Financial

Management

Jasmin S. Acosta
Instructor
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Chapter 1 - Introduction to
Financial Management
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Learning Objectives
 Discuss the primary objectives of financial
management;
 Distinguish profit maximization from
stockholder’s wealth maximization;
 Identify the primary functions of the
finance manager;
 Analyze problems that are applicable to
finance;
 Differentiate between sole proprietorship,
partnership and corporation; and.
 Define the basic features, advantages and
disadvantages of the different forms of
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business organization.
CHAPTER OUTLINE
1. Financial Management
2. The Firm’s Goal
3. Profit Maximization versus Stockholder’s Wealth Maximization
4. The Role of Financial Managers
5. Financial Decisions and Risk-Return Trade-Off
6. Types of Business Organizations
7. Agency Theory
8. Misconceptions About Financial Management
9. Social Responsibility
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Overview
The finance manager plays a vital
role in the company's success. As
cash flows into the company, the
finance manager thinks of how it will
be used daily and how it will help the
firm sustain its operations in the
future. If finance is in the heart of
everything that goes on in the
company, managing it is difficult
because the person handling it must
be involved in every activity that the
firm may perform. The financial
manager has to be in touch with the
operations, marketing, and overall
strategy of the company.
In the past, the finance manager was
only involved in simple bookkeeping
tasks such as documentation, record-
keeping, preparation of financial
reports and payments of company’s
bill. (Van Horne, 2005)
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As time went by, the task of
the finance manager
evolved, going deeply into
the major aspects of the
firm’s activities. The role
critically developed to what
is known as financial
management.
Normally, financial
management is immediately
associated with accounting.
Real financial management
starts where accounting
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ends.
FINANCIAL MANAGEMENT FR
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The financial management is generally concerned with procurement, allocation and control of
financial resources of a concern. The objectives can be;

 To ensure regular and adequate supply of funds to the concern.

 To ensure adequate returns to the shareholders which will depend upon the earning
capacity, market price of the share, expectations of the shareholders.

 To ensure optimum funds utilization. Once the funds are procured, they should be utilized
in maximum possible way at least cost.

 To ensure safety on investment, i.e, funds should be invested in safe ventures so that
adequate rate of return can be achieved.

 To plan a sound capital structure-There should be sound and fair composition of capital so
that a balance is maintained between debt and equity capital.

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FINANCIAL MANAGEMENT

Financial management is more concerned with raising, allocating, and controlling the firm’s fund. In
the times of financial trouble, the finance manager must find ways to get its financial position in
order.

If the firm has enough money, the finance manager again has to know how to allocate the money in
order to generate wealth for the stockholders.

A dividend policy decision is another aspect of financial management that has to be addressed. The
policy chosen by the firm determines the kind of investors the firm will have and the kind of
company it will be in the future.

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The Firm’s Goal

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THE FIRM’S GOAL
When people are asked about the goal of the firm, they commonly say it is profit maximization. However,FR
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there may be a long list of possible goals of a firm which consist of survival, avoiding financial distress and
bankruptcy, beating competition, maximizing sales or market share, minimizing costs, maximizing steady
earnings growth and maximizing profit.

These goals may be classified into two groupings namely those that are related to profitability and the second
group relates to bankruptcy avoidance.

Among the said goals, profit maximization, is commonly mentioned to be the goal of the firm. This goal may
not be considered to be the appropriate goal of the firm for the reasons that an enterprise may maximize the
profit by removing an expense such as research and development or advertising expense for the year. The
reduction of the said expense increases the profit of the enterprise for the year; however, the firm is affected
on the long-term basis. Removal of research and development expense may mean that the company will not
undertake research for new product which the competitors are currently carrying out for the growth of the
enterprise.

In conclusion, the appropriate goal of the firm is to maximize the wealth of its common stockholders through
the value of its common stocks. This is achieved when the financial manager is able to make financial
decisions that are for the interest of the owners by identifying goods and services that add value to the firm
by not to allow misinterpretations. 9
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FM

Profit Maximization versus

Stockholder’s Wealth
Maximization

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PROFIT MAXIMIZATION VERSUS STOCKHOLDER’S WEALTH MAXIMIZATION FM
Finance people disagree with accounting people over one point: the primary objective of conducting
a business. Finance people always tend to say “maximize stockholder’s wealth” while those in
accounting would say “maximize profits”. Though finance and accounting are related, the people in
these specialized areas could not agree to which one really contributes to making sound financial
decisions.

Finance people need accounting to have the necessary financial information to make quality
decisions. In making an analysis, financial and non-financial data are scrutinized to suit the need of
decision making. Finance people also used more tools and techniques that would make financial
reports very useful.

On the other hand, the accounting people are more involved in preparing financial reports for both
the internal and external users. The manner of reporting is based on certain accounting standards.
PROFIT MAXIMIZATION is assumed to be the dominant goal of a typical firm. This means
selling a quantity of a good or service, or fixing a price where total
revenue is at its greatest above total cost.
WEALTH MAXIMIZATION is the concept of increasing the value of a business in order to
increase the value of the shares held by its stockholders.
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WHY NOT MAXIMIZE PROFITS?
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Some of the arguments that oppose profit maximization as the main objective in financial management are
as follows:

1. A change in profit is also a change in risk – Profit maximization does not consider risk or uncertainty. In
wealth maximization, the cost and benefit should be first measured.

2. It fails to determine the timing of benefit – In profit maximization, the timing of the benefits is not
considered. The firm does not care if the cash flow is higher or lower in the early year of the project.

3. Accounting profits can not be measured accurately – The reported accounting profits are mere estimates
of how much net income is generated for a particular period of time. The real accounting profits are only
measured at the end of the life of the company.

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PROFIT MAXIMIZATION VERSUS STOCKHOLDER’S WEALTH MAXIMIZATION FR
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The Role of Finance

Managers

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THE ROLE OF FINANCIAL MANAGERS FR
FM

The financial manager of the firm plays a crucial role in the company’s goals, policies, and success. The
responsibilities of the financial manager include the following:

INVESTMENT DECISION This entails an outflow of resources with the

expectations of a benefit in the form of cash inflows in
the near future. The investment decision is the most
important of the three decisions when it comes to value
creation.
FINANCING DECISION The financial manager finds ways to provide money for
the activities of the firm. He or she must know how to
outsource its funds.
DIVIDEND POLICY DECISION It is equally important to know what sound dividend
policy is a good financial signal to the market that
continually assess the company.

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THE ROLE OF FINANCE IN A TYPICAL CORPORATE BUSINESS ORGANIZATION FR
FM

In a large scale industry, the financial responsibilities are carried out by the Treasurer, Controller and
Chief Financial Officer (CFO).

1. Treasurer – is responsible for managing corporate asset and liabilities, planning the finances,
budgeting the capital, financing the business, formulating a credit policy and managing the
investment portfolio.

2. Controller – is responsible for financial and cost accounting, taxes, budgeting, and control
functions.

3. Chief Financial Officer – oversees the entire financial activity and serves as the adviser in
finance matter to the board of directors.

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Financial Decisions and

Risk-Return Trade-Off

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FINANCIAL DECISIONS AND RISK-RETURN TRADE-OFF FR
F
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It is significant to note that an increase in return is coupled by a corresponding increase in
risk. It can not be expected that whatever financial decision is made will immediately favor
the firm.

The finance manager’s obligation is to ascertain that such risk present is tolerable. Risk is
common and ubiquitous. It could be credit, financial, political, interest and social.

The firm must recognize the risk and include it in whatever financial decisions it will make.
The aphorism “the higher the return, the higher the risk” must always be kept in mind.

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Types of Business
Organizations

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TYPES OF BUSINESS ORGANIZATION FR
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Sole Proprietorship

A sole proprietorship is a form of business organization which is owned by one individual. This
form of business organization is easy to set up- one merely starts its business operation; it is
inexpensive to form; and, it is covered by few government regulations. The Department of
Trade and Industry (DTI) is a government body that supervises of the sole proprietorship form
of business.

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TYPES OF BUSINESS ORGANIZATION FR
F
Partnership M
A partnership is composed of two or more persons who agree to contribute money, property,
or services for the purpose of dividing the profits between or among themselves. A basic
requirement for the registration of a partnership with the Securities and Exchange
Commission (SEC) is the filling of the Articles of Co-Partnership. The SEC is a government
body that supervises the affairs of the partnership and corporate form of business.

The ordinary partnership is subject to a tax similar to that of a corporation which is 30%. The
general professional partnership is tax-exempt for the sole purpose of exercising the partner’s
common profession (National Internal Revenue Code, sections 20 and 24)

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TYPES OF BUSINESS ORGANIZATION FR
F
Corporation M
A corporation is an artificial being created by the operation of the law, having the right of
succession and the powers, attributes and properties expressly authorized by law or incident
to its existence (Corporate Code of the Philippines, sec 1)

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Agency Theory

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AGENCY THEORY FR
F
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This theory exists due to the creation of an agency relationship. This relationship is borne as
soon as an individual or group of people, called the principal, hire the service of an individual
or organization called an agent, to perform a service and exercise decision-making for the
principal.

The primary agency relationships are those between:

a. Government and Masses

b. Employers and Employees
c. Business Owners and Management

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Misconceptions about
Financial Management

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MISCONCEPTION ABOUT FINANCIAL MANAGEMENT
Some of the most usual misconception about financial management are listed below:
1. Financial Management is Accounting.
2. Financial Management is a Review of
Mathematics.
3. Financial Management is a Branch of
Statistics.
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The most common mistake is thinking that financial
management is accounting because it utilizes financial
statements to arrive at a certain decision.
In making financial decisions, a lot of formulas are used
before arriving at a decision. With the computation of
present values, future values, annuities, and other
values, finance is thought to be too much mathematics.
Statistics is used at times to ascertain the risks involved
in decision-making. Standard deviation, correlation
coefficient, coefficient of determination, and forecasting
tools and techniques are used to measure the risk before
making financial decisions.
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Social
Responsibility

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SOCIAL RESPONSIBILITY FR
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 Social responsibility is a process with the aim to embrace responsibility for the company's
actions and encourage a positive impact through its activities on the environment,
consumers, employees, communities, stakeholders and all other members of the public
sphere who may also be considered as stakeholders.

 Social responsibility is having a sense of duty to society and everything that is a part of it.
In other words, “social responsibility” means managers are accountable to society at large,
not just their shareholders.

 Social responsibility is an important aspect of capitalism at large. Individuals and

consumers place trust in businesses to “do the right thing”, and take a leadership role in
making the world a better place. A world with more socially-responsible managers also
leads to fewer government regulations, since regulations are almost always introduced as
a reaction to businesses profiting at the loss of society around them.

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END OF WEEK 1 TOPIC
DISCUSSION!