INTRO TO FINANCIAL MANAGEMENT

FINANCE is a term for matters regarding the management, creation and study of money and investments.
Specifically, it deals with a term or broadly describing the study and system of money, investments and other
financial instruments:

*Finance can be broadly divided into three categories:

a.) public finance - defined as the study of government activities, which may include spending, deficits and taxation.

b.) corporate finance - how corporations address funding sources, capital structuring, accounting, and investment
decisions.

• Financial management - deals with decisions that are supposed to maximize the value of shareholders’ wealth.

Shareholder’s Wealth Maximization

- Maximizing shareholder’s wealth through maximization of stock price should be the overriding objective of
management as it covers the different facets of operating a company and it considers the different stakeholders of
the company.

CORPORATE ORGANIZATION STRUCTURE

SHAREHOLDERS

Board of Directors

President

VP for Production VP for Finance VP for Production VP for Administration

ROLE OF FINANCIAL MANAGER

1. Shareholders: The shareholders elect the Board of Directors (BOD). Each share held is equal to one voting right.
Since the BOD is elected by the shareholders, their responsibility is to carry out the objectives of the shareholders
otherwise, they would not have been elected in that position.

2. Board of Directors: The board of directors is the highest policy making body in a corporation. The board’s primary
responsibility is to ensure that the corporation is operating to serve the best interest of the stockholders.

The following are among the responsibilities of the board of directors:

- Setting policies on investments, capital structure and dividend policies.

- Approving company’s strategies, goals and budgets.

1
- 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

3. President (Chief Executive Officer): The roles of a president in a corporation may vary from one company to
another. Among the responsibilities of a president are the following:

- 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.

*The president cannot manage the company on his own, especially when the corporation has become too big. To
assist him are the vice presidents of different functional areas: finance, marketing, production and administration.

4. VP for Marketing: The following are among the responsibilities of VP for Marketing.

- Formulating marketing strategies and plans.

- Directing and coordinating company sales.

- Performing market and competitor analysis.

- Analyzing and evaluating the effectiveness and cost of marketing methods applied.

- Conducting or directing research that will allow the company identify new marketing opportunities, e.g. variants of
the existing products/services already offered in the market.

- Promoting good relationships with customers and distributors.

5. VP for Production: The following are among the responsibilities of VP for Production:

- Ensuring production meets customer demands.

-Identifying production technology/process that minimizes production cost and make the company cost competitive.

- Coming up with a production plan that maximizes the utilization of the company’s production facilities.

- Identifying adequate and cheap raw material suppliers.

6. VP for Administration: The following are among the responsibilities of VP for Administration:

- Coordinating the functions of administration, finance, and marketing departments.

- Assisting other departments in hiring employees.

- Providing assistance in payroll preparation, payment of vendors, and collection of receivables.

- Determining the location and the maximum amount of office space needed by the company.

- Identifying means, processes, or systems that will minimize the operating costs of the company.

7. VP for Finance: The role of the Financial Manager is to determine the appropriate capital structure of the
company. Capital structure refers to how much of your total assets is financed by debt and how much is financed by
equity.

*The three (3) main functions of VP for Finance:

2
a. Financing decisions - include making decisions on how to fund long term investments (such as company
expansions) and working capital which deals with the day to day operations of the company.

b. Operating decisions - deal with the daily operations of the company. The role of the VP for finance
is to determine how to finance working capital accounts such as accounts receivable and inventories. The company
has a choice on whether to finance working capital needs by long term or short term sources.

c. Dividend policies - cash dividends are paid by corporations to existing shareholders based on their shareholdings
in the company as a return on their investment. Some investors buy stocks because of the dividends they expect to
receive from the company.

*Non-declaration of dividends may disappoint these investors. Hence, it is the role of a financial manager to
determine when the company should declare cash.

- Before a company may be able to declare cash dividends, two conditions must exist:

1. The company must have enough retained earnings (accumulated profits) to support cash dividend declaration.

2. The company must have cash.

*Investments may either be short term or long term.

- Short term investment decisions are needed when the company is in an excess cash position.

- Long term investments should be supported by a capital budgeting analysis which is among the responsibilities of a
finance manager.

• To plan for this, the Financial Manager should be able to make use of Financial Planning tools such as budgeting
and forecasting.

• Capital budgeting analysis is a tool to assess whether the investment will be profitable in the long run.

The role of financial manager, particularly in business, is changing in response to technology advances that have
significantly reduce the amount it takes to produce financial reports. Financial managers typically perform different
roles in the company such as:

 Prepare financial statements, business activity reports and forecasts

 Monitor financial details to ensure that the legal requirements are met.

 Supervise employees who do financial reporting and budgeting

 Review company financial report and seek ways to reduce cost

 Analyze market trends to find opportunities for expansion or acquiring other companies.

 Help management make financial decision

*IMPORTANT SKILLS OF A FINANCIAL MANAGER

 Analytical Skills - Financial managers increasingly assist executives in making decisions that affect the
organization, a task for which they need analytical ability.

 Communication Skills - Excellent communication are needed to explain and justify complex financial
transactions.

 Attention Details - in preparing and analyzing report such as balance sheets and income statements, financial
manager must pay attention to detail.

3
  Math Skills - Financial managers must be skilled in math including algebra. An understanding of international
finance and complex financial documents also is important.

 Organizational Skills - Financial managers deal with a range of information and documents they must stay
organized to do their jobs respectively.

FINANCIAL INSTITUTIONS, FINANCIAL INSTRUMENTS AND FINANCIAL MARKETS

Financial Institutions – intermediaries that channel the savings of individuals, businesses, and governments into
loans or investments.

*Financial institutions actively participate in the financial markets as both suppliers and users of funds.

Examples of financial institutions:

- Commercial Banks - Individuals deposit funds at commercial banks, which use the deposited funds to provide
commercial loans to firms and personal loans to individuals, and purchase debt securities issued by firms or
government agencies.

Insurance Companies - Individuals purchase insurance (life, property and casualty, and health) protection with
insurance premiums. The insurance companies pool these payments and invest the proceeds in various securities
until the funds are needed to pay off claims by policyholders. Because they often own large blocks of a firm’s stocks
or bonds, they frequently attempt to influence the management of the firm to improve the firm’s performance, and
ultimately, the performance of the securities they own.

- Mutual Funds - Mutual funds are owned by investment companies which enable small investors to enjoy the
benefits of investing in a diversified portfolio of securities purchased on their behalf by professional investment
managers. When mutual funds use money from investors to invest in newly issued debt or equity securities, they
finance new investment by firms. Conversely, when they invest in debt or equity securities already held by investors,
they are transferring ownership of the securities among investors.

- Pension Funds - Financial institutions that receive payments from employees and invest the proceeds on their
behalf.

- Other financial institutions include pension funds like Government Service Insurance System (GSIS) and Social
Security System (SSS), unit investment trust fund (UITF), investment banks, and credit unions, among others.

Financial Instruments – is a real or a virtual document representing a legal agreement involving some sort-of
monetary value. These can be debt securities like corporate bonds or equity like shares of stock.

*When a financial instrument is issued, it gives rise to a financial asset on one hand and a financial liability or equity
instrument on the other.

Equity Instrument - is any contract that evidences a residual interest in the assets of an entity after deducting all
liabilities.

*When companies are in need of funding, they either sell debt securities (or bonds) or issue equity instruments. The
proceeds from the sale of the debt securities and issuance of bonds will be used to finance the company’s plans. On
the other hand, investors buy debt securities of equity instruments in hopes of receiving returns through interest,
dividend income or appreciation in the financial asset’s price.

Examples of Debt and Equity Instruments:

1.Debt Instruments generally have fixed returns due to fixed interest rates. Examples of debt instruments are as
follows:

4
• Treasury Bonds and Treasury Bills are issued by the Philippine government. These bonds and bills have usually low
interest rates and have very low risk of default since the government assures that these will be paid.

• Corporate Bonds are issued by publicly listed companies. These bonds usually have higher interest rates than
Treasury bonds. However, these bonds are not risk free. If the company which issued the bonds goes bankrupt, the
holder of the bonds will no longer receive any return from their investment and even their principal investment can
be wiped out.

Equity Instruments generally have varied returns based on the performance of the issuing company.

Returns from equity instruments come from either dividends or stock price appreciation. The following are types of
equity instruments:

Preferred Stock has priority over a common stock in terms of claims over the assets of a company.

This means that if a company were 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. Moreover, preferred
stockholders have also priority over common stockholders in cash dividend declaration. Dividends to preferred
stockholders are usually in a fixed rate. No cash dividends will be given to common stockholders unless all the
dividends due to preferred stockholders are paid first.

Holders of Common Stock on the other hand are the real owners of the company. If the company’s growth is
spurring, the common stockholders will benefit on the growth. Moreover, during a profitable period for which a
company may decide to declare higher dividends, preferred stock will receive a fixed dividend rate while common
stockholders receive all the excess.

Financial Markets – organized forums in which the suppliers and users of various types of funds can make
transactions.

Classification of Financial Markets:

Primary vs. Secondary Markets

• To raise money, users of funds will go to a primary market to issue new securities (either debt or equity) through a
public offering or a private placement.

*Primary Market - Financial market in which securities are initially issued; the only market in which the issuer is
directly involved in the transaction.

The sale of new securities to the general public is referred to as a public offering and the first offering of stock is
called an initial public offering. The sale of new securities to one investor or a group of investors (institutional
investors) is referred to as a private placement.

• However, suppliers of funds or the holders of the securities may decide to sell the securities that have previously
been purchased. The sale of previously owned securities takes place in secondary markets.

*Secondary market - Financial market in which preowned securities (those that are not new issues) are traded.

• The Philippine Stock Exchange (PSE) is both a primary and secondary market.

Money Markets vs. Capital Markets

• Money markets are a venue wherein securities with short-term maturities (1 year or less) are sold.

They are created because some individuals, businesses, governments, and financial institutions have temporarily idle
funds that they wish to invest in a relatively safe, interest-bearing asset.

At the same time, other individuals, businesses, governments, and financial institutions find themselves in need of
seasonal or temporary financing.

5
• On the other hand, securities with longer-term maturities are sold in Capital markets. The key capital market
securities are bonds (long-term debt) and both common stock and preferred stock (equity, or ownership).

*Money market - A financial relationship created between suppliers and users of short-term funds.

*Capital market - A market that enables suppliers and users of long-term funds to make transactions.

ACTIVITY #. Multiple Choice. Write the letter of the correct answer.

1. A ______ is one financial intermediary handling individual savings. It receives premium payments

that are placed in loans or investments to accumulate funds to cover future benefits.

A. life insurance company

B. commercial bank

C. savings bank

D. credit union

2. The key participants in financial transactions are individuals, businesses, and governments. Individuals are net
______ of funds, and businesses are net ______ of funds.

A. suppliers; users

B. purchasers; sellers

C. users; suppliers

D. users; providers

3. Which of the following is not a financial institution?

A. A pension fund

B. A newspaper publisher

C. A commercial bank

D. An insurance company

4. A ______ is set up so that employees of corporations or governments can receive income after retirement.

A. life insurance company

B. pension fund

C. savings bank

D. credit union

5. A ______ is a type of financial intermediary that pools savings of individuals and makes them available to business
and government users.

Funds are obtained through the sale of shares.

A. mutual fund

6
B. savings and loans

C. savings bank

D. credit union

6. Most businesses raise money by selling their securities in:

A. a direct placement.

B. a stock exchange.

C. a public offering.

D. a private placement.

7. Which of the following is not a service provided by financial institutions?

A. Buying the businesses of customers

B. Investing customers’ savings in stocks and bonds

C. Paying savers’ interest on deposited funds

D. Lending money to customers

8. Government usually:

A. borrows funds directly from financial institutions.

B. maintains permanent deposits with financial institutions.

C. is a net supplier of funds.

D. is a net demander of funds.

9. By definition, the money market involves the buying and selling of _________________

A. funds that mature in more than one year.

B. flows of funds.

C. stocks and bonds.

D. short-term funds.

10. The ______ is created by a financial relationship between suppliers and users of short-term funds.

A. financial market

B. money market

C. stock market

D. capital market

7
*Note: The figure above illustrates how the key financial institutions serve as intermediaries for suppliers and users
of funds.

The Role of Financial Manager in the Flow of Funds

-Financial managers make financing decisions that require funding from investors in the financial markets.
The Role of Financial Markets in the Flow of Funds
-The financial markets provide a forum in which firms can issue securities to obtain the funds that they
need and in which investors can purchase securities to invest their funds.
Role of Investors in the Flow of Funds
-Investors provide the funds that are to be used by financial managers to finance corporate growth.

ACTIVITY #: TRUE or FALSE. Write True if the statement is True otherwise write False.
1. To achieve the goal of profit maximization for each alternative being considered, the financial manager
would select the one that is expected to result in the highest monetary return. – True
2. Dividend payments change directly with changes in earnings per share. – False
3. The wealth of corporate owners is measured by the share price of the stock. – True
4. Financial markets are intermediaries that channel the savings of individuals, businesses, and government
into loans or investments. – False
5. The money market involves trading of securities with maturities of one year or less while the capital
market involves the buying and selling of securities with maturities of more than one year. – True

8
 STEPS IN THE FINANCIAL PLANNING PROCESS
- Planning is an important aspect of the firm’s perations because it provides road maps for guiding, coordinating, and
controlling the firm’s actions to achieve its objectives (Gitman & Zutter, 2012).

- Management planning is about setting the goals of the organization and identifying ways on how to achieve them.

• Long-term financial plans

- These are a set of goals that lay out the overall direction of the company.

- A long-term financial plan is an integrated strategy that takes into account various departments such as sales,
production, marketing, and operations for the purpose of guiding these departments towards strategic goals.

- Those long-term plans consider proposed outlays for fixed assets, research and development activities, marketing
and product development actions, capital structure, and major sources of financing.

• Short-term financial plans

- Specify short-term financial actions and the anticipated impact of those actions. Part of short term financial plans
include setting the sales forecast and other forms of operating and financial data. This would then translate into
operating budgets, the cash budget, and pro forma financial statements (Gitman & Zutter, 2012).

Long-Term Planning Short Term Planning

Persons Involved More participation from top management. Top management is still involved but there is
more participation from lower level managers
(production, marketing, personnel, finance and
plant facilities) because their inputs are crucial at
this stage since they are the ones who implement
these plans

Time Period 2 to 10 years 1 year or less

Level of Details Less More

Focus Direction of the company Everyday functioning of the co.

STEPS IN PLANNING

A. Set goals or objectives.

For corporations, long term and short term objectives are usually identified. These can be seen in the company’s
vision and mission statements. The vision statement states where the company wants to be while the mission
statement states the plans on how to achieve the vision.

B. Identify Resources.

The materials needed, manpower, machine, etc

C. Identify goal-related tasks.

Preparation in the accomplishment of the task

9
D. Establish responsibility centers for accountability and timeline.

Assign or distribute tasks/role to the members.

E. Establish the evaluation system for monitoring and controlling.

For corporations, the management must establish a mechanism which will allow plans to be monitored. This can be
done through quantified plans such as budgets and projected financial statements. The management will then
compare the actual results to the planned budgets and projected financial statements. Any deviations from the
budgets should be investigated.

F. Determine contingency plans.

In planning, contingencies must be considered as well.

• Budgets and projected financial statements are anchored on assumptions. If these assumptions do not become
realities, management must have alternative plans to minimize the adverse effects on the company.

CHARACTERISTICS OF AN EFFECTIVE PLAN

• In planning, the goal of maximizing shareholders’ wealth must always be put in mind.

• The following criteria may be used for effective planning:

-Specific – target a specific area for improvement.

-Measurable – quantify or at least suggest an indicator of progress.

-Assignable – specify who will do it.

-Realistic – state what results can realistically be achieved, given available resources.

-Time-related – specify when the result(s) can be achieved.

FORMAT FOR THE PREPARATION OF BUDGETS AND PROJECTED FINANCIAL STATEMENT

1. Cash

• Being the most liquid asset, cash is an important account in the balance sheet that will affect the liquidity, and
solvency of a company. It is also the most vulnerable when it comes to theft.

A good internal control must be properly implemented to safeguard this asset:

- A basic internal control system entails the assignment of custodial function and recording function to separate
individuals, unless you are the owner. Why is this so? Imagine a cashier of a company who is also the chief
accountant. If tempted, this person can steal cash from the company and can manipulate the records so that nobody
can discover that he is stealing. If you are the owner, you probably will not steal from yourself and adjust the
records?

- Cash collections should be supported by official receipts which are summarized in a daily collection report. The
daily collection report is going to useful for the next control measure for cash – depositing collections.

- A good internal control over cash is by depositing all collections intact. The daily collection reports are now
compared with the deposit slips to find out if all collections are indeed deposited.

- If all collections need to be deposited, then payments must be made through a check voucher system. There must
also be two signatories in the check to provide a check and balance. If the business is small then the entrepreneur’s
signature may suffice.

The check must also be cross-checked by drawing two lines on the payee section of the check.

10
This cross-checking requires depositing of a check. It cannot be encashed. This makes it more difficult for somebody
who stole a check to get the money.

2. Motives For Holding Cash

• The following are the reasons for holding cash:

- Primary Reasons

a. Transactional. This is the cash used for paying expenses such as salaries, utilities, rent and taxes, among others.

b. Compensating balance. This is the cash held to meet bank requirements such as the minimum cash balance you
maintain for checking accounts and if you have existing loans, banks may also require a minimum amount of deposit
with them.

- Secondary Reasons

a. Precautionary. This is the cash maintained for emergencies such as the additional cash you keep during political
and economic uncertainties. For example, if your business requires a substantial amount of importation, a relatively
higher amount of cash has to be maintained when the exchange rate becomes highly volatile due to political
instability such as what happened during EDSA II.

b. Speculative. This refers to the cash held by the company to take advantage of opportunities (e.g. buying stocks
during major corrections such as what happened at the height of the global financial crisis in 2008 and 2009 where
stock valuations went down by as such as 80% for some companies).

BUDGETING CASH

• The Cash Budget

- The cash budget provides information regarding the company’s expected cash receipts and disbursements over a
given period.

- It is useful for identifying future funding requirements or excess cash within a given period. This allows managers to
find possible sources of financing if the cash budget shows cash shortage or identify appropriate tenors for money
market placements for excess cash.

- Normally, a cash budget is prepared for a one year period broken down into smaller intervals like months. This
allows managers to see the seasonality of the business which affects the cash flows.

11
Basically, cash budget has the following parts:

- Cash Receipts include all of a firm’s inflows of cash in a given financial period. The most common components of
cash receipts are cash sales, collections of accounts receivable, and other cash receipts.

- Illustrative Example:

B. Bugay Industries, a defense contractor, is developing a cash budget for October, November, and December.
Jungaya’s sales in August and September were PHP100,000 and PHP200,000 respectively. Sales of PHP400,000,
PHP300,000, and PHP200,000 have been forecast for October, November, and December respectively.

Historically, 20% of the firm’s sales have been for cash, 50% have generated accounts receivable collected after 1
month, and the remaining 30% have generated accounts receivable collected after 2 months. In December, the firm
will receive a PHP30,000 dividend from stock in a subsidiary.

*Required: Prepare the cash receipts section of the cash budget.

The Solution:

Cash Disbursements include all outlays of cash by the firm during a given financial period. The most common cash
disbursements are:

• Cash purchases

• Purchasing fixed assets

• Payments of accounts payable

• Interest payments

• Rent (and lease) payments

• Cash dividend payments

• Wages and salaries

• Principal payments (loans)

• Tax payments

• It is important to recognize that depreciation and other noncash charges are not included in the cash budget,
because they merely represent a scheduled write-off of an earlier cash outflow.

• Illustrative Example:

Jungaya Industries has gathered the following data needed for the preparation of a cash disbursements schedule for
October, November, and December.

12
- Purchases - The firm’s purchases represent 70% of sales. Of this amount, 10% is paid in cash, 70% is paid in the
month immediately following the month of purchase, and the remaining 20% is paid 2 months following the month
of purchase.

Rent Payments - Rent of PHP5,000 will be paid each month.

- Wages and Salaries - Fixed salary cost for the year is PHP96,000, or PHP8,000 per month. In addition, wages are
estimated as 10% of monthly sales.

- Tax Payments - Taxes of PHP25,000 must be paid in December.

- Fixed Assets - New machinery costing PHP130,000 will be purchased and paid for in November.

- Interest Payments - An interest payment of PHP10,000 is due in December.

The Solution:

Forecasted purchase (70%) 70,000 140,000 280,000 210,000 140,000

  August September October November December

Cash Purchases (10%) P7,000 P14,000 P28,000 P21,000 P14,000

Payment of AP          

1st month (70%)   P49,000 P98,000 P196,000 P147,000

2nd month (20%)     P14,000 P28,000 P56,000

Total Cash Purchases  P7,000 P63,000  P140,000  P245,000  P217,000

Rent   P5,000  P5,000  P5,000

Wages and Salaries P48,000  P38,000  P28,000

Tax   P25,000

Machinery Purchases     P130,000 

Interest     P10,000

TOTAL CASH DISBURSEMENT P7,000  P63,000  P193,000 P418,000 P285,000

PRODUCTION BUDGET

What is production budget and how it is formulated?

Production budget provides information regarding the number of units that should be produced over a given
accounting period based on expected sales and targeted levels of inventories.

Computation of Production Budget

*Note: Ending inventory of current period is beginning inventory of next period.

13
Example: ABM Company forecasts sales in units for January to May as follows:

Condition:

• ABM Company would like to maintain 100 units in its inventory at the end of each month.

• Beginning inventory at the start of January amounts to 50 units.

Required:

• How many units should Company produce in order to fulfill the expected sales of the company?

Solution:

14