Chapter 1: Introduction to Financial Management 4. Appropriation.

It distributes part of the company

profits among the shareholders, debenture holders,
Financial Management while some are kept as reserves.
Financial Management is about preparing, directing, 5. Assessment. It means controlling all the financial
and managing the money activities of a company activities of the company. It checks if objectives are
such as buying, selling, and using money for best met; if otherwise, it determines what can be done
results to maximize wealth or to produce best value about it.
for money. Basically, it means applying the general
management concepts to the cash of the company. Finance Areas
Taking commercial business as the most common
organizational structure, the key objectives of The following are the major areas of finance
financial management include: (1) to create wealth 1. Financial Services – concerned with the design and
for the business; (2) to generate cash; and (3) to delivery of advice and financial products to
provide an adequate return on investment, bearing in individuals, business, and governments.
mind the business risks taken and the resources
invested. 2. Managerial Finance – concerned with the duties of
a Financial Manager working in a business. This
There are three key elements in the process of encompasses financial planning or budgeting, credit
financial management. These are extension to customers or other credit administration
1. Financial Planning. Management needs to ensure function, investment evaluation and analysis, and
that enough funding is available at the right time to obtaining of funds acquisition for a firm. Managerial
meet the needs of the business. In the short term, Finance is the management of the firm’s funds within
funding may be needed to invest in equipment and the firm.
stocks, pay employees and fund sales made on credit. Legal Forms of Business Organization
In the medium term and long term, funding may be
required for significant additions to the productive 1. Sole Proprietorship - a business owned by one
capacity of the business or to make acquisitions. person and operated for one’s own profit. The owner
is legally responsible for the debts and taxes of the
2. Financial control. Ensures business that objectives business an very involved in it day to day activities.
are met. Financial control determines if assets are
secured and being used efficiently. It also confirms if 2. Partnership – a business owned by two or more
management acts in the best interest of shareholders people and operated for profits. This is based on an
and in accordance with business rules. agreement called Article of Co-partnership. They are
legally responsible of the debts and taxes of the
3. Financial decision making. The key aspects of business. Partners must agree upon the amount each
financial decision-making include investment, partner will contribute to the business, percentage of
financing, and dividends. Though investment mush ownership of each partners, share of profits of each
be financed in some way there are always financing partner, duties each partner will perform, and the
alternatives that can be considered which depends on responsibility each partner has for the partnership’s
the type of source, period of financing, cost of debt.
financing, and the net present returns generated. The
key financing decision is whether profit earned by the 3. Corporation - is an entity created by law.
business should be retained instead of being Corporations have the legal powers of an individual
distributed to shareholders via dividends. is that it can sue and be sued, make and be party to
contracts, and acquire property in its own name. It is
Scope of Financial Management. publicly or privately-owned business entity that is
1. Anticipation. The financial needs of a company are separate from its owners and has a legal right to own
being estimated, as it finds out how much finance is property and do business in its own name. Thus the
required. stockholders are not responsible for the debts or taxes
of the business. A corporation is governed by the
2. Acquisition. It collects finance for the company Board of Directors, in case of a profits organizations,
from different sources. or Board of Trustees, in case of not-for-profit
organization. Goals of the Firm and the Role of the
3. Allocation. It uses the collected or acquired finance Finance Manager
to purchase fixed and current assets for the company.
Decision rule for managers:
Only take actions that are expected to increase the organization. An organizational chart is an example
share price! of a broad arrangement of corporate governance.
More detailed responsibilities would be established
The Rule means that whenever the financial manager within each part of the organizational chart. Business
decides or choose between or among alternatives, ethics includes the standards of conduct or moral
after assessing the risks and the returns, only actions judgement that apply to persons engage in industry or
that would increase share price are acceptable. commerce. Violations of these standards in finance
Otherwise, the alternative/s shall be rejected. include, but not limited to misstated financial
The Goal of the firm, and therefore of all mangers, is statements, misleading financial forecasts or
to maximize shareholders’ wealth. This can be projections, fraud, bribery, kickbacks, insider trading,
measure by share price. An increasing price per share excessive executive compensation, and options
of common stock relative to the stock market as a backdating. Bad publicity generally results to
whole indicates achievement of this goal. negative impacts on a firm. Ethics programs seek to
reduce lawsuits and judgment costs, uphold and
Given the following opportunities, which investment preserve a positive corporate image, build trust and
is preferred? confidence of the shareholders, and gain the loyalty
and respect of all stockholders. The expected result of
Earnings per Share such programs is to positively affect the firm’s share
price. The agency problem and the associated agency
Investment Year 1 Year 2 Year 3 Total
costs can be reduced through the following:
A ₱14.00 ₱10.00 ₱4.00 ₱28.00
1. Properly constructed and implemented corporate
B 6.00 10.00 14.00 30.00 governance structure.

Based on the information provided, the choice is not 2. Structured expenditures thru compensation plans.
obvious. Profit maximization is not consistent with
3. Market Forces such as shareholder crusading from
wealth maximization. It may not lead to the highest
large institutional investors.
possible share price due to the following reasons:
4. Threat of hostile takeovers.
1. Timing is important. The receipt of funds sooner
rather than later must be considered since the goal of
the firm is to maximize value.
FINANCIAL ANALYSIS: TOOLS AND
2. Profits do not necessarily result in cash flow TECHNIQUES
available to stockholders. In some instances, firm
may generate huge profit but may not have enough ANALYSIS- a consideration of anything in its
cash to continuously run the business. This happens separate parts and their relation to each other.
when expenses have shorter due date than expected
revenue. FINANCIAL ANALYSIS- refers to examination of
financial data of an entity or firm to determine
3. Profit maximization fails to account for risk.
Increased risk may decrease the share price, while its profitability, growth, solvency, stability and
return is likely to increase the share price. The two effectiveness of its management.
key activities that the financial manager does related 1. Financial Statement
to a firm’s balance sheet are the following:
 Are compact reports that summarize the financial
1. Investment decisions. The finance manager defines position of a firm as of a given
the most efficient level and the best structure of
assets. Investment decisions deal with the items that date, or the result of financial operation over a given
appear on the asset section of the balance sheet. period of time
2. Financing decisions. The finance manager  end products of the accounting process
determines and maintains the proper combination of
short-term and long-term financing. Corporate  BASIC FINANCIAL STATEMENTS:
Governance, Ethics and Agency Issues Corporate  BALANCE SHEEET/ STATEMENT OF
governance is a system of organizational control that FINANCIAL POSITION
defines and establishes the responsibility and
accountability of the major participants in an 2 FORMS:
1. REPORT FORM-simply lists the assets, followed 5. MERCHANDISE INVENTORY- Stocks available
by the liabilities then by the owner’s equity in vertical for sale by the business
sequence
6. PREPAID EXPENSES- advance payments made
2. ACCOUNT FORM-which lists the assets on the for benefits or services to be received by the business
left and the liabilities and owner’s equity on the right. in the future
 INCOME STATEMENT/ STATEMENT OF -PREPAID SUPPLIES, PREPAID RENT, PREPAID
FINANCIAL PERFORMANCE INSURANCE
2 FORMS: 7. ALLOWANCE FOR BAD DEBTS-CONTRA
ASSET
1. NATURAL FORM-also called as Single Step Form
where there are two sections: the revenue section and -which represents customer’sdoubtful accounts
the operating section
NON-CURRENT ASSETS
2. FUNCTIONAL FORM-presents the expenses
according to function: cost of sales, selling expenses, 1. LAND-lot or real estate
administrative expenses and financial expenses 2. BUILDING-structured used to house the office,
 CASH FLOW STATEMENT store or factory

 BALANCE SHEET-shows economic resources it 3. EQUIPMENT-computers,calculator,filing cabinet

controls, its financial structure (financing or 4. FURNITURE AND FIXTURES- chairs,wall
borrowing), its liquidity and solvency. decorations,tables
-list down the enity’s assets, liabilities, owner’s 5. ACCUMULTED DEPRECIATION-contra asset or
equity off-set account representing expired cost of the plant,
-shows an information about the economic resources property, or equipment as a result of usageang
and its capability to change. passage of time.

-the increase and decrease of the resources are useful LIABILITIES:

in predicting the ability of the enterprise to generate CURRENT-LIABILITIES
cash and cash equivalents in the future.
1. ACCOUNTS PAYABLE-purchase of goods or
COMPONENTS: ACCOUNT TITLES services on credit supported by oral or implied
CURRENT ASSETS promise to business

1. CASH-currencies, coins or negotiable instruments -other: NOTE PAYABLE-supported by a promissory

such as bank checks or a postal money order used as note
a medium of exchange.
2. LOAN PAYABLE- a liability to pay a bank or
 CASH ON HAND financing institutions for amount of money borrowed.
 CASH IN BANK 3. UTILITIES PAYABLE- liability to pay utility
 CASH EQUIVALENTS companies like pldt,meralco

2. MARKETABLE SECURITIES- Highly traded 4. OTHER PAYABLES- INTEREST PAYABLE-

securities-stocks, bonds interest bearing note

3. RECEIVABLES- collectibles from clients, - SALARIES PAYABLE—for the employees

customers and other persons for the goods, services - TAXES PAYABLE- based on sales, earnings or
or money given by the business. value of property
4. OTHER RECEIVABLES- Interest Receivable- NON-CURRENT LIABILITY
collectibles from promissory note, others: Rent
Receivable, Dividends Receivable 1. NOTE PAYABLE
2. MORTGAGE PAYABLE
3. BOND PAYABLE
OWNER’S EQUITY-Represents the claim of the
owner over assets of the business after the liabilities
have been deducted
 INCOME STATEMENT
- Shows the result (profitability)of operations of a
business entity for a given period of time
-list down revenues and expenses of the enterprise The changes can be summarized as follows:

 CASH FLOW STATEMENT 1. SOURCES OF FUNDS THAT INCREASE CASH

POSITION:
-statement that traces the inflow of funds from all
sources and the disbursement of funds for different  A net decrease in any asset other cash or fixed
undertakings during the period covered. assets

- How is cash obtained by the business?, How does it  A gross decrease in fixed assets
spend its cash? What causes the change in the cash?
 A net increase in any liability
- How cash is being managed.
 Proceeds from the sale of stocks
- AN INFLOW(SOURCE OR RECEIPT), AN
OUTFLOW(USE OR DISBURSEMENT)  Funds generated from operations

ACTIVITIES: 2. USES OF FUNDS THAT INCREASE CASH

POSITION:
1. OPERATING ACTIVITIES-INFLOW: cash comes
from revenue collections  A net increase in any asset other than cash or fixed
assets
-OUTFLOW: Cash goes to payment of expenses
 A gross increase in fixed assets
2. INVESTING ACTIVITIES- INFLOW: sale of
plant,property,and equipments, securities  A net decrease in any liability

-OUTFLOW: acquisition of plant, property, and  A retirement or purchase of stock

equipments  Payment of cash dividends
3. FINANCING ACTIVITIES- INFLOW: loans GENERAL FEATURES OF FINANCIAL
extended,cash contribution STATEMENT
-OUTFLOW: cash paid to creditors, cash 1. Fair presentation and Compliance with PFRS
contribution (Philippine Financial Reporting Standards)
The goal of every analyst will be to predict whether 2. Going Concern
the company being analyzed will have sufficient cash
to meet its ongoing cash needs and meet necessary 3. Materiality and Aggregation
requirements for a smooth sailing business.
4. Offsetting
The sources and uses of funds will come from the
following balance sheet changes 5. Frequency of Reporting
6. Comparative Information
7. Consistency of Presentation
USERS OF FINANCIAL STATEMENTS
1. Primary Users- parties to whom general purpose
financial reports are primarily directed
2. Other Users- users of financial information other Financial analysis is based on the client’s audited
than primary users financial statement which gives us insight on
companies past performance and provide vital
information concerning the position of the business
and the results of its operation.
1. PUBLISHED REPORTS- the annual report of a
publicly held corporation is an important source of
financial information
2. SEC REPORT- Publicly held corporation must file
annual, quarterly and current reports with the
Securities Exchange Commission
3. BUSINESS PERIODICALS
LIMITATIONS OF FINANCIAL STATEMENT:
1. Financial Statements present only information that
can e quantified in terms of monetary unit. Some
significant factors affecting the business firms do not
always lend themselves to such quantifications and
are therefore not found in the financial statements
Examples:
 The character,motivation, experience and age of
the people within the organization
 The quality of its research and development effort.
 The extent of its marketing network
 Details regarding product lines, machine
efficiency, advance planning
 Organization of structure, behavioural problems
and the extent of influence exercised by key-position
holders.

FINANCIAL ANALYSIS: 2. Financial statements are historical in nature and

their use for predictive purpose calls for informed/
- is the process of evaluating relationships between careful judgment by the users.
parts of the firm’s financial statements in order to
judge its performance. 3. Instability of Monetary Unit. The value of money
in terms of general purchasing power has undergone
- It provides a sound basis for credit worthiness and significant fluctuations and has gone pronounced
evaluates thoroughly and draws conclusions on the downward trends.
borrower’s / prospective borrower’s performance,
strengths, weaknesses and industry prospects. 4. Financial statements present the best possible
estimates, not absolutely accurate figures
STEPS IN FINANCIAL ANALYSIS:
FINANCIAL STATEMENT ANALYSIS
1. Determine relevant information STANDARDS:
2. Arrange information to highlight significant 1. RULE-OF-THUMB MEASUREMENT/
relationships ABSOLUTE STANTARDS
3. Interpret and draw conclusions -Many financial analysts and lenders use “ideal” or
rule of thumb measures for key financial ratios.
BASIS FOR FINANCIAL ANALYSIS:
-Are those that become generally recognized as - Is a comparative analysis which shows the increases
becoming desirable regardless of the type of a and decreases, in absolute amounts and in
company, the time, stage of the business cycle or percentages, of financial data for two given periods
objectives of the analysts.
- The increase or decrease, specifically if material in
- For example: it has been long thought that a current amount, will trigger an inquisition from management
ratio of 2.00:1 is acceptable. to determine whether the changes is good for the
company and what is the reason for the change.
2. PAST PERFORMANCE OF THE COMPANY
a. Comparative Statements
- an improvement over the rule-of-thumb method is
the comparison of financial measures or ratios of the -shows the increases and/ or decreases of account
same company over a period of time. balances and their corresponding percentages
-This standard will at least give the analyst some b. Trend Ratios
basis for judging whether the measure or ratio is
getting better or worse. - supplement the comparative statements, showing
the behaviour of financial data for successive periods
-Helpful in showing possible future trends.
2. VERTICAL ANALYSIS
3. INDUSTRY NORMS
-only one set of financial statement is used
- This standard will tell how the company being
analyzed compares with other companies in the same -involves the percentage changes to bring out the
industry quantitative relationships existing among different
items to the total in a single statement.
-For example: an average Return on Sales (ROS) of
the industry is 8%; in such case companies below 8% -It shows the relative importance of an item in
did not perform well. relation to other items and to a total.

THREE LIMITATIONS: -It sets a total figure in the statement equal to 100%
and computes the percentage of each component of
1. Although two companies seem to be in the same the figure(this figure would be total assets or total
industry, they may not be strictly comparable. liabilities and stockholders’ equity in the case of
balance sheet and revenues or sales in the case of the
2. Most large companies operate in more than one income statement.
industry.
-used in the importance (proportion) of individual
3. Companies in the same industry with similar items to the specific base item which is the total
operations use different accounting procedures. revenue (in the income statement) and the total assets
4. BUDGETED STANDARDS (in the balance sheet)

-a budget, ratios developed from actual performance -It shows changes in the relative size (importance) of
can be compared to planned ratios in the budget in each item to the specific base and whether it is good
order to determine the degree of accomplishment. or not depends on its effect on the financial position
or performance of the business.
TOOLS AND TECHNIQUES
a. Common size statement
For Short Term Decision Making:
- a statement wherein each item is expressed in terms
The tools of financial analysis are intended to show of a percentage of a common base number.
relationships and changes:
b. Financial Ratio
1. HORIZONTAL ANALYSIS
- shows the significant between items in the financial
- it enables one to draw a picture on what changes are statements expressed in mathematical form.
taking place in the financial activities of an
enterprise. Common Types of Ratios
1. Profitability Ratios-designed to measure the
success of the firm in generating profit
2. Liquidity Ratios- measure the firm’s ability to meet
the current obligations as they fall due
3. Investibility Ratios- measure the desirability of the
shares of a company as an investment outlet
4. Stability Ratios- measure the firm’s ability to meet
its long-term commitments when they fall due.

RATIO ANALYSIS
1. LIQUIDITY RATIOS
 Measure the amount of cash or investments that
can be converted to cash in order to pay expenses,
bills and other obligations as they come due
 The ratios that relate to this goal all have to do
with working capital or some part of it, because it is
out of working capital that debts are pad as they
mature.
 TWO DIMENSIONS TO PROPER EVALUATE
LIQUIDITY ARE:
a. The time necessary to convert the assets into
money
b. The degree of certainty associated with the
conversion ratio for the assets
2. PROFITABILITY RATIOS A company’s long-run
survival depends on its being able to earn a
satisfactory income. An evaluation of past
earning power may give the investor and
creditor a better understanding for decision
making. Measure and help control income.
3. SOLVENCY RATIOS Refers to the ability to
meet the interest and repayment schedules
associated with debts. It enables to point out
early whether the company is on the road of
bankruptcy.
 - This requires financial projections such as estimates
of cash flows, revenues, costs and expenses and the
resulting financial ratios
CORPORATE PLANNING
- Is a formal, systematic, managerial process,
organized by responsibility, time and information, to
ensure the operational planning, project planning and
strategic planning are carried out regularly to enable
top management to direct and control the future of
the enterprise.
BUDGETING
- Is the process of translating a plan in quantitative
terms
BUDGET
-is a formal statement of a planned course of action
expressed in quantitative terms.
OBJECTIVES OF BUDGETING
1. Planning
Example: Fixed Costs and Expenses amount P80,000.
Unit selling price is P40 and unit variable costs and - Financial plans of the different sub-units are
expenses amount to P30. prepared geared towards the attainment of the
company’s predetermined objectives
Financial planning- refers to the process of
determining the best uses of the financial resources of 2. Coordination
an organization to attain its predetermined objectives - Budgeting brings harmony and synchronized
and the procurement of the required funds at the least operations for the different levels of management
cost.
3. Control - Budgeting provides management with the
THE FINANCIAL PLANNING PROCESS yardstick in evaluating performance.
1. Analyze the current financial statements of a BUDGETARY CONTROL
company. - It answers the question “where are we
now?” - Refers to the use of budgets and budgetary reports
to coordinate, evaluate and control day-to day
- This is done to detect areas of strengths and operations to attain the goals specified by the budget.
weaknesses as indicated by the measures of liquidity,
profitability and stability. MASTER BUDGET
2. Interpret historical data - Refers to the consolidated budgets of the different
sub-units (departments, branches and sections)
- It answers the question “how did we get here?”
- This step reveals the causes of current financial
stability or difficulty such as sufficiency or
insufficiency of funds inflows from operations,
inability to plough back earnings by declaring the
greater portion of annual net income as dividends and
unprofitable operations of some sub-units.
3. Evaluate the different alternatives and choose the
best. - It answers the question “where do we want to
go?”
 - An extended version of the simple model, - A
financial planning method in which accounts are
varied depending on a firm’s predicted sales level. -
There are those that vary directly with sales and those
that do not.
FINANCIAL PLANNING MODEL: THE
INGREDIENTS/ ELEMENTS
1. Sales Forecast
- Determine the growth rate
- Driver, most pther values will be calculated based
on it.
2. Pro-Forma Statements
- “As a matter of form”
SOURCES OF CAPITAL - A financial plan will have a forecast balance sheet,
The 2 sources of capital in finance: income statement and statement of cash flows. -
Financial statements are the form we use to
1. EQUITY CAPITAL summarize the different events projected.
- Refers to the financial resources provided by 3. Asset Requirements
owners of the business
- The plan will describe projected capital spending
- These are capital from all investments made (initial
and additional) plus the earnings retained in the - Projected growth will make changes in our balance
business sheet.

- CORPORATION: equity of the owners is called 4. Financial Requirements

stockholders’ equity (consists of the payment of the - Plan will include a section about the necessary
stockholders for their shares of stock, increased by financing arrangements
additional issuances of shares of stocks and income
retained in business; decreased by dividends paid to - Discuss dividend policy, Debt Policy
stockholders
- Policy on raising funds
2. BORROWED CAPITAL
5. The Plug
- Refers to capital acquired that gives rise to liability
or to a debtor-creditor relationship - Some new amount of financing will often be
necessary because projected total assets will exceed
- Ways of acquiring borrowed capital projected total liabilities and equity. - It is the
designated sources and sources of financial planning
1. Buying property, equipment, raw materials and needed to deal wth any short fall or surplus.
availing of services on credit
2. Loans from financial intermediaries
6. Economic Assumptions
3. Issuance of commercial papers and bonds
- State explicitly the economic environment
4. Advances from affiliate companies and officers
FINANCIAL LEVERAGE
5. Accounts and notes receivable discounting
- The financial advantage derived from having
FINANCIAL PLANNING MODELS: additional funds (use of borrowed capital)
1. SIMPLE PLANNING MODEL considering the cost involves. - It arises from the use
of borrowed capital to enhance earnings per share and
2. PERCENTAGE OF SALES APPROACH rate of return on owner’s equity.
ILLUSTRATIVE EXAMPLE:
DY Corporation realizes income of P800,000 before
interest and income taxes. Its balance sheet shows:
Assets= P 1,500,000
Liabilities= P200,000
SHE= P1,300,000
There are 10,0000 shares outstanding, par value of
P100 per share. The company is evaluating a project
proposal requiring additional capital of P500,000 so
as to increase its operating income by P200,000.
Two alternative solutions have been presented:
1. Borrow P500,000 from a bank at 18%
2. Issue additional 2,500 shares of capital stock at the
market price of P200 per share
Tax rate is 32%
Compute for the Cost of Capital, Tax Benefit
Solution: