MODULE 1

Introduction to Financial Management

Subject Objectives

After studying Module 1, you should be able to:

1. Describe the nature, goal, and basic scope of financial management.
2. Discuss the importance or significance of financial management.
3. Analyze the financial system.
4. Identify financial instruments.
5. Enumerate the roles of the Vice President for Finance in a business
organization.
6. Assess the relationship between financial management, accounting,
and economics.

Nature of Financial Management

Financial management, also known as managerial finance, corporate finance,
and business finance, is a decision-making process concerned with planning,
acquiring, and utilizing funds to achieve the firm’s desired goals. Financial
management also is a part of a larger discipline called FINANCE relating to
raising and maximizing money by individuals, businesses, and governments
that concerns both financial management of profit-oriented business
organizations particularly the corporate form of business as well as concepts
and techniques applicable to individuals and to governments (Cabrera, 2015).

The Goal of Financial Management

For profit business, the goal of financial management is to make money and
add value for the owners. However, this goal is too vague and a more precise
definition is needed in order to come up with an objective as basis for making

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and evaluating financial decisions. Above all, the goal of financial
management is to maximize the wealth of shareholder (Cabrera, 2015).

Wealth maximization is the concept of increasing the value of a business in

order to increase the value of shares held by shareholders. The owners of the
organization, seeking for profit, are shareholders. They contribute their
investment in expectation of better returns. In return on the investments of
shareholders, the organization, comprising management and the board of the
directors, strive for maximization of the wealth of the shareholders. This is
the prime objective of the organizations seeking profit, besides other minor
objectives like better working environment for employees, prompt payment
mechanism for suppliers and so on.

While profitability is a major driver for increasing the value of stocks or

shares, there are many reasons why profit maximization should not be the
overriding objective of a company:

1) The company may need to borrow more just so it can increase sales and
augment production capacity; and

2) Management may also defer important repairs and maintenance just to

show better profits in the current accounting period (Cayanan & Borja, 2017).

Financial System
A financial system is a set of institutions that permit the exchange of funds
(Alpert, 2019). Comprehensively, it is a dense network of interrelated markets
and intermediaries that allocates capital and shares risks by linking savers
to spenders, investors to entrepreneurs, lenders to borrowers, and the risk-
averse to risk-takers (“The Financial System”, n.d.).

Figure 1. Financial system and the relationship between financial agents

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 FINANCIAL
INTERMEDIARIES
SAVERS Banks SAVERS
Household Insurance Household
Individuals Companies Individuals
Stock Exchange
Companies Companies
Stock Brokerage
Govenment Govenment
Agencies
Firms Agencies
Mutual Funds
Other Financial Institutions

Different functions that each financial intermediary may perform:

Banks may provide mechanism where savers can put their excess funds
through deposit. Banks give depositors interest on the money deposited to
them. Regulated by Bangko Sentral ng Pilipinas.

Insurance Companies offer life insurance and non-life insurance products.

Life insurance products protect the insured from loss of life while non-life
insurance products protect the insured from loss of or damage to properties.
Regulated by Insurance Commission.

The Philippine Stock Exchange (PSE) provides a system for the trading of
equity securities of publicly listed companies. Stock Brokerage Firms are the
avenue where investing in stock must be coursed through.

Mutual Funds provide opportunities for big and small investors to invest in
financial instruments. And other financial institutions are Government Service
Insurance System (GSIS), Social Security System (SSS), investment banks,
and credit unions, among others.

Financial Instruments
Financial instruments are documents detailing the issuing of assets that can
be traded or can also be packages of capital that may be traded (Kenton,
2020). Technically, a financial instrument is a piece of paper or a virtual
document with monetary value that is usually printed (“Financial
Instrument”, n.d.). In addition, a financial instrument is a monetary contract
between parties that can be created and modified; may be an evidence of

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ownership of part of something, like stocks and shares, contractual rights to
receive cash or bonds, are financial instruments (Market Business News,
n.d.).

Financial instruments are generally classified into two major categories:

equity securities and debt securities.

Equity securities are financial instruments that represent an ownership share

in a corporation. These instruments give its holder the right to a proportion
of the earnings of the issuing organization. One of the equity securities is
common stock, which gives its owner the right to a share of the residual value
of the issuing entity, in the event of a liquidation and the other one is preferred
stock, which provides its owner with a periodic dividend, along with other
rights that give it a priority interest over the holders of common stock (“Equity
security”, 2018).

To summarize:
Table 1. Difference between preferred and common stocks
Preferred Stocks Common Stocks
Claims over the asset after liquidation Priority Less priority
Cash dividend declaration Priority Less priority
Voting rights Cannot Can vote
Dividend per share Fixed Not fixed

Debt security, on the other hand, represents borrowed money that must be
repaid, with terms depending on the size of the loan, interest rate, and
maturity or renewal date. It includes government and corporate bonds,
certificates of deposit (CDs), and collateralized securities (such as CDOs and
CMOs), generally entitle their holder to the regular payment of interest and
repayment of principal (regardless of the issuer's performance).

Debt securities are issued for a fixed term and can be secured (backed by
collateral) or unsecured, and, if unsecured, may be contractually prioritized
over other unsecured, subordinated debt in the case of a bankruptcy (Kenton,
2020).

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Organizational Chart and the Roles of VP for Finance
An organizational chart is a visual chart that represents the structure of a
company. It shows the relationships and relative ranks of its parts and
positions. It also highlights how teams and departments are organized, the
reporting relationships across the organization, and every individual’s role
and responsibilities.

Board of Directors

President

VP for Sales and VP for

VP for Finance VP for Production
Marketing Administration

Figure 2. Common organizational chart of a corporation

The above-mentioned positions in the organization has the following

responsibilities:

Board of Directors
The highest policy-making boy in a corporation. The board’s primary
responsibility is to ensure that the corporation is operating to serve the best
interest of the stakeholders. The following are among the responsibilities of
the board of directors:

1) Setting policies on investments, capital structure, and dividends.

2) Approving company’s strategies, goals, and budgets.
3) Appointing and removing members of top management including the
president.
4) Determining top management’s compensation.
5) Approving the information and other disclosures reported in financial
statements.

President
The roles of president in a corporation may vary from one company to another.
Among the responsibilities of the president are:

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1) Overseeing the operations of the company and ensuring that the strategies
as approved by the board are implemented as planned.
2) Performing all management: planning, organizing, staffing, directing, and
controlling.
3) Representing the company in professional, social, and civic activities.

VP for Sales and Marketing

1) Formulating marketing strategies and plans.
2) Directing and coordinating company sales.
3) Analyzing and evaluating the effectiveness and cost of marketing methods
applied.
4) Conducting or directing research that will allow the company to identify
new marketing opportunities, for example, variants of the existing
products/services already offered in the market.
5) Promoting good relationships with customers and distributors.

VP for Production
1) Ensuring production meets customer demands.
2) Identifying production technology/process that minimizes production cost
and makes the company cost competitive.
3) Coming up with a production plan that maximizes the utilization of the
company’s production facilities.
4) Identifying adequate and competitively priced raw material suppliers.

VP for Administration
1) Coordinating the functions of administration, finance, and sales and
marketing departments.
2) Assisting other departments by hiring employees.
3) Helping in payroll preparation.
4) Determining the location and the maximum amount of office space needed
by the company.
5) Identifying means, processes, or systems that will minimize the operating
costs of the company.

VP for Finance

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1) Financing decisions- making decisions as to how to finance long-term
investments and working capital which deals with the day-to-day operations
of the company.
2) Investing decisions- to minimize the probability of failure, long-term
investments must be supported by a capital budgeting analysis which is
among the responsibilities of financial manager.
3) Operating decisions- determining how to finance working capital
accounts such as accounts receivables and inventories.
4) Dividend policies

Relationship Between Financial Management, Accounting, and

Economics

In many organizations, accounting and finance functions are connected, and

the finance function is often considered as part of the functions of the
accountant. Financial management, however, is 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.

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.

Financial management is the key function, and many firms prefer to

centralize the function to keep constant control on the finances of the firm.

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Any inefficiency in financial 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 speed up
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.

The finance manager must be familiar with the microeconomic and

macroeconomic environment aspects of business.

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 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

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rate of economy, government's foreign policy, financial intermediation,
banking system, and so forth.

Self-Assessment

I. Answer the following questions.

1. What is the purpose of financial management? Describe the kinds of
activities that financial management deals with.
2. What is the difference in perspective between finance and accounting?
3. Explain the shareholder wealth maximization goal of the firm and how
it can be measured. Make an argument for why it is a better goal than
maximizing profit.
4. What are the three types of financial management decisions? For each
type of decision, give an example of a business transaction that would
be relevant.
5. What goal should always motivate the action of a firm’s financial
management?

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 References

Cayanan, A.S & Borja, D.V. (2017). Business Finance. REX Book Store

Equity Security. (2018). Retrieved from

https://www.accountingtools.com/articles/2017/5/6/equity-security

Financial Instrument. (n.d.). Retrieved from

https://debitoor.com/dictionary/financial-instrument

Noor, Imran. (2016). Shareholders’ Maximization Objectives in Financial

Management

Kenton, W. (2020). Financial Instrument. Retrieved from

https://www.investopedia.com/terms/f/financialinstrument.asp

What is a financial instrument? (n.d.) Retrieved from

https://marketbusinessnews.com/financial-glossary/financial-
instrument/#:~:text=A%20financial%20instrument%20is%20a,receive%20c
ash%2C%20are%20financial%20instruments

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