Chapter 1: Introduction to Financial Management

Interrelated meaning of FINANCE

 The management of large amounts of money - especially by governments or large

companies;
 The giving of monetary support for an enterprise and;
 The monetary resources and affairs of a government, organization or person.

TYPES OF FINANCE

1. PUBLIC FINANCE
-The government helps deter markets collapse by regulating capital management, income
distribution, and economic stabilization.
-Daily support for these services is largely provided by taxation.
2. CORPORATED FINANCE
-Businesses bring in financing through equity investments and credit arrangements, and by
purchasing securities.
-Start ups may receive investments from angel investors or venture capitalists, and
established companies may sell stocks and bonds.
3. PERSONAL FINANCE
-Earning more money and spending less money is the basis of personal finance.
-Individuals may earn more money by starting a business, taking on additional jobs, or
investing.

CORPORATION ORGANIZATIONAL CHART FINANCE MANAGEMENT TEAM

CHIEF FINANCIAL OFFICER

ERP MANAGEMENT
CENTER

FINANCIAL DEPARTMENT

CAPITAL PURCHASE PRODUCTION SALES INVENTORY INTERNAL

MANAGEMENT ACCOUNTING ACCOUNTING ACCOUNTING ACCOUNTING AUDIT

FORMS OF BUSINESS ORGANIZATIONS

1. SOLE PROPRIETORSHIP
-consists of one individual doing the business.
ADVANTAGES:
- Ease of formation and dissolution
-Typically, there are low start up costs and low operational overhead.
-Ownership of all profits.
-Typically subject to fewer regulations.
-No corporate income taxes instead, declared on the owner’s individual income tax return.

DISADVANTAGES:
-Unlimited liability
-Limited life
-Difficulty in raising a capital for start up business. Common funding comes from personal
savings or personal loans.

2. PARTNERSHIP
-consists of two or more individuals in business together.

ADVANTAGES:
-Synergy. There is clear potential for the enhancement of value resulting from two or more
individuals combining strengths.
-Relatively easy to form however, considerable thought should be put into developing a
partnership agreement at the point of formation.
-Subject to fewer regulations that corporations.
-There is stronger potential of access to greater amounts of capital.
-No corporate income taxes instead, declare income by filing a partnership income tax
return.

DISADVANTAGES:
-Unlimited liabilities. General partners are individually responsible for the obligations of the
business, creating personal risk.
-Limited life. A partnership may end upon the withdrawal or death of a partner.
-There is real possibility of disputes or conflicts between partners which could lead to
dissolving the partnership.

3. CORPORATIONS
-are probably dominant form of business organizations in the Philippines.
-it is a legal entity doing business, and is distinct from the individuals within the entity.

Public Corporations - are owned by shareholders who elect a board of directors to oversee
primary responsibilities.

ADVANTAGES:
-Unlimited commercial life.
-Greater flexibility in raising capital through the sale of stock.
-Ease of transferring ownership by selling stock.
-Limited liability.
DISADVANTAGES:
-Regulatory restrictions.
-Higher organizational and operational costs.
-Double taxation.

FINANCIAL MANAGEMENT
 To collect funds for the company at a low cost.
 To use this collected funds for earning maximum profits.
 To plan and control the finance of the company.

From the perspective of the corporation:

Financial management deals with decisions that are supposed to maximize the value of the
shareholders’ wealth which simply means that corporations try to maximize the market value
of the shared of their stocks.

SHARES OF STOCKS
-represent the form of ownership in a corporation.

The changes in the price of a stock may vary due to the following:
1. Profitable operation
2. Nature of the business
3. Prospects of the business
4. Projected earnings and time frame for the realization of such projected earnings
5. Ability to meet maturing obligations
6. Appropriate capital structure
7. Dividend policies
8. Investing decisions
9. Management and market sentiments

FINANCIAL MANAGER
-is a person who takes care of all the important financial functions of an organization.

Main functions of a financial manager:

1. Raising of funds
2. Allocation of funds - points to consider in allocating the funds: The size of the firm and
its growth capability status of assets whether they are long term or short term mode by which
the funds are raised.
3. Profit Planning - proper usage of the profit generated by the firm.
4. Understanding capital markets - shares of the company are traded on stock exchange
and there is a continuous sale and purchase of securities.

Guiding principles for financial management systems:

1. Consistency - financial policies and systems must remain consistent over time.
2. Accountability - must be able to explain and demonstrate to all stakeholders how you
have used your resources and what you have achieved.
3. Transparency - must be open about its work and its finances, making information
available to all stakeholder.
4. Integrity - must be open with honesty and propriety.
5. Financial Stewardship - must take good care of the financial resources it has been given
and ensure that they are used for the purpose intended.
6. Accounting Standards - systems for keeping records and documentation must observe
accepted external accounting standards.

THE FINANCIAL INSTITUTIONS AND THE FINANCIAL MARKETS

 Is an establishments that conduct transactions such as investments, loans and deposits.
 Provide a mechanism for those with excess funds (savers) to lend to those who need
funds (borrowers).

FLOW OF FUNDS
 Financial system provides a transmission mechanism between saver-lenders and
borrowers-spenders.

SAVERS BENEFIT- earn interest

INVESTORS BENEFIT - access to money otherwise not available
ECONOMY BENEFIT - efficient means of bringing savers and borrowers together

 Fund flows indirectly from ultimate lenders (households) through financial

intermediaries (banks or insurance companies) or directly through financial markets
(stock exchange, bond markets) to ultimate borrowers (business firms, government or
other households).

MAJOR CATEGORIES OF FINANCIAL INSTITUTIONS AND THEIR ROLES IN

THE FINANCIAL SYSTEM:

 COMMERCIAL BANKS
- accepts deposits and provide securities and convenience to their clients.
- they also make loans that individuals and business use to buy goods and expand business
operations.
- they also served often under-appreciated roles as payments within the country and between
nations, e.g. Debit cards, Credit cards and cheque s.

 INVESTMENT BANKS
- is a financial intermediary that performs a variety of services for businesses and
government.
- these services include underwriting debt and equity offerings, facilitating mergers and other
corporate reorganizations and acting as a broker for institutional clients.

 INSURANCE COMPANIES
- they pool risk by collecting premiums from a large group of people who want, to protect
themselves and/or their loved ones against a particular loss such as a fire, car accident,
illness, lawsuits, disability or death.
- they help individuals and companies manage risk and preserve wealth.
 BROKERAGES
- acts as an intermediary between buyers and sellers to facilitate securities transactions.
- they are compensate via commission after the transaction has been successfully completed.

 INVESTMENT COMPANIES
- is a corporation or a trust through which individuals invest in diversified, professionally
managed portfolios of securities by pooling their fund with those of other investors, e.g.
mutual funds,
- they help individuals and companies manage risk and preserve wealth.

 NON-BANK FINANCIAL INSTITUTIONS

- SAVINGS AND LOANS - typically offers lower borrowing rates than commercial banks
and higher interest rates on deposits.
- CREDIT UNIONS - typically higher rates on deposits and charge lower rates on loans in
comparison to commercial banks.
- memberships are not open to public, but rather restricted to a particular membership group.

FINANCIAL MARKETS
 Is a market in which people trade financial securities, commodities and other fungible
items of value at low transaction costs and at prices that reflect, supply and demand.
 Some are relatively small with only few participants, while others like the Philippine
stock exchange (PSE) and the Makati stock exchange (MSE) markets trade trillions of
pesos daily.

Capital Markets - is one in which individuals and institutions trade financial securities.
They are intended for short term finance.

Stock Markets - allow investors to buy and sell shares in publicly traded companies.

Bond Markets - is a debt investment in which an investors loans money to an entity

(corporate or governmental) which borrows the funds for a defined period of time at a fixed
interest rate.

Money Markets - are also called as cash investments because of their short maturities.

Foreign Exchange (FOREX) and the Inter bank market - facilitate the trading of foreign
exchange.

PRIMARY MARKETS VS SECONDARY MARKETS

 Primary markets - also known as “New issue markets”, are facilitated by underwriting
groups, which consists of investment banks that will sell a beginning price range from a
given security and then oversee its sale directly to the investors.
 Secondary markets - is where investors purchase securities or assets from other
investors, rather than from issuing companies themselves.
 The over-the-counter (OTC) markets - refer as a dealer market. These are stocks that
are not trading on a stock exchange like PSE but instead from very small companies.
FINANCIAL INSTRUMENTS
- these are assets that can be traded.

Types of financial instruments:

1. Cash Instruments
- are directly influenced and determined by markets.
- these are securities that are easily transferable.
2. Derivative Instruments
- is a financial contract with a value that is derived from an underlying assets.

ASSETS CLASSES

1. Short term debt based - last for one year or less.

 Treasury bills or T-bills - a short dated government security, yielding no interest bu
issued at a discount on its redemption price.
 Commercial papers - promissory notes issued by financial institutions or large firms
with very short to short maturity period; usually 2 to 30 days, and not more than 270
days, and secured only by the reputation of the issuer.

2. Long term debt based - last for more than a year.

 Bonds - borrowers issued bonds to raise money from investors willing to lend them
money for a certain amount of time.
 Cash equivalents - investments securities that are for short-term investing and they have
a high credit quality for loans.
 Securities - are stocks (share or ownership in a corporation)