THE GOALS AND

ACTIVITIES OF FINANCIAL
MANAGEMENT
CRUZ, TALION AND TIMBANG
CA51012 Financial Management
UST Alfredo M. Velayo College of Accountancy
University of Santo Tomas
 A. LEARNING OBJECTIVES
• List some of the concepts of the field of finance
• Recognize that a firm can have many different forms of organization
• Describe how the relationship of risk to return is a central of focus of finance
• Explain the primary goal of financial managers
• Recall that financial managers attempt to achieve wealth maximization through
daily activities such as credit and inventory management and through longer-
term decisions related to raising funds
• Explain future and present value and how they relate to time value of money
 B. FIELD OF FINANCE
• Finance fits between economics and accounting

• Economic provides picture of business environment

• Consider consumers and producers

• Accounting provides financial data

• Income statements, balance sheets, cash flow statements
 B1. FIELD OF FINANCE
• Financial manager needs to know how to understand and interpret
financial statements

• Finance is closely tied to accounting

• CFO often in charge of financial planning, accounting, and tax
systems

• Finance is forward thinking vs accounting which measures business

activity results
C. FINANCE WITHIN THE
ORGANIZATION
Board of Directors

Chief Executive Officer (CEO)

Chief Operating Officer (COO) Chief Financial Officer (CFO)

Marketing, Production, Human Accounting, Treasury, Credit,

Resources, and Other Operating Legal, Capital Budgeting, and
Departments Investor Relations
 D. DEFINITION OF FINANCE

• is the study of how individuals, institutions, governments and

businesses acquire, spend and manage money and other financial
resources

• Procurement or gathering of funds, effective and efficient utilization

of financial resources, allocation of financial assets or resources
 E. INVESTMENTS VS CORPORATE
FINANCE
• Investments
• Investors use investment principles to value stocks and bonds of
companies
• Investors choose which to purchase
• Portfolio includes securities by multiple companies

• Corporate Finance
• Principles used to determine which assets the firm should develop
or buy
 E1. INVESTMENTS VS CORPORATE
FINANCE
• Financial management
• Term can be used interchangeable with corporate finance
• Related to various investment topics
• Include how outside investors evaluate the company
 F. THE VALUE OF STUDYING FINANCE
• Career opportunities include
• Corporate financial officers, banker, stockbroker, financial
analyst, portfolio manager, investment banker, financial
consultant, and personal financial planner
• CEO reports directly to the BOD
• Marketing managers interested in return on investment of
marketing initiatives
 G. ACTIVITIES OF FINANCIAL
MANAGEMENT
• Financial managers perform numerous activities
• Daily activities include monitor cash balances, manage credit
decisions, monitor inventory levels, collect and distribute cash
• Less routine activities include negotiations with banks for loans,
sale of stocks and bonds, establishment of capital budgeting and
dividend plans
• Risk and return trade off determined to maximize the market value
• Influences operational side (capital versus labor or Product A vs
Product B)
• Influences financial mix (stock vs bonds vs retained earnings)
 H. FUNCTIONS OF FINANCIAL
MANAGEMENT
• DAILY
• Credit management, inventory control, receipt and disbursement
of funds

• OCCASIONAL
• Stock issue, bond issue, capital budgeting, dividend declaration

• PROFITABILITY
• Trade off between risk and return with the goal of maximizing
shareholder wealth
I. GOALS OF FINANCIAL MANAGEMENT
• PRIMARY GOAL – maximization of profit
• Drawbacks
• Change in profit may also represent change in risk
• Fails to consider timing of benefits
• Impossible task of accurately measuring key variable profit
• Problems with inflation and international currency
transactions further complicate the issue
 J. VALUATION APPROACH
• Ultimate measure of performance – how earnings are valued by
investor

• Time value of money concept is key

• Businesses are valued in the present
• Most cash flows are not realized for many years
• Shareholders are interested in future earnings
• Investors want longer-term perspectives
 K. THE TIME VALUE OF MONEY
• Is the idea that a dollar received today is worth more than a dollar
that we expect to received in the future
• Future value of a dollar is greater than a dollar
• Present value is today’s dollar value

• FV = PV (1 + i)n

• FV = future value
• PV – present value
• i = interest rate
• n = number of periods
 K1. PRESENT VALUE
• Is the idea that a dollar received today is worth more than a dollar
that we expect to received in the future
• Future value of a dollar is greater than a dollar
• Present value is today’s dollar value

• FV = PV (1 + i)n

• FV = future value
• PV – present value
• i = interest rate
• n = number of periods
 L. MAXIMIZING SHAREHOLDER
WEALTH
• Shareholder wealth maximization is the broad goal of the firm
• Achieved through high value for the firm

• Residual claim – value of their claims is not fixed

• Financial manager cannot directly control firm’s stock price

• Can act in consistent way with shareholder desires
• Long-tern wealth is more important than daily value
 M. SOCIAL RESPONSIBILITY AND
ETHICAL BEHAVIOR
• Adopting policies that maximize value in market
• Attract capital
• Provide employment
• Offer benefits to society

• Socially desirable action like pollution control, equitable hiring

practices, and fair pricing standards may be inconsistent with
achieving maximum valuation in the market
 M1. SOCIAL RESPONSIBILITY AND
ETHICAL BEHAVIOR
• Insider trading
• Using information not available to public, making undue profit
from trading in company’s publicly traded securities
• Unethical and illegal practice protected against by SEC
• Has a negative impact on shareholder’s interest

• Ethical behavior creates invaluable reputation

 N. CORPORATE GOVERNANCE -
SARBANES OXLEY ACT (SOX ACT)
• Designed primarily to regulate corporate conduct in an attempt to promote
ethical behavior and prevent fraudulent financial reporting
• 301 – responsibilities of BOD and audit committee, appointment and
compensation

• 302 – CEO and CFO to sign and certify that the financial statements are
accurate

• 303, 304, 306 – ethical conduct by BOD, Executives and key employees

• 406 – public corporation to have code of ethics for senior executive

 N1. CORPORATE GOVERNANCE - DODD
FRANK ACT)

• Wall street reform and consumer protection act of 2010

• First major financial regulatory change since great depression

• Goal to reduce systemic risks that undermine financial system in the

US
 N2. CORPORATE GOVERNANCE -
CONCLUDED
• AGENCY THEORY
• Examines relationship and potential conflict between owners and
managers of firm
• Management operates versus owners focused on shareholders

• INSTITUTIONAL INVESTORS
• Have more to say bout how publicly owned companies are
managed
• Able to vote large blocks of shares for election of BOD
 O. ROLE OF FINANCIAL MARKETS
• Financial markets – meeting place for people, corporations and
institutions
• Have either a need to lend, borrow or invest money

• Participant can be national, state, local governments

• Their markets are public financial markets

• Corporate participants raise funds in corporate financial markets

 O1. STRUCTURE AND FUNCTIONS OF
FINANCIAL MARKETS

• Distinct parts of financial markets

• Domestic and international markets

• Corporate and government markets

• Money and capital markets

 O2. STRUCTURE AND FUNCTIONS OF
FINANCIAL MARKETS
• Money markets
• Deal with short term securities with life of one year or less
• Securities include
• Commercial paper sold by corporations to finance daily operations
• Certificates of deposit with maturities of less than one year sold by banks
• Capital markets
• Deal with securities that have life or more than 1 year
• Long-term markets
• Defined as either 1 to 10 years (intermediate markets) or greater than 10 years (long-
term markets)
• Securities include
• Common stock
• Preferred stock
• Corporate and government bonds
 P. ALLOCATION OF CAPITAL
• Primary market
• When corporation uses financial markets to raise new funds, sale
of securities made through new issue is called initial public
offering (IPO)

• Secondary market
• Securities bought/sold amongst investors
• Prices of securities keep changing continually
• Financial managers given feedback about firms performance
 P1. ALLOCATION OF CAPITAL
• Return maximization and risk minimization
• Investors can choose risk level that meets objective, maximizes
return for given risk level

• Companies rewarded with high-priced securities can raise new

funds in money and capital markets at lower cost than
competitors

• Firms may pay penalty for failing to perform competitively

 Q. INTERNATIONALIZATION OF
FINANCIAL MARKETS
• Allocation of capital and search for lower-cost sources of financing
in global markets

• Impact of international affairs and technology has resulted in need

for managers to understand
• International capital flows
• Computerized electronic fund transfer systems
• Foreign currency hedging strategies
 R. FORMS OF BUSINESS
ORGANIZATION
• Proprietorship

• Partnership

• Corporation

• (number of people in the organization, liability of

owners and complexity of state regulations
 R1. SOLE PROPRIETORSHIP AND
PARTNERSHIP
• Advantages
– Ease of formation
– Subject to few regulations
– No corporate income taxes
• Disadvantages
– Difficult to raise capital
– Unlimited liability
– Limited life
• Often set up through LLCs/LLPs.
 R2. CORPORATION
• Advantages
– Unlimited life
– Easy transfer of ownership
– Limited liability
– Ease of raising capital
• Disadvantages
– Double taxation
– Cost of setup and report filing
 S. BALANCING SHAREHOLDER
VALUE AND SOCIETY INTEREST
• The primary financial goal of management is shareholder wealth
maximization, which translates to maximizing stock price.
– Value of any asset is present value of cash flow stream to owners.
– Most significant decisions are evaluated in terms of their financial
consequences.
– Stock prices change over time as conditions change and as
investors obtain new information about a company’s prospects.

• Managers recognize that being socially responsible is not

inconsistent with maximizing shareholder value.
 T. STOCK PRICES AND INTRINSIC
VALUE
• In equilibrium, a stock’s price should equal its “true” or intrinsic
value.

• Intrinsic value is a long-run concept.

• To the extent that investor perceptions are incorrect, a stock’s price

in the short run may deviate from its intrinsic value.

• Ideally, managers should avoid actions that reduce intrinsic value,

even if those decisions increase the stock price in the short run.
 U. WHAT IS THE FIRM’S INTRINSIC VALUE? CURRENT STOCK
PRICE? IS THE STOCK’S “TRUE” LONG-RUN VALUE MORE CLOSELY
RELATED TO INTRINSIC VALUE OR CURRENT PRICE

• A firm’s intrinsic value is an estimate of a stock’s “true” value based

on accurate risk and return data. It can be estimated but not
measured precisely. A stock’s current price is its market price—the
value based on perceived but possibly incorrect information as seen
by the marginal investor. From these definitions, you can see that a
stock’s “true” long-run value is more closely related to its intrinsic
value rather than its current price.
V. WHEN IS A STOCK SAID TO BE IN EQUILIBRIUM? AT ANY GIVEN
TIME, WOULD YOU GUESS THAT MOST STOCKS ARE IN
EQUILIBRIUM AS YOU DEFINED IT?
• Equilibrium is the situation where the actual market price
equals the intrinsic value, so investors are indifferent
between buying or selling a stock. If a stock is in
equilibrium then there is no fundamental imbalance, hence
no pressure for a change in the stock’s price. At any given
time, most stocks are reasonably close to their intrinsic
values and thus are at or close to equilibrium. However, at
times stock prices and equilibrium values are different, so
stocks can be temporarily undervalued or overvalued.
 W. SUPPOSE 3 HONEST INDIVIDUALS GAVE YOU ESTIMATES OF STOCK X’S
INTRINSIC VALUE (ROOMMATE, PROFESSIONAL SECURITY ANALYST AND
COMPANY X’S CFO) THE 3 DIFFERED IN ESTIMATION, IN WHICH ONE WOULD
YOU HAVE CONFIDENCE
• If the three intrinsic value estimates for Stock X were different, you
would have the most confidence in Company X’s CFO’s estimate.
Intrinsic values are strictly estimates, and different analysts with
different data and different views of the future will form different
estimates of the intrinsic value for any given stock. However, a
firm’s managers have the best information about the company’s
future prospects, so managers’ estimates of intrinsic value are
generally better than the estimates of outside investors.
.
 X. IS IT BETTER FOR A FIRM’S ACTUAL STOCK PRICE IN
THE MARKET TO BE UNDER, OVER OR EQUAL TO ITS
INTRINSIC VALUE
• If a stock’s market price and intrinsic value are equal, then the stock is in
equilibrium and there is no pressure (buying/selling) to change the stock’s price.
So, theoretically, it is better that the two be equal; however, intrinsic value is a
long-run concept. Management’s goal should be to maximize the firm’s
intrinsic value, not its current price.
• So, stockholders in general would probably expect the firm’s market price to be
under the intrinsic value—realizing that if management is doing its job that
current price at any point in time would not necessarily be maximized.
• However, the CEO would prefer that the market price be high—since it is the
current price that he will receive when exercising his stock options. In addition,
he will be retiring after exercising those options, so there will be no
repercussions to him (with respect to his job) if the market price drops—unless
he did something illegal during his tenure as CEO.
 Y. DETERMINANTS OF INTRINSIC
@
VALUE AND STOCK PRICES
Managerial Actios, the Economic Environment,
Taxes, and the Political Climate

“True” Investor “True” n“Perceived” Investor “Perceived”

Cash Flows Risk Cash Flows Risk

Stock’s Stock’s
Intrinsic Value Market Price

Market Equilibrium:
Intrinsic Value = Stock Price
Z. SHOULD STOCKHOLDER WEALTH MAXIMIXZATION BE
THOUGHT OF AS A LONG OR SHORT TERM GOAL
• Stockholder wealth maximization is a long-run goal. Companies,
and consequently the stockholders, prosper by management making
decisions that will produce long-term earnings increases. Actions
that are continually shortsighted often “catch up” with a firm and, as
a result, it may find itself unable to compete effectively against its
competitors.
• There has been much criticism in recent years that U.S. firms are too
short-run profit-oriented. A prime example is the U.S. auto industry,
which has been accused of continuing to build large “gas guzzler”
automobiles because they had higher profit margins rather than
retooling for smaller, more fuel-efficient models.
 AA. SOME IMPORTANT BUSINESS
TRENDS
• Corporate scandals have reinforced the importance of business
ethics, and have spurred additional regulations and corporate
oversight.

• Increased globalization of business.

• The effects of ever-improving information technology have had a

profound effect on all aspects of business finance.

• Stockholders now have more control of corporate governance.

THE END!!!
MODULE 01