FINANCIAL MANAGEMENT

Copied from Financial Management: Comprehensive Volume, 2019-2020 Edition

By Cabrera, E.B. & Cabrera, G.A.B.

CHAPTER 1
NATURE, PURPOSE AND SCOPE OF FINANCIAL MANAGEMENT

NATURE OF FINANCIAL MANAGEMENT

Financial Management, also referred to as managerial finance, corporate finance, and business finance, is a
decision-making process concerned with planning, acquiring, and utilizing funds in a manner that achieves the
firm's desired goals. It is also described as the process for and the analysis of making financial decisions in the
business context. Financial management is part of a larger discipline called FINANCE which is a body of facts,
principles, and theories relating to raising and using money by individuals, businesses, and governments. This
concerns both financial management of profit-oriented business organizations particularly the corporate form of
business, as well as concepts and techniques that are applicable to individuals and to governments.

THE GOAL OF FINANCIAL MANAGEMENT

Assuming that we confine ourselves to for-profit businesses, the goal of financial management is to make
money and add value for the owners. This goal, however, is a little vague and a more precise definition is
needed in order to have an objective basis for making and evaluating financial decisions. The financial manager
in a business enterprise must make decision for the owners of the firm. He must act in the owners' or
shareholders' best interest by making decisions that increase the value of the firm or the value of the stock.

The appropriate goal for the financial manager can thus be stated as follows:

The goal of financial management is to maximize the current value per share of the existing stock or ownership
in a business firm.

The stated goal considers the fact that the shareholders in a firm are the residual owners. By this, we mean that
they are entitled only to what is left after employees, supplier, creditors, and anyone else with a legitimate claim
are paid their due. If any of these groups go unpaid, the shareholders or owners get nothing. So, if the
shareholders are benefiting in the sense that the residual portion is growing, it must be true that everyone else is
being benefited too. Because the goal of financial management is to maximize the value of the share(s), there is
a need to learn how to identify investments, arrangements and distribute satisfactory amount of dividends or
share in the profits that favorably impact the value of the share(s)

Finally, our goal does not imply that the financial manager should take illegal or unethical actions in the hope of
increasing the value of the equity in the firm. The financial manager should best serve the owners of the
business by identifying goods and services that add value to the firm because they are desired and valued in the
free marketplace.

SCOPE OF FINANCIAL MANAGEMENT

Traditionally, financial management is primarily concerned with acquisition. financing and management of
assets of business concern in order to maximize the wealth of the firm for its owners. The basic responsibility of
the Finance Manager is to acquire funds needed by the firm and investing those funds in profitable ventures that
will maximize the firm's wealth, as well as, generating returns to the business concern. Briefly, the traditional
view of Financial Management looks into the following functions that a financial manager of a business firm
will perform:

1. Procurement of short-term as well as long-term funds from financial institutions

2. Mobilization of funds through financial instruments such as equity shares, preference shares,
debentures, bonds, notes, and so forth
3. Compliance with legal and regulatory provisions relating to funds procurement, use and distribution as
well as coordination of the finance function with the accounting function.

With modern business situation increasing in complexity, the role of Finance Manager which initially is just
confined to acquisition of funds, expanded to judicious and efficient use of funds available to the firm, keeping
in view the objectives of the firms and expectations of the providers of funds.

More recently though, with the globalization and liberalization of world economy, tremendous reforms in
financial sector evolved in order to promote more diversified, efficient and competitive financial system in the
country. The financial reforms coupled with the diffusion of information technology have brought intense
competition, mergers, takeovers, cost management, quality improvement, financial discipline and so forth.

Globalization has caused to integrate the national economy with the global economy and has created a new
financial environment which brings new opportunities and challenges to the business enterprises. This
development has also led to total reformation of the finance function and its responsibilities in the organization.
Financial management has assumed a much greater significance and the role of the finance managers has been
given a fresh perspective.

In view of modern approach, the Finance Manager is expected to analyze the business firm and determine the
following:

a. The total funds requirements of the firm

b. The assets or resources to be acquired and
c. The best pattern of financing the assets

TYPES OF FINANCIAL DECISIONS

The three major types of decisions that the Finance Manager of a modern business firm will be involved
in are:

1. Investment decisions
2. Financing decisions
3. Dividend decisions

All these decisions aim to maximize the shareholders' wealth through maximization of the firm's wealth.

INVESTMENT DECISIONS
The investment decisions are those which determine how scarce or limited resources in terms of
funds of the business firms are committed to projects. Generally, the firm should select only those
capital investment proposals whose net present value is positive and the rate of return exceeding the
marginal cost of capital, It should also consider the profitability of each individual project proposal
that will contribute to the overall profitability of the firm and lead to the creation of wealth

FINANCING DECISIONS
Financing decisions assert that the mix of debt and equity chosen to finance investments should
maximize the value of investments made.
 The finance decisions should consider the cost of finance available in different forms and the risks
attached to it. The principle of financial leverage or trading on the equity should be considered when
selecting the debt-equity mix or capital structure decision. If the cost of capital of each component is
reduced, the overall weighted average cost of capital and minimization of risks in financing will
lead to the profitability of the organization and create wealth to the owner.

DIVIDEND DECISIONS
The dividend decision is concerned with the determination of quantum of profits to be distributed to
the owners, the frequency of such payments and the amounts to be retained by the firm

The dividend distribution policies and retention of profits will have ultimate effect on the firm's
wealth. The business firm should retain its profits in the form of appropriations or reserves for
financing its future growth and expansion schemes. If the firm, however, adopts a very conservative
dividend payments policy, the firm's share prices in the market could be adversely affected. An
optimal dividend distribution policy therefore will lead to the maximization of shareholders' wealth.

To summarize, the basic objective of the investment, financing and dividend decisions is to
maximize the firm's wealth. If the firm enjoys the stability and growth, its share prices in the market
will improve and will lead to capital appreciation of shareholders investment and ultimately
maximize the shareholders wealth.

SIGNIFICANCE OF FINANCIAL MANAGEMENT

The importance of financial management is known for the following aspects:

BROAD APPLICABILITY
Any organization whether motivated with earning profit or not having cash flow requires to be viewed
from the angle of financial discipline. The principles of finance are applicable wherever there is cash
flow. The concept of cash flow is one of the central elements of financial analysis, planning, control, and
resource allocation decisions Cash flow is important because the financial health of the firm depends on
its ability to generate sufficient amounts of cash to pay its employees, suppliers, creditors, and owners.

Financial management is equally applicable to all forms of business like sole traders. partnerships, and
corporations. It is also applicable to nonprofit organizations like trust, societies, government
organizations, public sectors, and so forth

REDUCTION OF CHANCES OF FAILURE

A firm having latest technology, sophisticated machinery, high caliber marketing and technical experts,
and so forth may still fail unless its finances are managed on sound principles of financial management.
The strength of business lies in its financial discipline. Therefore, finance function is treated as primordial
which enables the other functions like production, marketing purchase, and personnel to be effective in
the achievement of organizational goal and objectives

MEASUREMENT OF RETURN ON INVESTMENT

Anybody who invests his money will expect to cam a reasonable return on his investment. The owners of
business try to maximize their wealth. Financial management studies the risk-return perception of the
owners and the time value of money. It considers the amount of cash flows expected to be generated for
the benefit of owners, the timing of these cash flows and the risk attached to these cash flows. The greater
the time and risk associated with the expected cash flow, the greater is the rate of return required by the
owners.
RELATIONSHIP BETWEEN FINANCIAL MANAGEMENT, ACCOUNTING AND
ECONOMICS

FINANCIAL MANAGEMENT AND ACCOUNTING

Just as marketing and production are major functions in an enterprise, finance too is an independent
specialized function and is well knit with other functions.

Financial management is a separate management area. In many organizations, accounting and finance
functions are intertwined and the finance function is often considered as part of the functions of the
accountant. Financial management is however, something more than an art of accounting and
bookkeeping. Accounting function discharges the function of systematic recording of transactions relating
to the firm's activities in the books of accounts and summarizing the same for presentation in the financial
statements such as the Statement of Comprehensive Income, the Statement of Financial Position, the
Statement of Changes in Shareholders' Equity and the Cash flow Statement.

Financial statements help managers to make business decisions involving the best use of cash, the
attainment of efficient operations, the optimal allocation of funds among assets, and the effective
financing of investment and operations. The interpretation of financial statements is achieved partly by
using financial ratios, pro forma and cash flow statement.

The finance manager will make use of the accounting information in the analysis and review of the firm's
business position in decision making. In addition to the analysis of financial information available from
the books of accounts and records of the firm, a finance manager uses the other methods and techniques
like capital budgeting techniques, statistical and mathematical models, and computer applications in
decision making to maximize the value of the firm's wealth and value of the owner's wealth. In view of
the above, finance function is considered a distinct and separate function rather than simply an extension
of accounting function.

It should be pointed out that the managers of a firm are supplied with more detailed statistical information
than what appears in published financial statements. These data are especially important in developing
cash flow concepts for evaluating the relative merits of different investment projects. This information
permits managers to determine incremental cash flows (an approach that looks at the net returns a given
project generates in comparison with alternative investments), thus enabling them to make more accurate
assessments of the profitabilities of specific investments. It is the responsibility of managers to direct their
accountants to prepare internal statements that include this information so that they can make the best
investment decisions possible.

Financial management is the key function and many firins prefer to centralize the function to keep
constant control on the finances of the firm. Any inefficiency in nancial management will be concluded
with a disastrous situation. But, as far as the routine matters are concerned, the finance function could be
decentralized with adoption of responsibility accounting concept. It is advantageous to decentralize
accounting function to speedup the processing of information. But since the accounting information is
used in making financial decisions, proper controls should be exercised in processing of accurate and
reliable information to the needs of the firm. The centralization or decentralization of accounting and
finance functions mainly depends on the attitude of the top-level management.

FINANCIAL MANAGEMENT AND ECONOMICS

Financial managers can make better decisions if they apply these basic economic principles. For example,
economic theory teaches us to seek the best allocation of resources. To this end, financial managers are
given the responsibility to find the best and least expensive sources of funds and to invest these funds into
the best and most efficient mix of assets. In doing so, they try to find the mix of available resources that
will achieve the highest return at the least risk within the confines of an expected change in the economic
climate. Good financial management has a sound grasp of the way economic and financial principles
impact the profitability of the firm.
 Financial managers do a better job when they understand how to respond effectively to changes in supply,
demand, and prices (firm-related micro factors), as well as to more general and overall economic factors
(macro factors). Learning to deal with these factors provides important tools for effective financial
planning.

The finance manager must be familiar with the microeconomic and macroeconomic environment aspects
of business.

When making investment decisions, financial managers consider the effects of changing supply, demand,
and price conditions on the firm's performance. Understanding the nature of these factors helps managers
make the most advantageous operating decisions. Also, managers should determine when it is best to
issue equity shares, bonds or other financial instruments.

The sale of products at a profit depends heavily on how well managers are able to analyze and interpret
supply and demand conditions. Supply considerations relate specifically to the control of production costs,
where the key element is to hold costs down so that prices can be set at competitive levels. The best
machinery must be bought, and the most qualified product workers available must be hired. The goal is to
squeeze out the biggest possible profit under given supply conditions Maintaining a low-cost operation
will enable the firm to charge competitive prices for its products and maintain its market share while still
obtaining a reasonable return.

Knowledge of economic principles can be useful in generating the highest sales possible. Understanding
and appropriately responding to changes in demand allows financial managers to take full advantage of
market conditions. To accomplish this, the best managers develop and adopt reliable, workable statistical
techniques that forecast demand and pinpoint when directional changes in sales take place.

Microeconomics deals with the economic decisions of individuals and firms. It focuses on the optimal
operating strategies based on the economic data of individuals and firms. The concept of microeconomics
helps the finance manager in decisions like pricing, taxation, determination of capacity and operating
levels, break-even analysis, volume-cost-profit analysis, capital structure decisions, dividend distribution
decisions, profitable product-mix decisions, fixation of levels of inventory, setting the optimum cash
balance, pricing of warrants and options, interest rate structure, present value of cash flows, and so forth.

Macroeconomics looks at the economy as a whole in which a particular business concern is operating.
Macroeconomics provides insight into policies by which economic activity is controlled. The success of
the business firm is influenced by the overall performance of the economy and is dependent upon the
money and capital markets, since the investible funds are to be procured from the financial markets. A
firm is operating within the institutional framework, which operates on the macroeconomic theories. The
government's fiscal and monetary policies will influence the strategic financial planning of the enterprise.
The finance manager should also look into the other macroeconomic factors like rate of inflation, real
interest rates, level of economic activity, trade cycles, market competition both from new entrants and
substitutes, international business conditions, foreign exchange rates, bargaining power of buyers,
unionization of labor, domestic savings rate, depth of financial markets, availability of funds in capital
markets, growth rate of economy, government's foreign policy, financial intermediation, banking system,
and so forth.

FINANCIAL MANAGEMENT AND PUBLIC RESPONSIBILITY

Finance is a very challenging and rewarding field. Financial managers are given the responsibility to plan the
future growth and direction of a firm which can greatly affect the community in which it is based. The decisions
reached by a financial manager ultimately represent a blend of theoretical, technical and judgmental matters that
must reflect the concerns of society.
The primary goal for managers of publicly owned companies implies that decisions should be made to
maximize the long-run value of the firm's equity shares. At the same time, managers know that this does not
mean maximize shareholder value "at all costs". Managers have the obligation to behave ethically and they must
follow the law and other society-imposed constraints.

Financial managers have certain obligations to those who entrust them with the running of the firm. They must
have a clear sense of ethics and must avoid pay offs or other forms of personal gain. Managers should not
engage in practices that can damage the image of the firm but should articulate as much as possible in social
activities to demonstrate that they are cognizant of the importance of the community and those who buy their
products or services.

In short, financial managers must reconcile social and environmental requirements with profit-making motive.
Adherence to social values may not produce the most efficient use of assets or the lowest costs, but it will
enhance the image of the firm. Looking after the interest in community, setting up of training facilities, casing
for the safely and the welfare of the workers, providing free college education for the dependents of the
employees can produce long-term benefits in the form of higher productivity and more harmonious
relationships between labor and management. Although there may be conflict between promoting socially
responsible programs and the profit motive, maintaining some concern for social needs when pursuing the goal
of maximizing the wealth of the firm is a primary responsibility of a firm.

CHAPTER 2
RELATIONSHIP OF FINANCIAL OBJECTIVES
TO ORGANIZATIONAL STRATEGY AND OTHER ORGANIZATIONAL
OBJECTIVES

INTRODUCTION
At one time or another, most people have had occasion to hire agents to take care of a specific matter. In doing
so, responsibility is delegated to another person. For example, when suing for damages, individuals may
represent themselves or may hire a lawyer to plead their case in court. As an agent, the lawyer is given the
assignment to get the highest possible award. And so, it is with shareholders when they delegate the task of
running a firm to a financial manager who acts as an agent of the company. Obviously, the goal is to achieve the
highest value of an equity share for the firm's owners. But there are no standard rules that indicate which course
of action should be followed by managers to achieve this. The ultimate guideline is how investors perceive the
actions of managers. A good way to motivate managers is to offer them lucrative share options linked to
performance.

Finance permeates the entire business organization by providing guidance for the firm's strategic (long-term)
and day-to-day decisions. For long range planning and management control, a business firm establishes its
overall objectives. Such objectives are developed by the top management and they usually consist of general
statement or a series of statements in general terms stating what the company expects to achieve.

Objective setting is thus, an important phase in the business enterprise since upon correct objectives setting will
the entire structure of the strategies, policies and plans of a company rest. Firms have numerous goals but not
every goal can be attained without causing conflict in reaching other goals. Conflicts often arise because of the
firm's many constituents who include shareholders, managers, employees, labor unions, customers, creditors,
and suppliers. There are those who claim that the firm's goal is to maximize sales or market share; others
believe the role of business is to provide quality products and service; still others feel that the
firm has a responsibility for the welfare of society at large. For example, the objective may be stated in such
broad terms as:

 It is the goal of the company to be a leader in technology in the industry, or

  To achieve profits through a high-level manufacturing efficiency, or
 To achieve a high degree of customer satisfaction.

For the purpose though of measuring performance and degree of control, it is necessary to set objectives or goal
in more precise terms. The objectives are usually in quantitative terms and are set within a time frame. The
setting of physical targets to be accomplished within a set time period would provide the basis of conversion of
the targets into financial objectives.

STRATEGIC FINANCIAL MANAGEMENT

Strategic planning is long-range in scope and has its focus on the organization as a whole. The concept is based
on an objective and comprehensive assessment of the present situation of the organization and the setting up of
targets to be achieved in the context of an intelligent and knowledgeable anticipation of changes in the
environment. The strategic financial planning involves financial planning, financial forecasting, provision of
finance and formulation of finance policies which should lead the firm's survival and success.

The responsibility of a finance manager is to provide a basis and information for strategic positioning of the
firm in the industry. The firm's strategic financial planning should be able to meet the challenges and
competition, and it would lead to firm's failure or success.

The strategic financial planning should enable the firm to judicious allocation of funds, capitalization of relative
strengths, mitigation of weaknesses, early identification of shifts in environment, counter possible actions of
competitor, reduction in financing costs, effective use of funds deployed, timely estimation of funds
requirement, identification of business and financial risk, and so forth.

The strategic financial planning is likewise needed to counter the uncertain and imperfect market conditions and
highly competitive business environment. While framing financial strategy, shareholders should be considered
as one of the constituents of a group of stakeholders, debenture holders, banks, financial institutions,
government, managers, employees, suppliers and customers. The strategic planning should concentrate on
multidimensional objectives like
profitability, expansion growth, survival, leadership, business success, positioning of the firm, reaching global
markets and brand positioning. The financial policy requires the deployment of firm's resources for achieving
the corporate strategic objectives. The financial policy should align with the company's strategic planning. It
allows the firm in overcoming its weaknesses, enables the firm to maximize the utilization of its competencies
and to direct the prospective business opportunities and threats to its advantage. Therefore, the finance manager
should take the investment and finance decisions in consonance with the corporate strategy.

A company's strategic or business plan reflects how it plans to achieve its goals A and objectives. A plan's
success depends on an effective analysis of market demand and supply. Specifically, a company must assess
demand for its products and services, and assess the supply of its inputs (both labor and capital). The plan must
also include competitive analyses, opportunity assessments and consideration of business threats.

Historical financial statements provide insight into the success of a company's strategic plan and are an
important input of the planning process. These statements highlight portions of the strategic plan that proved
profitable and, thus, warrant additional capital investment. They also reveal areas that are less effective and
provide information to help managers develop remedial action.

Once strategic adjustments are planned and implemented, the resulting financial statements provide input into
the planning process for the following year, and this process begins again. Understanding a company's strategic
plan helps focus our analysis of the company's short-term and long-term financial objectives by placing them in
proper context.
SHORT-TERM AND LONG-TERM FINANCIAL OBJECTIVES OF A BUSINESS
ORGANIZATION
Among are the primary financial objectives of a firm are the following:

SHORT AND MEDIUM-TERM

 Maximization of return on capital employed or return on investment.
 Growth in earnings per share and price/earnings ratio through maximization of net income or
profit and adoption of optimum level of leverage.
 Minimization of finance charges.
 Efficient procurement and utilization of short-term, medium-term, and long-term funds.

LONG-TERM
 Growth in the market value of the equity shares through maximization of the firm's market share
and sustained growth in dividend to shareholders.
 Survival and sustained growth of the firm.

There have been a number of different, well-developed viewpoints concerning what the primary financial
objectives of the business firm should be. The competing viewpoints are:

 The owner's perspective which holds that the only appropriate goal is to maximize shareholder
or owner's wealth, and;
 The stakeholders perspective which emphasizes social responsibility over profitability
(stakeholders include not only the owners and shareholders, but also include the business's
customers, employees and local commitments)

While strong arguments speak in favor of both perspectives, financial practitioners and academics now
tend to believe that the manager's primary responsibility should be to maximize shareholder's wealth and
give only secondary consideration to other stakeholders' welfare.

Adam Smith, an 18th century economist was one of the first and well known proponent of this viewpoint.
He argued that, in capitalism, an individual pursuing his own interest tends also to promote the good of
his community. He also pointed out that acting through competition and the free price system, only those
activities most efficient and beneficial to society as a whole would survive in the long run. Thus, those
same activities would also profit the individual most. Owners of the firm hire managers to work on their
behalf, so the manager is morally, ethically, and legally required to act in the owners' best interests. Any
relationships between the manager and other firm stakeholders are necessarily secondary to the objective
that shareholders give to their hired managers.

The financial manager must have some goals or objectives to guide decision involving the management of
the firm's assets, liabilities and equity. Hence, priorities must be set to resolve conflicting goals.

To reiterate, the primary financial goal of the firm is to maximize the wealth of its existing shareholders or
owners. Therefore, the overriding premise of financial management is that the firm should be managed to
enhance owner(s) well-being. Shareholder's wealth depends on both the dividends paid and the market
price of the equity shares. Wealth is maximized by providing the shareholders with the target attainable
combination of dividends per share and share price appreciation. While this may not be a perfect measure
of shareholders' wealth, it is considered one of the best available measures.

The wealth maximization goal is advocated on the following grounds:

  It considers the risk and time value of money
 It considers all future cash flow, dividends and earnings per share
 It suggests the regular and consistent dividend payments to the shareholders
 The financial decisions are taken with a view to improve the capital appreciation of the share
price
 Maximization of firm's value is reflected in the market price of share since it depends on
shareholder's expectations regarding profitability, long-run prospects, timing difference of
returns, risk distribution of returns of the firm

Critics of the wealth maximization objective however say that, this objective is narrow and ignores the
concept of wealth maximization of society since society's resources are used to the advantage only of a
particular firm. The optimal allocation of the society's resources should result in capital formation and
growth of the economy which should ultimately lead to maximization of economic welfare of the society.

RESPONSIBILITIES TO ACHIEVE THE FINANCIAL OBJECTIVES

INVESTING
The finance manager is responsible for determining how scarce resources or funds are committed to
projects. The investing function deals with managing the firm's assets. Because the firm has numerous
alternative uses of funds, the financial manager strives to allocate funds wisely within the firm. This task
requires both the mix and type of assets to hold. The asset mix refers to the amount of pesos invested in
current and fixed assets.

The investment decisions should aim at investments in assets only when they are expected to earn a return
greater than a minimum acceptable return which is also called as hurdle rate. This minimum return should
consider whether the money raised from debt or equity meets the returns on investments made elsewhere
on similar investments.

The following areas are examples of investing decisions of a finance manager:

a. Evaluation and selection of capital investment proposal
b. Determination of the total amount of funds that a firm can commit for investment
c. Prioritization of investment alternatives
d. Funds allocation and its rationing
e. Determination of the levels of investments in working capital (i.e. inventory, receivables, cash,
marketable securities and its management)
f. Determination of fixed assets to be acquired
g. Asset replacement decisions
h. Purchase or lease decisions
i. Restructuring reorganization mergers and acquisition
j. Securities analysis and portfolio management

FINANCING
The finance manager is concerned with the ways in which the firm obtains and manages the financing it
needs to support its investments. The financing objective asserts that the mix of debt and equity chosen to
finance investments should maximize the value of investments made. Financing decisions call for good
knowledge of costs of raising funds, procedures in hedging risk, different financial instruments and
obligation attached to them. In fund raising decisions, the finance manager should keep in view how and
where to raise the money, determination of the debt-equity mix, impact of interest, and inflation rates on
the firm, and so forth.

The finance manager will be involved in the following finance decisions:

 a. Determination of the financing pattern of short-term, medium-term and long-term funds
requirements
b. Determination of the best capital structure or mixture of debt and equity financing
c. Procurement of funds through the issuance of financial instruments such as equity shares,
preference shares, bonds, long-term notes, and so forth
d. Arrangement with bankers, suppliers, and creditors for its working capital, medium-term and
other long-term funds requirement
e. Evaluation of alternative sources of funds

OPERATING
This third responsibility area of the finance manager concerns working capital management. The term
working capital refers to a firm short-term asset (i.e., inventory, receivables, cash, and short-term
investments) and its short-term liabilities (i.e., accounts payable, short-term loans). Managing the firm's
working capital is a day-to-day responsibility that ensures that the firm has sufficient resources to
continue its operations and avoid costly interruptions. This also involves a number of activities related to
the firm's receipts and disbursements of cash.

Some issues that may have to be resolved in relation to managing a firm's working capital are:

a. The level of cash, securities and inventory that should be kept on hand
b. The credit policy (i.e., should the firm sell on credit? If so, what terms should be extended?)
c. Source of short-term financing (i.e., if the firm would borrow in the short-term, how and where
should it borrow?)
d. Financing purchases of goods (i.e., should the firm purchase its raw materials or merchandise on
credit or should it borrow in the short-term and pay cash?)

ENVIRONMENTAL "GREEN" POLICIES AND THEIR IMPLICATIONS FOR THE

MANAGEMENT OF THE ECONOMY AND FIRM
Private property rights can promote prosperity and cooperation and at the same time protect the environment,
but do they protect the environment sufficiently? In recent years, people have increasingly turned to the
government to achieve additional environmental improvements. Sometimes, people turned to government
because property rights failed to hold polluters accountable for the costs they were imposing on others. In these
"external cost cases", government may be able to improve accountability and protect rights more efficiently by
regulation. In other instances, people with strong desires for various environmental amenities (for example,
green spaces, hiking trails and wilderness lands) want the government to force others to help pay for them.

Courts help owners protect their property against invasions by others, including polluters. In some cases
however, it is difficult - if not impossible - to define, establish and fully protect property rights. This is
particularly true when there is either a large number of polluters or a large number of people harmed by the
emissions, or both. In these large numbers of cases, high transaction costs undermine the effectiveness of the
property rights - market exchange approach. For example, consider the air quality in a large city such as Manila
or Quezon City Millions of people are harmed when pollutants are put into the air. But millions of people also
contribute to the pollution as they drive their cars. Property rights alone will be unable to handle large number
cases like this efficiently. More direct regulations may generate a better outcome.

Although government regulation is an alternative method of protecting the environment, the regulatory
approach also has a number of deficiencies. First, government regulation is often sought precisely because the
harms are uncertain and the source of the problem cannot be demonstrated, so relief from the courts is difficult
to obtain. But when the harms are uncertain, so are the benefits of reducing them. Second, by its very nature,
regulation overrides or ignores the information and incentives provided by market signals. Accountability of
regulators for the costs they impose is lacking, just as accountability for polluters is missing in the market sector
when secure and tradable property rights are not in place. The tunnel vision of regulators, each assigned to
oversee a small part of the economy, is not properly constrained by readily observable costs. Third, regulation
allows special interests to use political power to achieve objectives that may be quite different from the
environmental goals originally announced. The global warming issue illustrates all of these problems and the
uncertainties that they generate.

People turn to government to get what they cannot get in markets. In many cases, they are seeking to get what
they want with a subsidy from others. Government can provide protection from harms, as in regulation that
reduces pollution, or production of goods and services, as in the provision of national parks. Government can
indeed shift the cost of services from some citizens to others, and can do the same with benefits from its
programs. There is little reason, however, to expect a net increase in efficiency when the government steps in.
That is true in environmental matters, as well as in many other areas of citizen concern.

When it is difficult to assign and enforce private property rights, markets often result in outcomes that are
inefficient. This is often the case when large numbers of people engage in actions that impose harm on others.
Government regulation has some premise but also poses some problems of its own.

Global warming could exert a sizeable adverse impact on human welfare, but there is considerable uncertainty
about both its cause and the potential gains that might be derived from regulations such as those of the Kyoto
treaty. Global temperature changes have been observed previously, We do not know that the current warming is
the result of human activity. We do not even know whether on balance, a warming would exert an adverse
impact. These uncertainties increase the attractiveness of adaptation as an option to regulation.

Market-like schemes can reduce the costs of reaching a chosen environment goal, but the programs provide
little help in choosing the right goal.

Government ownership of national parks, as with other lands, has brought troublesome results along with
benefits, but there seems to be progress in moving closer to market solutions that provide better information and
incentives for government managers.

Given that stock market investors emphasize financial results and the maximization of shareholder value, one
can wonder if it makes sense for a company to be socially responsible. Can companies be socially responsible
and oriented toward shareholder wealth at the same time? Many businessmen think so and so do most big
business establishments that they have adopted well-laid environmental-saving strategies that can observe such
as recycling programs, pollution control, tree-planting activities and so forth. The benefits come a little at a time
but one can be sure they will add up. If an investor wants wealth maximization, management that minimizes
wastes might do the other little things right that make a company well-run and profitable.

CHAPTER 3
FUNCTIONS OF FINANCIAL MANAGEMENT

ROLE OF FINANCE MANAGER

Having examined the field of finance and some of its more recent developments, let us turn our attention to the
functions of the financial manager.
Figure 3-1 shows the financial manager's role in achieving the primary goal of the firm.

Financial Manager Makes Decisions Involving

Analysis and Planning Acquisition of Funds Utilization of Funds

Impact on Risk and Return

Affect the Market Price of Common Stock

Lead to Shareholder’s Wealth Maximization

Figure 3-1. The financial manager's role in achieving the goal of the firm.

In striving to maximize owners or shareholders' wealth, the financial manager makes decisions involving
planning, acquiring, and utilizing funds which involve a set of risk-return trade-offs. These financial decisions
affect the market value of the firm's stock which leads to wealth maximization.

In the short run, many factors affect the market price of a firm's shares which are beyond management's control.
Some of the changes in market price do not reflect a fundamental change in the value of the firm. In the long
run, increased prices of the firm's stock reflect an increase in the value of the firm. Hence, financial decision
making should take a longer-term perspective.

It is the responsibility of financial management to allocate funds to current and fixed assets, to obtain the best
mix of financing alternatives, and to develop an appropriate dividend policy within the context of the firm's
objectives. The daily activities of financial management include credit management, inventory control, and the
receipt and disbursement of funds. Less routine functions encompass the sale of stocks and bonds and the
establishment of capital budgeting and dividend plans.

The appropriate risk-return trade-off must be determined to maximize the market value of the firm for its
shareholders. The risk-return decision will influence not only the operational side of the business (capital versus
labor) but also the financing mix (stocks versus bonds versus retained earnings).

THE FINANCE ORGANIZATION

The financial management function is usually associated with a top officer of the firm such as a Vice President
of Finance or some other Chief Financial Officer (CFO). Figure 3-2 is a simplified organizational chart that
highlights the finance activity in a large firm. As shown, the Vice President of finance coordinates the activities
of the treasurer and the controller. The Controller's office handles cost and financial accounting, tax payments,
and management information systems. The Treasurer's office is responsible for managing the firm's cash and
credit, its financial planning, and its capital expenditures.

Board
of Directors
 Chairman of the Board and Chief
Executive Officer (CEO)

President and Chief

Operations Officer (COO)

Vice President Vice President Vice President

Marketing Finance (CFO) Production

Treasurer Controller

Cash Manager Credit Manager Cost Accounting Tax Manager

Manager

Capital Expenditure Financial Planning Financial Data Processing

Accounting Manager
Manager

Figure 3-2. A Sample of Simplified Organizational Chart

RELATIONSHIP WITH OTHER KEY FUNCTIONAL MANAGERS IN THE

ORGANIZATION
Finance is one of the major functional areas of a business. For example, the functional areas of business
operations for a typical manufacturing firm are manufacturing, marketing, and finance Manufacturing deals
with the design and production of a product. Marketing involves the selling, promotion, and distribution of a
product. Manufacturing and marketing are critical for the survival of a firm because these areas determine what
will be produced and how these products will be sold. However, these other functional areas could not operate
without funds. Since finance is concerned with all of the monetary aspects of a business, the financial manager
must interact with other managers to ascertain the goals that must be met, when and how to meet them. Thus,
finance is an integral part of total management and cuts across functional boundaries.

CORPORATE GOVERNANCE
Corporate governance is the process of monitoring managers and aligning their incentives with shareholders
goals. In reality, because shareholders are usually inactive, the firm actually seems to belong to management.
Generally speaking, the investing public does not know what goes on at the firm's operational level. Managers
handle day-to-day operations, and they know that their work is mostly unknown to investors. This lack of
supervision demonstrates the need for monitors. Figure 3-3 shows the people and organizations that help
monitor corporate activities.

Monitors

Inside the Company

Board of Directors

Inside the Company

Auditors
Analysts
Stockholders Managers
Bankers
Credit Agencies

Government
SEC, BIR, BSP

Figure 3-3. Corporate Governance Monitors

The monitors inside a public firm are the board of directors, who are appointed to represent shareholder’s
interest. The board hires the CEO, evaluates management, and can also design compensation contracts to tie
management's salaries to firm performance.

The monitors outside the firm include auditors, analysts, investment banks, and credit rating agencies. External
auditors examine the firm's accounting systems and comment on whether financial statements fairly represent
the firm's financial position. Investment analysts keep tract of the firm's performance, conduct their own
evaluations of the company's business activities, and report to the investment community. Investment banks,
which help firms access capital markets, also monitor firm performance. Credit analysts examine a firm's
financial strength for its debt holders. The Government also monitors business activities through the Securities
and Exchange Commission (SEC), Bureau of Internal Revenue (BIR), Bangko Sentral ng Pilipinas (BSP), and
so forth.

JOBS IN FINANCE
Finance prepares students for jobs in banking, investments, insurance, corporations and the government.
Accounting students need to know finance, marketing, management and human resources, they also need to
understand finance, for it affects decisions in all those areas. For example, marketing people propose advertising
programs, but those programs are examined by finance people to judge the effects of the advertising on the
firm's profitability. So to be effective in marketing, one needs to have a basic knowledge of finance. The same
holds for management - indeed, most important management decisions are evaluated in terms of their effects on
the firm's value.

It is also worth noting that finance is important to individuals regardless of their jobs. Some years ago, most
businesses provided pensions to their employees, so managing one's personal investments was not critically
important. That's no longer true. Most firms today provide what's called "defined contribution" pensions plans,
where each year the company puts a specified amount of money into an account that belongs of the employee.
The employee must decide how those funds are to be invested - how much should be divided among stocks,
bonds or money funds and how risky the equity shares and bonds should be. These decisions have a major
effect on people's lives, and the concepts covered in this book can improve decision-making skills.

ETHICAL BEHAVIOR
Ethics are of primary importance in any practice of finance. Finance professionals commonly manage other
people's money. For instance, corporate managers control the stockholders' firm, bank employees perform cash
receipts and disbursements functions and investment advisors manage people's investment portfolios.

These fiduciary relationships oftentimes create tempting opportunities for finance professionals to make
decisions that either benefit the client or benefit the advisors themselves. Strong emphasis on ethical behavior
and ethics training and standards are provided by professional associations such as the Finance Executives of
the Philippines (FINEX), Bankers Association of the Philippines, Investment Professionals, and so forth.
Nevertheless, as with any profession with millions of practitioners, a few are bound to act unethically. In a
number of instances, the corporate governance system has created ethical dilemmas and has failed to prevent
unethical managers from stealing from firms which ultimately means stealing from owners or stockholders.

Governments all over the world have passed laws and regulations meant to ensure compliance with ethical
codes of behavior. And if professionals do not act appropriately, governments have set up strong punishment for
financial fraud and abuse. Ultimately, financial manager must realize that they owe the owners/shareholders the
very best decisions to protect and further shareholder interests, but they also have a broader obligation to society
as a whole.

CHAPTER 4
BUSINESS ORGANIZATION AND TRENDS

THE ORGANIZATION OF THE BUSINESS FIRM

The business firm is an entity designed to organize raw materials, labor, and machines with the goal of
producing goods and/or services. Firms

1. purchase productive resources from households and other firms,

2. transform them into a different commodity, and
3. sell the transformed product or service to consumers

For business firms engaged in retail or trading activities, transforming purchased goods into a different
commodity does not necessarily take place.

Every society, no matter what type of economy it has, relies on business firms to organize resources and
transform them into products. In market economies, most firms choose their own price, output level, and
methods of production. They get the benefits of sales revenues, but they also must pay the costs of the resources
they use.
Business firms can be organized in one of three ways: as a proprietorship, a partnership, or a corporation. The
structure chosen determines how the owners share the risks and liabilities of the firm and how they participate
in making decisions.

LEGAL FORMS OF BUSINESS ORGANIZATION

PROPRIETORSHIP
A sole proprietorship is a business owned by a single person who has complete control over business
decisions. This individual owns all the firm's assets and is responsible for all its liabilities. More
businesses are sole proprietorship than any form of business organization. From a legal point of view, the
owner of a proprietorship is not separable from the business and is personally liable for all debts of the
business. From an accounting prospective, however, the business is an entity separate from the owner
(proprietor). Therefore, the financial statements of the business present only those assets and liabilities
pertaining to the business.

The owner cannot be paid salary or wages from the business. Instead, the owner may withdraw funds or
other property from the business. These withdrawals are treated as reduction of owner's equity or financial
interest of the owner in the business. The business itself does not pay any income taxes. The income or
loss of the business is reported on the owner's personal income tax return on a supporting schedule.

Among the advantages of a sole proprietorship are:

1. Ease of entry and exit
A sole proprietorship requires no formal charter and is inexpensive to form and dissolve.

2. Full ownership and control

The owner has full control, reaps all profits and bears all losses.

3. Tax savings
The entire income generated by the proprietorship passes directly to the owner. This may result
in a tax advantage if the owner's tax rate is less than the tax rate of a corporation.

4. Few government regulations

A sole proprietorship has the greatest freedom as compared with nay form of business
organization.

Major disadvantages of the proprietorship form include:

1. Unlimited liability
The owner is personally liable or responsible for any and all business debts. Thus, the owner's
personal assets can be claimed by the creditors if the firm defaults on its obligations.

2. Limitations in raising capital

Fund-raising ability is limited. Resources may be limited to the assets of the owner and growth
may depend on his or her ability to borrow money.

3. Lack of continuity
Upon death or retirement of the owner, the proprietorship ceases to exist.

Therefore, the proprietorship may be an ideal form of business organization when the following
conditions exist:

 The anticipated risk is minimum and adequately covered by insurance.

 The owner is either unable or unwilling to maintain the necessary organizational documents and
tax returns of more complicated business entities.
  The business does not require extensive borrowing.

PARTNERSHIP
A partnership is a legal arrangement in which two or more persons agree to contribute capital or services
to the business and divide the profits or losses that may be derived therefrom. Partnership may operate
under varying degrees of formality. For example, a formal partnership may be established using a written
contract known as the partnership agreement which is filed with the Securities and Exchange Commission

Partnership may be either general or limited.

A general partnership is one in which each partner has unlimited liability for the debts incurred by the
business. General partners usually manage the firm and may enter into contractual obligations on the
firm's behalf. Profits and asset ownership may be divided in any way agreed upon by the partners.

A limited partnership is one containing one or more general partners and one or more limited partners.
The personal liability of a general partner for the firm's debt is unlimited while the personal liability of
limited partners is limited to their investment Limited partners cannot be active in management.

Advantages of a partnership include among others the following:

1. Ease of formation
Forming a partnership may require relatively little effort and low start-up costs.

2. Additional sources of capital

A partnership has the financial resources of several individuals.

3. Management base
A partnership has a broader management base or expertise than a sole proprietorship.

4. Tax implication
A partnership like a proprietorship does not pay any income taxes. The income or loss of the
business is distributed among the partners in accordance with the partnership and each partner
reports his or her portion whether distributed or not on personal income tax return.

Disadvantages of partnership are:

1. Unlimited liability
General partners have unlimited liability for the debts and litigations of the business.

2. Lack of continuity
A partnership may dissolve upon the withdrawal or death of a general partner, depending on the
provisions of the partnership.

3. Difficulty of transferring ownership

It is difficult for a partner to liquidate or transfer ownership. It varies with conditions set forth in
the partnership agreement.

4. Limitations in raising capital

A partnership may have problems raising large amounts of capital because many sources of
funds are available only to corporations.

CORPORATION
A corporation is an artificial being created by law and is a legal entity separate and distinct from its
owners. This legal entity may own assets, borrow money and engage in other business entities without
directly involving the owners. In many corporations, owners who are also called shareholders do not
directly manage the firm. Instead, they select managers designated as the Board of Directors to run the
firm for them. The Board of Directors is authorized to act in the corporation's behalf.

The incorporation process is initiated by filing the articles of incorporation and other requirements with
the Securities and Exchange Commission (SEC). The articles of incorporation include among others the
following:

 Incorporators
 Name of the corporation
 Purpose of the corporation
 Capital stock
 Authorized shares

After the corporation is legally formed, it will then issue its capital stock. Ownership of this stock is
evidenced by a stock certificate. The corporate bylaws which are rules that govern the internal
management of the company are established by the board of directors and approved by the shareholders.
These bylaws may be amended or extended from time to time by shareholder.

Advantages of a corporation are:

1. Limited liability
Shareholders are liable only to the extent of their investment in the corporation. Thus,
shareholders can only lease what they have invested in the firm's shares, not any other personal
assets. However, limited liability is not all-encompassing. Government may pass through the
corporate shield to collect unpaid taxes. Also, it is not uncommon for creditors to require that
major shareholders personally co-sign for credit extended to the corporation. Thus, upon default
by the business, the creditors may sue both the corporation and shareholders who have co-signed.

2. Unlimited life
Corporations continue to exist even after death of the owners. The maximum legal life of a
corporation is 50 years but may be renewed for the desired additional life not to exceed 50 years.

3. Ease in transferring ownership

Shareholders can easily sell their ownership interest in most corporations by selling their stock
without affecting the legal form of business organizations. The ability to sell stock provides
corporations with a stronger financial base and the capital needed for expansion.

4. Ability to raise capital

Corporations can raise capital through the sale of securities such as bonds to investors who are
lending money to the corporations and equity securities such as common stock to investors who
are the owners.

Disadvantages of a corporation include:

1. Time and cost of formation
Registration of public companies with the SEC may be time-consuming and costly

2. Regulation
Corporations are subject to greater government regulations than other forms of business
organizations. Shareholders can not just withdraw assets from the business. They can only
 receive corporate assets when dividends are declared and these amounts may be subject to limits
imposed by law.

3. Taxes
Corporations pay taxes on income they have earned. The complexity of the subject of taxation
demands the advice of a qualified tax accountant

The need of large businesses for outside investors and creditors is such that, the corporate form will
generally be the best for such firms. We focus on corporations in the chapters ahead because of the
importance of the corporate form not only locally but also in world economies. Also, a few financial
management issues, such as dividend policy are unique to corporations. However, businesses of all types
and sizes need financial management, so the majority of the subjects we discuss bear on any form of
business.
IMPORTANT BUSINESS TRENDS
Four important business trends should be noted, namely:

 Increased globalization of business

 Ever improving information technology (IT)

 Corporate governance

 Outsourcing

Globalization of the Firm

Most large corporations operate on a global basis and with good reason: investing abroad has proven to be
highly profitable. Decisions to build plants and produce goods abroad are also motivated by the attraction
of low-cost labor and the easy transfer of highly efficient technology that gives competitive price
advantages to foreign operations.

As domestic demand reaches maturity, the search for new markets leads corporation to invest and sell
abroad. The trend to develop a presence abroad is also motivated by a desire to hedge against risks.
Because economic activity differs from one country to the next, diversification abroad tends to dampen
the overall fluctuations of sales and earnings, thus reducing the risk exposure of a corporation.
Fortunately, the advent of new financial instruments, including financial derivatives, such as futures and
swap agreements, provides managers with new tools for hedging and minimizing foreign risks.

Competition is intensified with the emergence of foreign industrial power, like Japan, South Korea and
China because of the opportunities for local firms to import lower priced goods for sale in the domestic
market. This not only saves the domestic firm the need to invest in new capacity, but it also allows to
share in the technological advances of that country.

Globalization of the firm will continue to provide highly profitable opportunities to domestic firms, but
this movement requires careful decision making and highly skillful financial management.

Ever-improving Information Technology (IT)

Improvements in IT are spurring globalization, and they are changing financial management as it is
practiced in North America, Europe, Southeast Asia and elsewhere. Firms are collecting massive data and
using them takes much of the guesswork out of financial decisions. For example, when Double-Dragon
Corporation is considering a potential site for a new mall, it can draw historical results from thousands of
other stores to predict results at the proposed site. This lowers the risk of investing in new stores.
Corporate Governance
This trend relates to the way the top managers operate and interface with stakeholders. At the same time,
the Securities and Exchange Commission (SEC) which has jurisdiction over the shareholders and the
information that must be given has made it easier to activist shareholders to changes the way things are
done within firm. Some years ago, the corporation's chairman of the board of directors was almost always
also the chief executive officer, and this person decides who would be elected to the board and therefore
would have complete control of the firm's operations. That made it impossible for shareholders to replace
a poor management team.

Currently, investors who control huge pools of capital (hedge funds and private equity groups or venture
capitalists) are constantly looking for underperforming firms and they quickly take control and replace
manager.

Most firms today have strong written codes of ethical behavior and companies also conduct training
programs to ensure that employees understand proper behavior in different situations. When conflicts
arise involving profits and ethics, ethical consideration are so obviously important that they dominate.

Outsourcing
Outsourcing occurs when domestic firms invest and produce goods in foreign countries or when these
firms choose to rely on imports rather than build domestic plans and produce these goods domestically.
Low labor-cost countries, like China, open up new investment opportunities for corporations from the
United States, Europe and Middle East. Growing competitive pressures are forcing domestic firms to
invest abroad or to import cheap foreign products.

One major factor responsible for outsourcing is the ease with which technology can be transferred abroad.
China, India and other Asian countries including the Philippines can claim technological parity while
enjoying low costs of production. That is why outsourcing is such an attractive investment option.

When evaluating the merits of outsourcing a corporate manager is forced to make central decisions.

1. Invest and produce domestically or move a plant overseas.

2. Import cheaper foreign goods to take advantage of low labor and other costs or shift to more
capital-intensive and technologically advanced operations.
3. Invest abroad in order to gain access to new rapidly growing foreign markets.

Outsourcing relieves managers from having to purchase raw materials or to hedge against the risk that the
prices of these raw materials will increase. An outsourcing firm does not have to incur the high costs of
pension plans, health benefits, pollution control, and worker safety. Some risks such as technological
obsolescence and unforeseen changes in demand become less important with outsourcing. These and
other advantages make outsourcing an attractive option.

Learning how to work with probability models will help a manager to evaluate the relative merits of
outsourcing compared to domestic investments. Also, given global cost disparities among countries,
outsourcing will continue to pay an important role in business decision making. However, when USA
President Donald Trump decided to impose higher tariff on goods imported from other countries such as
China, Japan, Canada and others, trade wars are said to have sparked among these nations.

-end-

Disclaimer: Nothing in this material intends to violate any rights. This is prepared solely for academic purpose.