FINANCIAL MANAGEMENT

Prescribed Textbook: Brigham, E.F., Houston, J.F., Hsu, JM., Kong, YK., and Bany-Ariffin,
AN. (2018). Essentials of Financial Management. Quezon City: C and E Publishing, Inc.

Additional References: Higgins, R., Koski, JL., & Mitton, T. (2019). Analysis for Financial
Management. New York: McGraw-Hill Education. Moyer, R.C., McGuigan, JR., & Kretlow, WJ.
(2018). Contemporary Financial Management. Boston, MA: Cengage Learning Inc. Titman, S.
(2018). Financial Management: Principles and Applications. Harlow: Person Inc. Kumar, R.
(2017). Strategic Financial Management Casebook. Singapore: Academic Press.

FINANCIAL MANAGEMENT – Overview

FINANCE

Finance is a term for matters regarding the management, creation, and study of money and
investments. Finance can be broadly divided into three categories, public finance, corporate
finance, and personal finance. There are many other specific categories, such as behavioral
finance, which seeks to identify the cognitive (e.g., emotional, social, and psychological)
reasons behind financial decisions.

FINANCIAL MANAGEMENT

For any business, it is important that the finance it procures is invested in a manner that the
returns from the investment are higher than the cost of finance. In a nutshell, financial
management:
 Endeavors to reduce the cost of finance
 Ensures sufficient availability of funds
 Deals with the planning, organizing, and controlling of financial activities like the
procurement and utilization of funds

Other Definitions:

“Financial management is the activity concerned with planning, raising, controlling and
administering of funds used in the business.” – Guthman and Dougal

“Financial management is that area of business management devoted to a judicious use of

capital and a careful selection of the source of capital in order to enable a spending unit to
move in the direction of reaching the goals.” – J.F. Brandley

“Financial management is the operational activity of a business that is responsible for

obtaining and effectively utilizing the funds necessary for efficient operations.”- Massie

Financial management is closely related to accounting. In most firms, both areas are the
responsibility of the vice president of finance or CFO. But the accountant’s main function is
to collect and present financial data. Financial managers use financial statements and other
information prepared by accountants to make financial decisions. Financial managers focus
on cash flows, the inflows and outflows of cash. They plan and monitor the firm’s cash flows
to ensure that cash is available when needed.
 The Financial Manager’s Responsibilities and Activities

Financial managers have a complex and challenging job. They analyze financial data prepared
by accountants, monitor the firm’s financial status, and prepare and implement financial
plans. One day they may be developing a better way to automate cash collections, and the
next they may be analyzing a proposed acquisition. The key activities of the financial
manager are:

 Financial planning: Preparing the financial plan, which projects revenues,

expenditures, and financing needs over a given period.

 Investment (spending money): Investing the firm’s funds in projects and securities

that provide high returns in relation to their risks.

 Financing (raising money): Obtaining funding for the firm’s operations and

investments and seeking the best balance between debt (borrowed funds) and equity (funds
raised through the sale of ownership in the business).

The Goal of the Financial Manager

The main goal of the financial manager is to maximize the value of the firm to its
owners. The value of a publicly owned corporation is measured by the share price of its stock.
A private company’s value is the price at which it could be sold.

To maximize the firm’s value, the financial manager has to consider both short- and long-
term consequences of the firm’s actions. Maximizing profits is one approach, but it should not
be the only one. Such an approach favors making short-term gains over achieving long-term
goals.

The Scope of Financial Management

The introduction to financial management also requires you to understand the scope of
financial management. It is important that financial decisions take care of the shareholders‘
interests.

Further, they are upheld by the maximization of the wealth of the shareholders, which
depends on the increase in net worth, capital invested in the business, and plowed-back
profits for the growth and prosperity of the organization.

The scope of financial management is explained in the diagram below:

You can understand the nature of financial management by studying the nature of
investment, financing, and dividend decisions.

Core Financial Management Decisions

In organizations, managers in an effort to minimize the costs of procuring finance and using it
in the most profitable manner, take the following decisions:

Investment Decisions: Managers need to decide on the amount of investment available out of
the existing finance, on a long-term and short-term basis. They are of two types:

 Long-term investment decisions or Capital Budgeting mean committing funds for a long
period of time like fixed assets. These decisions are irreversible and usually include
the ones pertaining to investing in a building and/or land, acquiring new
plants/machinery or replacing the old ones, etc. These decisions determine the
financial pursuits and performance of a business.

 Short-term investment decisions or Working Capital Management means committing

funds for a short period of time like current assets. These involve decisions pertaining
to the investment of funds in the inventory, cash, bank deposits, and other short-term
investments. They directly affect the liquidity and performance of the business.

Financing Decisions: Managers also make decisions pertaining to raising finance from long-
term sources (called Capital Structure) and short-term sources (called Working Capital). They
are of two types:

 Financial Planning decisions which relate to estimating the sources and application of
funds. It means pre-estimating financial needs of an organization to ensure the
availability of adequate finance. The primary objective of financial planning is to plan
and ensure that the funds are available as and when required.

 Capital Structure decisions which involve identifying sources of funds. They also
involve decisions with respect to choosing external sources like issuing shares, bonds,
borrowing from banks or internal sources like retained earnings for raising funds.

Dividend Decisions: These involve decisions related to the portion of profits that will be
distributed as dividend. Shareholders always demand a higher dividend, while the
management would want to retain profits for business needs. Hence, this is a complex
managerial decision.

Forms of Business Organization

Sole proprietorship

These businesses usually are owned by one person, aka the individual who has day-to-day
responsibility for running the business. Sole proprietors can be independent contractors,
freelancers or home-based businesses.

Partnerships

In a partnership, two or more people share ownership of a single business. Like

proprietorships, the law does not distinguish between the business and its owners. The
partners should have a legal agreement that establishes how decisions will be made, how
profits will be shared, how disputes will be resolved, how future partners will be admitted to
the partnership, how partners can be bought out or what steps will be taken to dissolve the
partnership when needed.

Corporations

A corporation is considered by law to be a unique entity, separate from those who own it. A
corporation can be taxed, sued and enter into contractual agreements. The corporation has a
life of its own and does not dissolve when ownership changes.

Agency Theory

Agency theory is a principle that is used to explain and resolve issues in the relationship
between business principals and their agents. Most commonly, that relationship is the one
between shareholders, as principals, and company executives, as agents.

An agency, in broad terms, is any relationship between two parties in which one, the agent,
represents the other, the principal, in day-to-day transactions. The principal or principals
have hired the agent to perform a service on their behalf.

Principals delegate decision-making authority to agents. Because many decisions that affect
the principal financially are made by the agent, differences of opinion, and even differences
in priorities and interests, can arise. Agency theory assumes that the interests of a principal
and an agent are not always in alignment. This is sometimes referred to as the principal-agent
problem.

By definition, an agent is using the resources of a principal. The principal has entrusted
money but has little or no day-to-day input. The agent is the decision-maker but is incurring
little or no risk because any losses will be borne by the principal.
Financial planners and portfolio managers are agents on behalf of their principals and are
given responsibility for the principals' assets. A lessee may be in charge of protecting and
safeguarding assets that do not belong to them. Even though the lessee is tasked with the job
of taking care of the assets, the lessee has less interest in protecting the goods than the
actual owners.

Ethics in Finance

The role of ethics in financial management is to balance, protect and preserve stakeholders'
interests. Eli Lilly and Company, for example, says its code of ethics in finance covers
obligations to management, fellow employees, business partners, the public and
shareholders. Typical standards found in a code of ethics in finance include:

 Act with honesty and integrity.

 Avoid conflicts of interest in professional relationships. Also, avoid the appearance of

such conflicts.
 Provide people with accurate, objective, understandable information. Disclose all
relevant information, positive and negative, so that your listeners have an accurate
picture.

 Comply with all rules and regulations governing your position and your company.

 Act with good faith and independent judgment. Don't allow self-interest or other
factors to sway your recommendations.

 Never share confidential information or use it for personal gain.

 Maintain an internal controls system to guard against unethical behavior.

 Report anyone you see violating the code.

 Financial managers shouldn't see the code as setting a limit on ethical behavior: Tick
off all the boxes, and you're good. Having ethics in finance means doing the right
thing, even in situations that aren't covered on the list. If in doubt, find someone with
the standing to give you ethical guidance.

Conflicts of Interest

Underlying the role of ethics in financial management is a fiduciary duty. Managers must act
in the interests of their clients and employers, not their own. If there's a conflict of interest
where you can enrich yourself while harming a client, you must side with the client.

That's why establishing internal controls is essential. When the risk of exposure is high, it's
less tempting to steal.