Cover designed by: Mr.

Medel Valencia

MODULE

Financial Management 1

AE 191

ACADEMIC YEAR 2020-2021

Prepared by:
Venus S. Palmenco, CPA
Instructor
 GUIDE ON HOW TO USE THE MODULE

A. For Faculty

The best way to use this module is to read the four lessons in sequence as you try to develop a
teaching strategy.
You may want to redesign the way the lectures are presented, as long as it is consistent with the
lesson objectives.
For timed activities(synchronous), inform the class ahead of time and allot ample time for
them to finish the activity
Provide reading suggestions (ebook, website) that will complement the main topics in this
module.
Since Accounting is a challenging subject, application of concepts are not presented in the
module, but rather to be presented during the synchronous sessions of the class in order to
encourage collaborative discussion.
In discussing the lesson, you may rearrange the sequence of the topics according to your
preference.

B. For Learners

Read the suggested readings before reading the Lecture

Do the activities specified honestly and religiously to make sure you understand the lesson.
Make your own notes or summary per lesson.
List down questions that come into your mind while studying and ask your instructor on
his/her consultation time or during your class hours.
Be proactive. Do extra problems to practice what you have learned. Your goal must be to finish
all the exercises in your book.
I suggest that you read the module from the first lesson to the last. As you read along, make
sure you understand the past topics because it helps you in connecting the concepts to enable
you to achieve an optimal level of comprehension.
Always do your activity in advance, and submit it before the due dates. Remember that it is not
the others but you who will be short-changed for not doing your work on time.
 FOREWORD

The course, Financial Management 1, covers topics regarding basic finance concepts.
The purpose of the course is to offer the students relevant, systematic, efficient and actual knowledge of
financial management that can be applied in practice with making financial decisions and resolving
financial problems. This learning module is developed with the aim to aid understanding of the students
through the lectures and activities that they can also apply with their personal lives.
Instructors want nothing but the best for their students that even in these trying times, they still
find ways on how to effectively convey the lessons now that face-to-face class is not possible.
 MODULE IN AE 191

Credits : 3 units
Pre-Requisite : AE 15

I. Lesson Title: Finance and Business

II. Learning Outcomes:
At the end of the lesson, the learners will be able to:
1. Explain the role of finance and the different types of jobs in finance.
2. Identify the advantages and disadvantages of different forms of business organization.
3. Describe the goal of the firm, and explain why maximizing the value of the firm is an
appropriate goal for a business.
4. Appreciate the importance of ethics in finance.

III. Lectures

References: Principles of Managerial Finance, Gitman and Zutter, 2015, Chapter 1

Types of Company Structures in the Philippines. (2019, March 5). Retrieved from
https://voffice.com.ph/Business-tips-Philippines/2019/03/05/types-of-company-structures-
in-the-philippines/

What is Finance?
Finance is defined as the science and art of managing money; from the point of planning where
to acquire the fund up to the point of using it through investment or any necessary means that the
individual or business would benefit from. It includes activities such as borrowing, lending, saving,
investing, budgeting and forecasting.

Career Opportunities in Finance

Finance prepares students for jobs in banking, investments, insurance, corporations, and the
government. Accounting students need to know finance, marketing, management, and human resources;
they also need to understand finance, for it affects decisions in all those areas. For example, marketing
people propose advertising programs, but those programs are examined by finance people to judge the
effects of the advertising on the firm’s profitability. So, to be effective in marketing, one needs to have a
basic knowledge of finance. The same holds for management—indeed, most important management
decisions are evaluated in terms of their effects on the firm’s value.
There are many career paths and jobs that perform a wide range of finance activities. As
mentioned in the book, careers in finance typically fall into one of two broad categories: (1) financial
services and (2) managerial finance.

(1) According to the finance and development department of the International Monetary
Fund (IMF), financial services are the processes by which consumers or businesses acquire
financial goods. For example, a payment system provider offers a financial service when it
accepts and transfers funds between payers and recipients. This includes accounts settled
through credit and debit cards, checks, and electronic funds transfers. One common
example is the Gcash App, where you can save money, invest money, deposit and transfer
money to different banks. Investment banking is also an area in financial services sector,
where they help companies to access capital markets (e.g. stock and bond market). This
allows corporations to raise funds for capital expansion or other needs. They will need the
help of this financial institution to find buyers for the bonds or stocks of company and
handle the paperwork. The reason may be to build new plants in other place or to establish
new branches. Financial goods (products), on the other hand, are not tasks. They are things.
 A mortgage loan may seem like a service, but it's actually a product that lasts beyond the
initial provision. Stocks, bonds, loans, commodity assets, real estate, and insurance policies
are examples of financial goods.
(2) Financial manager plays its role as the one who manages the finances of a company. It
includes developing financial plan or budget (i.e. it can help companies to determine in
advance whether they will have the enough money to do the things they need to do or would
like to do), extending credit to customers (i.e. they evaluate whether companies do have
enough money in meeting its obligations even when they allow customers to purchase on
account, where can also result to higher sales because of an increase in the customers’
purchasing power), evaluating proposed large expenditures (i.e. they evaluate the proposals
on large investments, may it be to acquire a fixed asset, securities like stocks or bonds, or
any other purpose which requires a large outlay of funds because they must ensure that the
actions to be taken by the company will still meet its established objectives), and raising
money to fund the firm’s operations (i.e. they seek better sources of funds, may it be through
debt financing or equity financing or both; debt financing relates to debt, they obtain funds
by issuing bonds or borrowing from a bank, whereas equity financing relates to stocks, they
raise capital through issuance of shares of stock to the public or intended buyers).

Legal Forms of Business Organization

The common differences between the three are the extent of liability of its owners, manner of
raising its capital and imposition of income tax. By the way, this topic had been covered already in
your Basic Accounting 1 and Income Tax for Individuals and Corporations, so let me assume that this
will now be easy for you.

Sole Proprietorships. It is owned and managed by only one person. Owners of proprietorships
invest funds to their businesses by utilizing their own money or by obtaining a loan from a
bank, or it can be both. As to the extent of liability, they are personally liable to any debt due
from the business. Also, their business income is liable for income tax applicable to individuals
by combining it to their compensation income (employer-employee relationship), if there’s any.

Partnerships. A partnership consists of two or more owners doing business together for profit.
Partnerships may either be general partnerships, where the partners have unlimited liability for
the debts and obligation of the partnership, or limited partnerships, where one or more general
partners have unlimited liability and the limited partners have liability only up to the amount
of their capital contributions. General professional partnerships do not pay income tax.
However, the owners or partners of a GPP do. As with sole proprietorships and limited liability
companies, partnerships are pass-through tax entities. This means the profits and losses of a
partnership trickle down to the business' owners, who must declare their share of the business'
income on their personal tax returns. This avoids certain tax issues, such as double taxation of
income, that businesses structured as a corporation must deal with. But it’s different with
ordinary / business partnerships where they are taxed in like manner as corporations, using the
current tax rate of 30%.

Corporations. The book says it all about corporations. Let me add this, a corporation’s profit
is taxable using the RCIT rate 30% of taxable income, but it can also be taxed using MCIT rate
2% of gross income, whichever is higher.

Table 1.1 Advantages and Disadvantages

Sole Proprietorship Partnership Corporation
Advantages The owner enjoys all the Easy to Start: Forming a Limited Liability - One
profits of the business: since general partnership of the most attractive
it is owned by a single usually takes a short things about a
person, he enjoys all the time since it does not corporation is that the
 profits that the business involve long legal owners have limited
accrues. procedures. liability. This means
Quick Decision Making: Requires less capital: that in case of debts,
When it comes to making The amount required to the assets of the
decisions about changing the start off a partnership is owners are very safe
type or quantity of not equal to the amount and remains untouched
commodities that the you need to start a by the creditors.
business deals in, you do not company. The amount of There is a possibility to
have to consult anyone. profit is shared lower taxes especially
Easy to Manage: As a single according to the ratio of when the owner and
business owner, it easy to capital contribution of the business share
manage your business since each partner. The higher profits.
there is no bureaucracy that the capital you At certain times,
you have to follow when contributed, the more the benefits may be
making decisions. profits you enjoy. deducted as business
Flexibility: This applies in
Consultation: The good expenses.
terms of changing the
thing with partnerships Ease in Transferring
commodities that you sell.
is that before arriving at Ownership - The
You can change them
a final decision, there is ownership of a
anytime you feel like as long
always consultation corporation is easily
as it is a general sole
between the partners. transferable. This
proprietorship with freedom
This leads to better means that in an event
to sell any product.
decisions that improve whereby the current
Easy to Start: Yes, this
the business. shareholders and
business type does not have
very long legal procedures to Quick Decision Making: directors foresee a dark
follow before it gets A partnership owned and future, they might sell
established. operated by two people the corporation and
Tax Savings- The entire is easy to make hence avoid losing
income generated by the decisions that can their capital
proprietorship passes directly enhance the performance investment.
to the owner (i.e. as business of the business. You Ability to Raise
income). This may result in a don’t need to call a Capital: Corporations
tax advantage if the owner’s meeting to discuss can raise capital
tax rate is less than the tax arising issues, just a through the sale or
rate of corporation. In some phone call is enough. securities such as
cases, it can also be Tax Implication: A bonds to investors who
exempted from income tax if partnership like a are lending money to
the total taxable income of proprietorship does not the corporations and
the owner is P250,000 and pay any income taxes. equity securities such
below. (Train Law) The income or loss of as common stock to
the business is investors who are the
distributed among the owners.
partners in accordance
with the partnership and
each partner reports
his/her portion whether
distributed or not on
personal income tax
return.
Disadvantages The owner incurs all the Unlimited liability: Time and cost of
losses: In case of losses, General partnerships formation: It is very
means that all the expensive compared to
 the sole proprietor bares all partners have unlimited setting up simple
the burden solely. liability. In case of business setups such as
Unlimited liability: This business debts that the sole proprietorship and
means that in case the business is unable to partnerships.
business runs bankrupt, the pay, the personal assets Taxes: A corporation
assets of the business owner of the partners are at risk operates as a separate
will be sold to clear off the of getting sold in order legal entity and hence
debts. to clear off the debt. is entitled to pay taxes.
The business owner pays Internal Wrangles:
Regulations:
personal income taxes on the Sometimes many
Corporations are
business net profits. partnerships do fail
subject to greater
Limitations in raising because of internal
government regulations
capital: Resources may be conflicts or personal
than other forms of
limited to the assets of the interests of a certain
busines organizations.
owner and growth may partner. The partners
depend on his ability to have a burden of paying There is slow decision
borrow money. personal income taxes making in corporations
Lack of Continuity: Since it on the net profits of the since the directors have
is owned by only one person, business. to be consulted before
upon his/her death or Lack of Continuity - any verdict is reached.
retirement, the proprietorship Partnership is dissolved
ceases to exist. when a partner
dies/retires.
Difficulty of transferring
ownership – It is
difficult to liquidate or
transfer ownership. It
varies with conditions
set forth in the
partnership agreement.
Limitations in raising
capital – A partner may
have problems raising
large amount of capital
because many sources of
funds are available only
to corporations.

Goal of the Firm

A goal is a desired result you want to achieve. You might use company goals to inform yearly
strategies and guide the direction of all your marketing efforts. An objective, on the other hand, defines
the specific, measurable actions each employee must take to achieve the overall goal. For an instance,
if your overall goal is to pass the licensure examination, your objectives should be to put more effort
in studying and to manage your time wisely. In this module, we’ll be talking about the goal of a
business. It is important to identify the measurable actions the manager should take to attain its goal.

What Should be the Goal of a Firm?

In finance, the goal of the firm is always described as “maximization of shareholder’s wealth”.
When business managers try to maximize the wealth of their firm, they are actually trying to increase
the company's stock price. As the stock price increases, the value of the firm increases, as well as the
shareholders' wealth. Stock prices are driven by a variety of factors, but ultimately the price at any
given moment is due to the supply and demand at that point in time in the market. Share price is the
value of the shares in the market, the price that shareholders are willing to sell their stocks. Recall that
in economics, when demand for shares exceeds supply, which means there are more buyers than sellers,
the prices increase, and when demand is less than supply, meaning that buyers are less than sellers, the
prices decrease. As the stock price increases, shareholder’s asset (investment) also increases. Financial
managers should evaluate what would be the impact of their decisions and actions to the share price of
the firm. They should only take actions that are expected to increase the share price and the two key
variables the managers should consider in making business decisions are return and risk, which profit
maximation-oriented managers do not consider.
Profit maximization is not always the same with wealth maximization. Basically, the main
motive of wealth maximization is to improve the market value of the shares of its owners, whereas the
concern of profit maximization is to make large amount of profit which is normally a short-term goal.
Profit maximization implies that every decision relating to business is evaluated in the light of profits.
All the decisions with respect to new projects, acquisition of assets, raising capital etc. are studied for
their impact on profits. If the result of a decision is perceived to have a positive effect on the profits,
the decision is taken further for implementation. As I’ve mentioned above, the drawbacks of profit -
oriented managers are:
(1) They don’t consider the timing of returns. They are more focus on the value that can be
derived from that investment/decision. For example, a profit-oriented manager would choose
an investment that can bring him a higher return regardless of the time it will take to earn it,
rather than an investment with a lower return that can be earned within a short period of time.
In finance, timing is important. Why do you think so? Because in finance, manager’s primary
goal is to maximize the shareholders wealth. How can managers do that? By choosing the
optimal decision that could positively affect the firm’s wealth, as well as its owners. Yes, the
other one can provide a higher return, but the question is, when can it be received by the firm?
The sooner the receipt of the return the better. Why? Because the manager can re-invest that
return. Dividends can be in any form; it can be in cash or in shares. (i.e. in cash dividend, the
firm will receive cash as a return on their investment and can either reinvest it in the same firm
or invest it to another firm, whereas in share dividend, the firm receives dividend in the form
of shares, meaning additional ownership). In the example, if Nick chooses Rotor, which has
lower EPS in 3 years. He can re-invest the return he’ll receive on the first year to either the
same firm, which is Rotor, or to another firm, which can be Valve. So, in the following years,
after the reinvestment, Neptune Manufacturing can earn greater earnings.

(2) Profits and cash flows are not identical. Generally, investors use the earnings updates as
basis on how stock are likely to be valued in the coming months. The problem is that not all
earnings share the same quality. Because the stock market tends to overvalue accounting
earnings, there’s a need to validate the quality of earnings that companies report by looking at
its cash flows. Firms can say that they’re performing well by showing higher profits in their
income statements, which in fact, don’t have enough cash to pay their obligations including the
firm’s obligation to pay dividends to its shareholders (typically, that’s the reason why they
invest, to earn a return). The two differs because income statement adopts the accrual basis and
uses different accounting policies, whereas cash flow statement is a more straightforward one
where it shows what comes in and out in the firm without the need to follow any complicated
policies, techniques and assumptions. For example, X Company delivered goods to customer
A. The total amount of the goods is P150,000, but it was all sold on account. Under the revenue
recognition principle, the company should recognize revenue since the goods have been
delivered already and record account receivable for no cash has been received. In relation to
that transaction, Company ABC includes P150,000 as part of their revenues, without any cash
reported in the cash flow statement. With that, we can say that profits do not necessarily result
in cash flows. Not all profits reported on the books are cash. In the example on the book, we
can assume that Valve may have been using different accounting policy in reporting COGS,
that’s why the income statement showed a higher profit than the other one or Valve capitalizes
certain expenses to lower operating expenses and boost income. That’s one reason why
financial managers give greater attention to the cash flow statement, rather than to the income
 statement, where the availability of cash can be seen. Indeed, companies use cash in paying its
obligations, not profits. In addition, an increase in earnings doesn’t necessarily result to an
increase in share price. A firm’s earnings shouldn’t be solely use as a basis in the
increases/decreases of share prices. There are other many factors that can influence its
movements in the stock market. It can be the demand and supply of the shares, interest rates (if
interest is low, there is a high demand for funds and subsequent demand for shares increases),
company news and announcement which includes dividend announcements (if it exceeds
investors’ expectation, share price tends to increase and vice versa), introduction of new
products, accounting errors and scandals and etc. This can also include the future cash flows of
a firm as an indicator. This may be a good sign that a company can give higher returns to its
investors, which may lead to an increase in share price. Like in the example, if the management
decides to reduce a significant amount from the cash allotted for equipment’s maintenance, or
instead of doing it for every 6 months the company chooses to do it once a year, of which the
products quality is not affected, this may result to an increase in cash flows available in future
years. If any of it happens, an increase in share price is expected. But if it leads to an inefficient
performance of the equipment, where it results to low-quality products or reduced number of
outputs, the firm’s share price is expected to go down. Why? The demand for their shares goes
down as many well-informed investors anticipates lower future cash flows. They are afraid to
suffer in the near future. They decide to sell their shares when the share price is still high.

(3) It ignores any risks. Profit maximization does not consider risk of the busines concern. A
decision solely based on profit maximization model would take a decision in favor of profits.
In the pursuit of profits, the risk involved is ignored which may prove unaffordable at times
simply because higher risks directly question the survival of a business. The trade-off between
return and risk means the higher the risk, the higher should be its return (risky investment) and
the lower the risk, the lower its acceptable return (safe investment). Recalling the topic above
about cash flows, we’ve determined that cash flow is directly related to share price; as the future
cash flows increase, the share price is also expected to increase. On the other hand, risk and
share price have an indirect relationship: the higher the risk, the lower the firm’s share price
because shareholders don’t like risks. Another example is the one that I think most of you have
already watched, Itaewon Class. Eight years ago, Saeroyi timed his entry of buying Jangga
Co.s stock when the value was low, due to Geun-Won’s drinking stunt which drove the stock
down. At that time, there’s a risk that the incident happened on the CEO’s successor(son) could
affect its future operations and therefore could result to reduced future cash flows.

What about Stakeholders?

Some examples of corporate social responsibility, which can provide long-run benefit to
shareholders:
Reducing carbon footprints
Improving labor policies
Participating in fair trade
Charitable giving
Volunteering in the community
Corporate policies that benefit the environment
Socially and environmentally conscious investments
 Source: https://d226aj4ao1t61q.cloudfront.net/mxs97wtiv_types-of-stakeholders.gif

Ethical Behavior in Business

Ethics are of primary importance in any practice of finance. It refers to a set of rules that describes
what is acceptable conduct in society. Knowing the difference between right and wrong and choosing
what is right is the foundation for ethical decision making. Finance professionals commonly manage
other people’s money. For instance, corporate managers control the stockholder’s firm, bank employees
perform cash receipts and disbursements functions, and investment advisors manage people’s
investment portfolios. These fiduciary relationships oftentimes create tempting opportunities for finance
professionals to make decisions that either benefit the client or benefit the advisors themselves. Some of
the actions which violate the ethical standards in business:

1. Creative accounting - consists of accounting practices that follow required laws and regulations,
but deviate from what those standards intend to accomplish. Creative accounting capitalizes on
loopholes in the accounting standards to falsely portray a better image of the company.
Laribee Wire Manufacturing Co. offers a good example of inventory manipulation. The copper-
wire maker was in trouble in the late 1980s as sales to the troubled construction industry faltered
and a big acquisition left it with massive debt. Laribee recorded phantom inventory and carried
other inventory at bloated values to convince banks to lend it $130 million. The company
reported $3 million in net income for the period, when it really lost $6.5 million.

2. Earnings management – Earnings management is the use of accounting techniques to

produce financial statements that present an overly positive view of a company's business activities
and financial position. It takes advantage of how accounting rules are applied and creates financial
statements that inflate or "smooth" earnings.
Example of earnings management is to change company policy so more costs
are capitalized rather than expensed immediately. Capitalizing costs as assets delays the
recognition of expenses and increases profits in the short term. Assume, for example, company
policy dictates that every item purchased under $5,000 is immediately expensed and costs over
$5,000 may be capitalized as assets. If the firm changes the policy and starts to capitalize all
items over $1,000, expenses decrease in the short-term and profits increase.

3. Misleading financial forecast – It contains deceiving financial information about estimated future
income and expenses of a business to attract future investors.

4. Insider trading – Insider trading is the buying or selling of a publicly traded company's stock by
someone who has non-public, material information about that stock. Material nonpublic information
is any information that could substantially impact an investor's decision to buy or sell the security
that has not been made available to the public.
In September 2017, former Amazon.com Inc. (AMZN) financial analyst Brett Kennedy was
charged with insider trading. Authorities said Kennedy gave fellow University of Washington
 alumni Maziar Rezakhani information on Amazon's 2015 first quarter earnings before the
release. Rezakhani paid Kennedy $10,000 for the information. In a related case, the SEC said
Rezakhani made $115,997 trading Amazon shares based on the tip from Kennedy.

5. Fraud – It involves the false representation of facts, whether by intentionally withholding important
information or providing false statements to another party for the specific purpose of gaining
something that may not have been provided without the deception. An example of fraud is when a
person promises you that you can make a lot of money by investing with him, but then just takes
your money and disappears.

6. Excessive executive compensation – It involves giving compensation to an executive which is not

tantamount to the services it provides. Many executives are given raises and bonuses even when
their companies are faltering. Comparing pay to stock performance can help you determine whether
executives are overpaid.

7. Options backdating – Options backdating is the process of granting an option that is dated before
the actual issuances of the option. In this way, the exercise price of the granted option can be set at
a lower price than that of the company's stock at the granting date. This process makes the granted
option "in the money" and of value to the holder.

8. Bribery – Bribery refers to the offering, giving, soliciting, or receiving of any item of value as a
means of influencing the actions of an individual holding a public or legal duty. It is offering
something desirable or something of value in exchange for getting something in return.

9. Kickbacks – It is an illegal payment intended as compensation for preferential treatment or any

other type of improper services received. Kickbacks are often referred to as a type of bribery.

Importance of Ethics in Finance

Business ethics are vital as it help maintain a great reputation for the entity, help avoid significant
financial and legal issues, and ultimately benefit everyone involved. It can positively affect the firm’s
share price (market value of a share) by maintaining and enhancing cash flow and reducing perceived
risk.

IV. Academic Activity

(1) Please read Principles of Financial Management by Gitman and Zutter, pages 4-14

V. Life Activities
Personal Finance:
(1) Ann and Jack have been partners for several years. Their firm, A & J Tax Preparation, has been very
successful, as the pair agree on most business-related questions. One disagreement, however,
concerns the legal form of their business. Ann has tried for the past 2 years to get Jack to agree to
incorporate. She believes that there is no downside to incorporating and sees only benefits. Jack
strongly disagrees; he thinks that the business should remain a partnership forever.
First, take Ann’s side, and explain the positive side to incorporating the business. Next, take
Jack’s side, and state the advantages to remaining a partnership. Lastly, what information would you
want if you were asked to make the decision for Ann and Jack?
 (2) The end-of-year parties at Yearling, Inc., are known for their extravagance. Management provides
the best food and entertainment to thank the employees for their hard work. During the planning for
this year’s bash, a disagreement broke out between the treasurer’s staff and the accounting’s staff.
The treasurer’s staff contended that the firm was running low on cash and might have trouble paying
its bills over the coming months; they requested that cuts be made to the budget for the party. The
accounting’s staff felt that any cuts were unwarranted as the firm continued to be very profitable.

Can both sides be right? Explain your answer.

VI. Assessment

Grading Criteria for Class Standing: (Curriculum emphasis may vary every grading period)
Major Exams = 30%
Class Standing = 70%
100%
CLASS STANDING
Quizzes = 50%
Recitation = 25%
Academic and Life Activities = 25%
100%