DON HONORIO VENTURA STATE UNIVERSITY

COLLEGE OF BUSINESS STUDIES

Bacolor, Pampanga

LESSON 1: THE ROLE AND ENVIRONMENT OF FINANCIAL MANAGEMENT

WHAT IS FINANCE?

Finance, branch of economics concerned with providing funds to individuals, businesses, and governments.
Finance allows these entities to use credit instead of cash to purchase goods and invest in projects. For
example, an individual can borrow money from a bank to buy a home. An industrial firm can raise money
through investors to build a new factory. Governments can issue bonds to raise money for projects.

Gitman (2006, p4) defines Finance as “the art & science of managing money. Virtually all individuals and
organizations earn or raise money and spend or invest money.”

“Finance is concerned with the process, institutions, markets, and instruments involved in the transfer of
money among individuals, businesses and governments.”

WHAT IS MANAGEMENT?

Management used to describe the techniques and expertise of efficient organization, planning, direction
and control of operations of a business.

MANAGEMENT FUNCTIONS AND THE NEED FOR MANAGERIAL ACCOUNTING

INFORMATION

1. Planning- It involves: a.) setting of immediate, as well as long range goals for the organization,
b) predicting future conditions that are expected to prevail, c.) considering the different means or
strategies by which the goals may achieve and d) deciding which of the strategies should be used
to attain such goals.

2. Directing and Motivating- involves overseeing the day to day activities, seeing to it that the
organization is functioning smoothly and the members of the organization are mobilized to carry
out plans

3. Controlling- involves checking the performance of activities against the plan or standards set and
deciding what corrective actions to take should there be any deviation between the actual and
planned (standard) performance.

THE DECISION – MAKING PLANNING AND CONTROL PROCESS

1. Identify Objectives

2. Search for alternative courses of action- involves the acquisition of information concerning
future opportunities and environments. Firms should consider all alternatives courses of action

3. Gather data about alternatives- Example: Data on the selling prices of competitors, estimated
demand at selling prices, when the data have been gathered,

This lecture is taken from a financial management material from the College of Business Studies of
DHVSU. Credit goes to the owner of this material. For reference purposes only.
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga
4. Select alternatives courses of action- Decision making involves choosing between competing
alternative courses of action

5. Implement the decisions- Preparation of Budgets

6. Compare actual and planned outcomes- To monitor performance, the accountant produces
performance reports and presents them to the appropriate managers who are responsible for
implementing the various decisions.

MAJOR OPPORTUNITIES IN FINANCE

Financial Services- is the area of finance concerned with the design and delivery of advice and financial
products to individuals, business, and government.

Managerial Finance- is concerned with duties of the financial manager in the business firm. Financial
Managers actively manage the financial affairs of any type of businesses- financial, and non financial,
private and public, large and small, profit seeking and nor for profit. They perform such varied financial
tasks as planning, extending credit to customers, evaluating proposed large expenditures and raising money
to fund the firm’s operations.

NATURE OF BUSINESS

Business- is the process of producing (manufacturing) goods (products) and services and then distributing
(selling) them to those who desire or need them.

In this process, there are several key ingredients needed to support economic activity. These items are called
the factors of production.

FOUR FACTORS OF PRODUCTION

1) Natural Resources- These include the Land and the materials that come from the land, such as
timber, mineral deposits, oil deposits, and water.
2) Labor( Human Resource) – This encompasses the mental and physical efforts of all workers
regardless of their skill or education, who perform the many tasks required to produce.
3) Capital- This factor includes the buildings, machinery, and tools used to produce goods and
services.
4) Entrepreneurship- This factor refers to the people willing to accept the opportunities and risks of
starting and running a business.

The objective of most businesses is to maximize profits. Profit is the difference between the amounts
received from customers for goods or services provided and the amounts paid for the inputs used to provide
the goods or services.

OBJECTIVES OF BUSINESS

(Why do People go into business?

This lecture is taken from a financial management material from the College of Business Studies of
DHVSU. Credit goes to the owner of this material. For reference purposes only.
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga
1. Profit
2. Prestige and Popularity
3. Family control
4. Social Consciousness
5. Satisfaction of Personal Objectives
6. Economy and effectiveness of operations
7. Livelihood
8. Power
9. Protection

KINDS OF BUSINESS

1. Commerce- It refers to the transfer or exchange of goods and services with the movement of
goods from the point of production to the point of consumption.

Example: Buying and Selling, Marketing

2. Industry- It refers to business firms which are mainly concerned with the production.

Classification of Industry

a.) Genetic Industry- Those involved in agriculture, forestry and Fish Culture

b.) Extractive Industry- Those involved in the extraction of goods from natural resources which
include mining, lumbering, hunting and fishing.

c.) Manufacturing Industry- Those which convert raw materials into a finish product.

d.) Construction Industry- Consists of firms which engaged in building infrastructures.

3. Service- these enterprises cater to personal needs of people, or with the rendering of personal
service.

Classification of Service

a.) Recreation- Movie Houses, TV and Radio Station, Theaters

b.) Personal- Restaurant, Hotels, Transportation

c.) Finance- Bank, Insurance Companies, Financing Companies

FORMS OF BUSINESS ORGANIZATIONS

A business may be organized and take one of the following three legal forms:

1. Sole Proprietorship- is a business organized by one person who usually acts as manager. As a
owner he or she gets all the profits.

Advantages Disadvantages

This lecture is taken from a financial management material from the College of Business Studies of
DHVSU. Credit goes to the owner of this material. For reference purposes only.
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga
Easy to organize and end Risk of loss (unlimited liability)

Freedom of action Limited in size

Profits not shared Problems or difficulties of management

Low taxes Uncertain future

Personal pride of ownership Limited judgment and wisdom

Low capital

2. Partnership- is a contract of two or more persons binding themselves to contribute money,

property or industry to a common fund with the intention of dividing profits among themselves.

Advantages Disadvantages

More Capital Available Risk of dissolution

Better Management Possibility of Disagreement

More interests in the business Unlimited liability of partners

Simple organization Limited in size

Low taxes General agency

A Partnership has access to greater or better

credit standings

3. Corporation- is an artificial being created by operation of law having the right of succession
and the powers, attributes and properties expressly authorized by operation of law or incident
to its existence.

Advantages Disadvantages

Shareholders are not liable for the liability Limitations on the corporate activities
of the corporation beyond their investment
in stocks

Greater stability of existence and continuity Special reports are to be submitted

of operation

More capital can be accumulated Pay taxes

This lecture is taken from a financial management material from the College of Business Studies of
DHVSU. Credit goes to the owner of this material. For reference purposes only.
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga
Liquidation of investment is easier Increased clerical work specially if the
number of stockholders is large

Flexible ownership Control may be exercised by only a small

group of stockholders

Legal entity

TYPES OF BUSINESS OPERATIONS

1. Service Business- is the simplest type of business which performs service, for a fee, to a client or
customer.

Ex. Doctors, CPA’s, Lawyers, Barber Shops, Airlines

2. Merchandising Business- is one in which buys and sells goods or merchandise.

Involved in selling of finished goods produced by other businesses

Merchandisers could either be a wholesaler or retailer.

Wholesaler Merchandiser- is a company that buys its products from the manufacturer and then
sells the product to the company that eventually sells it to the consumer.

Ex. Macro Inc., Uniwide Corporation

Retailer Merchandiser- is a company that buys its products from a wholesaler or manufacturer
and then sells the product to the end consumers.

Ex. Shoemart, Rustan’s Department store, Gift shops, clothing stores

3. Manufacturing Business- buys raw materials first and after changing the form sells the product
to the customer.

Ex. Garment Factories, shoe factories, drug laboratories, and food processing companies

TWO MAIN SOURCES OF FINANCING

1. Equity Financing - money invested into your business in exchange for a share in its ownership.
2. Debt Financing - usually in the form of a loan where the principal amount borrowed and interest
accumulated on the loan needs to be paid.

There are a number of sources of equity finance available to business. This includes:

• Personal Savings: money that you personally invest into the business.
• Friends and Relatives: people that you personally know invest into the business to lend
assistance.
• Angel Investors: wealthy individuals who lend their personal finances to a business in return for a
share in its ownership.

This lecture is taken from a financial management material from the College of Business Studies of
DHVSU. Credit goes to the owner of this material. For reference purposes only.
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga
• Venture Capital: applications to professionally managed third parties such as a superannuation
fund who lend finance based on a good business plan.

There are also a range of opportunities to secure debt financing such as:

• Leasing: hiring out equipment for a regular fee for the duration of the lease term, with no outlay
to actually purchase equipment.
• Term Loans: paid back to a financial institution over an agreed period.
• Credit Cards: easy to acquire financial institution loans that carry high interest rates.
• Bank Overdrafts: where you withdraw more than your account contains, with interest calculated
on your outstanding balance.
• Commercial Bills: short term loans where the amount must be paid in full upon reaching expiry.
• Loan Programs: short term loans set up to assist small business with initial start up expenses.
• Trade Credit: deferred payment of goods and services purchased form a supplier

FINANCIAL MANAGEMENT

Financial Management is concerned with the maintenance and creation of economic value of wealth. This
course focuses on decision making with an eye toward creating wealth.

Financial Management is concerned with the acquisition, financing and management of assets with some
overall goal in mind.

It is the process of planning decisions in order to maximize the owner's wealth.[1]

Financial management means the management and control of money and money related operations within
a business

Companies have finance departments that are responsible for money and money related operations. The
executive in charge of these departments is Chief Financial Officer (CFO).

To illustrate, consider two firms, Merck and IBM. At the end of 2008, the total market value of Merck, a
large pharmaceutical company was $ 46 billion. Over the life of the business, Merck’s investors had
invested about $ 17 billion in the business. In other words, management created $ 29 billion in additional
wealth for the shareholders..

It is concerned with the three important areas

1. Acquisition or Investment Decision

2. Financing Decision
3. Asset Management Decision

1. Acquisition or Investment Decision:

It is the most important part of the organization's three major decisions when it is about value creation.
It begins with a determination of the total amount of assets needed to be held by the organization.
For Example,

This lecture is taken from a financial management material from the College of Business Studies of
DHVSU. Credit goes to the owner of this material. For reference purposes only.
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga
How much of the organization do total assets should be given to cash or to inventory?
You must consider what will be the size of the firm i.e. the assets side or the left hand side in Balance Sheet.

2. Financing Decision

It is concerned with the makeup of the right hand side of the balance sheet.
On one side some organizations have relatively large amount of debt, and on the other side some
organizations are almost debt free. It will be not an Ideal situation but on the other side a certain mix of
financing can be thought of as best.

In Organization's financing decision Dividend payout ratio is viewed as an integral part.

Dividend Payout Ratio

It determines the amount of earnings that can be retained in the organization.

As a means of equity financing a balance is required between the values of the dividends paid to
stockholders against the opportunity cost of retained earnings lost.

Once the financing mix has been decided, there is still one more thing required that how best to physically
acquire the needed funds.

3. Asset Management Decision

Now after the assets have been acquired and appropriate financing provided, the next thing is how to
manage these assets efficiently.
It means that now financial manager should be more concerned with the management of current assets than
with that of fixed assets.

“Every successful person has a painful story and a beautiful ending. No one can go
back and change a bad beginning but anyone can start and create a wonderful ending.
Life maybe tough and difficult, but the values we gain from trials make it worth the
journey.”

This lecture is taken from a financial management material from the College of Business Studies of
DHVSU. Credit goes to the owner of this material. For reference purposes only.