Introduction to

Financial Management
Definition of Finance
Finance can be defined as the
science and art of managing
money. (Gitman & Zutter,
2012)
Definition of Budgeting

Budgeting is the act of estimating

revenue (in the form of their
allowance) and expenses over a period
of time.
Forms of Business Organizations:

 SoleProprietorship - A business owned by

one person and operated for his or her own
profit.
-Partnership - A business owned by two or
more people and operated for profit.
-Corporation – An entity created by law
owned by shareholders.
-Corporations may either be privately owned or
publicly owned.
-Privately owned corporations are often owned
by family members whose stocks may not be
offered to outsiders unless consent by the family
members is secured.
-Companies which are publicly listed are owned
by unrelated investors and are traded in
organized exchanges like the Philippine Stock
Exchange.
What do you think of a
company who has very
large amount of cash?
Possible answer:

 They may say that this is good because the

company will always have enough cash to pay its
obligations.) Tell them that though having a lot of
cash has its advantages, it also signals unhealthy
company practices. It may tell them that
management has not been putting the company’s
resources into good use. Also, keeping too much
cash in the books is like hiding your extra
allowance under their bed. They will be missing
out on investment opportunities.
 The overall objective of a shareholder
should be wealth maximization.
 What defines a shareholder’s wealth?
 Assume a learner bought 10 shares of Globe
Telecom at PHP2,510 each on September 9,
2010. This brings his investments to
PHP25,100. What happens to the value of
his investment if the price goes up to
PHP2,600 per share or it goes down to
PHP2,300 per share?
 Shareholders’wealth is measured based on
the current market price of the
corporation’s stocks.
 Themarket price changes across different
periods. Hence, the value of your
investment changes in different points on
time based on the market value at that
time.
 An increase of the share price to PHP2,600 per
share means that people are willing to buy the
shares for that amount. If the learners were to
sell their shares at this point, it will result to a
profit of PHP90 per share or PHP900 on their
whole investment.
 Hence, the value of their investment increased
from PHP25,100 to PHP26,000. Therefore, there is
an increase in shareholder’s wealth.
 On the other hand, a decrease in the share
price to PHP2,300 per share means that
people are only willing to buy shares for
PHP2,300. If the learners were to sell their
investment at this point, they will receive
PHP23,000 which would result to a loss of
PHP2,100. The decrease in value of their
investment leads to a decrease in
shareholder’s wealth.
Factors that Influence Market Price
Profitability

 • Profit is a measure of the financial performance of a

company for a period of time.
 • Although it is a major driver for increasing the value of
stock, an investor should not rely on profits alone. As
discussed earlier, it is possible that the company has
profits but its cash flow is negative.
 - Examples: Suppose the following Income Statements and
Cash Flow Statements of companies A, B and C were
presented to you. Which do you think is a more attractive
company?
 Company A is profitable but generated
negative cash flows which resulted from the
uncollected accounts receivable of
PHP100,000. Without adequate cash inflows to
meet its obligations, the company will face
liquidity problems, regardless of its level of
profits.
• Company B on the other hand has a positive
cash flow but is unprofitable. This is a result of
the company’s delay in payment of its costs.
Accordingly, the Company will soon have to pay
the remaining PHP100,000 liability and its cash
will no longer be sufficient. Again, without
adequate cash inflows to meet its obligations, the
company will face liquidity problems.
• Company C is profitable and has a positive cash
flow. Based on the information provided,
Company C seems to be the best.
Good liquidity and reasonable leverage
position
-• Liquidity and leverage refers to the company’s
management of the type and amount of assets
and liabilities that it will hold in the course of its
operations. This will further be discussed in
Lesson 2.
Dividends

 • Holders of shares receive dividends from a corporation

as returns on their investments in form of cash or other
properties. Companies which have better dividend policies
are generally more attractive than companies who do not
pay out dividends.
 • Note that there may be times that companies do not pay
out dividends because of future expansions. Same with the
other factors affecting share price, dividend policies
should go hand in hand with other factors in determining
market price.
- Competent management

• Competent managers may have any of the

following attributes: 1) visionary 2) decisive 3)
people-oriented, 4) inspiring, 5) innovative, 6)
respected and 7) experienced/seasoned manager
Corporate plans that improve the
business prospects
 • Example: Company A which is in the business of selling Halo-halo in the Dapitan
area (or any other area) for 5 years. Company A is consistently earning profits and
has a positive cash flow. When asked how Company A sees itself after 5 more years,
Company A answered that it would continue to sell Halo-halo in Dapitan (or any
other area).
 • On the other hand, Company B sells Buko Juice in Katipunan area (or any other
area different from Company A’s area) for 5 years. Company B is consistently earning
profits and has a positive cash flow. When asked how Company B sees itself after 5
more years, Company B answered that it has generated enough cash to expand its
business to Cubao area (or any other area) to take advantage of the growing demand
of Buko Juice in Cubao.
 • Between Company A and Company B, which would be a better investment?
Company B. Since it has more concrete future prospects allowing investors to hope
for better revenues and net income
• External Factors

- These factors influences the general reaction of

investors in making an investment decision.
- Its effect is not only to a specific company but
on all companies or a group of companies under
similar circumstances.
- Such factors are a result of the environment a
company operates in rather than the decisions of
the company’s management.
Role of Financial Management

 Given the factors that influence market price, how will the company ensure
that such objectives will be achieved? Reveal the answer that this is achieved
through financial management.
 • Financial management deals with decisions that are supposed to maximize
the value of shareholders’ wealth. (Cayanan)
 - These decisions will ultimately affect the markets perception of the
company and influence the share price.
 - The goal of financial management is to maximize the value of shares of
stocks.
 - Managers of a corporation are responsible for making the decisions for the
company that would lead towards shareholders’ wealth maximization.
The Corporate organization Structure
The Corporate organization Structure
 • Shareholders: The shareholders elect the Board of Directors (BOD). Each
share held is equal to one voting right. Since the BOD is elected by the
shareholders, their responsibility is to carry out the objectives of the
shareholders otherwise, they would not have been elected in that position. Ask
the learners again what the objective of the shareholders is just to refresh.
 • Board of Directors: The board of directors is the highest policy making body
in a corporation. The board’s primary responsibility is to ensure that the
corporation is operating to serve the best interest of the stockholders. The
following are among the responsibilities of the board of directors:
 - Setting policies on investments, capital structure and dividend policies.
 - Approving company’s strategies, goals and budgets.
 - Appointing and removing members of the top management including the
president.
 - Determining top management’s compensation.
 - Approving the information and other disclosures reported in the financial
statements (Cayanan, 2015)
The Corporate organization Structure
• President (Chief Executive Officer): The roles
of a president in a corporation may vary from one
company to another. Among the responsibilities of
a president are the following:
- Overseeing the operations of a company and ensuring
that the strategies as approved by the board are
implemented as planned.
- Performing all areas of management: planning,
organizing, staffing, directing and controlling.
- Representing the company in professional, social, and
civic activities.
The Corporate organization Structure
 • VP for Marketing: The following are among the
responsibilities of VP for Marketing
 - Formulating marketing strategies and plans.
 - Directing and coordinating company sales.
 - Performing market and competitor analysis.
 - Analyzing and evaluating the effectiveness and cost of marketing
methods applied.
 - Conducting or directing research that will allow the company
identify new marketing opportunities, e.g. variants of the existing
products/services already offered in the market.
 - Promoting good relationships with customers and distributors.
(Cayanan, 2015)
The Corporate organization Structure
• VP for Production: The following are among the
responsibilities of VP for Production:
- Ensuring production meets customer demands.
- Identifying production technology/process that
minimizes production cost and make the company cost
competitive.
- Coming up with a production plan that maximizes the
utilization of the company’s production facilities.
- Identifying adequate and cheap raw material
suppliers. (Cayanan, 2015)
The Corporate organization Structure
• VP for Administration: The following are among
the responsibilities of VP for Administration:
- Coordinating the functions of administration, finance,
and marketing departments.
- Assisting other departments in hiring employees.
- Providing assistance in payroll preparation, payment
of vendors, and collection of receivables.
- Determining the location and the maximum amount of
office space needed by the company. Identifying
means, processes, or systems that will minimize the
operating costs of the company. (Cayanan, 2015)
Message from the CFOs:
 Unilever: “Finance plays a critical role across every
aspect of our business. We enable the business to turn our
ambition and strategy into sustainable, consistent and
superior performance” - Jean-Marc Huët (Unilever)
 - Jollibee: “It’s very exciting because you are not just
thinking of today but what the company will need in the
future” - Ysmael V. Baysa (Morales, 2013)
 - Globe Telecom: “Yesterday’s solutions are never
adequate for the future” - Albert De Larrazabal
(Klobucher, 2015)
 - SM Corporation: “Now, we don’t go out because we
need funds. We go out because it’s an opportunity.” – Jose
T. Sio (Montealegre, 2015
Functions of a Financial Manager

 • Identify the four functions of a VP for finance (CFO) as follows:

 - Financing
 - Investing
 - Operating
 - Dividend Policies
Financing decisions

 Financing decisions include making

decisions on how to fund long term
investments (such as company expansions)
and working capital which deals with the
day to day operations of the company (i.e.,
purchase of inventory, payment of
operating expenses, etc.)
Financing

Financing – to determine the

appropriate capital structure of the
company and to raise funds from debt
and equity.
 The role of the VP for Finance of the Financial Manager is to determine the
appropriate capital structure of the company. Capital structure refers to how
much of your total assets is financed by debt and how much is financed by
equity. To illustrate, show/draw the figure below:
Investments may either be short term or
long term
 - Short term investment decisions are needed when the company is in an
excess cash position.
 • To plan for this, the Financial Manager should be able to make use of
Financial Planning tools such as budgeting and forecasting which will be
discussed in Lesson 3: Financial Planning Tools and Concepts.
 • Moreover, the company should choose which type of investment it should
invest in that would provide an most optimal risk and return trade off. We
will learn more about this on Lesson 6: Introduction to investments.
 - Long term investments should be supported by a capital budgeting analysis
which is among the responsibilities of a finance manager.
Investments may either be short term or
long term
 • Capital budgeting analysis is a tool to assess whether the investment will
be profitable in the long run and will be further discussed in Lesson 5: Basic
Long Term Financial Concepts. This is a crucial function of management
especially if this investment would be financed by debt.
 • The lenders should have the confidence that the investments that
management will push through with will be profitable or else they would not
lend the company any money.
Operating decisions
 • Operating decisions deal with the daily operations of the company. The role
of the VP for finance is determining how to finance working capital accounts
such as accounts receivable and inventories. The company has a choice on
whether to finance working capital needs by long term or short term sources.
Why does a Financial Manager need to choose which source of financing a
company should use? What do they need to consider in making this decision?
 - Short Term sources are those that will be payable in at most 12 months. This
includes short-term loans with banks and suppliers’ credit. For short-term
bank loans, the interest rate is generally lower as compared to that of long-
term loans. Hence, this would lead to a lower financing cost.
 - Suppliers’ credit are the amounts owed to suppliers for the inventories they
delivered or services they provided. While suppliers’ credit is generally free
of interest charges, the obligations with them have to be paid on time to
maintain good supplier relationship. Such relationships should be nurtured to
ensure timely delivery of inventories.
Operating decisions

 - Short term sources pose a trade-off between profitability and liquidity risk.
Because this source matures in a short period, there is a possibility that the
company may not be able to obtain enough cash to pay their obligation (i.e.
liquidity risk).
 - Long term sources, on the other hand, mature in longer periods. Since this
will be paid much later, the lenders expect more risk and place a higher
interest rate which makes the cost of long term sources higher than short term
sources. However, since long term sources have a longer time to mature, it
gives the company more time to accumulate cash to pay off the obligation in
the future.
 - Hence, the choice between short and long term sources depends on the risk
and return trade off that management is willing to take. The learners will
learn more about this on Chapter 4: Sources and uses of funds.
Dividend Policies

• Dividend Policies. Recall that cash dividends

are paid by corporations to existing shareholders
based on their shareholdings in the company as a
return on their investment. Some investors buy
stocks because of the dividends they expect to
receive from the company. Non-declaration of
dividends may disappoint these investors. Hence,
it is the role of a financial manager to determine
when the company should declare cash dividends.
-Before a company may be able to declare
cash dividends, two conditions must exist:
 1.
The company must have enough retained
earnings (accumulated profits) to support
cash dividend declaration.
 2. The company must have cash.
 What do you think will affect the decision of management in paying
dividends?
 Dividends come from the company’s cash and availability of unrestricted
retained earnings.

 • Availability of financially viable long-term investment

 • Access to long term sources of funds
 • Management’s Target Capital structure