow. When asked how Company B sees itself after 5 more years, Company B
answered that it has generated enough cash to expand its business to Cubao area (or any other
area) to take advantage of the growing demand of Buko Juice in Cubao.
- Between Company A and Company B, which would be a better investment? Company B. Since
it has more concrete future prospects allowing investors to hope for better revenues and net
income.
Uncontrollable External Factors
- These factors influence the general reaction of investors in making an investment decision.
- Its effect is not only to a specific company but on all companies or a group of companies under
similar circumstances.
- Such factors are a result of the environment a company operates in rather than the decisions
of the company’s management.

Role of Financial Management

Given the factors that influence market price, the company ensures that such business
objectives will be achieved through financial management. Financial management deals with
decisions that are supposed to maximize the value of shareholders’ wealth. (Cayanan)
- These decisions will ultimately affect the markets perception of the company and
influence the share price.
- The goal of financial management is to maximize the value of shares of stocks.
- Managers of a corporation are responsible for making the decisions for the company
that would lead towards shareholders’ wealth maximization.
To Note: For the next parts of this course, you will fill in the shoes of a Chief Financial Officer (CFO) and every
problem that you will encounter for this course should be dealt with having shareholders wealth maximization
in mind.

The Corporate Organization Structure

1.3. Illustration of the Corporate Organization Structure (Source: DepEd Business Finance Teaching Guide)
This particular set of people each play a role in the decision making of the company.
Each line is working for the interest of the person on the line above them. Since the managers
of the company are making decisions for the interest of the board of directors and the board of
directors does the same for the interest of the shareholders, it follows that the goal of each
individual in a corporate organization should have an objective of shareholders’ wealth
maximization.
Shareholders: The shareholders elect the Board of Directors (BOD). Each share held is equal to
one voting right. Since the BOD is elected by the shareholders, their responsibility is to carry out
the objectives of the shareholders otherwise, they would not have been elected in that
position. Ask the learners again what the objective of the shareholders is just to refresh.
Board of Directors: The board of directors is the highest policy making body in a corporation.
The board’s primary responsibility is to ensure that the corporation is operating to serve the
best interest of the stockholders. The following are among the responsibilities of the board of
directors:
- Setting policies on investments, capital structure and dividend policies.
- Approving company’s strategies, goals and budgets.
- Appointing and removing members of the top management including the president.
- Determining top management’s compensation.
- Approving the information and other disclosures reported in the financial statements
(Cayanan, 2015)
President (Chief Executive Officer): The roles of a president in a corporation may vary from one
company to another. Among the responsibilities of a president are the following:
- Overseeing the operations of a company and ensuring that the strategies as approved
by the board are implemented as planned.
- Performing all areas of management: planning, organizing, staffing, directing and
controlling.
- Representing the company in professional, social, and civic activities.
Although the president carries out the decision making for all functions, it would be
difficult for him/her to do this alone. The president cannot manage the company on his own,
especially when the corporation has become too big. To assist him are the vice presidents of
different functional areas: finance, marketing, production and administration.
VP for Marketing: The following are among the responsibilities of VP for Marketing
- Formulating marketing strategies and plans.
- Directing and coordinating company sales.
- Performing market and competitor analysis.
- Analyzing and evaluating the effectiveness and cost of marketing methods applied.
- Conducting or directing research that will allow the company identify new marketing
opportunities, e.g. variants of the existing products/services already offered in the
market.
- Promoting good relationships with customers and distributors. (Cayanan, 2015)
VP for Production: The following are among the responsibilities of VP for Production:
- Ensuring production meets customer demands.
- Identifying production technology/process that minimizes production cost and make
the company cost competitive.
- Coming up with a production plan that maximizes the utilization of the company’s
production facilities.
- Identifying adequate and cheap raw material suppliers. (Cayanan, 2015)
VP for Administration: The following are among the responsibilities of VP for Administration:
 - Coordinating the functions of administration, finance, and marketing departments.
- Assisting other departments in hiring employees.
- Providing assistance in payroll preparation, payment of vendors, and collection of
receivables.
- Determining the location and the maximum amount of office space needed by the
company. Identifying means, processes, or systems that will minimize the operating
costs of the company. (Cayanan, 2015)
Now let's focus our attention to the role of the VP for finance as this is where the rest of
the topics for this course will revolve.

Functions of a Financial Manager

- Financing
- Investing
- Operating
- Dividend Policies
Financing
Financing is to determine the appropriate capital structure of the company and to raise
funds from debt and equity. Financing decisions include making decisions on how to fund long
term investments (such as company expansions) and working capital which deals with the day
to day operations of the company (i.e., purchase of inventory, payment of operating expenses,
etc.).
The role of the VP for Finance of the Financial Manager is to determine the appropriate
capital structure of the company. Capital structure refers to how much of your total assets is
financed by debt and how much is financed by equity. To illustrate, show/draw the figure
below:

1.4. Sample Capital Structure (Source: DepEd Business Finance Teaching Guide)
Recall that Assets = Liabilities + Owner’s Equity. To be able to acquire assets, our funds
must have come somewhere. If it was bought using cash from our pockets, it is financed by
equity. On the other hand, if we used money from our borrowings, the asset bought is financed
by debt. In the figure above, the total assets is financed by 60% debt and 40% equity.
Accordingly, the capital structure is 60% debt and 40% equity.
Is there an ideal mix of debt and equity across corporations? The mix of debt and equity
varies in different corporations depending on management’s strategies. It is the responsibility
of the Financial Manager to determine which type of financing (debt or equity) is best for the
company. The advantages of debt and equity financing will be discussed in later module:
Sources and Uses of Funds.
Investing
Short term investment decisions are needed when the company is in an excess cash
position.
- To plan for this, the Financial Manager should be able to make use of Financial
Planning tools such as budgeting and forecasting which will be discussed in module:
Financial Planning Tools and Concepts.
- Moreover, the company should choose which type of investment it should invest in
that would provide the most optimal risk and return trade off and would secure the best
profits. We will learn more about this on module: Introduction to investments.
Long term investments should be supported by a capital budgeting analysis which is
among the responsibilities of a finance manager.
- Capital budgeting analysis is a tool to assess whether the investment will be profitable
in the long run and will be further discussed in Lesson 5: Basic Long Term Financial
Concepts. This is a crucial function of management especially if this investment would
be financed by debt.
- The lenders should have the confidence that the investments that management will
push through with will be profitable or else they would not lend the company any
money.
Operating
Operating decisions deal with the daily operations of the company. The role of the VP
for finance is determining how to finance working capital accounts such as accounts receivable
and inventories. The company has a choice on whether to finance working capital needs by long
term or short term sources. Why does a Financial Manager need to choose which source of
financing a company should use? What do they need to consider in making this decision?
- Short Term sources are those that will be payable in at most 12 months. This includes
short-term loans with banks and suppliers’ credit. For short-term bank loans, the
interest rate is generally lower as compared to that of long-term loans. Hence, this
would lead to a lower financing cost.
- Suppliers’ credits are the amounts owed to suppliers for the inventories they delivered
or services they provided. While suppliers’ credit is generally free of interest charges,
the obligations with them have to be paid on time to maintain good supplier
relationship. Such relationships should be nurtured to ensure timely delivery of
inventories.
- Short term sources pose a trade-off between profitability and liquidity risk. Because
this source matures in a short period, there is a possibility that the company may not be
able to obtain enough cash to pay their obligation (i.e. liquidity risk).
 Two types of liquidity risk:
a. Risk that the company will fail to pay its short term obligations.
b. Risk that you will not be able to sell investments in financial assets immediately.
- Long term sources, on the other hand, mature in longer periods. Since this will be paid
much later, the lenders expect more risk and place a higher interest rate which makes
the cost of long term sources higher than short term sources. However, since long term
sources have a longer time to mature, it gives the company more time to accumulate
cash to pay off the obligation in the future.
- Hence, the choice between short and long term sources depends on the risk and
return trade off that management is willing to take. The learners will learn more about
this on module: Sources and uses of funds.
Dividend Policies
Dividend Policies determine when the company should declare cash dividends. Recall
that cash dividends are paid by corporations to existing shareholders based on their
shareholdings in the company as a return on their investment. Some investors buy stocks
because of the dividends they expect to receive from the company. Non-declaration of
dividends may disappoint these investors. Hence, it is the role of a financial manager to
determine when the company should declare cash dividends.
Before a company may be able to declare cash dividends, two conditions must exist:
1. The company must have enough retained earnings (accumulated profits) to support
cash dividend declaration.
2. The company must have cash.
Dividends come from the company’s cash and availability of unrestricted retained
earnings. In deciding paying dividends, the manangement considers:
- Availability of financially viable long-term investment
- Access to long term sources of funds
- Management’s Target Capital structure
Recall that one of the functions of a finance manager is investing and its available cash
may be used to invest in long term investments that would increase the profitability of the
company. Some small enterprises which are undergoing expansion may have limited access to
long term financing (both long term debt and equity). This results to these small companies
reinvesting their earnings into their business rather than paying them out as dividends.
On the other hand, a company which has access to long term sources of funds may be
able to declare dividends even if they are faced with investment opportunities. However these
investment opportunities are generally financed by both debt and equity.
- The management usually appropriates a portion of retained earnings for investment
undertakings and this may limit the amount of retained earnings available for dividend
declaration.
- Creditors are not willing to finance entirely the cost of a company’s long term
investment. Hence, the need for equity financing (e.g. internally generated funds or
issuance of new shares).
- Examples of these companies are publicly listed companies such as PLDT, Globe
Telecom, and Petron. PLDT and Globe are two of the Philippine listed companies which
 have generously distributed cash dividends for the last five years (information as of
2014).
For companies which have limited access to capital and have target capital structure,
they may end up with a residual dividend policy. This means that when companies are faced
with investment opportunities, internally generated funds will be used first to finance these
investments and dividends can only be declared if there are excess funds.

III. SUMMARY OF LESSON

 The overall objective of a shareholder is wealth maximization.
 Factors that influence market price controllable by management are profitability, good
liquidity and reasonable leverage position, dividends, competent management, corporate
plans that improve the business prospects.
 Factors that influence market price uncontrollable by managment are macroeconomic
conditions, political stability, prospects of the industry where the company operates,
general market sentiment, flow of foreign funds invested in the Philippine stock market.
 The functions of a financial manager are financing, investing, operating and dividend
policies.

IV. ENRICHMENT
A. Importance of Finance and The Shareholder
Direction: Answer the following questions in 3-5 sentences. Write your answers on the spaces
provided. (5 pts. each; Correctness of Ideas - 3, Organization of Ideas - 2)
1. Aside from the factors mentioned during class, what other factors can influence the
investor’s perception on the company’s performance which would ultimately affect share
price?

2. Why is the study of finance important to you?

B. Functions of the Financial Manager

Direction: Answer the following question in 3-5 sentences. Write your answers on the spaces
provided. (5 pts. each; Correctness of Ideas - 3, Organization of Ideas - 2)
1. Explain why shareholder wealth maximization should be the overriding objective of
management.

2. What other positions can you think of that are related to financial management?

V. EVALUATION
A. True/False
Direction: Write True if you agree to the statement. Otherwise, write False. (2 pts. each)
1. High cash flow is generally associated with a higher share price whereas higher risk
tends to result in a lower share price.
2. When considering each financial decision alternative or possible action in terms of its
impact on the share price of the firm's stock, financial managers should accept only
those actions that are expected to increase the firm's profitability.
3. To achieve the goal of profit maximization for each alternative being considered, the
financial manager would select the one that is expected to result in the highest
monetary return.
4. Dividend payments change directly with changes in earnings per share.
5. The wealth of corporate owners is measured by the share price of the stock.
6. Risk and the magnitude and timing of cash flows are the key determinants of share
price, which represents the wealth of the owners in the firm.
7. When considering each financial decision alternative or possible action in terms of its
impact on the share price of the firm's stock, financial managers should accept only
those actions that are expected to maximize shareholder value.
8. An increase in firm risk tends to result in a higher share price since the stockholder
must be compensated for the greater risk.
9. Stockholders expect to earn higher rates of return on investments of lower risk and
lower rates of return on investments of higher risk.

B. Multiple Choice
Direction: Encircle the letter of the correct answer. (2 pts. each)
1. The primary goal of the financial manager is
A. minimizing risk.
B. maximizing profit.
C. maximizing wealth.
D. minimizing return.
2. Corporate owner's receive realizable return through
A. earnings per share and cash dividends.
B. increase in share price and cash dividends.
C. increase in share price and earnings per share.
D. profit and earnings per share.
3. The wealth of the owners of a corporation is represented by
A. profits.
B. earnings per share.
C. share value.
D. cash flow.
4. Wealth maximization as the goal of the firm implies enhancing the wealth of
A. the Board of Directors.
B. the firm's employees.
C. the federal government.
D. the firm's stockholders.
5. The goal of profit maximization would result in priority for
A. cash flows available to stockholders.
B. risk of the investment.
C. earnings per share.
D. timing of the returns.
6. Profit maximization as a goal is not ideal because it does NOT directly consider
A. risk and cash flow.
B. cash flow and stock price.
C. risk and EPS.
D. EPS and stock price.
7. Profit maximization as the goal of the firm is not ideal because
A. profits are only accounting measures.
B. cash flows are more representative of financial strength.
C. profit maximization does not consider risk.
D. profits today are less desirable than profits earned in future years.
8. Profit maximization fails because it ignores all EXCEPT
A. the timing of returns.
B. earnings per share.
C. cash flows available to stockholders.
D. risk.

9. The key variables in the owner wealth maximization process are

 A. earnings per share and risk.
B. cash flows and risk.
C. earnings per share and share price.
D. profits and risk.
10. Cash flow and risk are the key determinants in share price. Increased cash flow results in
________, other things remaining the same.
A. a lower share price
B. a higher share price
C. an unchanged share price
D. an undetermined share price
11. Cash flow and risk are the key determinants in share price. Increased risk, other things
remaining the same, results in
A. a lower share price.
B. a higher share price.
C. an unchanged share price.
D. an undetermined share price.
12. Financial managers evaluating decision alternatives or potential actions must consider
A. only risk.
B. only return.
C. both risk and return.
D. risk, return, and the impact on share price.
13. A financial manager must choose between four alternative Assets: 1, 2, 3, and 4. Each asset
costs $35,000 and is expected to provide earnings over a three-year period as described below.
Based on the profit maximization goal, the financial manager would choose

A. Asset 1.
B. Asset 2.
C. Asset 3.
D. Asset 4.
14. A financial manager must choose between three alternative investments. Each asset is
expected to provide earnings over a three-year period as described below. Based on the wealth
maximization goal, the financial manager would
 A. choose Asset 1.
B. choose Asset 2.
C. choose Asset 3.
D. be indifferent between Asset 1 and Asset 2.

VII. RESOURCES
DepEd Business Finance Teaching Guide