PRELIM: FINMAN NOTES with God all things are possible

LESSON 1: Introduction to Financial o Financial Control

Management o Financial Decision Making

FINANCIAL MANAGEMENT 1) Financial Planning

- Management needs to ensure that
- Is about preparing, directing and enough funding is available at the right
managing the money activities of a time to meet the needs of the business.
company such as buying, selling, and In the short term, funding may be
using money for best results to maximize needed to invest in equipment and
wealth or to produce best value for stocks, pay employees, and fund sales
money. Basically, it means applying made on credit.
general management concepts to the
cash of the company. - In the medium and long term, funding
may be required for significant additions
- Taking commercial business as the most to the productive capacity of the
common organizational structure, the business or to make acquisitions. This
key objectives of financial management
links in with the financial decision-
include: making process and forecasting.
1) To create wealth for the
business;
2) To generate cash; and 2) Financial Control
3) To provide an adequate return - This element ensures business that
on investment, bearing in mind objectives are met.
the business risks taken and the
resources invested - Financial control determines if assets are
secured and being used efficiently. It also
- Personal finance deals with an confirms if management acts in the best
individual’s decisions on the spending interest of shareholders and in
and investing of income. It includes accordance with business rules.
answers to how much of their earnings
they should spend, how much they
should save, and how they should invest 3) Financial Decision Making
their savings. - The key aspects of financial decision-
making include investment, financing,
and dividends. Though investments
- Business finance involves same type of must be financed in some way, there are
decisions focusing on how the firms raise always financing alternatives that can be
money from investors, how to invest considered which depends on the type
money to earn a profit, and how to of source, period of financing, cost of
reinvest profits in the business or financing, and the net present returns
distribute them back to investors. generated.

- The key financing decision is whether

THREE KEY ELEMENTS IN FINANCIAL profit earned by the business should be
MANAGEMENT PROCESS retained instead of being distributed to
shareholders via dividends. Dividends
o Financial Planning
PRELIM: FINMAN NOTES with God all things are possible

that are too high may cause the business - Career opportunities: within the areas of
to starve of funding to reinvest in banking, personal financial planning,
growing revenues and profits further. investments, real estate, and insurance.

✓ Managerial Finance
SCOPE OF FINANCIAL MANAGEMENT - Concerned with the duties of a financial
o Anticipation manager working in a business. This
- The financial needs of a company are encompasses financial planning or
being estimated, as it finds out how budgeting, credit extension to customers
much finance is required. or other credit administration function,
investment evaluation and analysis, and
obtaining of funds acquisition for a firm.
o Acquisition Managerial finance is the management
- It collects finance for the company from of the firm’s funds within the firm.
different sources.

- Career opportunities: financial analyst,

o Allocation capital budgeting analyst, and cash
- It uses the collected or acquired finance manager
to purchase fixed and current assets for
the company. PROFESSIONAL CERTIFICATION IN FINANCE
◼ Chartered Financial Analyst (CFA)
o Appropriation - This is a graduate-level course of study
- It distributes part of the company profits offered by CFA Institute which is focused
among the shareholders, debenture largely on the investment side of finance.
holders, while some are kept as reserves.

◼ Certified Treasury Professional (CT)

o Assessment - This program requires students to pass a
- It means controlling all the financial single exam that assesses knowledge
activities of the company. and skills needed in working for a
corporate treasury department.

- It checks if objectives are met; if

otherwise, it determines what can be ◼ Certified Financial Planner (CFP)
done about it. - To obtain CFP status, students shall pass
a 10-hour exam covering a wide range of
topics related to personal financial
FINANCE AREAS AND CAREER OPPORTUNITIES planning.
✓ Financial Services
- Concerned with the design and delivery
of advice and financial products to ◼ American Academy of Financial
individuals, businesses, and Management (AAFM)
governments. - This administers certification programs
for financial professionals in a wide
range of fields. The certifications they
PRELIM: FINMAN NOTES with God all things are possible

issue include the Charter Portfolio government regulations to follow. It can

Manager, Chartered Asset Manager, be discontinued with great ease and the
Certified Risk Analysy, Certified Cost tax rate is relatively at the minimum.
Accountant, Certified Credit Analyst, and
many other programs. - However, the owner may lack expertise
or experience to run a business. The
owner may also incur unlimited liability.
◼ Professional Certifications in Accounting Suggestion: In cases when the owner
- These include Certified Public lacks experience or expertise in running
Accountants (CPA), Certified a business, there is a tendency for the
Management Accountant (CMA), owner to incur unlimited liabilities.
Certified Internal Auditor (CIA) and many Generally, the owner has relatively
other programs. limited availability of outside financing.

2) Partnership
- Through studying or preparing to pass
certification exams, employees and or - a business owned by two or more
other professionals can continue their people and operated for profit. This is
education beyond their undergraduate based on an agreement called Article of
degrees. The study focuses on an area of Co-Partnership. They are legally
finance, which is possibly needed in responsible for the debts and taxes of
doing their jobs better. Furthermore, the business. Partners must agree upon
employers could advertise the additional the amount each partner will
training their employees have contribute to the business, percentage
completed, as a way of attracting more of ownership of each partner, share of
businesses. profits of each partner, duties each
partner will perform, and the
responsibility each partner has for the
LEGAL FORMS OF BUSINESS partnership’s debts.
1) Sole Proprietorship
- A business owned by one person and
operated for one: own profit. The owner - Typical partnerships include those
is legally responsible for the debts and professional services such as medical
taxes of the business and very involved and dental practices, accounting,
in its day-to day activities. architectural, and law firms.

- This is the most common form of

business organization. Many sole - With a partnership form of business,
proprietorships operate in the there is ease in organization compared
wholesale, retail services, and to corporation. In partnership, there are
construction industries. combined talents, more available brain
power, and managerial skills. In terms of
- There are various advantages in forming available financing, it can raise more
a sole proprietorship. It is simple and the capital for the firm than a sole
owner has the freedom to make all proprietorship.
decisions and enjoy all the profit it has
minimal legal restrictions and only a few
PRELIM: FINMAN NOTES with God all things are possible

- However, there is unlimited liability for - For accounting purposes, all forms of
general partners and limited life for the business entities are considered
firm. Partnership is dissolved when a separate entities. However, the
partner withdraws or dies, and it is corporation is the only form of
difficult to liquidate or transfer business that is a separate legal
partnership. entity.

- Two or more heads may be better for the 4) Cooperatives

firm but there is also a possibility of - The policy of the state, as far as
divided authority that could lead to cooperative is concerned, is well-
possible disagreements on major amplified in the Cooperative Code
decisions and issues. which states, “to foster the creation
and growth of cooperatives as
practical vehicle for promoting self-
3) Corporation reliance and harnessing people
- An entity created by law. power towards the attainment of
Corporations have the legal powers economic development and social
of an individual in that it can sue and justice. The State shall encourage
be sued, make and be part to the private sector to undertake the
contracts, and acquire property in its actual formation and organization of
own name. It is publicly or privately- cooperatives and shall create an
owned business entity that is atmosphere that is conducive to the
separate from its owners and has a growth and development of these
legal right to own property and od cooperatives.”
business in its own name.

FINANCE, ECONOMICS, AND ACCOUNTING

- Thus, the stockholders are not • ECONOMICS – is a study of choice. It is a
responsible for the debts or taxes of social science that deals with individual
the business. A corporation is or collective economic activities such as
governed by the Board of Directors, production, consumption, distribution,
in case of a profit organization, or and transfer of money and wealth. This
Board of Trustees, in case of not-for- is because our resources are scarce and
profit organization. Some need to be deliberately and
advantages of forming a corporation systematically allocated.
include the limited liability of
stockholders and perpetual life. • FINANCE – the study of financial
There is ease of transferring allocation that can provide insights on
ownership and expansion obtaining where to put one’s money and why it is
resources or financing.
necessary. It is often considered a form
of applied economics. Firms operate
- Bound by relatively more within the economy, and they must be
government regulations and aware of the economic principles,
restrictions and may be expensive to changes in economic activity, and
organize. economic policy. Marginal cost-benefit
analysis is the primary economic
principle that is being used in managerial
PRELIM: FINMAN NOTES with God all things are possible

finance. This principle reminds decision • Given the following opportunities, which
makers to choose options and to take investment is preferred?
actions only when it results to a firm’s
net advantage, which means that the EARNINGS PER SHARE
added benefits exceed the added costs. Investment Year 1 Year 2 Year 3 Total
A 14.00 10.00 4.00 28.00
• ACCOUNTING – one of the major B 6.00 10.00 14.00 30.00
differences in the focus of finance and
accounting is that accountants generally DECISION MAKING PROCESS
use the accrual method, while in finance,
the emphasis is on cash flows. - Based on the information provided,
Accountants recognize revenues at the the choice is not obvious. Profit
point of sale and consider expenses maximization is not consistent with
when incurred, regardless of the wealth maximization. It may not lead
direction of cash flow in the firm. On the to the highest possible share price
other hand, the financial manager due to the following reasons:
focuses on the actual inflows and
outflows of cash, recognizing revenues
when cash is collected and considering 1) Timing is important.
expenses when actually paid. - The receipt of funds sooner rather
than later is preferred.
- Project B is expected to provide the
GOALS OF THE FIRM AND THE ROLE OF FINANCE
higher overall increase in earnings,
MANAGER
thus, is the more profitable project.
✓ Decision Rule for Managers But since the gold of the firm is to
- “Only take actions that are expected maximize value, timing must be
to increase the share price!” considered to determine which
- This rule means that whenever the project is superior. Profit
financial manager decides or choose maximization may lead to value
between or among alternatives, maximization, but it is not an
after assessing the risks and the absolute case.
returns, only actions that would
increase share price are acceptable. 2) Profits do not necessarily result in cash
Otherwise, the alternatives shall be flows available to stockholders.
rejected. - In finance, cash is king. It is not
unusual for a firm to be profitable
✓ Goal of the Firm yet experience a cash crunch. They
- The goal of a firm, and therefore of might have so much profits, but
all managers, is to maximize some may not have enough cash to
shareholders wealth. This can be continuously run the business. The
measured by share price. An most common cause is when
increasing price per share of expenses have shorter due date than
common stock relative to the stock expected revenue. In such cases, the
market as a whole indicates firm must arrange short-term
achievement of this goal. financing to meet its debt
obligations before the revenue
arrives.
PRELIM: FINMAN NOTES with God all things are possible

3) Profit maximization fails to account for - An organizational chart is an

risk. example of a board arrangement of
- Risk is the chance that actual corporate governance. More
outcomes differ from expected detailed responsibilities would be
outcomes. Financial managers stablished within each part of the
consider both risk and return organizational chart.
because of their inverse effect on the
share price of the firm.
- Increased risk may decrease the BUSINESS ETHICS
share price, while increased return is - Includes the standards of conduct or
likely to increase the share price. moral judgment that apply to
persons engaged in industry or
KEY ACTIVITIES OF INANCIAL MANAGER commerce. Violations of these
standards in finance include, but not
1) Investment Decisions limited to, misstated financial
- The finance manager defines the statements, misleading financial
most efficient level and the best forecasts or projections, fraud,
structure of assets. Investment bribery, kickbacks, insider trading,
decisions deal with the items that excessive executive compensation,
appear on the asset section of the and options backdating.
balance sheet.

2) Financing Decisions - Bad publicity generally results to

- The finance manager determines negative impacts on a firm. Ethics
and maintains the proper programs seek to reduce lawsuits
combination of short-term and long- and judgment costs, uphold and
term financing. Also, one raises the preserve a positive corporate image,
needed financing in the most build trust and confidence of the
economical manner. Financing shareholders, and gain the loyalty
decisions generally refers to the and respect of all stakeholders. The
items that appear on the liability and expected result of such programs is
equity section of the balance sheet. to positively affect the firm’s share
price.

CORPORATE GOVERNANCE
AGENCY ISSUES
- Corporate governance is a system of
organizational control that defines - Shareholders are the owners of a
and establishes the responsibility corporation, and they purchase
and accountability of the major stocks because they want to earn a
participants in an organization. good return on their investment
Shareholders, board of directors, without undue risk exposure.
managers, and officers of - In most cases, shareholders elect
corporations, and other directors, who then hire managers to
stakeholders are the major run the corporation on a day-to-day
participants included here. basis. Because managers are
PRELIM: FINMAN NOTES with God all things are possible

supposed to be working on behalf of o Market forces such as shareholder

shareholders, they should pursue crusading from large institutional
policies that enhance shareholder investors
value. Also, to achieve this goal, the - Institutional investors hold large
financial manager would take only quantities of shares in many of the
those actions that are expected to corporations in their portfolio. The
make a major contribution to the power of institutional investors far
firm’s overall profits. exceeds the voting power of
individual investors. Managers of
these institutions should be active in
- When managers, deviate from the monitoring the management and in
goal of maximization of shareholder voting their shares for the benefit of
wealth by putting their personal the shareholders.
goals above the goals of
shareholders, this results to agency - This can lessen or avoid an agency
problems and issues. This kind of problem because these groups can
problem increases agency costs. put pressure on management to take
Agency costs are the costs borne by actions that maximize shareholder
shareholders due to the occurrence wealth. They may use their voting
and avoidance of agency problems. power to elect new directors who
Both cases represent a reduction in are aligned with their objectives and
the shareholders’ wealth. will act to replace poorly or non-
performing managers.

AGENCY PROBLEM AND COST SOLUTIONS o Threat of hostile takeovers

o Properly constructed and implemented - It occurs when a company or group
corporate governance structure not supported by existing
- This should be designed to institute management attempts to acquire
a system of checks and balances to the firm. Because the acquirer looks
reduce the ability and incentives of for companies that are poorly
management to deviate from the managed and undervalued, this
goal of shareholder wealth threat provokes managers to act in
maximization. the best welfare of the firm’s
owners.

o Structured expenditures through

compensation plans
- This may be the most popular way to
deal with an agency problem by the
most expensive one. It could either
be incentive or performance plans.
Incentive plans tie management
performance to share price. When
the managers take actions that
maximize stock, they could be given
stock options giving them the right
to purchase stock at a set price.