Unit 1: Introduction to Financial Management

Lesson 1.1
Financial Management
Contents
Introduction 2

Learning Objectives 3

Quick Look 3

Learn the Basics 5

Financial Management 6
The Financial System 7
Financial institutions 7
Financial Markets 8
Financial Instruments 9
Shareholders’ Wealth Maximization 10
The Corporate Organizational Structure 12
The Board of Directors 13
The President and Chief Executive O cer (CEO) 13
Vice-President for Sales and Marketing 13
Vice-President for Production 14
Vice-President for Administration 14
Vice-President for Finance 14
The Roles of Financial Manager 15
Financing Decisions 16
Investing Decisions 17
Operation Decisions 18
Dividend Policies 18
Case Study 19
Keep in Mind 20
Try This 21
Practice Your Skills 22
Challenge Yourself 24
Bibliography 25
Unit 1: Introduction to Financial Management

Lesson 1.1

Financial Management

Introduction

Every day, people deal with various transactions involving money. As a student, your financial
activities may include receiving and budgeting your allowance, borrowing money, and buying
items from stores. These daily economic activities can be associated with the concept of
financial management.

Managing your finances helps you achieve your personal goals. For instance, if you want to
buy a new item, visit new places, contribute financially to socio-civic causes, or save up for an
emergency fund, you need to plan your spending and saving strategies. You may also need
to find ways to earn or receive some extra money.

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Unit 1: Introduction to Financial Management

Similarly, businesses also need to manage their finances to achieve their business goals.
Setting up a new business, expanding into new markets, and introducing new products
(goods and services) cannot be achieved successfully without careful financial planning. In
this lesson, you will learn the fundamental concepts related to financial management.

Learning Objectives DepEd Competency

● Explain the major role of financial

In this lesson, you should be able to do the
management and the different individuals
following:
involved (ABM_BF12-IIIa-1).
● Explain financial management and its
purpose.
● Discuss the financial system and its
components.
● Identify the key people involved in
financial management and their roles.
● Evaluate the importance of financial
management for individuals and
businesses through real-life situations.

Quick Look

Personal Financial Goals

Observing healthy financial habits will contribute tremendously to your success and
prosperity in life. To secure your financial future, you need to establish and maintain these
practices early so these can become strongly integrated into your character as a person.

This habit begins with identifying your personal financial goals. You have to be clear with
what you want to achieve so that you can figure out the strategies and activities that you
need to do and perform. For instance, you may target saving a particular amount of money

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within a time frame or cutting your expenses by a certain percentage. In order to do this, you
need to have good financial understanding and awareness. You may obtain this knowledge
by consulting a financial advisor who can help you plan, allocate, invest and monitor your
money.

In the same way, companies seek the advice of financial managers to manage and control
their funds. Financial managers are instrumental in identifying and executing business
strategies. Organizations would rely on the expertise of financial managers to achieve their
fiscal goals just as how you can count on the advice of financial advisors to attain your
personal financial goals.

Questions to Ponder
1. What are your personal financial goals for this year?
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2. Try to talk to a financial expert or read articles that provide financial advice. What are
the activities that you need to do and practice to achieve your financial goals?
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3. Why do you think it is important to consult experts such as financial advisors and
financial managers in setting and achieving financial goals?
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Unit 1: Introduction to Financial Management

Learn the Basics

Experts relate finance with the activities of acquiring, spending, and managing money and
other financial assets by individuals, institutions, governments and businesses (Melicher and
Norton 2017). Personal finance, for example, deals with saving, investing, and spending
money depending on personal goals and desires. Public finance involves government
taxation, budgeting, spending, and debt to provide services to the public. In businesses,
finance deals with obtaining, managing, and using funds1 to achieve the company's goal of
maximizing shareholder value.

Finance is a broad field that deals with activities in the financial system. It has three areas of
study that interact with each other: financial institutions and markets, investments, and
financial management. Financial institutions and markets, such as banks, insurance
companies, and investment companies help facilitate the flow of funds between savers and
borrowers or investors. Meanwhile, financial management involves financial analysis and
planning, as well as decisions on investment2, financing and capital structure, and
asset-management to achieve business goals. Therefore, finance deals with the study of how
the components of a financial system manage resources and formulate important and sound
decisions.

Finance is different from accounting. Accounting is concerned with recording, preparing

periodic reports, analysis, and dissemination of information about a company’s assets,
liabilities, and equities. Financial managers utilize this accounting information and the
information obtained from financial markets to decide how a business should manage its
assets, liabilities, and equity.

1
Fund — (noun) a pool of money
2
Investment — (noun) a commitment that generates income or an increase in assets

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Essential Question

How can financial management help individuals, businesses, and

governments achieve their goals?

Financial Management
Financial management is one of the areas of study in finance. Financial management is “the
science and art of managing money” (Gitman and Zutter 2012). Here, there is an effective and
efficient application of management functions such as planning, organizing, leading, and
controlling financial assets to achieve organizational goals.

Setting up a business from the seed of an idea is not as simple as waiting for a plant to grow.
Business start-ups need initial and continuous financing, complemented by constant effort
towards growth. Plans such as offering new products, increasing production, and expanding
to new markets have to be funded. But the acquisition of funds should never be conducted in
an unanticipated manner. Financial management determines the amount of additional funds
needed and the means to obtain it. On the other hand, it also decides on how, where, and
when to invest should there be excess funds. Sound financial management and decisions
require information from the analysis of a business’s financial position and its financial
environment or situation in the financial system.

Check Your Progress

How does financial management differ from accounting?

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The Financial System

A financial system exists when people, businesses, and governments interact to facilitate
and expedite the flow of funds or financial capital between savers and borrowers or investors,
or from savings to investments. It consists of financial institutions, financial markets, and
financial instruments where the exchange of funds occurs. These transactions involve savings,
spending, paying taxes, earning interest, receiving a salary (wages), or investments. The image
below shows how funds in a financial system flow from sources to the users.

Figure 1. The financial system facilitates the flow of funds from sources to users..

Financial institutions
A financial institution is an organization that directs the transfer of financial resources from
its source to potential users (Kaliski 2007). It plays the part of an intermediary, managing the
efficient flow of funds between savers and borrowers (Collins 2012).

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Financial institutions are involved with deposit taking, finance, insurance, investment,
pension, and risk management (Kaliski 2007). They may also be broadly categorized as either
depository or non-depository institutions. Commercial banks, investment banks, and credit
unions are examples of depository institutions, whereas finance companies, insurance
companies, brokerage firms, and pension funds may be classified as non-depository (Collins
2012).

Closer Look

Commercial Banks and Insurance Companies

You might have observed your parents or elder relatives keeping a
savings account in a commercial bank. You might have also seen them
withdrawing cash from ATMs or using their debit cards as a mode of
payment for certain transactions. You may have also seen posts on social
media about various insurance and investment companies. The
organizations responsible for these activities are called financial
institutions.

Financial Markets
Financial markets pave the way for the financial manager to acquire funds from various
sources (Kaliski 2007). The exchange of financial resources happens in financial markets,
which can either be capital or money markets.

Capital markets deal with long-term debt and corporate shares. These include securities3
which are traded through brokers and dealers, which may or may not occur in an organized
stock exchange. On the other hand, money markets involve short-term debt securities such
as treasury bills4, commercial paper5, and negotiable instruments6 from the government and
other financial institutions (Collins 2012).

3
Securities — (noun) are fungible and tradable financial instruments used to raise capital in public and private markets.
4
Treasury bills — (noun) or popularly known as T-Bills are peso-denominated, short-term, fixed income securities issued by
the Republic of the Philippines through its Bureau of Treasury.
5
Commercial Paper — (noun) is an unsecured form of promissory note that pays a fixed rate of interest.
6
Negotiable Instruments — (noun) refer to securities whose ownership is easily transferable from one party to another.

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Closer Look

The Stock Exchange

You might have seen a section in the national newspaper which presents
the different stock prices of corporations in the Philippine Stock Exchange
(PSE). The PSE is where the buying and selling of stocks happen. The PSE
is an example of a well-known capital market.

Financial Instruments
A financial instrument is referred to as any contract which produces a financial asset of one
party while creating a financial liability or equity instrument of another (IFAC 2020). The
agreement is contained in a real or virtual document which deals with money. Corporate
bonds, checks, futures7, option contracts8, and shares of stock are examples of financial
instruments.

Closer Look

Credit Cards and Checks

You may have observed your parents or relatives using credit cards or
checks whenever they purchase goods or pay bills. Credit cards and
checks are classified as financial instruments.

7
Futures — (plural nouns) are derivative financial contracts obligating the buyer to purchase an asset or the seller to sell an
asset at a predetermined future date and set price.
8
Option Contracts — refer to an agreement between two parties to facilitate a potential transaction involving an asset at a
preset price and date.

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Check Your Progress

What are the main components of a financial system?

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Shareholders’ Wealth Maximization

As mentioned in the previous section, the overall goal in business finance is to maximize
shareholder value. The maximization of shareholders' wealth9 is considered a more credible
long-term goal than those concerned with either return (growth) or stability (survival) as single
objectives since it accounts for both risks10 and returns11 simultaneously. For instance, the
returns expected from two businesses, say Business X and Business Y, are equal. However,
Business Y is considered riskier. In effect, rational investors will naturally value Business X
more highly than Business Y.

Wealth maximization also balances short-term and long-term benefits in a way that
profit-maximizing goals cannot (McLaney 2009, 23). The stockholders have to be satisfied with
their investments in the company because it motivates them to invest more.

Wealth maximization is the idea of increasing the business's value to increase the value of
shares held by its stockholders. The concept requires the management to constantly seek the
highest possible returns on invested funds while decreasing any associated risk of loss. This
requires a comprehensive cash flow analysis connected with investment and consistent
attention to the business strategies.

9
Wealth — (noun) it determines the value of all the assets owned by a person, company, or country
10
Risk — (noun) a financial term for the chance of an investment’s actual gains will differ from an expected outcome or return
11
Return — (noun) it is the change in value of an asset, investment, or project over time. It can be a positive return (gain) or
negative return (loss)

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Closer Look

Increased value of shares

If a business spends the funds to develop a valuable property, say
expansion, the investment coalition possibly recognizes the future positive
cash flows associated with the new property by venturing up the price of
the company's shares. This is a concrete example of wealth maximization.

The principle of shareholders' wealth maximization should hold the objective of ensuring the
maximum return to shareholders12. This means financial management is maximizing the
price of a firm's13 common stock14. To obtain this objective, managers should consider the
risk and timing linked with expected earnings per share to maximize the stock price.

Profit maximization, unlike wealth maximization, is a short-term goal. A company may

maximize its short-term profits15 at the expense of its long-term profitability. To obtain this
goal, the company may need to borrow money to increase sales or expand production
capacity. Remember, too much borrowing may result in bankruptcy. The management may
tend to delay significant repairs and maintenance to avoid expenses and to show better
profits. Without providing necessary actions to these concerns may affect the efficiency of
the production in the long run.

An excellent performing company is a result of efficient employees. If the employees feel

safe and sound in their workplace, they will surely preserve the goal of the company. A
satisfying work environment is likely to be perceived favorably by investors. Unsatisfactory
treatment of employees may lead to a lack of commitment by staff and frequent staff
turnovers. This would be expected to lead to an unprofitable and uncertain future for the
business. A common goal will be attained if all the employees and staff of the company are
considered in the same light.

12
Shareholder — (noun) also referred as stockholder; a person, company, or institution that owns at least one share of a
company’s stock
13
Firm — (noun) it is a for-profit business that is usually a partnership type of business that provides professional services
14
Stock — (noun) also referred to as equity; it represents the ownership of a fraction of a corporation
15
Profit — (noun) it is the financial benefit of a business when the revenue produced exceeds the expenses

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Check Your Progress

How is profit maximization different from wealth maximization?

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The Corporate Organizational Structure

To maximize the wealth of the owners, financial managers need to determine the appropriate
assets16 for a business, how to acquire them, and how to use them to get the best possible
financial return from their use. Hence, the financial managers need to be familiar with the
flow of funds within the company. This task requires a good understanding of the company’s
corporate organizational structure.

A common corporation17 is divided into various departments, each of which is responsible for
a different set of tasks.

Figure 2. Financial managers have to understand the corporate organizational structure.

16
Asset — (noun) represents the economic status or resource of a company. It is something that a company or business
owns that gives future use
17
Corporation — (noun) it is a legal entity that separates the business from its owners

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The Board of Directors

A corporation is guided by a board of directors (BOD). The members of the BOD are elected
by the shareholders. The BOD represents the shareholders in overseeing the business. The
following are some of the responsibilities of the board of directors:
1. Set direction for the business and establish corporate policy18
2. Hire and terminate members of the top management including the president
3. Determine the compensation of the key executives
4. Review and disclose19 major business decisions

The President and Chief Executive Officer (CEO)

The employed management of a corporation is headed by the President and Chief Executive
Officer (CEO). The following are some of the responsibilities of a President and CEO:
1. Carries out the strategy and policy of the board of directors
2. Provides leadership for management and employees
3. Sets long-term operational direction
4. Takes accountability for all company activities and results in the BOD

In some companies, the President and the CEO are separate persons and entities; in this case,
the CEO is the highest officer in the company, and the president is the second-in-command.
The CEO focuses on growing the company's value and maximizing its wealth, while the
president works to ensure business operations go smoothly and other short-term goals, such
as profit maximization, are met.

Vice-President for Sales and Marketing

The Sales and Marketing department is generally responsible for growing the revenue and
client portfolio of the company. The Vice-President for Sales and Marketing, who heads this
department, has the following responsibilities:
1. Generates campaigns, business, and market development
2. Provides strategic direction, promotion, and advertising
3. Develops strategic sales plans based on company goals that will promote sales growth
and customer satisfaction

18
Policy — (noun) a set of guidelines or rules that determine a course of action
19
Disclose — (verb) the action of making new or secret information known

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4. Creates collateral20 materials, and management of market research

5. Oversees the developments in sales and marketing, including the activities of the team
members

Vice-President for Production

The production department is responsible for the creation of goods and services. The
Vice-President for Production heads this department, and has the following responsibilities:
1. Provides leadership and management to the production team and tracks the
development of the products
2. Oversees maintenance staff that is responsible for the equipment
3. Plans, directs, and coordinates the development and manufacture of all products that
meet customers' demands
4. Ensures that the company uses the most efficient, effective, and economically viable
methods for the production of the company's products

Vice-President for Administration

This office conducts much of the human resources and general management activities. It is
headed by the Vice-President for Administration who has the following responsibilities:
1. Ensures security and safety in publications activities
2. Coordinates with finance, and sales and marketing departments
3. Provides property management
4. Assists in recruitment
5. Assists with payroll21, employee training, and performance reviews

Vice-President for Finance

The Vice-President for Finance or the Chief Financial Officer (CFO) supervises all phases of
financial activity, and is responsible for planning and managing the company’s financial
resources. The following are the responsibilities of the Vice-President for Finance:
1. Acquires funds through financing methods
2. Leads and formulates investing decisions
3. Plans and control funds for operating activities

20
Collateral — (noun) something pledged as security for repayment of a loan, to be forfeited in the event of a default
21
Payroll — (noun) a list of a company's employees and the amount of money they are to be paid

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4. Formulates effective dividend policies

Under the CFO are several managers. The top-level financial managers in many companies
are the treasurer and the controller. Both of these positions are supported by a number of
financial specialists.

The treasurer handles external financing matters and has responsibility for the management
of a company’s cash, investments, and other financial resources as well as relationships with
investors and creditors.

The controller is concerned with internal matters such as being in charge of accounting and
the financial records of the organization and provides support for executives and other
managers in understanding and using financial data and reports.

Check Your Progress

What are the four major roles of a chief financial officer?

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The Roles of Financial Manager

Financial managers play very crucial and challenging roles. Aside from monitoring the
company's financial status, they are also tasked to analyze financial information prepared by
the accountants and implement financial plans. The following are the responsibilities and
roles of a financial manager:

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Figure 3. Financial managers are involved in different decisions.

Financing Decisions
Financial managers determine when, where, and how a company will acquire funds. These
funds can be obtained in different ways. The two major methods are equity financing and
debt financing.

Equity financing allows an ownership interest in the company to investors. Corporate equity
financing is done through the sale of stocks. In other words, if the funds come from the
company or owners themselves, then it is referred to as equity financing.

When a company borrows funds from other organizations to finance its activities, it is deemed
debt financing. It uses borrowed money to obtain needed assets. Individuals or institutions
providing debt financing are the creditors who receive payment in the form of principal and
interest.

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Unit 1: Introduction to Financial Management

The combination of equity and debt used by a company to finance its operations and growth
is known as the company’s capital structure. There is no one type of capital structure
prescribed for all companies. It is the responsibility of the financial manager to determine the
right capital structure for the organization.

Figure 4. Financial managers determine the capital structure of a company.

Investing Decisions
Investments are made to obtain the assets needed for business operations. One of the most
important roles of a financial manager is to help the company make effective profitable
investments. Investment also involves short-term and long-term decisions of using the funds
from selling assets.

Short-term investment decisions are related to the everyday operation of a business. These
are also called working capital decisions because they are related to current assets and
current liabilities such as cash, inventories22, receivables, etc.

Long-term investment decisions are related to the investment of funds for a long period,
which is usually more than one year. They are also called Capital Budgeting decisions.

22
Inventory — (noun) the accounting of items, component parts and raw materials a company uses in production, or sells

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Unit 1: Introduction to Financial Management

Operation Decisions
Operating decisions involve the daily operations of the company. In relation to this, the
financial manager needs to determine how to finance working capital accounts like accounts
receivables and inventories, and to plan objectives and goals concerning routine tasks. The
company has options on whether to finance working capital needs by long-term or short-term
sources.

Dividend Policies
A common goal of all business ventures is to earn profit or to have a positive return. In the
case of profitability, the financial manager decides how much should be distributed among
the shareholders and how much should be retained for future contingencies23.

In accounting, you might have learned that dividends, which are part of the corporation's
earnings, are distributed to its investors. The factors affecting the dividend decision of a
company are the following: earnings, stability of dividends, growth prospects, cash flow
positions, and preference of shareholders. It is the financial manager’s responsibility to
determine the best dividend policy which maximizes the market value of the firm.

23
Contingency — (noun) a potentially negative event that may occur in the future

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Case Study
A Retail Company Turning Into a Bank?
A widely-popular international company engaged in retail business and
operation of superstores has consistently nudged its way into the business
of finance. The company already offers financial services and products
such as prepaid, reloadable credit cards with cash-back features,
encashment of checks, and sale of money orders. Its customers can also
apply for a small business loan from its club stores.

The retail company started to build its financial services offerings so that
“customers will continue to drop the banks and buy (the company’s
prepaid) cards.” The company’s investing decision to venture into financial
services proved to be advantageous for the shareholders. In its full-year
report, the company announced that its financial services experienced
strong double-digit income growth. Experts also expect that the low-cost
banking services offered by the company would create a consumer ‘lock
in’.

The said company initially planned to purchase several banks but received
negative reactions from stakeholders and other competitors. However,
financial analysts say that due to its growing involvement in finance, it is
possible that the company would eventually become a bank. Once the
retail company meets the legal requirement to become a bank, it would be
classified as a financial institution.

Why Walmart Could Become a Serious Player in Banking

Avi Salzman, “Why Walmart Could Become a Serious Player in
Banking,” Barron’s, March 1, 2021.
https://www.barrons.com/articles/why-walmart-could-become-a-
serious-player-in-banking-51614618870, last accessed on
December 1, 2021.

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Keep in Mind
● Financial management helps individuals, governments, and businesses achieve their
goals. It involves finance: the activity of acquiring, spending, and managing money and
other financial assets.

● Financial management is the effective and efficient management of assets, liabilities,

and equity to achieve the company’s primary goal: the maximization of shareholders’
wealth. To do this, financial managers consider the long-term results, the risks or
uncertainty, the timing of returns, and the stockholders’ return.

● Financial managers also make decisions based on the information they obtain from the
financial system. The financial system is a mix of institutions and mechanisms that
expedite the flow of funds from savings to investments.
● The four important roles of a financial manager are financing, investing, operating, and
dividend policy.

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Try This

A. Short-Answer Response. Write the correct answer in the provided space before
each number.

________________ 1. It involves financial analysis and planning, as well as

investment decisions, financing and capital structure
decisions, and handling of financial resources to achieve
business goals.

________________ 2. It has three areas of study that interact with each other:
financial institutions and markets, investment, and financial
management.

________________ 3. This person is accountable to the board of directors for all

company activities and results.

________________ 4. It exists when people, businesses, and governments in a

country have a significant financial relationship.

________________ 5. It is a long-term goal and should be considered as the main

goal of financial managers.

________________ 6. This person supervises all phases of financial engagement

and serves as a financial advisor to the board of directors.

________________ 7. It refers to the financial decision that involves borrowing

money to acquire the desired assets.

________________ 8. This person is responsible for assuring the use of the most
efficient, effective, and economically viable methods to
produce the company’s product.

________________ 9. It is a component of the financial system which acts as the

intermediaries between savers and borrowers.

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Unit 1: Introduction to Financial Management

________________ 10. This person is concerned with internal matters such as

accounting and the financial records of the organization.

B. True or False. Write true if the statement is correct. Otherwise, write false.

_______________ 1. The shareholders’ wealth is measured by the stock price.

_______________ 2. Financial markets may either be depositary or non-depositary.

_______________ 3. Profit maximization is the primary goal of a financial manager.

_______________ 4. In achieving the objective of profit maximization, the financial

manager tends to select the one that is expected to result in
the highest return.

_______________ 5. The financial manager suggests the best capital structure for
the company.

Practice Your Skills

Briefly answer the following questions in NOT MORE THAN five (5) sentences.

1. You are the financial manager of Company JKL, which posted a consistent increase in
profits for the whole year. However, the business environment is still full of
uncertainties because of the pandemic. You are tasked to propose how much the
shareholders should receive and how much should be retained for future
contingencies. As a financial manager, what factors should you consider in
determining Company JKL’s dividend policy?
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2. A conference for owners of small and mid-size enterprises (SMEs) was organized to
educate them on the importance of setting up their business goals. You were invited
to speak in one of the sessions and encourage them to increase their business value
rather than just going for higher profits. How would you explain to them the
difference between wealth maximization and profit maximization?
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3. Financial managers make decisions based on a company's financial position and goals
and obtain information based on the financial environment's situation. If you were
hired by a company as a financial manager, how would you explain to the business
owners how the financial system works? Why is it vital for them to be aware of it?
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4. Don and Ana are classmates who decided to pursue a business idea and set up a
start-up company. Since they had no experience or knowledge in business
management and operations, they decided to approach you as their financial advisor
to ask you if investment and financial decisions should be considered at the early
stages of establishing their company. How would you explain to them the particular
importance of investment and financing decisions to their business?
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5. Corporation XYZ wants to expand its courier delivery business to service new
locations. To expand the geolocation software coverage and to recruit new riders,
they need to acquire additional funds. They approached you as their financial advisor.

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What are the various financing options for XYZ? Explain the difference between these
options.
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Challenge Yourself
Answer the following questions briefly and concisely.

1. Why is it important for start-up entrepreneurs to have a good understanding of

finance? Provide a business situation and assess the impact of good financial
management.
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2. Over the past years, people have increasingly used digital money for their financial
transactions. How does this affect the financial system? Evaluate its effect based on
how the financial system works.
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3. What appeals to you the most about being a financial manager? Why do you think this
role is important to you?
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Bibliography

Bragg, Steven. Accounting Reference Desktop. New York: John Wiley & Sons, 2002.
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g%20Reference%20Desktop.pdf

Collins, Karen. An Introduction to Business. Accessed October 17, 2021.

https://2012books.lardbucket.org/pdfs/an-introduction-to-business-v1.0.pdf

Dlabay, Les, and James Burrow. Business Finance. Ohio: Thomson South-Western, 2007.

Gitman, Lawrence, and Chad Zutter. Principles of Managerial Finance. Boston: Pearson
Prentice Hall, 2012.

International Federation of Accountants (IFAC). The Handbook of International Public Sector

Accounting Pronouncements. New York: IFAC, 2021.
https://www.ifac.org/system/files/publications/files/IPSASB-HandBook-2018-Volume-1
.pdf

Kaliski, Burton S. Encyclopedia of Business and Finance, Volume 1. New York: Macmillan
Reference USA, 2006.

Melicher, Ronald, and Edgar Norton. Introduction to Finance: Markets, Investments, and
Financial Management. New York: John Wiley & Sons, 2017.

McLaney, Eddie. Business Finance: Theory and Practice. Essex: Pearson Education, 2009.
https://pdf4pro.com/amp/cdn/business-finance-business-finance-mec-5b8929.pdf

1.1. Financial Management 24