FINANCIAL

MANAGEMENT
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FINANCIAL MANAGEMENT
Financial Management focuses on decisions relating to how much and what types of assets to acquire, how to
raise the capital needed to purchase assets, and how to run the firm so as to maximize its value.

Financial statement analysis Involves the evaluation of an entity’s past performance, present condition and
business potentials by way of analyzing the financial statements.

Tools:
1. Horizontal Analysis

→ Also called trend analysis

→ Evaluate FS items over a period of

time

→ Changes as % ∆

2. Vertical (common size) Analysis

→ Evaluate items w/n the FS as a

percentage of a base amount

BS → Total Assets

IS → Sales → Used when

comparing the companies

(intercompany analysis)
3. Ratio Analysis Characteristics:
a. Liquidity – ability to pay short-term obligations
→ Evaluate relationships among FS
(suppliers)
items b. Solvency – ability to pay long-term obligations (banks)
c. Profitability – analyze the performance of a company
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FORMULAS:
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Working Capital Management

- The administration and control of current assets and current liabilities with the goal of maximizing
the value of the firm with appropriate balance between profitability and risk.

Working Capital → resources of the business used in everyday operations

Objective: To achieve balance between risk and return (income)
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Working Capital Formula:

Current Assets
– Current Liabilities
Working Capital

1. Cash Management – maintain optimal

level of cash
Reasons for holding cash
1. Transaction motive - to facilitate
normal transactions of the business.
2. Precautionary motive - to provide for buffer against contingencies.
3. Speculative motive - to avail of business and investment opportunities.
4.Contractual motive - by provisions of a contract (e.g., compensating balance in a bank)
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2. Inventory Management – to maintain optimal level of inventory

EOQ Model resolves how many units to order.

Re-Order Point determines when to order.

3. Accounts Receivable Management

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4. Accounts Payable Management

5. Short-Term Loans Management → Usual questions: What is the annual effective interest rate?

6. Bank Loans
- Single-payment notes – if the interest is payable upon maturity, the effective interest
rate is equal to the nominal rate.
- Discounted Note – the effective interest rate is higher than the nominal rate.
Effective interest rate = Interest Principal amount - Discounted interest

If the term is less than a year, the interest rate is annualized.

- Compensating Balance (CB) – an arrangement whereby a borrower is required to
maintain a certain percentage of amount borrowed as compensating balance in the
current account of the borrower.
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CAPITAL BUDGETING
→ Involves long-term investment decision

→ involves choosing among various projects to find the one(s) that will maximize a
company’s return on its financial investment.
→ Top management/BOD are involved → accept/reject

Non-Discounting
- Payback Period
● Time it takes to recover the initial investment (years)
● The shorter the payback period, the more attractive the
investment.
- Accounting Rate of Return (ARR) / ROI
● Measures the profitability of project based on income

● The required rate of return is generally based on the company’s cost of capital.
● Decision Rule: Acceptable if rate of return > management’s required rate of
return.
● The higher the rate of return for a given risk, the more attractive the investment.

Discounting
- Uses discounted CF – Present Value – considers Time Value of Money
- Net Present Value - The higher the positive net present value, the more attractive the investment.
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- Profitability Index (PI) - method that compares the relative merits of alternative capital
investment projects.

- Internal Rate of Return (IRR) - The interest rate that makes the PVCI = PVCO (NPV = 0)

Sensitivity Analysis uses a number of outcome estimates to get a sense of the variability among
potential returns.
- In general, a higher risk project should be evaluated using a higher discount rate.

Risks and Leverage

Business risk is the riskiness inherent in the firm's operations if it uses no debt. It is the variability or
uncertainty in a firm's operating income.

Degree of Operating Leverage Degree of Financial Leverage Degree of Total Leverage

measures given in the change in measures the percentage change measures the given change in
sales have a multiplicative effect in EPS for a unit change in sales have a multiplicative effect
on operating profit. operating income, also known as on operating profit (EBIT)
earnings before interest and taxes
(EBIT)
Operating Leverage is the use of Financial leverage is the use of
mostly fixed costs rather than debt and preferred stock.
variable costs.
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The more financial leverage,

higher the ROE, the higher the EPS.

The higher the EPS, the higher the

ROE, higher chances that the price
of stock will also increase.

CAPITAL STRUCTURE AND LONG-TERM FINANCING DECISION

Capital structure refers to the mix of debt, preferred stock and ordinary (common) equity that the firm
uses to finance the firm's assets.

Tools applied in managing capital structure:

1. Traditional Approach - suggests that there is a trade-off between cheaper debt and higher priced
equity that leads to an optimal capital structure. It also implies that a firm can lower its weighted
average cost of capital and increase its market value by the judicious use of financial leverage.

Value of the Firm = Market Value of Debt + Market Value of Common Shares Outstanding or Equity

2. Modigliani and Miller (MM) Approach

a. Perfect World Approach - Firm value depends only on its real assets, making capital
structure irrelevant. Assumes no taxes, bankruptcy, or brokerage costs, and equal information
for investors and managers—idealized assumptions with limited real-world relevance.
b. Modigliani and Miller Approach with Corporate taxes - Debt offers a tax advantage since
interest is tax-deductible, lowering the firm’s cost of capital and increasing value.
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3. Contemporary Approach Trade-Off Theory - identifies several factors that can lead to an optimal
capital structure for a given firm such as tax effects (corporate and personal), financial distress and
related costs
Value of the Levered Firm with Taxes
+ Present Value of net Tax Savings
- Present value of Financial Distress and Related costs
Value of the levered Firm with taxes, Financial Distress, and Related Costs

Sources of Intermediate and Long-Term Financing

Funding, or financing, involves providing resources to support a program, project, or requirement.

Corporations often seek external capital, beyond internal funds like retained earnings, to expand into
new markets, open additional locations, or invest in research and development. Funding can be for
short-term or long-term objectives and comes from various sources, which are as follows:

1. Retained earnings – The retained earnings can be either be:

a. distributed to shareholders as dividends
b. used to invest in projects and grow the business.
2. Debt capital - Companies that initiate debt issues are borrowers because they exchange
securities for cash needed for certain operations.
3. Equity capital - Companies can raise capital from the public in exchange for a proportionate
ownership in the company in the form of shares and investors will become shareholders after
purchasing those securities.
4. Other Funding Sources which include: private equity, venture capital, donations, grants, and
subsidies that do not have a direct requirement for return on investment, except for private
equity and venture capital. They are also called “crowdfunding” or “soft funding.”
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Debt financing - company obtains a loan, and promises to repay it over a period of time, with an
agreed interest. It also occurs when a firm sells fixed income products or securities, such as bonds,
bills, or notes, to investors to get a capital needed to expand its activities and operations.

a. Bank/Term Loans - most common type of debt financing

b. Bonds - long-term debt instrument issued to raise capital

Equity financing - process of raising capital through selling of shares in which they sell ownership of
the company in return for cash, non-cash assets, or services.

a. Common Stock - true owners of a corporate business are the common or the ordinary
stockholders.
b. Preferred Stock - has a par value and a fixed dividend that must be paid before dividends
can be paid on the common stock.
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Cost of Capital
- Also known as discount rate, required return,
minimum rate of return, hurdle rate
- Used in capital budgeting, long term financing,
and optimal capital structure
● Optimal Capital Structure is the mix of
debt, preferred stocks, and common equity
that maximizes the stock’s intrinsic value.
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FINANCIAL MARKETS

Financial markets refer broadly to any marketplace where securities trading occurs, including the stock
market, bond market, forex market, and derivatives market. Financial markets are vital to the smooth
operation of capitalist economies.

A. Money Market
● Focus on short-term debt securities.
● Operate in dealer-driven markets.
● Characterized by low default risk.
● Often seen as a substitute for cash.

Types of Money Market:

1. Money Market Funds
2. Money Market Accounts
3. Certificates of Deposit (CDs)
4. Treasury Bills
5. Commercial Paper
6. Banker's Acceptances
7. Repurchase Agreement (Repos)

B. Capital Market
● Focus on long-term debt and equity securities.
Fixed Income Instruments are types of investment security that pays the investor a
fixed amount on a fixed schedule.
1. Treasury Bonds, Bills, and Notes
2. Municipal Bonds
3. Corporate Bonds
4. Government Bonds
5. Asset-Backed Securities (ABS)

Stock market is an exchange mechanism that helps investors buy and sell shares in
publicly traded companies.
1. Common Stock
2. Preferred Stock
3. Convertible Securities
4. Warrants
5. Rights Issues
6. Exchange-Traded Funds (ETFs)
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References:

Accounting Notes
(Compiled notes sourced from an anonymous user, referred to as April Kae.)

MAS OCTOBER 2024 CPALE Review Notes

(Compiled notes sourced from an anonymous user, referred to as ARdalmatian.)

MS Last Minute by Hercules Notes

(Compiled notes sourced from an anonymous user, referred to as Hercules.)

MS MAY 2024 CPALE REVIEW NOTES

(Compiled notes sourced from an anonymous user, referred to as AMBE.)

MS Notes and Pinnacle Handout (Sir Brad’s Lecture)

(Compiled notes sourced from an anonymous user, referred to as CPM.)