Goals of Financial Management

1. Stockholder Wealth Maximization.

2. Profit Maximization.

• Stockholder Wealth Maximization translate

into maximizing the price of the firm’s
common stock.
• Profit Maximization means the
maximization of profits within a given
period of time.
The Role of Financial Managers
1. Management of financial resources.
2. Financial analysis and planning.
3. Investment Decisions.
4. Financing and capital structure decisions
 Forms of Business Organizations
1. Sole Proprietorship.
2. Partnership
3. Corporation

• The financial manager’s role is delineated

in part by the type of business
organization in which he operates.
 Single Proprietorship
Is a business owned by one individual.
Advantages:
1. No formal charter is required.
2. Organizational costs are minimal.
3. Profits and control are not shared.

Disadvantages:

1. Capital is limited.
2. Unlimited liability of owner.
3. Limited life (co-terminus with owner)
 Partnership
• Is an association of two or more persons
who bind themselves to contribute money,
property, or industry to a common fund,
with the intention of dividing the profits
among themselves.
 Corporation
• Is an artificial being created by operation
of law, having the right of succession and
the powers, attributes and properties
expressly authorized by law or incident to
its existence.
Basic Documents Required by SEC
• Partnership
• 1. Articles of Co-Partnership
•
• Corporation
• 1. By-Laws of the Corporation.
• 2. Articles of Incorporation
 Distinctions of Corporation and
Partnership
• 1. Manner of Creation.
• 2. Commencement of Judicial Personality.
• 3. Right of Succession.
• 4. Term of Existence.
• 5. Transferability of Interest
 Financial Statements
• Are summaries of financial data that are
intended to communicate an entity’s
financial position at a point in time and its
results of operations for a period then
ended.
• 3 Basic Financial Statements
• 1. Balance Sheet
• 2. Income Statement
• 3. Cash Flow Statement
 Anatomy of a Balance Sheet
• Assets = Liabilities + Networth/Equity
• Assets – Liabilities = Networth/Equity
• Assets are economic resources of the company.

• Liabilities are everything with money value that

the company owes to a creditor.
• Networth/Equity represents the excess of assets
over liabilities (owner’s equity).
• Balance Sheet shows the financial position of
the company as of particular date.
 Anatomy of an Income Statement
• Sales – Cost of Sales= Gross Profit
• Gross Profit –Operating Expenses
=Operating Profit – Interest –Taxes=Net
Profit (Loss) + Retained Earnings (Beg) –
Preferred stocks dividends=Retained
Earnings (End).
• Income Statement shows the results of
operations of the company over a
specified period of time.
Anatomy of a Cash Flow Statement
• Cash flow statement refers to the flow of cash into and out of
the business over a specific period of time.

• Elements of Cash Flow Statement

• 1. Cash flows from operating activities.

• 2. Cash flows from Investing activities.

• 3. Cash Flows from financing activities.

•
•
•
 Financial Analysis
• Involves the assessment and evaluation of
the company’s past and present financial
performance including its future business
potentials. It analysis the meaningful and
significant relationship among the
financial data of the financial statements.
 Techniques in Financial Analysis
• 1. Horizontal Analysis which involves
comparison of figures shown in the financial
statements of two or more accounting periods.
• 2. Vertical Analysis is the process of relating
figures in the statement to a common base.
• 3. Ratio Analysis which indicates the significant
relationship between items in the financial
statements expressed in mathematical forms (in
percentage, decimal, fraction or times).
 Financial Ratios
• 1. Liquidity Ratios

• 2. Profitability Ratios

• 3. Solvency/Stability Ratios (Leverage)

• 4. Turnover/Efficiency Ratios
 Liquidity Ratios
• Measure the company’s capability to pay
its maturing short-term debts/obligations
out of its current assets.

• Current Ratio
• Equals to current assets divided by current
liabilities.
 Liquidity Ratios
• Quick (Acid-Test) Ratio
• Equals to most liquid current assets (cash,
marketable securities, and receivables)
divided by current liabilities. (Inventory is
not included in the current assets. Prepaid
expenses are also not included because
they are not convertible into cash to pay
current liabilities).
 Profitability Ratios
• Measure the company’s ability to earn a
satisfactory profit and return on investment.

• 1. Gross Profit Margin

• Reveals the percentage each peso left
• over after the business has paid its
• goods.
• Equals Gross Profit divided by Net Sales.
 Profitability Ratios
• Net Profit Margin Ratio
• Indicates the bottom line profitability
generated from revenue.

• Equals Net Profit divided by Net Sales.

 Profitability Ratios
• Return on Investment IROI)
• 1. Return on Total Assets (ROA)
• Indicates the efficiency with which
management has used its resources to
generate income.
• Equals Net Income divided Average Total
Assets
 Profitability Ratios
• Return of Investments (ROI)
• 2. Return on Equity (ROE)
• Measures the rate of return earned on
the common stockholders’ investments.
Equals Earnings Available to Common
Stockholders divided by Average
Stockholders’ Equity
 Profitability Ratios
• Dupont ROA Formula:
• Equals Net Profit Margin x Total Assets
Turnover”
• = (Net Income over Net Sales) x (Net Sales over
Average Total Assets)
• Note:
• The ROA can be raised by increasing either the
profit margin or the assets turnover.
 Profitability Ratios
• Earning Per Share (EPS)
• Indicates the amount of earnings for each
common share held.

• Equals Net Income – Preferred Dividends

divided by Common Stocks Outstanding.
 Profitability Ratios
• Price/Earnings Ratio
• Evaluates the company’s relationship with its
stockholders.
• Equals to Market Price per Share of stock
divided by the Earning Per Share (EPS).

• A high P/E ratio indicates that the investing

public considers the company’s stocks as a
profitable investments and vice-versa.
 Profitability Ratios
• Book Value Per Share
• Is the net assets available to common
stockholders .
• Equals (Total Stockholders’ Equity – Preferred
Stocks) divided by Total Shares Issued and
Outstanding.
• Comparing the book value per share with the
market price per share gives an indication of
how investors regard the company’s stocks.
 Profitability Ratios
• Dividend Ratios
• 1. Dividend Yield = Dividend per Share
divided by Market Price per Share
• 2. Dividend Payout = Dividends per Share
divided by Earnings per Share (EPS)
• Note:
• A decline in these ratios signals a decline
in value of dividends and would cause
concerns to stockholders.
 Leverage (Solvency) Ratios
• Measure the company’s ability to meet
maturing long-term obligations.

• Debt Ratio
• Compares total liabilities to total assets. It
shows the percentage of total funds
obtained from creditors.
• Equals Total Liabilities divided by Total
Assets. Creditors prefer low debt ratio.
 Leverage Ratios
• Debt/Equity Ratio
• Measures the solvency of the company
that ensures the high or low degree of
safety to creditors.
• Equals to Total Liabilities divided by
Stockholders’ Equity.
• A low debt/equity ratio is favored by
creditors.
 Leverage Ratios
• Times Interest Earned (Interest Coverage) Ratio

• Reflects the number of times before-tax earnings

cover interest expense.
• Equals to Earnings before Interest and Taxes
(EBIT) divided by Interest Expense
• It is a safety margin indicator since it shows how
much decline in earnings can a company absorb
and still be able to pay interest charges.
Activity (Turnover/Efficiency) Ratios
• Accounts Receivable Ratios
• Measure collection efficiency/
• 1. Accounts Receivable Turnover
• Gives the number of times accounts
• receivable is collected during the
• year.
• Equals to Net Credit Sales divided by Average
Accounts Receivable. A high receivable
turnover is favorable to the company.
 Receivable Ratios
• Average Collection Period
• Measures the number of days it takes to
collect the receivables.
• Equals to 365 or 360 days divided by the
Account Receivable Turnover.
• Note: The average collection period
should be compared against the
company’s credit term.
 Inventory Ratios
• Inventory Turnover
• This measures the over or under stocking
of goods.

• Equals to Cost of Goods Sold divided by

Average Inventory.
• A high inventory turnover is favorable to
the company.
 Inventory Ratios
• Average Age of Inventory
• Measure the holding period of inventory.

• Equals to 365 or 260 divided by Inventory

• Turnover.
 Efficiency Ratios
• Operating Cycle
• Indicates the number of days it takes to
convert inventory and receivables to cash.

• Equals to Average Collection Period+

Inventory Age of Inventory.

• A short operating cycle is desirable.

 BUDGETING
• The BUDGET is the company’s financial
plan. It is a set of pro forma statements
about the company’s finances and
operations. It is a tool for a) planning
b) coordination and c) control.

• The process of translating this financial

plan into financial terms is called
BUDGETING.
 Types of Budgets
• 1. Sales Budget
• 2. Production Budget
• 3. Capital Expenditures Budget
• 4. Master Budget
 Types of Budget
• Sales Budget
• This budget details the total sales
expected over a given period.

• Sales will be shown in terms of their

quantities and/or values and are often
viewed by product groups.
 Production Budget
• It specifies the various quantities of goods
to be produced throughout the period in
question, as well as the costs of the direct
materials, direct labor and factory
overheads involved in producing these
amounts.
 Capital Expenditures Budget
• Is concerned with the estimated
expenditures on capital investments
(assets of permanent, long-term value to
the company, like land, building,
equipment, machinery, etc.)
 Master Budget
• Budgeted Income Statement

• Shows the firm’s estimated sales revenue

over a given period of time and all
expected relevant costs and expenses to
be incurred in order to generate that
revenue, leaving a profit or a loss.
 Master Budget
• Budgeted Balance Sheet

• Sets out the firm’s assets, liabilities and

equity accounts at the end of the given
period.
 Master Budget
Cash Budget

Sets down the on-going cash position of a

firm by anticipating cash inflows and
outflows during the given period.
 The Budget Committee
• Basic Functions:
• 1. Formulate general policies relating to the
budgetary system.
• 2. Review and revise (if necessary) budget
estimates from different segments of the
organization.
• 3. Approve budgets.
• 4. Evaluate and analyze budget reports.
• 5. Recommend necessary actions to improve
operational efficiency and effectiveness.
 Working Capital Management
• Working capital is equal to current assets.
• Net working capital is equal to current
assets less current liabilities.
• Working Capital Management and Risk-
Return Trade-off:
• Too much working capital reduces
profitability while too little working capital
decreases liquidity.
 Cash Management
• Involves having the optimum, neither
excessive nor deficient amount of cash on
hand at the right time.

• The objective of cash management is to

invest excess cash for a return while
retaining sufficient liquidity to satisfy future
needs.
 Rationale for Holding Cash
• 1. Transaction Balance

• 2. Precautionary Balance

• 3. Speculative Balance

• 4. Compensating Balance
Cash Management Techniques
• 1. Cash Flow Synchronization.
• 2. Playing the Float.
• 3. Lockbox Plan
• 4. Concentration Banking
• 5. Automatic Bank Credits
• 6. Payables Centralization
• 7. Zero-Balance Accounts
• 8. Overdraft System
 Rationale for Holding Marketable
Securities
• 1. Marketable securities as a substitute
for cash or temporary investments:
• a. To finance seasonal or cyclical
operations.
• b. To meet future financial
requirements.
 Factors Influencing the Choice of
Marketable Securities
• 1. Default Risk
• 2. Interest Rate Risk
• 3. Inflation Risk
• 4. Marketability Risk
 Baumol Model for Balancing Cash
and Marketable Securities
• An economic model that determines the optimal
cash balance by using economic ordering
quantity (EOQ) concepts.
• Formula:
• Optimal Cash Balance
• = Square Root of 2(F)(T)/k
• Where: F is the fixed cost of trading a security; T
is the annual cash requirements and k interest
rate of marketable security (opportunity cost)
 Receivable Management
• Formulation of Credit Policy
• 1. Credit Standards
• 2. Credit Terms (2/10, net 30)
• -Credit Period
• -Discount
• 3. Collection Policy
• 5. Discount Policy
 The Five (5) Cs of Credit
• 1. Character
• 2. Capacity
• 3. Capital
• 4. Collateral
• 5. Conditions
 Inventory Management
• Involves a trade-off between the costs
associated with keeping inventory versus
the benefits of holding inventory.
• High inventory level results in increased
inventory costs but low inventory level can
result to possible stockouts and lost sales.
• The goal is to provide inventories required
for operation at the lowest possible
inventory costs.
 Types of Inventories
• 1. Raw Materials

• 2. Goods-in-Process

• 3. Finished Goods
 Inventory Costs
• 1. Ordering Costs
• The costs of placing and receiving the
orders.

• 2. Carrying Costs
• The costs associated with carrying
inventory (storage, depreciation, etc.)
 Inventory Mgt. Models
• Economic Order Quantity (EOQ) Model
• To determine the particular quantity to order
which will minimize the total inventory costs.
• Formula:
• EOQ=Square Root of 2SP/C where:
• S is the estimated annual sales
• P is the fixed cost per order
• C is carrying cost per unit
 Reorder Point
• The inventory level at which an order
should be placed.
• Formula:
• Reorder Point
• =Lead Time Usage plus Safety Stock
• Where Lead time usage is the normal sale
or consumption during lead time while
safety stock is the additional inventory
carried to guard against stockout.
Basic Strategies of Working Capital
Management
• 1. Accelerate collection of receivables

• 2. Stretching accounts payables

• 3. Accelerate Inventory turnover

 Short-Term Financing
• Is essentially to provide capital deficit business
funds for short-term period of a year or less.
• Can be classified as Secured and Unsecured.
• Four major types of short-term financing:
• Accruals
• Trade Credit (Accounts Payable)
• Bank Loans
• Commercial Papers
• Receivable Financing (with or without recourse)
• Inventory Financing