BAM 199/FIN 081 REVIEWER

I. INTRODUCTION
Finance is the system that includes the circulation of money. It has 3 areas:
1. Financial management is the efficient and effective planning and controlling of financial resources, so, as to
maximize profitability and ensuring liquidity for an individual (personal finance), government (public finance),
and for profit and not-for-profit organizations/firms (corporate/managerial finance).
o Is not accounting; it starts where accounting ends. It more concerned with raising, allocating and controlling the
firm’s fund.
o According to Howard and Upton, financial management is an application of general managerial principles to
the area of financial decision-making.
o According to Weston and Bringham, financial management is an area of financial decision-making,
harmonizing, individual motives and enterprise goals.
o According to Richard A. Brealey, financial management is a process of putting the available funds to the best
advantage from the long-term point of view of business objectives.
2. Capital Markets is where interest rates, stocks and bond prices are determined.
3. Investments relates to decisions concerning stocks and bonds.
FORMS OF ORGANIZATION
Forms Advantages Disadvantages
Sole Proprietorship – business o Ease of formation o Difficult to raise capital
owned by 1 individual o Subject to few regulations o Unlimited liability
Partnership – business owned by 2 o No corporate income taxes o Limited life
or more persons
Corporation – a legal entity o Unlimited life o Double taxation
created by state, separate and o Easy transfer of ownership o Cost of setup and reporting file
distinct from its owners and o Limited liability
managers. o Easy of raising capital
Managers aim to perform well so that they get incentives such as bonuses. Compensation plans that can motivate
them:
a. Reasonable compensation packages c. The threat of hostile takeovers
b. Firing of managers who don’t perform well
Stockholders wants their share to increase by earning profits; prefer riskier projects, higher return if they succeed.
Debtholders prefer contracts with fixed payments and limiting risks. Concerned with the firm’s use of additional
debt.
Business ethics is a company’s attitude and conduct toward its employees, customers, community, and stockholders.
CHARACTERISTICS OF FINANCIAL MANAGEMENT
1. Analytical Thinking – financial problems are analyzed and considered.
2. Continuous Process – before it was required rarely, now it remains busy throughout the year.
3. Basis of Managerial Decisions – all managerial decisions relating to finance are taken after considering the report
prepared by the finance manager.
4. Maintaining Balance between Risk and Profitability – larger the risk, larger the expectation of profits.
5. Coordination between Process – always a coordination between various processes of the business.
6. Centralized Nature.
Financial management is the lifeblood of the organization because the success or failure of any organization relies
not only on the quality and extent of the assets but rather how these assets are managed within the organization.
SCOPE OF FINANCIAL MANAGEMENT
1. Anticipation – future financial need it finds out how much finance is required by the company
2. Acquisition – collects finance for the company from different sources
3. Allocation – uses the collected finance to purchase fixed and current assets for the company
4. Appropriation – divides the company’s profits among shareholders, debenture holders, etc.
5. Assessment – controls all the financial activities of the company
THE FINANCIAL MANAGEMENT PROCESS
1. Financial planning. Management needs to ensure that enough fund is available at the right time to meet the needs
of the business.
2. Financial control. It is a critically important activity to help the business ensure that the business is meeting its
objectives.
3. Financial decision making.
 o Investment Decision – value creation; determines the composition of assets found on the left side of the balance
sheet (Capital Budgeting and Working Capital Management).
o Dividend Decision – whether all profits be distributed or it should be retained.
o Financing Decision – concerned with the make-up of the right hand side of the balance sheet (Capital Structure/
mix if debt and equity)
o Liquidity Decision – current asset management
10 AXIOMS THAT FORM THE BASICS OF FINANCIAL MANAGEMENT

II. TIME VALUE OF MONEY

A dollar received today is worth more than a dollar received tomorrow. Reasons are:
1. Money received now can be saved or invested now and earn interest or a return, resulting in more money in the
future;
2. Any promise of future payments of cash will always carry the risk of default; and
3. It is simple human nature for people to prefer making their purchases of goods and services in the present rather
than waiting to make them at some future time.
It can be said that a dollar was worth more to us, and thus carried more value, yesterday than it is to us
today. It also then follows that a dollar in our possession right now carries a greater value for us than a dollar we
might receive tomorrow or at some other point in the future.
A. FUTURE VALUE
FV = P (1+ r) n - 1 * n will be multiplied according to compound less 1
You invested 150,000 for 3 years at 12% compounded You invested 150,000 for 3 years at 12% compounded
annually, what is the value of your investment after 3 semi-annually, what us the value of your investment in
years? 3 years.
Step 1: 150,000 (1+.12) 3 - 1 Step 1: 150,000 (1+.12) 6 - 1
Step 2: 1.12 and then press multiply twice Step 2: 1.12 and then press multiply twice
Step 3: Press multiply 2 times Step 3: Press multiply 5 times
Step 4: Multiply it to 150,000 Step 4: Multiply it to 150,000
Total must be 210,739,20 Total must be 212,777.87
B. PRESENT VALUE
PV = P (1 + r) n *Rate will be divided according to the compound.
What is the present value of 200,000 in 12 years at What is the present value of 450,000 in 1 year,
11%? compounded semi-monthly at an annual rate of 12%?
Step 1: 200,000 (1 + .11) 12 Step 1: 450,000 (1+ .005) 24
Step 2: 1.11 and then press divide twice *note: divide the rate to 24 because of the
Step 3: Press multiply 12 times for 12 years compounding.
Step 4: Multiply it to 200,000 Step 2: Press divide twice.
Total must be 57, 168.16 Step 3: Press multiply 24 times.
Step 4: multiply it to 450,000
Total must be 399,233.55
III. COMMON SIZE ANALYSIS AND RATIO
ANALYSIS
1. Common size analysis expresses line items or accounts in
the financial statements as percentages.
a. Horizontal analysis (trend analysis) is based on two
dates. Comparative: allows trend over time to be
assessed.
 b. Vertical analysis is based on its line item for the same period only. Within-period relationship can be assessed.

2. Ratio Analysis is the second major technique for financial statement analysis. Most powerful in financial
statements.
a. Liquidity ratio is used to assess the short term debt-paying ability of a company.
i. Current ratio measures the ability of a company to pay its short-term liabilities out of short-term assets.

ii. Quick ratio or acid-test ratio measures the liquidity that compares only the most liquid assert with current
liabilities. QA can be Cash + marketable
securities + accounts receivable
(whichever is available.
iii. Accounts receivable turnover measures the liquidity of receivable or how long it turns into cash. A low
turnover may suggest a need to modify credit and collection policies to speed up the conversion of receivable
to cash.

iv. Inventory turnover ratio tells how many times the average inventory turnover or is told, during the year.
A low turnover ratio may signal the presence of too much inventory or sluggish sales.

b. Leverage ratio can help an individual to elevate a company’s debt-carrying ability. Measures the ability to meet
long term and short term obligation. Provides a measure of degree of protection provided to a company’s
creditor.
i. Times-interest-earned ratio uses the iii. Debt-to-equity ratio compares the amount of debt
income statement to assess a company’s ability to that is financed by stockholders. Creditors would
service its debts. like this ratio to be relatively low. Stockholders
would like this ratio to be higher.

ii. Debt ratio measures the degree of

protection afforded to creditors in case of
insolvency.

c. Profitability ratio gives an idea how profitable the firm is operating and utilizing its assets
i. Return on sale is the profit margin on sales. iv. Earnings per share is the profitability on a per
share basis.

ii. Return on total assets measures hoe v. Price-earnings ratio is an indicator of stock
efficiently assets are used to generate profits. values.

iii. Return on common stockholder’s equity vi. Dividend yield and payout ratio tell as investor
provides a measure that can be used to compare the proportion of earning that a company pays in
against other return measures. dividends.

RATIO ANALYSIS ADVANTAGES AND LIMITATIONS

Advantages: Simplifies financial statements, facilitates interfirm comparison, helps in planning, helps in investment
decisions.
Limitations: limitations of financial statements, comparative study required, ratio not adequate, problems of price
changes, limited use of single ratios, personal bias, incomparable.
ADDITIONAL MATERIALS
NOTES CONTINUATION