Chapter 1: Introduction to Financial Management
It distributes part of the company profits
Financial Management
Financial Management is about preparing,
directing, and managing the money activities of a company
such as buying, selling, and using money for best results to
maximize wealth or to produce best value for money.
Basically, it means applying the general management
concepts to the cash of the company.
Taking commercial business as the most common
organizational structure, the key objectives of
financial management include: (1) to create wealth for the
business; (2) to generate cash; and (3) to provide an
adequate return on investment, bearing in mind the
business risks taken and the resources invested.
There are three key elements in the process of financial
management. These are:
1. Financial Planning. Management needs to ensure that
enough funding is available at the right time to meet the
needs of the business. In the short term, funding may be
needed to invest in equipment and stocks, pay employees
and fund sales made on credit. In the medium term and
long term, funding may be required for significant
additions to the productive capacity of the
business or to make acquisitions.
2. Financial control. Ensures business that objectives are
met. Financial control determines if assets are secured and
being used efficiently. It also confirms if management acts
in the best interest of shareholders and in accordance with
business rules.
3. Financial decision making. The key aspects of financial
decision-making include investment, financing, and
dividends. Though investment mush be financed in some
way there are always financing alternatives that can be
considered which depends on the type of source, period of
financing, cost of financing, and the net present returns
generated. The key financing decision is whether profit
earned by the business should be retained instead of being
distributed to shareholders via dividends.
Scope of Financial Management.
1. Anticipation. The financial needs of a company are being
estimated, as it finds out how much finance is required.
2. Acquisition. It collects finance for the company from
different sources.
3. Allocation. It uses the collected or acquired finance to
purchase fixed and current assets for the company.
4. Appropriation.
among the shareholders, debenture holders, while some
are kept as reserves.
5. Assessment. It means controlling all the financial
activities of the company. It checks if objectives are met; if
otherwise, it determines what can be done about it.
Finance Areas
The following are the major areas of finance
1. Financial Services – concerned with the design and
delivery of advice and financial products to individuals,
business, and governments.
2. Managerial Finance – concerned with the duties of a
Financial Manager working in a business. This encompasses
financial planning or budgeting, credit extension to
customers or other credit administration function,
investment evaluation and analysis, and obtaining of funds
acquisition for a firm. Managerial Finance is the
management of the firm’s funds within the firm.
Legal Forms of Business Organization
1. Sole Proprietorship - a business owned by one person
and operated for one’s own profit. The owner is legally
responsible for the debts and taxes of the business an very
involved in it day to day activities.
2. Partnership – a business owned by two or more people
and operated for profits. This is based on an agreement
called Article of Co-partnership. They are legally
responsible of the debts and taxes of the business.
Partners must agree upon the amount each partner will
contribute to the business, percentage of ownership of
each partners, share of profits of each partner, duties each
partner will perform, and the responsibility each partner
has for the partnership’s debt.
3. Corporation - is an entity created by law. Corporations
have the legal powers of an individual is that it can sue and
be sued, make and be party to contracts, and acquire
property in its own name. It is publicly or privately-owned
business entity that is separate from its owners and has a
legal right to own property and do business in its own
name. Thus the stockholders are not responsible for the
debts or taxes of the business. A corporation is governed
by the Board of Directors, in case of a profits organizations,
or Board of Trustees, in case of not-for-profit organization.
Goals of the Firm and the Role of the Finance Manager
Decision rule for managers:
Only take actions that are expected to increase the share
price!
The Rule means that whenever the financial
manager decides or choose between or among alternatives,
after assessing the risks and the returns, only actions that
would increase share price are acceptable. Otherwise, the
alternative/s shall be rejected.
The Goal of the firm, and therefore of all mangers,
is to maximize shareholders’ wealth. This can be measure
by share price. An increasing price per share of common
stock relative to the stock market as a whole indicates
achievement of this goal.
Based on the information provided, the choice is
not obvious. Profit maximization is not consistent with
wealth maximization. It may not lead to the highest
possible share price due to the following reasons:
1. Timing is important. The receipt of funds sooner rather
than later must be considered since the goal of the firm
is to maximize value.
2. Profits do not necessarily result in cash flow available
to stockholders. In some instances, firm may generate
huge profit but may not have enough cash to
continuously run the business. This happens when
expenses have shorter due date than expected revenue.
3. Profit maximization fails to account for risk. Increased
risk may decrease the share price, while return is likely
to increase the share price.
The two key activities that the financial manager
does related to a firm’s balance sheet are the following:
1. Investment decisions. The finance manager defines the
most efficient level and the best structure of assets.
Investment decisions deal with the items that appear on
the asset section of the balance sheet.
2. Financing decisions. The finance manager determines
and maintains the proper combination of short-term
and long-term financing.
Corporate Governance, Ethics and Agency Issues
Corporate governance is a system of
organizational control that defines and establishes the
responsibility and accountability of the major participants
in an organization. An organizational chart is an example of
a broad arrangement of corporate governance. More
detailed responsibilities would be established within each
part of the organizational chart.
Business ethics includes the standards of conduct
or moral judgement that apply to persons engage in
industry or commerce. Violations of these standards in
finance include, but not limited to misstated financial
statements, misleading financial forecasts or projections,
fraud, bribery, kickbacks, insider trading, excessive
executive compensation, and options backdating.
Bad publicity generally results to negative impacts
on a firm. Ethics programs seek to reduce lawsuits and
judgment costs, uphold and preserve a positive corporate
image, build trust and confidence of the shareholders, and
gain the loyalty and respect of all stockholders. The
expected result of such programs is to positively affect the
firm’s share price.
The agency problem and the associated agency
costs can be reduced through the following:
1. Properly constructed and implemented corporate
governance structure.
2. Structured expenditures thru compensation plans.
3. Market Forces such as shareholder crusading from large
institutional investors.
4. Threat of hostile takeovers.
 FINANCIAL ANALYSIS: TOOLS AND TECHNIQUES
ANALYSIS - a consideration of anything in its separate parts
and their relation to each other.
FINANCIAL ANALYSIS - refers to examination of financial
data of an entity or firm to determine its
profitability, growth, solvency, stability and
effectiveness of its management.
1. Financial Statement
 Are compact reports that summarize the
financial position of a firm as of a given
date, or the result of financial operation
over a given period of time
 end products of the accounting process
 BASIC FINANCIAL STATEMENTS:
 BALANCE SHEET/ STATEMENT OF FINANCIAL
POSITION
2 FORMS:
1. REPORT FORM-simply lists the assets, followed
by the liabilities then by the owner’s equity in
vertical sequence
2. ACCOUNT FORM-which lists the assets on the
left and the liabilities and owner’s equity on the
right.
 INCOME STATEMENT/ STATEMENT OF FINANCIAL
PERFORMANCE
2 FORMS:
1. NATURAL FORM-also called as Single Step Form
where there are two sections: the revenue
section and the operating section
2.FUNCTIONAL FORM-presents the expenses
according to function: cost of sales, selling
expenses, administrative expenses and
financial expenses
 CASH FLOW STATEMENT
 BALANCE SHEET-shows economic resources it
controls, its financial structure(financing or
borrowing), its liquidity and solvency.
-list down the enity’s assets, liabilities, owner’s
equity
-shows an information about the economic
resources and its capability to change.
-the increase and decrease of the resources are
useful in predicting the ability of the enterprise to
generate cash and cash equivalents in the future.
COMPONENTS: ACCOUNT TITLES
CURRENT ASSETS
1. CASH - currencies, coins or negotiable instru-
ments such as bank checks or a postal money
order used as a medium of exchange.
 CASH ON HAND
 CASH IN BANK
 CASH EQUIVALENTS
2. MARKETABLE SECURITIES - Highly traded
securities-stocks, bonds
3. RECEIVABLES - collectibles from clients,
customers and other persons for the goods,
services or money given by the business.
4. OTHER RECEIVABLES - Interest Receivable-
collectibles from promissory note, others: Rent
Receivable, Dividends Receivable
5. MERCHANDISE INVENTORY - Stocks available
for sale by the business
6. PREPAID EXPENSES - advance payments made
for benefits or services to be received by the
business in the future
- PREPAID SUPPLIES, PREPAID RENT,
PREPAID INSURANCE
7. ALLOWANCE FOR BAD DEBTS-CONTRA ASSET
- which represents customer’sdoubtful accounts
NON-CURRENT ASSETS
1. LAND - lot or real estate
2. BUILDING - structured used to house the office,
store or factory
3.EQUIPMENT - computers, calculator, filing
cabinet
4.FURNITURE AND FIXTURES - chairs, wall deco-
rations, tables
5. ACCUMULTED DEPRECIATION - contra asset or
off-set account representing expired cost of the
plant, property, or equipment as a result of usage
and passage of time.
LIABILITIES:
CURRENT-LIABILITIES
1. ACCOUNTS PAYABLE-purchase of goods or
services on credit supported by oral or implied
promise to business
-other: NOTE PAYABLE-supported by a promissory
note
2. LOAN PAYABLE - a liability to pay a bank or
financing institutions for amount of money
borrowed.
3. UTILITIES PAYABLE - liability to pay utility c
ompanies like pldt,meralco
 4. OTHER PAYABLES The changes can be summarized as follows:
-INTEREST PAYABLE-interest bearing 1. SOURCES OF FUNDS THAT INCREASE CASH
note POSITION:
- SALARIES PAYABLE—for the employees  A net decrease in any asset other cash or
-TAXES PAYABLE - based on sales, fixed assets
earnings or value of property  A gross decrease in fixed assets
NON-CURRENT LIABILITY  A net increase in any liability
1. NOTE PAYABLE  Proceeds from the sale of stocks
2. MORTGAGE PAYABLE  Funds generated from operations
3. BOND PAYABLE 2. USES OF FUNDS THAT INCREASE CASH
POSITION:
OWNER’S EQUITY - Represents the claim of the  A net increase in any asset other than cash
owner over assets of the business after or fixed assets
the liabilities have been deducted.  A gross increase in fixed assets
 A net decrease in any liability
 INCOME STATEMENT  A retirement or purchase of stock
- Shows the result (profitability)of operations of a  Payment of cash dividends
business entity for a given period of time
-list down revenues and expenses of the GENERAL FEATURES OF FINANCIAL STATEMENT
enterprise 1. Fair presentation and Compliance with PFRS
(Philippine Financial Reporting Standards)
 CASH FLOW STATEMENT 2. Going Concern
-statement that traces the inflow of funds from all 3. Materiality and Aggregation
sources and the disbursement of funds for different 4. Offsetting
undertakings during the period covered. 5. Frequency of Reporting
- How is cash obtained by the business?, How 6. Comparative Information
does it spend its cash? What causes the change in the cash? 7. Consistency of Presentation
- How cash is being managed. USERS OF FINANCIAL STATEMENTS
1. Primary Users - parties to whom general
AN INFLOW(SOURCE OR RECEIPT), AN purpose financial reports are primarily directed
OUTFLOW(USE OR DISBURSEMENT) ACTIVITIES: 2. Other Users - users of financial information
1. OPERATING ACTIVITIES other than primary users
-INFLOW: cash comes from revenue collections
-OUTFLOW: Cash goes to payment of expenses
2. INVESTING ACTIVITIES
-INFLOW: sale of plant,property,and equipments, FINANCIAL ANALYSIS:
securities - is the process of evaluating relationships
-OUTFLOW: acquisition of plant, property, and between parts of the firm’s financial statements in order to
equipments judge its performance.
3. FINANCING ACTIVITIES - It provides a sound basis for credit worthiness
-INFLOW: loans extended,cash contribution and evaluates thoroughly and draws conclusions on the
-OUTFLOW: cash paid to creditors, cash borrower’s/prospective borrower’s performance, strengths,
contribution weaknesses and industry prospects.
The goal of every analyst will be to predict whether the
company being analyzed will have sufficient cash to meet STEPS IN FINANCIAL ANALYSIS:
its ongoing cash needs and meet necessary requirements 1. Determine relevant information
for a smooth sailing business. 2. Arrange information to highlight significant
relationships
3. Interpret and draw conclusions
CURRENT ASSETS CURRENT LIABILITIES
FIXED ASSETS LONG-TERM DEBT
BASIS FOR FINANCIAL ANALYSIS:
OTHER ASSETS EQUITY
Financial analysis is based on the client’s audited
(+) USE (+) SOURCE financial statement which gives us insight on companies
(-) SOURCE (-) USE
past performance and provide vital information concerning
the position of the business and the results of its operation.
1. PUBLISHED REPORTS- the annual report of a
publicly held corporation is an important source
of financial information
2. SEC REPORT- Publicly held corporation must file
annual, quarterly and current reports with the
Securities Exchange Commission
3. BUSINESS PERIODICALS
LIMITATIONS OF FINANCIAL STATEMENT:
1. Financial Statements present only information that can e
quantified in terms of monetary unit. Some significant
factors affecting the business firms do not always lend
themselves to such quantifications and are therefore not
found in the financial statements
Examples:
 The character,motivation, experience and
age of the people within the organizatio
 The quality of its research and
development effort.
 The extent of its marketing network
 Details regarding product lines, machine
efficiency, advance planning
 Organization of structure, behavioural
problems and the extent of influence
exercised by key-position holders.
2. Financial statements are historical in nature and their
use for predictive purpose calls for informed/ careful
judgment by the users.
3. Instability of Monetary Unit. The value of money in
terms of general purchasing power has undergone
significant fluctuations and has gone pronounced
downward trends.
4. Financial statements present the best possible estimates,
not absolutely accurate figures
FINANCIAL STATEMENT ANALYSIS STANDARDS:
1. RULE-OF-THUMB MEASUREMENT/ ABSOLUTE
STANTARDS
-Many financial analysts and lenders use “ideal”
or rule of thumb measures for key financial ratios.
- Are those that become generally recognized as
becoming desirable regardless of the type of a
company, the time, stage of the business cycle or
objectives of the analysts.
- For example: it has been long thought that a
current ratio of 2.00:1 is acceptable.
2. PAST PERFORMANCE OF THE COMPANY
- an improvement over the rule-of-thumb method
is the comparison of financial measures or ratios
of the same company over a period of time.
- This standard will at least give the analyst some
basis for judging whether the measure or ratio is
getting better or worse.
- Helpful in showing possible future trends.
3. INDUSTRY NORMS
- This standard will tell how the company being
analyzed compares with other companies in the
same industry
-For example: an average Return on Sales (ROS) of
the industry is 8%; in such case companies below
8% did not perform well.
THREE LIMITATIONS:
1. Although two companies seem to be in the
same industry, they may not be strictly
comparable.
2. Most large companies operate in more than
one industry.
3. Companies in the same industry with similar
operations use different accounting procedures.
4. BUDGETED STANDARDS
- a budget, ratios developed from actual
performance can be compared to planned ratios
in the budget in order to determine the degree of
accomplishment.
TOOLS AND TECHNIQUES
For Short Term Decision Making:
The tools of financial analysis are intended to show
relationships and changes:
1. HORIZONTAL ANALYSIS
- it enables one to draw a picture on what
changes are taking place in the financial activities
of an enterprise.
- Is a comparative analysis which shows the
increases and decreases, in absolute amounts and
in percentages, of financial data for two given
periods
- The increase or decrease, specifically if material
in amount, will trigger an inquisition from
management to determine whether the changes
is good for the company and what is the reason
for the change.
a. Comparative Statements RATIO ANALYSIS
-shows the increases and/ or decreases of
account balances and their corresponding 1. LIQUIDITY RATIOS
percentages ⮚ Measure the amount of cash or investments
b. Trend Ratios that can be converted to cash in order to pay
- supplement the comparative statements, expenses, bills and other obligations as they come
showing the behaviour of financial data for due
successive periods ⮚ The ratios that relate to this goal all have to do
with working capital or some part of it, because it
2. VERTICAL ANALYSIS is out of working capital that debts are pad as
-only one set of financial statement is used they mature.
- involves the percentage changes to bring out the ⮚ TWO DIMENSIONS TO PROPER EVALUATE
quantitative relationships existing among LIQUIDITY ARE:
different items to the total in a single statement. a. The time necessary to convert the
- It shows the relative importance of an item in assets into money
relation to other items and to a total. b. The degree of certainty associated
- It sets a total figure in the statement equal to with the conversion ratio for the assets
100% and computes the percentage of each
component of the figure(this figure would be total
assets or total liabilities and stockholders’ equity
in the case of balance sheet and revenues or sales
in the case of the income statement.
- used in the importance (proportion) of individual
items to the specific base item which is the total
revenue (in the income statement) and the total
assets (in the balance sheet)
- It shows changes in the relative size (importance)
of each item to the specific base and whether it is
good or not depends on its effect on the financial
position or performance of the business.
a. Common size statement
- a statement wherein each item is expressed in
terms of a percentage of a common base number.

b. Financial Ratio
- shows the significant between items in the
financial statements expressed in mathematical
form.

Common Types of Ratios

1. Profitability Ratios - designed to measure the
success of the firm in generating profit
2. Liquidity Ratios- measure the firm’s ability to
meet the current obligations as they fall due.
3. Investibility Ratios- measure the desirability of
the shares of a company as an investment outlet
4. Stability Ratios- measure the firm’s ability to
meet its long-term commitments when they fall
due.
2. PROFITABILITY RATIOS
⮚ A company’s long-run survival depends on its being able to earn a satisfactory income.
⮚ An evaluation of past earning power may give the investor and creditor a better
understanding for decision making.
⮚ Measure and help control income.
3. SOLVENCY RATIOS
⮚ Refers to the ability to meet the interest and
repayment schedules associated with debts.
⮚ It enables to point out early whether the
company is on the road of bankruptcy.