CHAPTER 1:

Introduction to
Financial Management
 Objectives

1. Have an appreciation of what the overall objective of management should be.

2. Present an overview of the financial system and discuss the different functions of
the financial intermediaries.
3. Distinguish a financial institution from a financial instrument and financial markets.
4. Compare and contrast the different financial instruments.
5. Explain the major functions of key management positions in a typical organization,
highlighting the crucial role of a finance manager.

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“ Beware of little expenses. A
small leak will sink a great
ship.

-Benjamin Franklin

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 FINANCIAL MANAGEMENT
 Starts with a plan. This applies to both individuals and companies.
 From the perspective of a corporation, financial management deals with decisions that are
supposed to maximize the value of a shareholder’s wealth. This means maximizing the
market value of the shares of stocks. Shares of stocks represent the form of ownership in a
corporation.
 To illustrate, Globe Telecom Inc. shares closed at P2,200 on April 25, 2016. As of that
date, Globe’s total shares outstanding was P132,742,402. The market value of the shares
as of that date was more than P292 billion. ( P2,200 X 132,742,402 = P292,033,284,400 ). This
amount represents the value of the shareholders’ wealth.

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Factors that influence the price of a stocks

1. Profitable operation
2. Nature of business
3. Prospects of the business
4. Projected earnings and timeframe
5. Ability to meet maturing obligations
6. Appropriate capital structure
7. Dividend policies
8. Investing decisions
9. Management and market sentiments
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 Shareholders’ Wealth Maximization

 Maximizing shareholders’ wealth through maximization of stocks price should be the

overriding objective of management as it covers the different facets of operating a
company and it considers the different stakeholders in the organization.
 Stakeholders are not limited to the stockholders of the company.
 Stakeholders also include management employees, suppliers, customers, regulatory
agencies, and the community where the company operates.
 Maximizing shareholders’ wealth motivates members of a top management to develop a
longer perspective for the company that they manage. With this objective in mind,
management will try to make their customers happy by providing good products and
services at reasonable prices. To achieve this, management may have to innovate, invest
in technology, and be more efficient in their production and operation.
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 Shareholders’ Wealth Maximization

 The interest of the employees has to be considered in managing company.

 Paying suppliers and creditors on time is good business practice that will improve
relationships with these parties.

 Compliance with the requirements of regulatory agencies also ensures more smooth
operations.

 Supporting the community where the company operates, in whatever capacity it can,
increases the company’s chances of continuous operations in the area.
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 Financial System

Financial User of Funds

Savers
Intermediaries (Borrowers/Investors)
 Households  Households
 Banks
 Individuals  Individuals
 Insurance companies
 Corporations/  Corporations/
 Stock exchange
Companies Companies
 Stock brokerage firms
 Government  Government
 Mutual funds
Agencies Agencies
 Other financial
institutions

Figure 1: Overview of the Financial System 8

 Savings can came from households, individuals, companies, government agencies and
any other entity whose cash inflows are greater than their cash outflows. The financial
system through financial intermediaries provides a mechanism by which these savings
can be channeled to users of funds, borrower, and investors.

 As shown in Figure 1, the same entities can be savers and users of funds. One entity may
have savings today but maybe needing funds in the future, for example, for expansion.

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 Different functions that each financial
intermediary may perform

▰ Banks ▰ Insurance Companies ▰ Stock Exchange

 provide mechanism where  offer different products.  The Philippine Stock

savers can put their excess Insurance products can Exchange(PSE) provides
funds through deposits. be broadly categorized a system for the trading
into life insurance of equity securities of
products and non-life publicly listed
insurance products. Life companies.
insurance products  These equity securities
protect the insured from are common stocks and
loss of wife while non- preferred stocks.
life insurance products
protect the insured from
the loss of or damage to 10
properties.
 Different functions that each financial
intermediary may perform

▰ Stocks Brokerage ▰ Mutual Funds ▰ Other Financial

Firms Institutions
 Investing in the stock market  Provide opportunities for big and
 Other financial
has to be coursed through stock small investors to invest in financial
institutions include
brokerage firms. instruments which they would not
pension funds like
have considered but do not have time
 A present, there are online Government Service
or the expertise to do it.
brokers and live brokers. Insurance System(GSIS),
 These includes investments in the and Social Security
 Online brokers, one can trade in stock market, bonds, treasury notes, System(SSS), investment
the stock market through the and other money market instrument banks, and credit unions,
internet.( COL Financial and like treasury bills. among others.
BPI Trade)
 To invest in mutual fund, he has to
 Live brokers, one needs a buy shares and the buying price
telephone to call brokers and depends on the net asset value(NAV)
place orders. of that fund when the purchase is 11
made.
 Financial Instruments
 The interest of the employees has to be considered in managing company.

 Paying suppliers and creditors on time is good business practice that will improve
relationships with these parties.

 Compliance with the requirements of regulatory agencies also ensures more smooth
operations.

 Supporting the community where the company operates, in whatever capacity it can,
increases the company’s chances of continuous operations in the area.
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 Board of Directors

President

VP for Sales and VP for VP for

Marketing VP for Finance Administration
Production

Figure 2: Organizational Chart 13

 Board of Directors
 The board of directors is the highest policy-making body in a corporation.
 The boards primary responsibility is to ensure that the corporation is operating to serve
the best interest of the stockholders.
 The members of the board who are called directors are elected by the stockholders.
 The ability to elect a director in the board is contingent on the amount of shares owned
and the number of directors in the board.
 To illustrate, assume that there are 10 directors in the board. If the stockholder owns 10%
of the voting shares of the company, then this stockholder can elect 1 director in the
board.
 This is the reason why some investor want to own the majority shares of the company if
they want to control over that company. 14
 Responsibilities of the board of directors

 Setting policies on investments, capital structure, and dividends

 Approving company’s strategies, goals, and budgets
 Appointing and removing members of the top management including the
president
 Determining top management’s compensation
 Approving the information and other disclosures reported in the financial
statements

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 Presidents
Responsibilities of a Presidents

 Overseeing the operations of a company and ensuring that the

strategies as approved by the board are implemented as planned.
 Performing all areas of management: planning, organizing, staffing,
directing, and controlling
 Representing the company in professional, social, and civic activities

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 VP for Sales and Marketing
 The following are among the responsibilities of VP for Sales and Marketing

o Formulating marketing strategies and plans

o Directing and coordinating company sales
o Performing market and competitor analysis
o Analyzing and evaluating the effectiveness and cost of marketing methods applied
o Conducting or directing research that will allow the company to identify new
marketing opportunities, for example, variants of existing products/services already
offered in the market
o Promoting good relationship with customers and distributors

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 VP for Production
 The following are among the responsibilities of VP for Production

o Ensuring production meets customer demands

o Identifying production technology/process that minimizes production cost and
makes the company cost competitive
o Coming up with a production plan that minimizes the utilizations of the company’s
production facilities
o Identifying adequate and competitively priced raw material suppliers

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 VP for Administration
 The following are among the responsibilities of VP for Administration

o Coordinating the functions of administration, finance, and sales and marketing

departments
o Assisting other departments in hiring employees
o Providing assistance in payroll preparation
o Determining the location and the maximum amount of office space needed by the
company
o Identifying means, processes, or systems that will minimize the operating cost of
the company

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 VP for Finance
 Shown in Figure 3 are the functions of VP for Finance

Financing

Investing

Operating

Dividend Policies

Figure 3: Functions of VP for Finance 20

Financing Decisions
 Financing decisions include making decisions as how to finance long-term
investments and working capital which deals with the day-to-day operations of the
company.
 The VP for finance is also responsible for determining the appropriate capital
structure of the company, that is, how much of the total assets should be financed
by debt and equity.
 This responsibility is crucial because if the company is aggressively financed, that
is, it is heavily financed by debt, the company becomes vulnerable to adverse
economic conditions which may result in higher volatility in earnings. The
company can bankrupt because of too much debt.
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 Financing Decisions
 Capital structure decisions vary from one company to another.
 It is affected by the stability of cash flows, extent of fixed operating expenses and variable
expenses.
 Companies which are capital intensive and are characterized by high-fixed operating
expenses such as utility and mining companies are supposedly more conservatively
financed. This means, these companies have to financed more by equity
 These companies have to generate high levels of revenues before they can cover their
expenses.
 If these companies are heavily financed by debt, then interest expense adds up to the
already high-fixed operating expenses. This would mean higher revenues for profits to be
made.
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 Investing Decisions
 To minimize the profitability of failure, long-term investments have to be supported by a
capital budgeting analysis which is among the responsibilities of a finance manager.
 Capital budgeting analysis is a technique used to determine the financial viability of a
long-term investments.
 This requires forecasting the cost of investment and the streams of cash flow expected to
be generated from the investment.
 The investment can only be considered if it satisfies certain financial parameters that are
acceptable to the top management.

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 Operating Decisions
 Operating decisions deal with the daily operations of the company.
 The role of the VP for Finance is determining how to finance working capital accounts
such as accounts receivable and inventories.
 Should the company finance these two accounts substantially by short-term sources of
financing or long-term sources of financing?
 The decision regarding the financing of these working capital accounts depends on the
appetite of top management for risk. If the company is more aggressive, then these
accounts receivable and inventories can be substantially financed by short-term sources.
 Basically, short-term sources of funds are cheaper. Interest on short-term loans is generally
lower than the interest on long-term loans. Hence, using short-term loans can boost the
profitability of a company.
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 Operating Decisions
 While financing through short-term sources of financing may minimize the financing cost
of the company, this however, has a trade-off.
 Financing working capital accounts mostly through short-term sources may expose the
company to a liquidity problem where obligations are already due but the company does
not have sufficient cash to pay for the obligations.
 A more conservative management will opt to finance working capital accounts mostly
trough long-term sources.

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 Dividend Policies
 Some investors buy stocks because of the dividends they expect to receive from the
company.
 Non-declaration of dividends may disappoint these investors.
 PLDT and GLOBE are two of the Philippine-listed companies which have generously
distributed cash dividends for the last 5 years.
 Two conditions must exist before a company can declare cash dividends. (1) The company
must have enough retained earnings to support cash dividend declaration. When cash
dividends are declared, the retained earnings of the company go down to the extent of such
declaration. (2) The company must have cash.

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 Dividend Policies
How much cash dividends of a company declares is within the purview of the VP for Finance.
There are several factors considered in declaring cash dividends. Listed below are among
these considerations.
 Availability of investments opportunities – this is especially true for small and medium enterprises
(SMEs) which access to long term sources of funds is limited. These SMEs may rarely heavily on internally
generated funds to finance expansion. Hence, the decision to declare cash dividends can be substantially influenced
by the availability of investments opportunities.

 Access to long-term sources of funds – Publicly listed companies like PLDT, GLOBE, or PETRON
have a better access to long-term sources of funds. These companies can afford to declare cash dividends even if
they are faced with huge amounts of investments, for as long as their retained earnings can support such
declarations. The reason is these companies are big, publicly listed, and have much better access to long term
sources of funds.
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 Dividend Policies
 Capital Structure – The capital structure of a company can depend largely on the nature of its
business. As previously stated, companies which are capital intensive have to be more conservatively
financed. Therefore, the amount of cash dividends to be declared depends on how such declarations
can affect the structure of a company.

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