INTRODUCTION TO FINANCIAL MANAGEMENT

Finance is the most important factor in which a company can rely on. Planning certainly offers a
foundation but when you're talking about infrastructure, financing is the only key to business growth
and diversification. This helps companies take advantage of opportunities, recruit workers to meet
corporate goals, receive licenses, provide assistance during bad times and it helps to sustain the
business much more when the economy is good. Any attempt to start a company involves a detailed
understanding and knowledge of Business Finance.

Finance is always of great importance, be it in a business or one's everyday life. It is important

to manage risks in business, it is equally important to manage risks in life as well. Risk is nothing
but an uncertain event that might damage your assets and when it is financial risk, it creates loss
of Finance. Some books define Finance as the science and art of managing money.
DEFINITION OF FINANCE

Finance has distinct but connected and associated definitions:

1) “Handling large amounts of money-particularly by governments or large companies”,

2) Providing monetary support to a business organization,

3) The monetary resources of a nation, companies , or entity.

Therefore, as described by Gitman and Zutter (2012), “finance is the art and science of proper handling
of money”.

“TYPES OF FINANCE”

As for the different types of finance, Public finance covers tax structures, government expenditures,
budgeting processes, instruments of stabilization, debt problems and other financial concern while
Corporate finance is the administration of a company's properties and debts. The third one is Personal
finance which requires careful control of the income and expenditures of a person, so that there is
enough money left over for savings or which can be used for investment.

• “Public Finance”*

The government helps deter market collapse by regulating capital management, income distribution,
and economic stabilization. Daily support for these services is largely provided by taxation. The other
methods which may aid the government funds are borrowing from banks, insurance agencies, and
governments; collecting grants and aid; and raising dividends from their enterprises. Furthermore, fees
from usage of ports, airport stations, and other facilities also help; fines arising from violating laws; taxes
from licenses and fees, such as driving; and government bond sales are also sources of public or
government funds.

• “Corporate Finance”*

Businesses offer financing through equity contributions and loan agreements, and through bond
purchases. Start-ups may obtain investments from “angel investors” also known as “venture capitalists”
which help budding companies with great potential or they may sell stocks or bonds from existing
companies. Businesses can buy stocks that pay dividends, blue-chip bonds (bonds sold by large
corporations) or *interest-bearing bank deposits. Debt acquisition and careful management will help a
company earn more profit and expand operations.

• “Personal Finance”*

Personal finance is focused on making more money and doing one’s best to spend less. By starting a
small company like small sole proprietorship, taking on second job or part-time jobs, or saving,
individuals will earn more money. It could be possible to spend less money by determining if what is
being bought really is worth the price paid. One example is just cooking dishes at home instead of eating
in expensive restaurants or a person can buy coffee packs at a grocery store instead of buying coffee
every day from a café and make the coffee at home for far less money.

Debt relief and the development of an emergency savings fund are both important aspects of personal
finance. In the case of job losses, medical problems, car accidents or other big expenses, having at least
six months' income or one-year income set aside helps a person to pay cash for expenses rather than
pay them and accumulate more debt. Another requirement for sound personal finance is having
retirement fund. People must learn to set aside or save enough money to live when they choose to stop
working at a certain age and enjoy the freedom to choose and do what they are passionate about.

FINANCIAL MANAGEMENT

When business expands, there is a need to shift from a flat organizational 1structure to one that will
assign multiple main managers and report directly to the business owner. An operational structure
organizes undertakings by departments, with one of these being finance. Even though finance is only
one of the several departments in a company, it is important to take note that financial management
takes place in all departments to ensure sustainability for the business.

“Financial management* means”:

• Gathering* funds at lower cost for the company;

• Using these funds earned to gain full income or to maximize profit 1 of the company

So financial management means the company's finances are managed and regulated. It is planned and
executed carefully to meet the company's goals. The most significant and considered to be one of the
most complicated activity of a firm is any activity that involves financial operations.

Financial Management deals with the decisions that are supposed to maximize the value of
shareholder’s wealth (Cayanan). These decisions will ultimately affect the market's 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 toward shareholder wealth maximization.
The organizational structure of the company is important, especially in the financial aspect of
the business, and the particular set of people, each plays a role in the decision-making of the
company. See the diagram below.

From the diagram presented, emphasized that each line is working for the interest of the person
on the line above them. Since the managers of the company are making decisions in the interest
of the board of directors and the board of directors does the same for the interest of the
shareholders, it follows the goal of each individual in a corporate organization should have an
objective of shareholders wealth maximization.

The roles of each position are identified.

1. Shareholders: The shareholders elect the Board of Directors (BOD). Each share held is
equal to one voting right. Since the shareholders elect the BOD, their responsibility is to carry
out the objectives of the shareholders. Otherwise, they would not be elected to that position. Ask
the learners again, what the objective of the shareholders is, just to refresh.

2. 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:

a. Setting policies on investments, capital structure, and dividend policies.

b. Approving the company’s strategies, goals, and budgets.

c. Appointing and removing members of the top management including the president.
d. Determining top management’s compensation.

e. Approving the information and other disclosures reported in the financial statements (Cayanan,
2015)

f. Validation of the details stated in the financial statements and other reports

3. 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:

a. Approving the information and other disclosures reported in the financial statements.
Overseeing the operations of a company and ensuring that the strategies as approved by the
board are implemented as planned.

b. Performing all areas of management: planning, organizing, staffing, directing and

controlling.

c. Representing the company in professional, social, and civic activities.

d. Supervising a corporation’s activities and maintaining that the plans accepted by the Board are
executed as expected.

4. VP for Marketing: The following are among the responsibilities:

a. Formulating marketing strategies and plans. Directing and coordinating company

sales.

b. Performing market and competitor analysis.

c. Analyzing and evaluating the effectiveness and cost of marketing methods

applied.

d. Conducting or directing research that will allow the company to identify new
marketing opportunities, e.g. variants of the existing products/services already offered in
the market.

e. Promoting good relationships with customers and distributors. (Cayanan, 2015)

5. VP for Production: The following are among the responsibilities:

a. Ensuring production meets customer demands.

b. Identifying production technology/process that minimizes production cost and

makes the company cost competitive.
 c. Coming up with a production plan that maximizes the utilization of the
company’s production facilities.

The role of the VP for Finance/Financial Manager is to determine the appropriate capital
structure of the company. Capital structure refers to how much of your total assets are financed
by debt and how much is financed by equity. To be able to acquire assets, our funds must have
come somewhere. If it has been bought using cash from our pockets, it has been financed by
equity. On the other hand, if we used money from our borrowings, the asset bought has financed
by debt.

What are the functions of Financial Managers?

1. Financing decisions- include making decisions as to how to finance long-term

investments and working capital-which deals with the day-to-day operations of the company.

They consist of planning and executing decisions regarding methods on financing long-term acquisitions
(such as business expansions) and working capital that corresponds with the company's daily
operations* like product purchase, operating expenses payment, etc. The job of the ‘VP for Finance or
the Financial Director* is to decide the company's adequate “capital structure*”. Capital structure
shows how much of the overall assets are financed by debt, and how much is funded by equity. Recall
that Assets = Liabilities + Owner’s Equity. To be able to acquire assets, our funds must have come
somewhere. If it was bought using cash from our pockets, it is financed by equity. On the other hand, if
we used money from our borrowings, the asset bought is financed by debt.

2. Investing Decisions- To minimize the probability of failure, long-term investments have

been supported by a capital budgeting analysis.

Investing means deciding on where to put your excess cash to make it more profitable. We expand that
definition by including cash held taken from funds as a result of financing decisions. Investments may
either be under the category of “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*” must be knowledgeable on utilizing Financial Planning* tools
such as budgeting and forecasting. ✓ Moreover, the firm must be able to select the kind of investment ”
to utilize that would provide the most optimal risk and return trade off.

• Long term investments should be supported by a capital budgeting analysis which is among the
responsibilities of a finance manager. ✓ Capital budgeting analysis is a tool to assess whether in the long
run* of firm’s operations, the investment* will be profitable or not*. ✓ ‘Creditors* 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.
3. Operating Decisions – deal with the daily operations of the company, especially on how
to finance working capital accounts such as accounts receivable and inventories.

Operating actions deal with the company's day to day activities. The VP 's task for finance is to decide
“how work capital accounts such as receivable accounts and inventories”* can be funded. The business
has an option of whether “long-‘‘term or short-‘term assets*” are used to fund working capital needs.
The decision executed to finance these working capital accounts depends on the personal decision-
making skill of top management for risk. If the company is more aggressive, then these accounts
receivable and inventories can be substantially financed by short-term sources (example of this is loan
from the bank payable in less than 12 months). On the other hand, a more conservative management
will opt to finance working capital accounts mostly through long-term sources (like loans that mature or
payable longer than 12 months).

4. Dividend Policies – Dividend is a part of profits that are available for distribution, to equity
shareholders. The Finance manager must decide whether the firm should distribute all the profits
or retain them or distribute a portion and retain the balance.

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 job of a “financial manager^” to be able to identify when cash dividends’ must be
declared* or given by the firm. 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. “A financia’l manager is the one who oversees all
of the firm's essential financial operations”. His decisions have full impact on the firm's productivity,
growth and reputation

Figure 1. Financial system and the relationship between financial agents

The financial system links the savers and the users of funds. Savings can come from households,
individuals, companies, government agencies, or any other entity whose cash inflows are greater
than their cash outflows. The financial system through financial intermediaries provides a
mechanism by which these savings can be channeled to users of funds, borrowers, and investors.

Some of the financial instruments issued by users of funds such as the shares of stocks and
corporate bonds of publicly listed companies and the debt securities issued by the National
Government have traded.

Differentiate the Financial instruments, financial institutions, and financial markets

1. Financial institutions are companies in the financial sector that provide a broad range of
business and services including banking, insurance, and investment management.

Identify examples of financial institutions/Intermediaries:

a. Commercial Banks - Individuals deposit funds at commercial banks, which use

the deposited funds to provide commercial loans to firms and personal loans to
individuals, and purchase debt securities issued by firms or government agencies.

Commercial banks receive deposits and provide their customers with security and
convenience. Part of the banks' original intent was to provide safe keeping* for their money to
customers. While holding physical cash at home or in a pocket, the possibility of loss due to
robbery and incidents exists, not to mention the loss of future interest income. Consumers no
longer need to keep huge quantities of money on hand with banks; rather purchases may be
done with checks, debit * cards or credit cards*.” Commercial banks often allow loans which
are used by individuals and companies to buy products or increase business operations; this in
turn leads to more deposited* funds finding their way to banks. If banks can lend money at a
higher rate of interest than they must pay for funds and operating expenses, then they are
making money with this operation. Banks* often play under-estimated positions as payment
agents within a country and among nations. We can also arrange wire transfers with other
institutions as well as issuing debit features that allow account holders to pay for products
with the swipe of a finger. Banks effectively underwrite financial transactions by lending their
integrity and legitimacy to the transaction; a check is simply just a promissory* note between
two individuals, but no merchant will approve it without a bank 's name and identification on
that note. As payment agents, banks make commercial purchases even more convenient;
there is no need to hold huge quantities of physical currency or bills when dealers acquired the
checks, debit cards or credit cards that were given by banks

b. Insurance Companies - Individuals purchase insurance (life, property and

casualty, and health) protection with insurance premiums. The insurance companies
pool these payments and invest the proceeds in various securities until the funds are
needed to pay off claims by policyholders. Because they often own large blocks of a
firm’s stocks or bonds, they frequently attempt to influence the management of the firm
to improve the firm’s performance, and ultimately, the performance of the securities
they own.

c. Mutual Funds - Mutual funds owned by investment companies that enable small
investors to enjoy the benefits of investing in a diversified portfolio of securities
purchased on their behalf by professional investment managers. When mutual funds use
money from investors to invest in newly issued debt or equity securities, they finance
new investments by firms. Conversely, when they invest in debt or equity securities
already held by investors, they are transferring ownership of the securities among
investors.

d. Pension Funds - Financial institutions that receive payments from employees and
invest the proceeds on their behalf.

e. “Investment Banks*” Although investment banks are called "banks," their operations
vary greatly from those of receiving deposits from commercial banks. An investment bank is a
financial institution offering a range of services for businesses and certain governments. These
activities include underwriting debt and equity deals, acting as an intermediary between a
securities issuer and the trading public, developing markets, facilitating mergers and other
corporate reorganizations, and serving as a broker for institutional clients. They can also
provide businesses with research and financial consulting services. Investment banks typically
concentrate on initial public offerings ( IPOs), as well as broad public and private equity
offerings. Investment banks are typically more subject to less policies than commercial banks.
Thus, investment banks operate under the oversight of regulatory bodies including SEC*
(Securities and Exchange Commission*) and BSP* (Bangko Sentral ng Pilipinas*). When it
comes to retaining capital requirements or launching new goods, usually fewer constraints
apply.
 f. Investment Companies* Investment 1 companies are corporations wherein individuals
and other organizations invest in investment portfolios that are managed by professionals who
are tasked to keep track of market trends and the performance of different financial products
or instruments. The most common example of investment companies are mutual fund
companies. Investors pool their funds together, and the combined funds are then placed by
the company in different investment options. With the aid of technology, investors can
monitor if they are losing or earning money. The company sets up an account for each
investor. Each account is secured with a password and only the investor has access to
information related to his or her own account.

Other financial institutions include pension funds like Government Service Insurance System
(GSIS) and Social Security System (SSS), unit investment trust fund (UITF), investment banks,
and credit unions, among others.

2. Financial Instruments-is a real or a virtual document representing a legal agreement

involving some sort of monetary value. These can be debt securities like corporate bonds or
equity-like shares of stock. When a financial instrument is issued, it gives rise to a financial
asset on one hand and a financial liability or equity instrument on the other.

a. A Financial Asset is any asset that is:

• Cash

• An equity instrument of another entity

• A contractual right to receive cash or another financial asset from another entity.

• A contractual right to exchange instruments with another entity under conditions that are
potentially favorable. (IAS 32.11)

• Examples: Notes Receivable, Loans Receivable, Investment in Stocks, Investment in

Bonds

b. A Financial Liability is any liability that is a contractual obligation:

• To deliver cash or other financial instrument to another entity.

 • To exchange financial instruments with another entity under conditions that are
potentially unfavorable. (IAS 32)

• Examples: Notes Payable, Loans Payable, Bonds Payable

c. An Equity Instrument is any contract that evidences a residual interest in the assets of an
entity after deducting all liabilities. (IAS 32)

• Examples: Ordinary Share Capital, Preference Share Capital

• Identify common examples of Debt and Equity Instruments.

d. Debt Instruments generally have fixed returns due to fixed interest rates.

Examples of debt instruments are as follows:

• Treasury Bonds and Treasury Bills issued by the Philippine government. These
bonds and bills have usually low-interest rates and have a very low risk of default since
the government assures that these have been paid.

• Corporate Bonds issued by publicly listed companies. These bonds usually have
higher interest rates than Treasury bonds. However, these bonds are not risk-free. If the
company issued the bonds goes bankrupt, the holder of the bonds will no longer receive
any return from their investment and even their principal investment has wiped out.

e. Equity Instruments generally have varied returns based on the performance of the issuing
company. Returns from equity instruments come from either dividends or stock price
appreciation.

The following are types of equity instruments:

•Preferred Stock has priority over common stock in terms of claims over the assets of a
company. This means that if a company has liquidated and its assets have to be distributed, no
asset be distributed to common stockholders unless all the claims of the preferred stockholders
have been given. Moreover, preferred stockholders have also priority over common
stockholders in cash dividend declaration. Dividends to preferred stockholders are usually at a
 fixed rate. No cash dividends are given to common stockholders unless all the dividends due to
preferred stockholders are paid first. (Cayanan, 2015)

Preferred stock ensures that if a corporation is to be liquidated and its assets are to be dispersed, no
assets can be allocated to common stockholders until all the preferred stockholders' claims have been
made. This demonstrates that in terms of demands over a firm's properties, preferred stock has
advantage over a common stock. ” “Additionally, if all the dividends are paid first due to preferred
stockholders, there will be no remaining cash dividends* that will be issued to common
stockholders*. It means that preferred stockholders have priority over common stockholders in
reporting cash dividends.

• Holders of Common Stock on the other hand are the real owners of the company. If the
company’s growth is encouraging, the common stockholders will benefit from the growth.
Moreover, during a profitable period for which a company may decide to declare higher
dividends, preferred stock will receive a fixed dividend rate while common stockholders
receive all the excess.

Common Stock investors, on the other hand, are the firm 's primary shareholders. If the performance
of the firm is driven, the success would favor the common stockholders. In turn, preferred stock may
receive a fixed dividend rate over a profitable time during which a business can want to pay much
higher dividends, while common stockholders may receive all the excesses. Moreover, common
shareholders have voting rights, a luxury which is not open to preferred shareholders.

3. Financial Market - refers to a marketplace, where the creation and trading of financial
assets, such as shares, debentures, bonds, derivatives, currencies, etc. take place.

Classify Financial Markets into comparative groups:

- Primary vs. Secondary Markets • To raise money, users of funds will go to a primary market
to issue new securities (either debt or equity) through a public offering or a private placement.

• The sale of new securities to the public is referred to as a public offering and the first
offering of stock is named an initial public offering. The sale of new securities to one investor
or a group of investors (institutional investors) is referred to as a private placement.

• However, suppliers of funds or the holders of the securities may decide to sell the securities
that have been purchased. The sale of previously owned securities takes place in secondary
markets.
 • The Philippine Stock Exchange (PSE) is both a primary and secondary market.

Money Markets vs. Capital Markets •Money markets are a venue wherein securities with short-
term maturities (1 year or less) are sold. They have been created because some individuals,
businesses, governments, and financial institutions have temporarily idle funds that they wish to
invest in a relatively safe, interest-bearing asset. At the same time, other individuals, businesses,
governments, and financial institutions find themselves in need of seasonal or temporary
financing.

• On the other hand, securities with longer-term maturities are sold in Capital markets. The key
capital market securities are bonds (long-term debt) and both common stock and preferred stock
(equity, or ownership).

The role of Financial Managers: make financing decisions that require funding from investors in
the financial markets.

THE FINANCIAL* SYSTEM* OR FLOW* OF FUNDS* The users of funds (for individual or public
consumption) and the savers (individuals or institutions) are connected in the financial system*. Shown
in Figure 2 is an overview of the financial system.

Savings can come from households, individuals, companies, government agencies, or any other entity
whose cash inflows are greater than their cash outflows. The financial system through financial
intermediaries provides a mechanism by which these savings can be channeled to users of funds,
borrowers, and investors. Some of the financial instruments issued by users of funds such as the shares
of stocks and corporate bonds of publicly listed companies and the debt securities issued by the
National Government can be traded. The financial market provides a system for the trading of these
securities. A company can become publicly listed through the help of investment banks that aid
corporations for their initial public offering* (IPO) where shares will be offered for the first time to many
investors. The offering of the shares will be coursed through an investment bank which will underwrite
the offering of the shares. As shown in Figure 2, the same entities can be savers and users of funds. One
entity may have savings today but may be needing funds in the future, for example, for expansion.