INTRODUCTION TO FINANCIAL MANAGEMENT

NATURE OF FINANCIAL MANAGEMENT

Financial Management is broadly concerned with the acquisition and use of funds by a business firm. It refers to planning, acquiring,
utilization and controlling of financial resources/activities. It is the business function that deals with investing the available financial resources in a
way that greater business success and return-on-investment (ROI) is achieved.

 Estimates capital requirements  Decides capital structure

 Select source of fund  Select investment pattern
 Raises shareholders value  Management of cash
 Apply financial controls

THE GOAL OF FINANCIAL MANAGEMENT

 is to make money and add value for the owners.

 to maximize shareholder wealth. For public companies this is the stock price, and for private companies this is the market value of the
owners' equity.

THERE ARE TWO GOALS OF FINANCIAL MANAGEMENT

1. PROFIT MAXIMIZATION (PROFIT AFTER TAX)

main aim of any business and therefore it is also an objective of financial management. It represents the process or the
approach by which profits Earning Per Share (EPS) is increased. In simple words, all the decisions whether investment of financing etc. are
focused on maximizing the profits to optimum levels. Profit maximization is the traditional approach and the primary objective of
financial management. It implies that every decision relating to business is evaluated in the light of profits. All the decisions with respect
to new projects, acquisition of assets, raising capital etc. are studied for their impact on profits and profitability. If the result of a decision
is perceived to have a positive effect on the profits, the decision is taken further for implementation.

ADVANTAGES DISADVANTAGES
• Measurement standard • Haziness of the concept " profit"
• Social welfare • Ignores time value of money
• Economical welfare • Ignore risk
• Ignore quality

2. MAXIMIZING EARNINGS PER SHARE (EPS)

STEPS FOR ACHIEVING THE OBJECTIVE OF WEALTH MAXIMIZATION
The objectives of financial management are such that they should be beneficial to owners, management, employees &
customers. These objectives can be accomplished only by maximizing the Value of the firm through the following ways:

PROFIT MAXIMIZATION WEALTH MAXIMIZATION

• It take into account time value of money • It does not take into account time value of money.
• It takes into account the risk factor • It does not take into consideration the uncertainty of future
• It takes into account the effect of dividend policy earnings
on market price of shares • It does not consider the effect of dividend policy on market
• Considers the different strategies for long term price of shares
and short term profits. • It does not differentiate between the short term and long term
profits
• Increase in profits • Minimize Risk
• Reduction in cost • Long run value
• Sources of Funds • Good track record of dividend payment

"Wealth maximization is superior criteria than profit maximization"

 Financial management is one of the important parts of overall management, which is directly related with various functional departments
like personnel, marketing and production. Financial management covers wide area with multidimensional approaches.

Financial management helps a particular organization to utilize their finances most profitably. This is achieved via the following two
conducts:

1. Traditional Approach
Financial management is primarily concerned with acquisition, financing and management of assets of business concern in
order to maximize the wealth of the firm for its owners.
The basic responsibility of the finance manager is to acquire funds needed by the firm and investing those funds in profitable
ventures that will maximize the firm’s wealth, as well as, generating returns to the business concern.
Briefly, the traditional view of financial management looks into the following functions that a financial manger of a business firm will
perform:
a. Procurement of short term as well as long term funds from financial institutions
b. Mobilization of funds through financial instruments such as equity shares, preference shares, debentures, bonds, notes and so
forth
c. Compliance with legal and regulatory provisions relating to funds procurement, use and distribution as well as coordination of
the finance function with the accounting function.

2. Modern Approach
With modern business situation increasing in complexity, the role of finance manger which initially is just confined to
acquisition of funds, expanded to judicious and efficient use of funds available to the firm , keeping in view the objectives of the firms and
expectations of the providers of funds.
In view modern approach, the finance manager is expected to analyze the business firm and determine the total funds
requirements of the firm, the assets or resources to be acquired, the best pattern of financing the assets and how best to satisfy the
investors’ expected return on their investment.

TYPES OF FINANCIAL DECISIONS

1. INVESTMENT DECISION
A financial decision which is concerned with how the firm’s funds are invested in different assets is known as investment
decision. Investment decision can be long-term or short-term.

Long term investment decision Short term investment decision

( Capital budgeting decisions ) ( Working Capital decisions )

 Which involve huge amounts of long-term investments
and are irreversible except at a huge cost.
 A bad capital budgeting decision normally has the
capacity to severely damage the financial fortune of a
business.
 Which affect day to day working of a business. It
includes the decisions about the levels of cash,
inventory and receivables
 A bad working capital decision affects the liquidity and
profitability of a business.

FACTORS AFFECTING INVESTMENT DECISION/CAPITAL BUDGETTING DECISIONS:

a. Cash flows of the project

The series of cash receipts and payments over the life of an investment proposal should be considered and analyzed for
selecting the best proposal.

b. Rate of return
The expected returns from each proposal and risk involved in them should be taken into account to select the best proposal.

c. Investment criteria involved

The various investment proposals are evaluated on the basis of capital budgeting techniques. Which involve calculation
regarding investment amount, interest rate, cash flows, rate of return etc. It is to be considered which technique to use for evaluation of
projects

2. FINANCING DECISION
 Concerned with the amount of finance to be raised from various long term sources of funds like, equity shares, preference
shares, debentures, bank loans etc. Is called financing decision. In other words, it is a decision on the ‘capital structure’ of the company.

Financial Risk:
The risk of default on payment of periodical interest and repayment of capital on ‘borrowed funds’ is called financial risk.

Factors Affecting Financing Decision:

The cost of raising funds from different sources is different. The cost of equity is more than the cost of debts. The cheapest
source should be selected prudently.
The risk associated with different sources is different. More risk is associated with borrowed funds as compared to owner’s
fund as interest is paid on it and it is also repaid after a fixed period of time or on expiry of its tenure.

Flotation Cost
The cost involved in issuing securities such as broker’s commission, underwriter’s fees, expenses on prospectus etc. Is called
flotation cost. Higher the flotation cost, less attractive is the source of finance.

Cash Flow Position Of The Business

In case the cash flow position of a company is good enough then it can easily use borrowed funds.

Control considerations
In case the existing shareholders want to retain the complete control of business then finance can be raised through borrowed
funds but when they are ready for dilution of control over business, equity shares can be used for raising finance.

State of capital markets

During boom period, finance can easily be raised by issuing shares but during depression period, raising finance by means of
debt is easy.

3. DIVIDEND DECISION
A financial decision which is concerned with deciding how much of the profit earned by the company should be distributed
among shareholders (dividend) and how much should be retained for the future contingencies (retained earnings) is called dividend
decision.
Dividend refers to that part of the profit which is distributed to shareholders. The decision regarding dividend should be taken
keeping in view the overall objective of maximizing shareholder s wealth.

Factors affecting Dividend Decision:

a. EARNINGS
Company having high and stable earning could declare high rate of dividends as dividends are paid out of current and
past earnings.
b. STABILITY OF DIVIDENDS
Companies generally follow the policy of stable dividend. The dividend per share is not altered in case earning
changes by small proportion or increase in earnings is temporary in nature.
c. GROWTH PROSPECTS
In case there are growth prospects for the company in the near future then, it will retain its earnings and thus, no or
less dividend will be declared.

d. CASH FLOW POSITIONS

Dividends involve an outflow of cash and thus, availability of adequate cash is foremost requirement for declaration
of dividends.
e. PREFERENCE OF SHAREHOLDERS
While deciding about dividend the preference of shareholders is also taken into account. In case shareholders desire
for dividend then company may go for declaring the same. In such case the amount of dividend depends upon the degree of
expectations of shareholders.
f. TAXATION POLICY
A company is required to pay tax on dividend declared by it. If tax on dividend is higher, company will prefer to pay
less by way of dividends whereas if tax rates are lower, then more dividends can be declared by the company.

SIGNIFICANCE/IMPORTANCE OF FINANCIAL MANAGEMENT

 • Financial Planning
• Financial management helps to determine the financial
requirement of the business concern and leads to take financial
planning of the concern. Financial planning is an important part
of the business concern, which helps to promotion of an
enterprise.
• Acquisition of Funds
• Financial management involves the acquisition of required
finance to the business concern. Acquiring needed funds play a
major part of the financial management, which involve possible
source of finance at minimum cost.
• Proper Use of Funds
• Proper use and allocation of funds leads to improve the
operational efficiency of the business concern. When the
finance manager uses the funds properly, they can reduce the
cost of capital and increase the value of the firm.
• Financial Decision
• Financial management helps to take sound financial
decision in the business concern. Financial decision will
affect the entire business operation of the concern.
• Improve Profitability
• Profitability of the concern purely depends on the
effectiveness and proper utilization of funds by the
business concern.
• Increase the Value of the Firm
• Financial management is very important in the field of
increasing the wealth of the investors and the business
concern. Ultimate aim of any business concern will achieve
the maximum profit and higher profitability leads to
maximize the wealth of the investors as well as the nation.
• Promoting Savings
• Savings are possible only when the business concern
earns higher profitability and maximizing wealth.

Relationship between Financial Management and Accounting

The terms financial management and financial accounting are subsidiaries of the word FINANCE. Financial accounting and financial
management are two separate functions of finance where financial accounting requires reporting past financial transactions. In contrast, on the
other hand, financial management requires planning for future transactions.

FINANCE deals with money management, while accounting assesses financial deals and activities. To define both of them precisely,
Finance is the process of money management that deals with the flow of money through an organization. On the other hand, accounting is the
process of recording, reporting, and evaluating the financial deals and transaction of a business. It helps prepare statements or declarations that
concern assets and liabilities and the outcome of business operations.

Finance is the branch of accounting and hence they are interrelated to each other. Accounting analyses the historical transaction of
organizations and prepares financial statements on the basis of the information and data. it states what assets and liabilities are held by a company
by presenting a balance sheet.

HERE ARE A FEW WAYS HOW FINANCE IS RELATED TO ACCOUNTING

1. Accounting prepares financial statements and keeps the record of financial transactions, liabilities, and assets of an organization, and
finance makes investment decisions by evaluating this record and data
2. Financial management includes the planning and control of all financial activities, while management accounting deals with the internal
management of finance
3. The financial manager evaluates the accounts statement, prepare additional data and makes a planned decision.
4. A good financial management is the outcome of a good accounting.

WHAT IS STRATEGIC FINANCIAL MANAGEMENT?

Strategic financial management means not only managing a company's finances but managing them with the intention to succeed—that
is, to attain the company's long-term goals and objectives and maximize shareholder value over time.

The Elements of Strategic Financial Management

A company will apply strategic financial management throughout its organizational operations, which involves designing elements that
will maximize the firm's financial resources and use them efficiently. Here a firm needs to be creative, as there is no one-size-fits-all approach to
strategic management, and each company will devise elements that reflect its own particular needs and goals. However, some of the more
common elements of strategic financial management could include the following.

• Planning
• Budgeting
• Managing and assessing Risk
• Establishing Ongoing Procedures

Financial Business Objectives

 Financial objectives typically focus on increasing a business's profits or sales, but they may also focus on investments and economic
stability. Financial objectives are often measurable goals that businesses can track and reach. These objectives typically focus on long-term success.

Responsibilities To Achieve The Financial Objectives

• Investing
• Financing
• Operating

FUNCTIONS OF FINANCIAL MANAGEMENT (CHAPTER 3)

ROLE OF FINANCE MANAGER

Having examined the field of finance and some of its more recent developments, let us turn our attention to the functions of the financial manager.

THE FINANCE ORGANIZATION

The financial management function is usually associated with a top officer of the firm
such as Vice President of Finance or some other Chief Financial Officer (CFO). The chart presents
the simplified organizational chart that highlights the finance activity in large firm. As shown, the
Vice President of finance coordinates the activities of the treasurer and the controller. The
Controller’s office handles cost and financial accounting, tax payments, and management
information systems. The Treasurer’s office is responsible for managing the firm’s cash and credit,
its financial planning, and its capital expenditures.

RELATIONSHIP WITH OTHER KEY FUNCTIONAL MANAGERS IN THE ORGANIZATION

Finance is one of the major functional areas of a business. For example, the functional
areas of business operations for a typical manufacturing firm are manufacturing, marketing, and
finance. Manufacturing deals with the design and production of a product. Marketing involves the
selling, promotion, and distribution of a product. Manufacturing and marketing are critical for the
survival of a firm because these areas determine what will be produced and how these products
will be sold. However, these other functional areas could not operate without funds. Since finance
is concerned with all of the monetary aspects of a business, the financial manager must interact
with other managers to ascertain the goals that must be met, when and how to meet them. Thus,
finance is an integral part of total management and cuts across functional boundaries.

CORPORATE GOVERNANCE

Corporate governance is the process of monitoring managers and aligning their

incentives with shareholders goals. In reality, because shareholders are usually
inactive, the firm actually seems to belong to management.
 The monitors inside a public firm are the board of directors. who are appointed represent shareholders'
interest. The board hires the CEO, evaluates management and can also design compensation contracts to tie
management's salaries to firm performance.

The monitors outside the firm include auditors, analysts, investment banks, and credit rating agencies.
External auditors examine the firm's accounting systems and comment on whether financial statements fairly represent
the firm's financial position. Investment analysts keep tract of the firm's performance, conduct their own evaluations of
the company's business activities, and report to the investment community. Investment banks, which help firms access
capital markets, also monitor firm performance. Credit analysts examine a firm's financial strength for its debt holders.
The Government also monitors business activities through the Securities and Exchange Commission (SEC), Bureau of
Internal Revenue (BIR). Bangko Sentral ng Pilipinas (BSP), and so forth.

Jobs in Finance

Finance prepares students for jobs in banking, investments, insurance, corporations and the government. Accounting
students need to know finance, marketing, management and human resources; they also need to understand finance,
for it affects decisions in all those areas.

• For example, marketing people propose advertising programs, but those programs are examined by finance
people to judge the effects of the advertising on the firm's profitability.

So, to be effective in marketing, one needs to have a basic knowledge of finance. It is also worth noting that
finance is important to individuals regardless of their jobs. Some years ago, most businesses provided pensions to their
employees, so managing one's personal investments was not critically important. That's no longer true. Most firms
today provide what's called "defined contribution" pensions plans, where each year the company puts a specified
amount of money into an account that belongs of the employee. The employee must decide how those funds are to be
invested - how much should be divided among stocks, bonds or money funds and how risky the equity shares and bonds
should be. These decisions have a major effect on people's lives, and the concepts covered in this book can improve
decision-making skills.

ETHICAL BEHAVIOR

Ethics are of primary importance in any practice of finance. Finance professionals commonly manage other
people's money. For instance, corporate managers control the stockholders' firm, bank employees perform cash receipts
and disbursements functions and investment advisors manage people's investment portfolios.

These fiduciary relationships oftentimes create tempting opportunities for finance professionals to make
decisions that either benefit the client or benefit the advisors themselves. Strong emphasis on ethical behavior and
ethics training and standards are provided by professional associations such as the Finance Executives of the Philippines
(FINEX), Bankers Association of the Philippines, Investment Professionals, and so forth. Nevertheless, as with any
profession with millions of practitioners, a few are bound to act unethically. In a number of instances, the corporate
governance system has created ethical dilemmas and has failed to prevent unethical managers from stealing from firms
which ultimately means stealing from owners or stockholders.

BUSINESS ORGANIZATION AND TRENDS

THE ORGANIZATION OF THE BUSINESS FIRM

Business firm- is an entity designed to organize raw materials, labor, and machines with the goal of producing goods
and/or services.

1. purchase productive resources from household and other firms

2. transform them into a different commodity

3. sell the transformed product or service to consumers

Business firms can be organized in one of three ways: as a proprietorship, partnership, or corporation

LEGAL FORMS OF BUSINESS ORGANIZATION

Proprietorship

A sole proprietorship is a business owned by a single person who has complete control over business decisions. This
individual owns all the firm's assets and is responsible for all its liabilities.

Advantage
1. Ease of entry and exit
A sole proprietorship requires no formal charter and is
inexpensive to form and dissolve.
2. Full ownership and control
The owner has full control, reaps all profit and bears all
losses.
3. Tax savings
The entire income generated by the proprietorship
passes directly to the owner. This may result in a tax
advantage if the owner's tax rate is less than the tax rate
of a corporation.
4. Few government regulations
A sole proprietorship has the greatest freedom as
compared with any form of business organization
Disadvantage
1. Unlimited liability
The owner is personally liable or responsible for any and
all business debts. Thus, the owner's personal assets can
be claimed by the creditors if the firm defaults on its
obligations.
2. Limitations in raising capital
Fund-raising ability is limited. Resources may be limited
to the assets of the owner and growth may depend on his
or her ability to borrow money.
3. Lack of continuity
Upon death or retirement of the owner, the
proprietorship ceases to exist.
The proprietorship may be ideal form of business
organization when the following conditions exist.
• The anticipated risk is minimum and adequately
covered by insurance.
• The owner is either unable or unwilling to maintain the
necessary organization documents and tax returns of
more complicated business entities.
• The business does not require extensive borrowing.

PARTNERSHIP

A partnership is a legal arrangement in which two or more persons agree to contribute capital or services to the business
and divide the profits or losses that may be derived thereform. Partnership may operate under varying degrees of
formality. For example, a formal partnership may be established using a written contract known as the partnership
agreement which is filed with the Securities and Exchange Commission.

Partnership may be either general or limited.

A general partnership is one in which each partner has unlimited liability for the debts incurred by the business. General
partners usually manage the firm and may enter into contractual obligations on the firm's behalf. Profits and asset
ownership may be divided in any way agreed upon by the partners.

A limited partnership is one containing one or more general partners and one or more limited partners. The personal
liability of a general partner for the firm's debt is unlimited while the personal liability of limited partners is limited to
their investment. Limited partners cannot be active in management.

Advantage Disadvantage
1. Ease of formation 1. Unlimited liability
 Forming a partnership may require relatively little effort
and low start-up costs
2. Additional sources of capital
A partnership has the financial resources of several
individuals.
3. Management base
A partnership has a broader management base or
expertise than a sole proprietorship.
4. Tax implication
A partnership like a proprietorship does not pay any
income taxes. The income or loss of the business is
distributed among the partners in accordance with the
partnership and each reports his or her portion whether
distributed or not on personal income tax return.
General partners have unlimited liability for the debts
and litigations of the business.
2. Lack of continuity
A partnership may dissolve upon the withdrawal or death
of a general partner, depending on the provisions of the
partnership.
3. Difficulty o transferring ownership
It is difficult for a partner to liquidate or transfer
ownership. It varies with conditions set forth in the
partnership agreement.
4. Limitations in raising capital
A partnership may have problems raising large amounts
of capital because many sources of funds are available
only to corporations.

CORPORATION

A corporation is an artificial being created by law and is a legal entity separate and distinct from its owners. This legal
entity may own assets,borrow money and engage in other business entities without directly involving the owners. In
many corporations, owners who are also called shareholders do not directly manage the firm. Instead they select
managers designated as the Board of Directors to run the firm for them. The Board of Directors is authorized to act in
the coporation's behalf.

The incorporation process is initiated by filing the articles of incorporation and other requirements with the Securities
and Exchange Commission (SEC). The articles of incorporation includes among others the following:

• Incorporators

• Name of the corporation

• Purpose of the corporation

• Capital Stock

• Authorized shares

After the corporation is legally formed, it will then issue its capital stock. Ownership of this stock is evidenced by a stock
certificate. The corporate bylaws which are rules that govern the internal management of the company are established
by the board of directors and approved by the shareholders. These bylaws may be amended or extended from time to
time by shareholder.

Advantage
1. Limited Liability
- Shareholders are liable only to the extent of their
investment in the corporation.
2. Unlimited Life
- Corporations continue to exist even after death of
the owners. The maximum legal life of a corporation is 50
years but may be renewed for the desire additional life
not to exceed 50 years.
3. Ease in transferring ownership
- Shareholders can easily sell their ownership
interest in most corporations by sellinh their stock
without affecting the legal form of business
Disadvantage
1. Time and cost of formation
- Registration of public companies with the SEC may
be time-consuming and costly.
2. Regulation
- Corporations are subject to greater government
and regulations than other forms of business
organizations. Shareholders cannot just withdraw assets
from the business. They can only receive corporate assets
when dividends are declared and these amounts may be
subject to limits imposed by law.
3. Taxes
- Corporations pay taxes on income they have
 organizations. The ability to sell stock provides earned. The complexity of the subject of taxation
corporations with a stronger financial base and the demands the advice of a qualified tax accountant.
capital needed for expansion.

4. Ability to raise capital

- Corporations can raise capital through the sale of
securities such as bonds to investors who are lending
money to the corporation and equity securities such as
common stock to investors who are the owners.

Important Business Trends

Four Important Business trends should be noted, namely:

- Increased globalization of business

- Ever Improving information technology (IT)

- Corporate Governance

- Outsourcing

1. Globalization of the Firm

- Most large corporations operate on a global basis and with good reason: investing abroad hs proven to be highly
profitable. Decisions to build plants and produce goods abroad are also motivated by the attraction of low-cost labor
and the easy transfer of highly efficient technology that gives competitive price advantages to foreign operations.

2. EVER-IMPROVING INFORMATION TECHNOLOGY

Improvements in IT are spurring globalization l, and they are changing financial management as it is practiced in North
America, Europe, Southeast Asia and elsewhere. Firm's are collecting massive data and using them takes much of the
guesswork out of financial decisions.

3. CORPORATE GOVERNANCE

This trend relates to the way the top managers operate and interface with stakeholders. At the same time, the Securities
and Exchange Commission (SEC) which has jurisdiction over the shareholders and the information that must be given has
made it easier to activist shareholders to changes the way things are done within firm.

4. OUTSOURCING

Outsourcing occurs when domestic firm invest and produce goids in foreign countries or when these firms choose to rely
on imports rather than build domestic plan and produce these goods domestically.