CHAPTER 1:

Introduction to
Financial Management
 Objectives

1. Have an appreciation of what the overall objective of management should be.

2. Present an overview of the financial system and discuss the different functions of the
financial intermediaries.
3. Distinguish a financial institution from a financial instrument and financial markets.
4. Compare and contrast the different financial instruments.
5. Explain the major functions of key management positions in a typical organization,
highlighting the crucial role of a finance manager.

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“ Beware of little expenses. A small
leak will sink a great ship.

-Benjamin Franklin

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 FINANCIAL MANAGEMENT
▪ Starts with a plan. This applies to both individuals and companies.
▪ From the perspective of a corporation, financial management deals with decisions that are
supposed to maximize the value of a shareholder’s wealth. This means maximizing the
market value of the shares of stocks. Shares of stocks represent the form of ownership in a
corporation.
▪ To illustrate, Globe Telecom Inc. shares closed at P2,200 on April 25, 2016. As of that
date, Globe’s total shares outstanding was P132,742,402. The market value of the shares
as of that date was more than P292 billion. ( P2,200 X 132,742,402 = P292,033,284,400 ).
This amount represents the value of the shareholders’ wealth.

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Factors that influence the price of a stocks

1. Profitable operation
2. Nature of business
3. Prospects of the business
4. Projected earnings and timeframe
5. Ability to meet maturing obligations
6. Appropriate capital structure
7. Dividend policies
8. Investing decisions
9. Management and market sentiments
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 Shareholders’ Wealth Maximization

▪ Maximizing shareholders’ wealth through maximization of stocks price should be the

overriding objective of management as it covers the different facets of operating a
company and it considers the different stakeholders in the organization.
▪ Stakeholders are not limited to the stockholders of the company.
▪ Stakeholders also include management employees, suppliers, customers, regulatory
agencies, and the community where the company operates.
▪ Maximizing shareholders’ wealth motivates members of a top management to develop a
longer perspective for the company that they manage. With this objective in mind,
management will try to make their customers happy by providing good products and
services at reasonable prices. To achieve this, management may have to innovate, invest in
technology, and be more efficient in their production and operation.
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 Shareholders’ Wealth Maximization

▪ The interest of the employees has to be considered in managing

company.
▪ Paying suppliers and creditors on time is good business practice that
will improve relationships with these parties.
▪ Compliance with the requirements of regulatory agencies also
ensures more smooth operations.
▪ Supporting the community where the company operates, in
whatever capacity it can, increases the company’s chances of
continuous operations in the area. 7
 Financial System

Financial User of Funds

Savers
Intermediaries (Borrowers/Investors)

▪ Households ▪ Households
▪ Banks
▪ Individuals ▪ Individuals
▪ Insurance companies
▪ Corporations/ ▪ Corporations/
▪ Stock exchange
Companies Companies
▪ Stock brokerage firms
▪ Government ▪ Government
▪ Mutual funds
Agencies Agencies
▪ Other financial
institutions

Figure 1: Overview of the Financial System 8

▪ Savings can came from households, individuals, companies,
government agencies and any other entity whose cash inflows are
greater than their cash outflows. The financial system through
financial intermediaries provides a mechanism by which these
savings can be channeled to users of funds, borrower, and investors.

▪ As shown in Figure 1, the same entities can be savers and users of

funds. One entity may have savings today but maybe needing funds
in the future, for example, for expansion.
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 Different functions that each financial
intermediary may perform

▰ Banks ▰ Insurance Companies ▰ Stock Exchange

▪ offer different products. Insurance
▪ provide products can be broadly
mechanism categorized into life insurance
where savers products and non-life insurance
products. Life insurance products
can put their
protect the insured from loss of
excess funds
through wife while non-life insurance
products protect the insured from
deposits.
the loss of or damage to
properties.
▪ The Philippine Stock
Exchange(PSE) provides a
system for the trading of
equity securities of
publicly listed companies.
▪ These equity securities are
common stocks and
preferred stocks.
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 Different functions that each financial
intermediary may perform
▰ Stocks Brokerage Firms
▪ Investing in the stock market has
to be coursed through stock
brokerage firms.
▪ A present, there are online
brokers and live brokers.
▪ Online brokers, one can trade in
the stock market through the
internet.( COL Financial and BPI
Trade)
▪ Live brokers, one needs a
telephone to call brokers and
place orders.
▰ Mutual Funds ▰ Other Financial Institutions
▪ Provide opportunities for big and
▪ Other financial institutions
small investors to invest in financial
include pension funds like
instruments which they would not have
Government Service
considered but do not have time or
Insurance System(GSIS),
the expertise to do it.
and Social Security
▪ These includes investments in the stock System(SSS), investment
market, bonds, treasury notes, and banks, and credit unions,
other money market instrument like among others.
treasury bills.
▪ To invest in mutual fund, he has to buy
shares and the buying price depends
on the net asset value(NAV) of that
fund when the purchase is made. 11
 Financial Instruments
▪ Financial instruments are generally classified into two
major categories:
1. Equity securities
2. Debt securities
▪ Equity securities include common stock and preferred
stocks
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 Financial Instruments
▪ Preferred stocks – has a priority over a common stocks in
terms of claims over the assets of the company. This means
that if a company is to be liquidated and its assets have
to be distributed, no asset will be distributed to common
stockholders unless all the claims of the preferred
stockholders have been given.

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 Financial Instruments
▪ Preferred stockholders – also have the priority over
common stockholders in cash dividend declaration. No
cash dividends will be given to common stockholders unless
all the dividends due to preferred stockholders are paid
first.

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 Financial Instruments
▪ The main difference between preferred and common stock is that
preferred stock gives no voting rights to shareholders while
common stock does.
▪ Preferred shareholders have priority over a company's income,
meaning they are paid dividends before common shareholders.
▪ Common stockholders are last in line when it comes to company
assets, which means they will be paid out after creditors,
bondholders, and preferred shareholders.
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 Financial Instruments
▪ Equity securities represent a claim on the earnings and assets of a
corporation, while debt securities are investments in debt instruments. For
example, a stock is an equity security, while a bond is a debt security.
When an investor buys a corporate bond, they are essentially loaning the
corporation money, and have the right to be repaid the principal and
interest on the bond.

▪ In contrast, when someone buys stock from a corporation, they essentially

buy a piece of the company. If the company profits, the investor profits
as well, but if the company loses money, the stock also loses money.
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 Financial Instruments
▪ Equity securities are financial
assets that represent shares of
a corporation
▪ Equity securities represent a
claim on the earnings and
assets of a corporation
▪ Debt securities are financial assets
that define the terms of a loan
between an issuer and an investor
▪ Debt securities are financial assets
that entitle their owners to a stream
of interest payments.
▪ Bonds, such as government bonds,
corporate bonds, municipal bonds,
collateralized bonds, and zero-
coupon bonds, are a common type of
debt security.
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 Board of Directors

President

VP for Sales and VP for VP for

Marketing VP for Finance Administration
Production

Figure 2: Organizational Chart 18

 Board of Directors
▪ The board of directors is the highest policy-making body in a corporation.
▪ The boards primary responsibility is to ensure that the corporation is operating to serve the
best interest of the stockholders.
▪ The members of the board who are called directors are elected by the stockholders.
▪ The ability to elect a director in the board is contingent on the amount of shares owned
and the number of directors in the board.
▪ To illustrate, assume that there are 10 directors in the board. If the stockholder owns 10%
of the voting shares of the company, then this stockholder can elect 1 director in the board.
▪ This is the reason why some investor want to own the majority shares of the company if
they want to control over that company.
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 Responsibilities of the board of directors

▪ Setting policies on investments, capital structure, and

dividends
▪ 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
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 Presidents
Responsibilities of a Presidents
▪ 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
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 VP for Sales and Marketing
▪ The following are among the responsibilities of VP for Sales and Marketing

o Formulating marketing strategies and plans

o Directing and coordinating company sales
o Performing market and competitor analysis
o Analyzing and evaluating the effectiveness and cost of marketing methods
applied
o Conducting or directing research that will allow the company to identify new
marketing opportunities, for example, variants of existing products/services
already offered in the market
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o Promoting good relationship with customers and distributors
 VP for Production
▪ The following are among the responsibilities of VP for Production
o Ensuring production meets customer demands
o Identifying production technology/process that minimizes
production cost and makes the company cost competitive
o Coming up with a production plan that minimizes the utilizations
of the company’s production facilities
o Identifying adequate and competitively priced raw material
suppliers
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 VP for Administration
▪ The following are among the responsibilities of VP for Administration

o Coordinating the functions of administration, finance, and sales and

marketing departments
o Assisting other departments in hiring employees
o Providing assistance in payroll preparation
o Determining the location and the maximum amount of office space needed
by the company
o Identifying means, processes, or systems that will minimize the operating cost
of the company
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 VP for Finance
▪ Shown in Figure 3 are the functions of VP for Finance

Financing

Investing

Operating

Dividend Policies

Figure 3: Functions of VP for Finance 25

 Financing Decisions
▪ Financing decisions include making decisions as how to finance long-term
investments and working capital which deals with the day-to-day operations
of the company.
▪ The VP for finance is also responsible for determining the appropriate
capital structure of the company, that is, how much of the total assets should
be financed by debt and equity.
▪ This responsibility is crucial because if the company is aggressively financed,
that is, it is heavily financed by debt, the company becomes vulnerable to
adverse economic conditions which may result in higher volatility in earnings.
The company can bankrupt because of too much debt.
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 Financing Decisions
▪ Capital structure decisions vary from one company to another.
▪ It is affected by the stability of cash flows, extent of fixed operating expenses and
variable expenses.
▪ Companies which are capital intensive and are characterized by high-fixed operating
expenses such as utility and mining companies are supposedly more conservatively
financed. This means, these companies have to financed more by equity
▪ These companies have to generate high levels of revenues before they can cover their
expenses.
▪ If these companies are heavily financed by debt, then interest expense adds up to the
already high-fixed operating expenses. This would mean higher revenues for profits to be
made.
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 Investing Decisions
▪ To minimize the profitability of failure, long-term investments have to be supported
by a capital budgeting analysis which is among the responsibilities of a finance
manager.
▪ Capital budgeting analysis is a technique used to determine the financial viability
of a long-term investments.
▪ This requires forecasting the cost of investment and the streams of cash flow
expected to be generated from the investment.
▪ The investment can only be considered if it satisfies certain financial parameters
that are acceptable to the top management.
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 Operating Decisions
▪ 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.
▪ Should the company finance these two accounts substantially by short-term sources of
financing or long-term sources of financing?
▪ The decision regarding the financing of these working capital accounts depends on the
appetite of top management for risk. If the company is more aggressive, then these
accounts receivable and inventories can be substantially financed by short-term sources.
▪ Basically, short-term sources of funds are cheaper. Interest on short-term loans is generally
lower than the interest on long-term loans. Hence, using short-term loans can boost the
profitability of a company. 29
 Operating Decisions
▪ While financing through short-term sources of financing may
minimize the financing cost of the company, this however, has a
trade-off.
▪ Financing working capital accounts mostly through short-term sources
may expose the company to a liquidity problem where obligations
are already due but the company does not have sufficient cash to
pay for the obligations.
▪ A more conservative management will opt to finance working capital
accounts mostly trough long-term sources. 30
 Dividend Policies
▪ Some investors buy stocks because of the dividends they expect to receive from
the company.
▪ Non-declaration of dividends may disappoint these investors.
▪ PLDT and GLOBE are two of the Philippine-listed companies which have
generously distributed cash dividends for the last 5 years.
▪ Two conditions must exist before a company can declare cash dividends. (1) The
company must have enough retained earnings to support cash dividend
declaration. When cash dividends are declared, the retained earnings of the
company go down to the extent of such declaration. (2) The company must have
cash.
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 Dividend Policies
How much cash dividends of a company declares is within the purview of the VP for Finance.
There are several factors considered in declaring cash dividends. Listed below are among
these considerations.
▪ Availability of investments opportunities – this is especially true for small and medium enterprises
(SMEs) which access to long term sources of funds is limited. These SMEs may rarely heavily on internally generated
funds to finance expansion. Hence, the decision to declare cash dividends can be substantially influenced by the
availability of investments opportunities.

▪ Access to long-term sources of funds – Publicly listed companies like PLDT, GLOBE, or PETRON have a
better access to long-term sources of funds. These companies can afford to declare cash dividends even if they are
faced with huge amounts of investments, for as long as their retained earnings can support such declarations. The
reason is these companies are big, publicly listed, and have much better access to long term sources of funds.

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 Dividend Policies
▪ Capital Structure – The capital structure of a company can depend largely on
the nature of its business. As previously stated, companies which are capital
intensive have to be more conservatively financed. Therefore, the amount of cash
dividends to be declared depends on how such declarations can affect the
structure of a company.

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