UNIVERSIDAD DE MANILA

A.J. Villegas St. Mehan Gardens, Manila City

FINANCIAL MANAGEMENT JA LABAY

OVERVIEW

Financial Management means planning, organizing, directing, and controlling the financial
activities such as procurement and utilization of funds of the enterprise. It means applying general
management principles to financial resources of the enterprise.

Scope/Elements of Financial Management

1. Investment decisions includes investment in fixed assets (called as capital budgeting).
Investment in current assets are also a part of investment decisions called as working capital
decisions.

2. Financial decisions - They relate to the raising of finance from various resources which will
depend upon decision on type of source, period of financing, cost of financing and the returns
thereby.

3. Dividend decision - The finance manager has to take decision with regards to the net profit
distribution. Net profits are generally divided into two:
a. Dividend for shareholders - Dividend and the rate of it has to be decided.
b. Retained profits - Amount of retained profits has to be finalized which will depend upon
expansion and diversification plans of the enterprise.

Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation with regards to
capital requirements of the company. This will depend upon expected costs and profits and future
programs and policies of a concern. Estimations have to be made in an adequate manner which
increases earning capacity of enterprise.

2. Determination of capital composition: Once the estimation has been made, the capital structure
has to be decided. This involves short- term and long- term debt equity analysis. This will depend
upon the proportion of equity capital a company is possessing and additional funds which have to
be raised from outside parties.

3. Choice of sources of funds: For additional funds to be procured, a company has many choices
like-
a. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each source and period of financing.

4. Investment of funds: The finance manager has to decide to allocate funds into profitable ventures
so that there is safety on investment and regular returns is possible.

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5. Disposal of surplus: The net profit decision has to be made by the finance manager. This can be
done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and other benefits
like bonus.
b. Retained profits - The volume has to be decided which will depend upon expansional,
innovational, diversification plans of the company.

6. Management of cash: Finance manager has to make decisions with regards to cash management.
Cash is required for many purposes like payment of wages and salaries, payment of electricity and
water bills, payment to creditors, meeting current liabilities, maintenance of enough stock,
purchase of raw materials, etc.

7. Financial controls: The finance manager has not only to plan, procure and utilize the funds but
he also has to exercise control over finances. This can be done through many techniques like ratio
analysis, financial forecasting, cost and profit control, etc.

WORKING CAPITAL MANAGEMENT CONCEPTS

Working Capital Management – the administration and control of the company’s working
capital. The primary objective is to achieve a balance between return (profitability) and risk. It
relates to the management of short-term investment (i.e., current assets) and short-term liabilities
(i.e., current liabilities).

Working Capital – is the firm’s investment in current assets (cash, marketable securities, accounts
receivable, inventories, and other current assets).

Net Working Capital – is the excess of current assets over current liabilities. Effective
management of working capital will improve the firm’s overall return on investment performance.

Objectives of Working Capital Management

To make sure each type of working capital investment is productive in (1) generating income for
the business, (2) reducing the amount of investment needed to support sales and production, and
(3) both generating income and reducing the amount of investment needed to support sales and
production.

Working Capital Financing Policies

1. Conservative (Relaxed) Policy – operations are conducted with too much working capital;
involves financing almost all asset investment with long-term capital.

Advantages:
 reduces risk of liquidity
 eliminates the firm’s exposure to fluctuating loan rates and potential unavailability of
short credit

Disadvantage:
 less profitable because of higher financing costs

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2. Aggressive (Restricted) Policy – operations are conducted on a minimum amount of working

capital; uses short-term liabilities to finance, not only temporary, but also part or all of the
permanent current asset requirement.

Advantage:
 increases return on equity (profitability) by taking advantage of the cost differential
between long-term and short-term debt

Disadvantages:
 exposure to risk arising from low working capital position
 puts too much pressure on the firm’s short-term borrowing capacity so that it may have
difficulty in satisfying unexpected needs for funds

3. Matching Policy (also called self-liquidating policy or hedging policy) – matching the maturity
of a financing source with specific financing needs.
 short-term assets are financed with short-term liabilities
 long-term assets are funded by long-term financing sources

4. Balanced Policy – balances the trade-off between risk and profitability in a manner consistent
with its attitude toward bearing risk.

Deciding on an Appropriate Working Capital Policy

The amount of net working capital that a company should have depends on the amount of risk it
is willing to take. The primary consideration therefore is the trade-off between returns
(profitability) and risk (risks of illiquidity) associated with:
1. Asset Mix Decision – appropriate mix of current and non-current assets.

2. Financing Mix Decision – appropriate mix of short-term and long-term liabilities to finance
current assets.

Risk Return Trade-off

 The greater the risk, the greater is the potential for larger returns.

 More current assets lead to greater liquidity but yield lower returns (profit).

 Fixed assets earn greater returns than current assets.

 Long-term financing has less liquidity risk than short-term debt, but has a higher explicit
cost, hence, lower return.

Components of Working Capital

1. Cash and Marketable Securities
2. Accounts Receivable
3. Inventories
4. Short-term Financing

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MULTIPLE CHOICE QUESTIONS

1. Financial Management is mainly concerned with ______________.

A. All aspects of acquiring and utilizing financial resources for firms’
activities
B. Arrangement of funds
C. Efficient Management of every business
D. Profit maximization

2. The primary goal of the financial management is ____________.

A. to maximize the return
B. to minimize the risk
C. to maximize the wealth of owners
D. to maximize profit

3. In his traditional role the finance manager is responsible for ___________.

A. proper utilization of funds
B. arrangement of financial resources
C. acquiring capital assets of the organization
D. efficient management of capital

4. Working capital management is managing ____________.

A. short term assets and liabilities
B. long term assets
C. long terms liabilities
D. only short-term assets

5. Traditional approach confines finance function only to _________ funds.

A. raising
B. mobilizing
C. utilizing
D. financing

6. The decision to invest a substantial sum in any business venture expecting to earn a minimum
return is called ____________.
A. working capital decision
B. an investment decision
C. a production decision
D. a sales decision

7. Net working capital is the excess of current asset over ____________.

A. Current liability
B. Net liability
C. Total payable
D. Total liability

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8. Dividends are paid________________.

A. monthly
B. quarterly
C. semi-annually
D. yearly

9. Which of the following is not an objective of financial management?

A. Maximization of wealth of shareholders
B. Maximization of profits
C. Mobilization of funds at an acceptable cost
D. Ensuring discipline in the organization.

10. The only feasible purpose of financial management is

A. Wealth Maximization
B. Sales Maximization
C. Profit Maximization
D. Assets maximization

11. Financial management process deals with

A. Investments
B. Financing decisions
C. Both a and b
D. None of the above

12. Finance Function comprises

A. Safe custody of funds only
B. Expenditure of funds only
C. Procurement of finance only
D. Procurement & effective use of funds

13. The objective of wealth maximization takes into account

A. Amount of returns expected
B. Timing of anticipated returns
C. Risk associated with uncertainty of returns
D. All of the above

14. Financial management mainly focuses on

A. Efficient management of every business
B. Brand dimension
C. Arrangement of funds
D. All elements of acquiring and using means of financial resources for
financial activities

15. In finance, "working capital" means the same thing as

A. total assets.
B. fixed assets.

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C. current assets.
D. current assets minus current liabilities.

16. Which of the following would be consistent with a more aggressive approach to financing
working capital?
A. Financing short-term needs with short-term funds.
B. Financing permanent inventory buildup with long-term debt.
C. Financing seasonal needs with short-term funds.
D. Financing some long-term needs with short-term funds.

17. Which of the following illustrates the use of a hedging (or matching) approach to financing?
A. Short-term assets financed with long-term liabilities.
B. Permanent working capital financed with long-term liabilities.
C. Short-term assets financed with equity.
D. All assets financed with a 50 percent equity, 50 percent long-term debt
mixture.

18. In deciding the appropriate level of current assets for the firm, management is confronted with
A. a trade-off between profitability and risk.
B. a trade-off between liquidity and marketability.
C. a trade-off between equity and debt.
D. a trade-off between short-term versus long-term borrowing.

19. Permanent working capital

A. varies with seasonal needs.
B. includes fixed assets.
C. is the amount of current assets required to meet a firm's long-term
minimum needs.
D. includes accounts payable.

20. Net working capital refers to

A. total assets minus fixed assets.
B. current assets minus current liabilities.
C. current assets minus inventories.
D. current assets.