FINANCIAL
MANAGEMENT
2nd
Edition
LUZVIMINDA S. PAYONGAYONG, CPA
RYAN C. ROQUE, CPA, MBA
OLIVIA C. AYUYAO, CPA, MBA
This study source was downloaded by 100000846117336 from CourseHero.com on 04-27-2022 10:15:18 GMT -05:00
https://www.coursehero.com/file/94367516/Chapter-1pdf/
FINANCIAL MANAGEMENT
TABLE OF CONTENTS
CHAPTER
TOPIC
PAGE
1
1
Introduction to Financial Management
2
Financial Statements Analysis
11
3
Working Capital and Cash Management
61
4
Receivable Management
87
5
Inventory Management
105
6
Short Term Financing Management
125
7
Financial Planning
139
8
Time Value of Money
167
9
Capital Budgeting
193
10
Long-Term Financing Decisions
249
11
Risk and Rates of Return
279
This study source was downloaded by 100000846117336 from CourseHero.com on 04-27-2022 10:15:18 GMT -05:00
https://www.coursehero.com/file/94367516/Chapter-1pdf/
INTRODUCTION TO
FINANCIAL MANAGEMENT
0)
Learning Objectives:
1.
2.
3.
4.
5.
6.
7.
Define finance management and the three key elements to the process of financial management.
Identify the major areas and opportunities available in the field of finance.
Determine and compare the legal forms of business organization.
Describe the managerial finance function and its relationship to economics and accounting.
Determine the roles of the financial manager.
Identify the goal of the firm, corporate governance, the role of ethics, and the agency issue.
Discuss business taxes and their importance in financial decisions.
Introduction
Finance plays an important role in the student's professional and even personal life. Each
chapter of this book emphasizes the relevance of the topic to majors in accounting, management,
marketing, operations and information systems.
In this chapter, the students were introduced into the field of finance and the opportunities in
the financial services and managerial finance. The basic legal forms of business organization such as the
sole proprietorship, partnership, and corporation are described and differentiated from each other. The
strengths and weaknesses of these three basic legal forms of organizations were identified. The
managerial finance function is defined and compared with economics and accounting. The financial
manager's goals, which are to maximize the shareholders' wealth and to preserve stakeholder wealth,
were discussed. The role of ethics in achieving these goals is presented. The chapter then summarizes
the three key activities of the financial manager. It also includes discussion of the agency problem- the
conflict that exists between managers and owners in a large corporation.
Financial Management
Financial Management is about preparing, directing and managing the money activities of a
company such as buying, selling and using money to its best results to maximize wealth or produce
best value for money. Basically, it means applying general management concepts to the cash of the
company.
Taking a commercial business as the most common organizational structure, the key objectives
of financial management would be to create wealth for the business, generate cash and provide an
adequate return on investment bearing in mind the risks that the business is taking, and the resources
invested
Personal finance is deals with an individuals' decisions concerning the spending and investing
of income. It includes the answers as to how much of their earnings should they spend, how much
should they save, and how should they invest their savings.
Business finance involves same type of decisions focusing on how the firms raise money from
investors, how to invest money to earn a profit, and how to reinvest profits in the business or distribute
them back to investors.
This study source was downloaded by 100000846117336 from CourseHero.com on 04-27-2022 10:15:18 GMT -05:00
https://www.coursehero.com/file/94367516/Chapter-1pdf/
Chapter 1 Introduction to Financial Management
2
There are three key elements to the process of financial management. These are the financial
planning, financial control and financial decision making.
1. Financial Plmmi11g. Management need to ensure that enough funding is available at the right
time to meet the needs of the business. In the short term, funding may be needed to invest in
equipment and stocks, pay employees and fund sales made on credit. In the medium and
long term, funding may be required for significant additions to the productive capacity of
the business or to make acquisitions. This links in with the financial decision-making
process and forecasting.
2. Financial control helps the business ensure that the objectives are being met. Financial control
determines if assets are secured and being used efficiently. It also identifies if the
management act in the best interest of shareholders and in accordance with business rules.
3. Financial decision making. The key aspects of financial decision-making include investment,
financing and dividends. Investments must be financed in some way. However, there are
always financing alternatives that can be considered, which will depend on the type of
source, period of financing, cost of financing and the net present returns generated. The key
financing decision is whether profit earned by the business should be retained instead of
distributing to shareholders via dividends. Dividends that are too high may cause the
business to starve of funding to reinvest in growing revenues and profits further.
Scope of Financial Management
Financial management has a wide scope. It includes the following five 'A's as stated by Dr. S. C.
Saxena:
1. Anticipatioll. The financial needs of the company are being estimated. That is, it finds out how
2.
3.
4.
5.
much finance is required by the company.
Acquisition. It collects finance for the company from different sources.
Allocation. It uses this collected or acquired finance to purchase fixed and current assets for the
company.
Appropriation. It distributes part of the company profits among the shareholders, debenture
holders, and some are kept ass reserves.
Assessment. It also means controlling all the financial activities of the company. It checks if the
objectives are met. If not, it determines what can be done about it.
Finance Areas and Career Opportunities
The following are the major areas in the field of finance:
l. Financial sen1ice - the one concerned with the design and delivery of advice and financial
products to individuals, businesses, and governments.
Career opportunities: within the areas of banking, personal financial planning, investments, real
estate, and insurance.
This study source was downloaded by 100000846117336 from CourseHero.com on 04-27-2022 10:15:18 GMT -05:00
https://www.coursehero.com/file/94367516/Chapter-1pdf/
_"apter 1 Introduction to Financial Management
3
2. Managerial finance - concerned with the duties of the financial manager working in a business.
This encompasses financial planning or budgeting, extending credit to customers or other credit
administration function, investment evaluation and analysis, and obtaining of funds for a firm.
Managerial finance is the management of the firm's funds within the firm.
Career opportunities: financial analyst, capital budgeting analyst, and cash manager.
The recent global financial crisis and subsequent responses by governmental regulators,
creased global competition, and rapid technological change also increase the importance and
mplexity of the financial manager's duties. Increasing globalization has increased demand for
nancial experts who can manage cash flows in different currencies and protect against the risks that
naturally arise from international transactions.
The following are the professional certifications in finance:
1. Chartered Financial Analyst (CFA) - a graduate-level course of study focused largely on the
investments side of finance. This is offered by the CFA Institute.
2. Certified Treasury Professional (CTP) - this program requires students to pass a single exam
that is focused on the knowledge and skills needed for those working in a corporate treasury
department.
3. Certified Financial Planner (CFP) - Students should pass a 10-hour exam covering a wide range
of topics related to personal financial planning in order to obtain CFP status.
4. American Academy of Financial Management (AAFM) - This administers certification
programs for financial professionals in a wide range of fields. Their certifications include the
Charter Portfolio Manager, Chartered Asset Manager, Certified Risk Analyst, Certified Cost
Accountant, Certified Credit Analyst, and many other programs.
5. Professional Certifications in Accounting - include Certified Public Accountant (CPA), Certified
Management Accountant (CMA), Certified Internal Auditor (CIA), and many other programs.
Through studying or preparing to pass certification exams, employees and/ or other
professionals can continue their education beyond their undergraduate degree. The study will be
focused on one area of finance, which is likely to be that needed to do their job better. Furthermore,
employers could advertise the additional training of their employees, thus, attracting more businesses.
Legal Fonns of Business Organization
Sole proprietorship is the most common form of business organizations. It is a business owned
by one person and operated for his or her own profit. He is legally responsible for the debts and taxes
of the business and very involved in its day to day activities. This is the most common form of business
organization. Many sole proprietorships operate in the wholesale, retail, service, and construction
industries.
There are various advantages in forming a sole proprietorship. It is simple and the owner has
freedom to make all decisions and enjoy all the profit. It has minimal legal restrictions and government
regulation. It can be discontinued with great ease and the tax rate is relatively at the minimum.
However, the owner may lack expertise or experience to run business. The owner may also incur
unlimited liability. Generally, the owner has relatively limited availability of outside financing.
This study source was downloaded by 100000846117336 from CourseHero.com on 04-27-2022 10:15:18 GMT -05:00
https://www.coursehero.com/file/94367516/Chapter-1pdf/
Chapter 1 Introduction to Financial Management
4
A partnership is a business owned by two or more people and operated for profit. This is based
on an agreement called Article of Co-Partnership. They are legally responsible for the debts and taxes
of the business. Partners must agree upon amount each partner will contribute to the business,
percentage of ownership of each partner, share of profits of each partner, duties each partner will
perform, and the responsibility each partner has for the partnership's debts. Typical partnership
includes those professional services such as medical and dental practices, accounting, architectural and
law firms.
With a partnership form of business organization, there is ease of organization compared to
corporation. In partnership, there are combined talents, more available brain power and managerial
skill. In terms of available financing, it can raise more capital for the firm than a sole proprietorship.
However, there is unlimited liability for general partners and limited life for the firm. Partnership is
dissolved when a partner withdraws or dies, and it is difficult to liquidate or transfer partnership. Two
or more heads may be better for the firm but there is also a possibility of divided authority that could
lead to possible disagreement on major decisions and issues.
A corporation is an entity created by law. Corporations have the legal powers of an individual
in that it can sue and be sued, make and be party to contracts, and acquire property in its own name. It
is a publicly or privately-owned business entity that is separate from its owners and has a legal right to
own property and do business in its own name. But the stockholders are not responsible for the debts
or taxes of the business. A corporation is governed by the Board of Directors, in case of a profit
organization, or Board of Trustees in case of not-for-profit organization.
Some advantages of forming a corporation include the limited liability of stockholders and
perpetual life. There is ease of transferring ownership, expansion obtaining resources or financing.
Corporations are bound by relatively more government regulations/restrictions and maybe expensive
to organize.
For accounting purposes, all forms of business entities are considered separate entities.
However, the corporation is the only form of business that is a separate legal entity.
Finance, Economics and Accounting
Economics is a study of choice. It is a social science that deals with individual or collective
economic activities such as production, consumption, distribution and transfer of money and wealth.
This is based on the fact that our resources are scarce and need to deliberately and systematically
allocated.
Finance is the study of financial allocation and answers the questions like where to put your
money and why. It is often considered a form of applied economics. Firms operate within the economy
and they must be aware of the economic principles, changes in economic activity, and economic policy.
Marginal cost-benefit analysis is the primary economic principle that is being used in managerial
finance. This principle reminds the decision makers to choose and take actions only when the firm will
have a net advantage, which means that the added benefits exceed the added costs.
One of the major differences in the focus of finance and accounting is that accountants generally
use the accrual method while in finance, the emphasis is on cash flows. Accountants recognize
revenues at the point of sale and expenses when incurred regardless on when cash will flow into or out
of the firm. On the other hand, the financial manager focuses on the actual inflows and outflows of
cash, recognizing revenues when cash is collected and expenses when actually paid.
This study source was downloaded by 100000846117336 from CourseHero.com on 04-27-2022 10:15:18 GMT -05:00
https://www.coursehero.com/file/94367516/Chapter-1pdf/
5
_ apter 1 Introduction to Financial Management
- als of the Finn and the Role of the Finance Manager
Decision rule for managers:
Only take actions that are expected to i11crease the share price!
This rule means that whenever the financial manager decides or choose between or among
atives, after assessing the risks and the returns, only actions that would increase share price shall
accepted. Otherwise, the alternative/ s shall be rejected.
The goal of a firm, and therefore of all managers, is to maximize shareholders' wealth. This can
measured by share price. An increasing price per share of common stock relative to the stock market
~ a whole indicates achievement of this goal.
Given the following opportunities, which investment is preferred?
Investment
A
B
Earnings per Share
Year2
Year3
Yearl
P4.00
P14.00
P10.00
10.00
14.00
6.00
Total
P28.00
30.00
Based on the information provided, the choice is not obvious. Profit maximization is not
consistent with wealth maximization. It may not lead to the highest possible share price due to the
allowing reasons:
1. Timing is important- the receipt of funds sooner rather than later is preferred. Project B is
expected to provide the higher overall increase in earnings, thus, is the more profitable project.
But since the goal of the firm is to maximize value, and therefore, timing must be considered to
determine which project is superior. Profit maximization may lead to value maximization, but it
is not an absolute case.
2. Profits do not necessarily result in cash flows available to stockholders. In finance, cash is king. It is not
unusual for a firm to be profitable yet experience a cash crunch. They might have so much
profit but less do not have enough cash to continuously run the business. The most common
cause is when expenses have a shorter due date than expected revenue. In such cases, the firm
must arrange short-term financing to meet its debt obligations before the revenue arrives.
3. Profit maximization fails to account for risk. Risk is the chance that actual outcomes may differ
from expected outcomes. Financial managers must consider both risk and return because of
their inverse effect on the share price of the firm. Increased risk may decrease the share price,
while increased return is likely to increase the share price.
Financial managers administer the financial affairs of all types of businesses such as private and
rublic, large and small, profit-seeking and not-for-profit. Typically, he handles a firm's cash, investing
~plus funds when available and securing outside financing when needed. He also oversees a firm's
rension plans and manages critical risks related to movements in foreign currency values, interest
rates, and commodity prices. The treasurer in a mature firm must make decisions with respect to
This study source was downloaded by 100000846117336 from CourseHero.com on 04-27-2022 10:15:18 GMT -05:00
https://www.coursehero.com/file/94367516/Chapter-1pdf/
Chapter 1 Introduction to Financial Management
6
handling financial planning, acquisition of fixed assets, obtaining funds to finance fixed assets,
managing working capital needs, managing the pension fund, managing foreign exchange, and
distribution of corporate earnings to owners.
The two key activities that the financial manager does as related to a firm's balance sheet are the
following:
1. Investment decisions. The finance manager defines the most efficient level and the best structure
of assets. Investment decisions deals with the items that appear on the asset section of the
balance sheet.
2. Financing decisions: The finance manager determines and maintains the proper combination of
short- and long-term financing. Also, he raises the needed financing in the most economical
manner. Financing decisions generally refers to the items that appear on the liability and equity
section of the balance sheet.
Corporate Governance, Ethics and Agency Issues
Corporate governance is a system of organizational control that defines and establishes the
responsibility and accountability of the major participants in an organization. Shareholders, board of
directors, managers and officers of the corporations, and other stakeholders are the major participants
included here. An organizational chart is an example of a broad arrangement of corporate governance.
More detailed responsibilities would be established within each part of the organizational chart.
Business ethics are the standards of conduct or moral judgment that apply to persons engaged
in industry or commerce. Violations of these standards in finance include, but not limited to misstated
financial statements, misleading financial forecasts or projections, fraud, bribery, kickbacks, insider
trading, excessive executive compensation, and options backdating.
Bad publicity generally results to negative impacts on a firm. Ethics programs seek to reduce
lawsuits and judgment costs, uphold and preserve a positive corporate image, build trust and
confidence of the shareholders, and to gain the loyalty and respect of all stakeholders. The expected
result of such programs is to positively affect the firm's share price.
Shareholders are the owners of a corporation, and they purchase stocks because they want to
earn a good return on their investment without undue risk exposure. In most cases, shareholders elect
directors, who then hire managers to run the corporation on a day-to-day basis. Because managers are
supposed to be working on behalf of shareholders, they should pursue policies that enhance
shareholder value. Also, to achieve this goal, the financial manager would take only those actions that
were expected to make a major contribution to the firm's overall profits.
When managers deviate from the goal of maximization of shareholder wealth by putting their
personal goals above the goals of shareholders, this results to agency problems and issues. This kind of
problems increases agency costs. Agency costs are the costs borne by shareholders due to the
occurrence and avoidance of agency problems. Both cases represent a reduction in the shareholders'
wealth.
The agency problem and the associated agency costs can be reduced with the following:
1. Properly constructed and implemented corporate governance structure. This should be
designed to institute a system of checks and balances to reduce the ability and incentives of
management to deviate from the goal of shareholder wealth maximization.
This study source was downloaded by 100000846117336 from CourseHero.com on 04-27-2022 10:15:18 GMT -05:00
https://www.coursehero.com/file/94367516/Chapter-1pdf/
_ er , Introduction to Financial Management
•
Structured expenditures thru compensation plans. This maybe the most popular way to deal
with the agency problem but this is 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. This incentive plan may not be favorable because of
market behavior that has a substantial impact on share price and is beyond the control of the
management. That's why performance plans are more popular today. In this plan,
compensation is based on performance measures, such as earnings per share and/ or its growth,
or other return ratios. Managers may receive performance shares and/ or cash bonuses when
the set performance goals are attained.
·
\ 1arket forces such as shareholder crusading from large institutional investors. Institutional
investors hold large quantities of shares in many of the corporations in their portfolio. The
power of institutional investors far exceeds the voting power of individual investors. Managers
of these institutions should be active in the monitoring of management and vote their shares for
the benefit of the shareholders. This can lessen or avoid the agency problem because these
groups can put pressure on management to take actions that maximize shareholder wealth.
They may use their voting power to elect new directors who are aligned with their objectives
and will act to replace poorly or non-performing managers.
"%.
Threat of hostile takeovers. It occurs when a company or group not supported by existing
management attempts to acquire the firm. Because the acquirer looks for companies that are
poorly managed and undervalued, this threat provokes managers to act in the best welfares of
the firm' s owners.
This study source was downloaded by 100000846117336 from CourseHero.com on 04-27-2022 10:15:18 GMT -05:00
https://www.coursehero.com/file/94367516/Chapter-1pdf/
Powered by TCPDF (www.tcpdf.org)
7