An Overview of Financial Management 10 Financial Management Principles

1. Demand Higher returns for higher risk

Definition of Finance: 2. Apply the concept of time value of

- Finance refers to the “art and science of money

managing money”
3. Cash-Not Profits-Is King

4. Additional cash flows are relevant

Asset: Something valuable 5. Competition can be a challenge

1. Real Assets (Tangible)

6. Capital Markets are efficient

2. Financial Assets (Intangible)

7. The agency problem exists

8. Taxes influence decision making

The objective of the Firm Formula: Tax Equivalent Yield (TEY) = Tax-
Maximizing Profit Vs. Maximizing free Yield/ (1-T)

Shareholder Wealth
Example: what is the TEY if a municipal bond
has a yield of 9% and the tax rate is 30%?

1. If the main objective is to maximize profit

then the main focus is earnings per share
TEY = 0.09 / (1-0.30) = 12.8571428% or
2. If the main objective is maximizing 12.86%

shareholder wealth/value then the main Taxable investment (after taxes) =

focus is to maximize the Market price per 12.8571428% * (1-0.30) = 8.9999999% or
share (MPS)
9%

Earnings Per Share (EPS)

Example 2: Taxable investment has a yield of
- EPS = Net Income Available for common 15%, tax-free investment yields 10%, and
shareholders/ # of common shares the tax rate is 30%. Which is better: taxable
outstanding
investment or the tax-free investment?

Example: If EPS = PHP10 (80% is retained,

20% will be given to investors as dividends)
Taxable investment (after taxes) = 15% * (1 -
Example: If EPS = PHP10 (100% is retained, 0.30) = 10.5%

0% will be given to investors as dividends)

Thus, the taxable investment is better
because its yield after taxes is higher than
Kinds of Business Organization the tax free investment (10.5% is > than
1. Sole Proprietorship (owned and run by 10%)

one person)

2. Partnership
Personal Equity Retirement Account (PERA)

- General Partnership
- A retirement account that has tax
- Limited Partnership & Limited Liability incentives

Company (LLC)
Tax Benefits:

3. Corporation
- 5% annual tax credits

- Tax-exempt employer contributions

The Function of the Financial Manager

- Tax-exempt investment earnings

1. Treasurer - Finance
- Tax-free withdrawals (generally uses the
Examples: Cash management, A/R “55 & 5 rule”)

management, inventory management, - Protection against creditors

CAPEX, Fundraising, financial planning, etc.

9. Unequal Risks

2. Controller - Accounting
10. Business Ethics is a concern

Example: Financial Statement (FS)

preparation, cost accounting, taxes, etc.
Financial Statements and Ratio Analysis:

Financial Statements:

The Firm & the Financial Markets

1. Income Statements (I/S)

1. Primary Market: a market wherein new - “For the period [date]”

securities are traded

2. Balance Sheet (B/S)

2. Secondary Market
- “as of [date]”

3. Cash Flow (CF) Statement

- CFs from Operating Activities

- CFs from Investing Activities

- CFs from Financing Activities