FM112 – Financial Management: An Overview CHAPTER 1

Chapter I
Financial Management: An Overview

Chapter Overview and Objectives Time Frame – 3 hours

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After this chapter, the students must be able to:
1. Describe the nature, goal, objectives and basic scope of Financial
Management
2. Discuss the importance or significance of Financial Management
3. Describe the relationship between Financial Management, Accounting,
Economics and Public Responsibility
4. Explain briefly the types of decision finance manager makes
5. Understand the role of a Financial Manager
6. Be familiar with the Philippine Financial System
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“Most of the important things in the world have been accomplished by

people who have kept on trying when there seemed to be no hope at all” - Dale
Carnegie

WARM UP ACTIVITY
Picture yourself as a potential financial manager five years from now, what
should you do now to equip yourself with the necessary tools? Whatever your
answer is…MAKE it your goal!

Lesson 1
Introduction
In order to understand Financial Management, we must first understand
what Finance is.
Finance is a body of facts, principles and theories relating to raising and
using money by individuals, businesses and governments. (E. Cabrera)
Finance is also defined as the art and science of managing money, or simply
the management of money.

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1. Nature of Financial Management

Financial management is:
- also referred to as Managerial Finance, Corporate Finance and
Business Finance
- a decision-making process concerned with planning, acquiring and
utilizing funds in a manner that achieves the firm’s desired goals.
- is also described as the process for and the analysis of making
financial decisions in the business context.
- part of a larger discipline called FINANCE.
This concerns both financial management of profit-oriented
business organizations particularly the corporate form of business,
as well as, concepts and techniques that are applicable to individuals
and to governments.

2. The Goal of Financial Management

The goal of Financial Management is to make money and add value
for the owners. The financial manager in a business enterprise must make
decision for the owners of the firm. He must act in the owners’ or
shareholders’ best interest by making decisions that increase the value of
the firm or the value of the stock.
Thus, the appropriate goal for the financial manager can be sated as
follows:

The goal of Financial Management is to maximize the current value

per share of the existing stock or ownership in a business firm (or
simply to increase the value of the firm and its current stock price)

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The stated goal considers the fact that the shareholders in a firm are
residual owners. By this, we mean that they are entitled only to what is left
after employees, suppliers, creditors and anyone else with legitimate claim
are paid their due. If any of these groups go unpaid, the shareholder or
owners get nothing. So, if shareholders are benefiting in the sense that the
residual portion is growing, it must be true that everyone else is being
benefited too. Because the goal of Financial Management is to maximize
the value of the shares, there is a need to learn how to identify
investments, arrangements and distribute satisfactory amount of dividends
or share in the profits that favorably impact the value of the shares.
Finally, our goal does not imply that the Financial Manager should
take illegal or unethical actions in the hope of increasing the value of the
equity in the firm. The Financial Manager should best serve the owners of
the business by identifying goods and services that add value to the firm
because they are desired and valued in the free market. Thoughtful
shareholders do not want the maximum possible stock price. They want
the maximum honest stock price.

3. Scope of Financial Management

Traditionally, Financial Management is primarily concerned with
acquisition, financing and management of assets of business concern in
order to maximize the wealth of the firm for its owners. More recently
though, with the globalization and liberalization of world economy,
tremendous reforms in financial sector evolved in order to promote more
diversified, efficient and competitive financial system in the country. The
financial reforms coupled with the diffusion of information technology have

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brought intense competition, mergers, takeovers, cost management, quality

improvement, financial discipline and so forth.
In view of modern approach, the Finance Manager is expected to
analyze the business firm and determine the following:
1. The total funds requirements of the firm
2. The assets or resources to be acquired and
3. The best pattern of financing the assets

4. Functions of Financial Management

The functions of Financial Management are actually the topics we shall
cover in this course.
Financial management functions in the following areas:
1. Estimation of capital requirements. Estimation has to be made in
an adequate manner which increases the earning capacity of an enterprise.
2. Determination of capital composition. Once the estimation has
been made, the capital structure has to be decided. This involves short-term
and long-term debt equity analysis. This will depend upon the proportion of
equity capital a company is processing and additional funds which is to be
raised.
3. Choice of sources of funds. For additional funds needed, a
company has many choices such as issuance of shares of stocks, loans from
banks and financial institutions and issuance of bonds.
4. Investment of funds. The financial manager has to decide to
allocate funds into profitable ventures so that there is safety on investment.
5. Disposal of surplus. This can be through dividend declaration or
using the retained earnings for expansion, innovation and diversification of
the company.
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6. Management of cash. The financial manager has to make decision

as regards cash management.
7. Financial controls. The financial manager has to exercise control
over finances. This can be done through many techniques like ratio analysis,
financial forecasting, cost and profit control, etc.

5. Significance of Financial Management

The importance of Financial Management is known for the following
aspects:
1. Broad Applicability
2. Reduction of Chances of Failure
3. Measurement of Return on Investment

Broad Applicability
Any organization whether motivated with earning profit or not
having cash flow requires to be viewed from the angle of financial
discipline. The principles of finance are applicable wherever there is cash
flow. The concept of cash flow is one of the central elements of financial
analysis, planning, control, and resource allocation decisions. Cash flow is
important because the financial health of the firm depends on its ability to
generate sufficient amounts of cash to pay its employees, suppliers,
creditors, and owners.
Financial Management is equally applicable to all forms of business,
like sole traders, partnerships, and corporations. It is also applicable to
nonprofit organizations like trust, societies, government organizations,
public sectors, and so forth.

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Reduction of Chances of Failure

A firm having latest technology, sophisticated machinery, high
caliber marketing and technical experts, and so forth may still fail unless its
finances are managed on sound principles of financial management. The
strength of business lies in its financial discipline. Therefore, finance
function is treated as primordial which enables the other functions like
production, marketing, purchase, and personnel to be effective in the
achievement of organizational goal and objectives.

Measurement of Return on Investment

Anybody who invests his money will expect to earn a reasonable
return on his investment. The owners of business try to maximize their
wealth. Financial Management studies the risk-return perception of the
owners and the time value of money. It considers the amount of cash flows
expected to be generated for the benefit of owners, the timing of these
cash flows and the risk attached to these cash flows.

6. Objectives of Financial Management

1. Financial Planning generally refers to the allocation of financial
resources. In accordance with the company’s financial objectives and
standards, projects or activities and operations are carefully planned,
evaluated based on certain criteria and subsequently ranked for the
allocation of financial resources.
2. Financing involves the procurement of funds. Procurement function
requires awareness of different sources of funds with varying requirements
and conditions.

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3. Investment entails the effective and efficient utilization of financial

resources. Financial resources must be utilized in a manner that minimizes
company costs arising from wastage and loss of opportunities due to delays
in operations and idle and nonproductive resources. It requires adoption of
effective control measures.
Efficient utilization of financial resources refers to their economical use. In
other words, one sees to it that financial resources are actually being used
for what they were intended. Inefficiency in the usage of resources maybe
caused by extravagance in the choice of property or equipment,
unnecessary expenditures, tardiness of personnel and nonproductive
resources.
Effective utilization of resources refers to their use towards the attainment
predetermined objectives. This requires a periodic review of operations to
determine whether they are in accordance with plans and whether the
plans, as prepared, will enable the company to attain short term and long-
term objectives considering the changes brought about the economic
development.

7. Relationship between Financial Management, Accounting, Economics

and Public Responsibility
1. FINANCIAL MANAGEMENT AND ACCOUNTING
Financial Management is a separate management area. In
many organizations, accounting and finance functions are
intertwined and the finance function is often considered as part of
the functions of the accountant. Financial management is however,
something more than an art of accounting and bookkeeping.
Accounting function discharges the function of systematic recording
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of transactions relating to the firm’s activities in the books of

accounts and summarizing the same for presentation in the financial
statement.
Financial statements help managers to make business
decisions involving the best use of cash, the attainment of efficient
operations, the optimal allocation of funds among assets, and the
effective financing of investment and operations.
The Finance Manager will make use of the accounting
information in the analysis and review of the firm’s business position
in decision making and will use other methods and techniques (like
capital budgeting techniques, statistical and mathematical models
and computer application) to maximize the value of the firm’s
wealth and value of the owner’s wealth. In view of the above,
finance function is considered a distinct and separate function rather
than simply an extension of accounting function.

2. FINANCIAL MANAGEMENT AND ECONOMICS

Financial Managers can make better decisions if they apply
the basic economic principles. Financial managers do a better job
when they understand how to respond effectively to changes in
supply and demand, prices as well as to more general and overall
economic factors.

3. FINANCIAL MANAGEMENT AND PUBLIC RESPONSIBILITY

Financial Managers have certain obligations to those who
entrust them with the running of the firm. They must have a clear
sense of ethics and must avoid pay offs or other forms of personal
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gain. Managers should not engage in practices that can damage the
image of the firm but should articulate as much as possible in social
activities to demonstrate that they are cognizant of the importance
of the community and those who buy their products or services.

Lesson 2
8. The Finance Organization
The financial management function is usually associated with
a top officer of the firm as a Vice President of Finance or some other
Chief Financial Officer (CFO). The Vice President of Finance
coordinates the activities of the Treasurer and the Controller. The
Controller’s office handles cost and financial accounting, tax
payments, and management information systems. The Treasurer’s
office is responsible for managing the firm’s cash and credit, its
financial planning, and its capital expenditures.

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9. The Role of the Financial Manager

The financial manager is a member of the firm’s top management
with expertise in the management of financial assets. He participates in
the corporate strategic planning, makes financial decisions to promote
the successful operations and growth of the firm. He is an adviser of the
firm regarding advantages and costs in the prevailing market using his
expertise because of his wide imagination and proficiency in costing. He
can project to a certain degree of accuracy the organization’s capital
structure based on available statistics. He supervises the efficient
utilization of the firm’s assets in order to achieve adequate profit as
management goal.

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1. Analyze and plan the company’s performance. Analyzing

and planning company’s operations occupy much of the financial
manager’s time. Company progress depends on the management’s
knowing where the company now and where in the future it wants
the company to be. The financial manager gives opinion on the
consequences of the different alternative courses of action.
Assessing the financial strengths and weaknesses of the
company requires the financial manager to work with people from
accounting, marketing and production. Company accountants
develop the income statement showing sales revenues and expenses
for a period of time; they also prepare the balance sheet which is a
listing of company assets, liabilities and the owner’s equity. Based on
these financial statements and projected versions of these
statements, the financial manager assesses company strengths and
weaknesses, both currently and in the future to a large degree, the
plans of the production department and sales forecasts of the
marketing department.
2. Anticipate the company’s financial needs. The need to
anticipate future events is one of the roles of the financial manager.
Forecasting company expenditures for assets and their required
financing avoids surprises and the problems these surprises create.
Being involved in the planning process of other departments and top
management. Monitoring developments in the economy that
impinge on the company’s products. Keeping track of what is
happening in the markets for the company’s securities. 18 To develop
reliable forecasts and plans, a financial manager must understand not
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only finance and accounting but company operations as well; product

lines, manufacturing processes, customer groups, potential suppliers
of raw materials, vendors of equipment and so on. A basic
understanding of the operations enables the financial manager to
identify and anticipate costs of future asset acquisitions and needed
financing.
3. Procure the funds the company needs. Financial managers
procure and manage funds that a company needs to finance
operations. To obtain these funds, the company can issue shares of
stocks, borrow money or use a combination of the two. The company
that borrows must repay its debts at maturity.
4. Allocate funds to acquire the most profitable assets.
Equally critical as the financing decision to the success of a company
is the investment decision, the process of allocating funds for
investment in competing assets. The investment decision must not
overemphasize one sort of asset and slight another. For instance, it
would be unwise to use so much cash to invest in a building that the
company could not pay its bills when due. The financial manager
plays a key role in the allocation of funds to competing assets. The
goal is to select fixed assets that will generate large returns and
minimal risks.

Lesson 3
10. Types of Financial Decision
Principal Financial Decisions:
1. Investment Decision
2. Financing Decision
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Financial Managers face two broad financial questions: First, what

investments should the corporation make? Second, how should it
pay for those investments? The first decision is the investment
decision; the second is the financing decision. The investment
decision involves spending money; the financing decision involves
raising money.
Examples of investment and financing decisions by major
international corporations during the past years:
Company Investment Financing Decision
Decision
In 2008, announced In 2008, raised
plans to invest over $2.5 billion by an
Wal Mart
a billion dollars in issue of 5-year and
90 new stores in 30-year bonds.
Brazil
Expanded its chain Borrowed $400
of retail stores to million for 5 years
Lenovo
cover 2,000 cities from a group of
banks

Financial Managers do not make major investment decisions in

solitary confinement. They may work as part of a team of engineers
and managers from manufacturing, marketing, and other business
functions. Also, do not think of the financial manager as making
billion-dollar investments on a daily basis. Most investment
decisions are smaller and simpler, such as the purchase of a truck,
machine tool, or computer system.
Companies raise equity financing in two ways. First, they can
issue new shares of stock. The investors who buy new shares put up
cash in exchange for a fraction of a company’s future cash flow and

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profits. Second, the company can take the cash flow generated by
its existing assets and reinvest the cash in new assets. In this case
the company is reinvesting on behalf of existing stockholders. No
new shares are issued.

In some ways financing decisions are less important than investment

decisions. In fact, the most successful corporations sometimes have the
simplest financing strategies. Take Microsoft as an example. Microsoft is
said to have an estimated net worth of about $1 Trillion. Where did this
value come from? It came from Microsoft’s product development, and
from its ability to make profitable future investments. The value did not
come from sophisticated financing.

Other Finance Decisions:

4. Dividend Decision - In order to achieve the wealth
maximization objective, an appropriate dividend policy is to decide
whether to distribute all the profits in the form of dividends or to
distribute a part of the profits and retain the balance.
5. Working Capital Decision - This is concerned with making
decisions related to the investment in current assets and current
liabilities. Current assets are convertible into cash within one year.
Similarly, current liabilities are those which are likely to mature for
payment within an accounting year.

REFERENCES:
1. Cabrera, Ma. Elenita B. and Cabrera, Gilbert Anthony B. (2019-2020 Edition)
Financial Management Comprehensive Volume. GIC Enterprises & Co. Inc.
2. Brealey, Myers and Allen. Principles of Corporate Finance. (2019). South
Western Cengage Learning

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-Thank you and have a nice day!-

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