Financial Management

- the practice of making a business plan and then ensuring all departments stay on track
- the purpose is to guide businesses or individuals on financial decisions that affect financial stability both now and in the future

Objectives of Financial Management Scope of Financial Management

a. maximizing profits a. planning
b. tracking liquidity and cash flows b. budgeting
c. ensuring compliance c. risk management
d. developing financial scenarios d. reporting
e. manage relationships

Financial Statements
- the financial statement preparation is vital for decision making process
- these statements will give the decision makers an overall insight on the financial condition of the business

Four Basic Financial Statement

Statement of Statement of Financial Statement of Cash Flow Statement of Changes in
Comprehensive Income Position Equity
- shows the result of the - shows the assets, - shows the inflows and - explains the movement
business’ operation – liabilities and equity of outflows of cash for a of reserves that make up
whether it gains profits the business as of a specific period the shareholder’s equity
or incurred a loss specific period for a specific period of
time

General Approach to FS Analysis

- outside parties use this to understand the overall health of an organization, as well as to assess its business worth and financial
performance
- internal management use it as a financial management reporting tool

a. background study and evaluation of firm industry b. operating efficiency and profitability analysis
c. short-term solvency analysis d. other considerations
e. capital structure and long-term solvency analysis

Limitations of Financial Statement Analysis

a. information derived are only indicators of profitability and financial strength but not absolute measures
b. limitation inherent in accounting data due to some factors, like, failure to reflect changes in purchasing power, etc.
c. limitation of performance measures used
d. management may influence the outcome of financial statements

Mode of Financial Statement Analysis

A. Horizontal Analysis
- measures a company’s operating performance by comparing its reported financial statements
- formula for conducting horizontal analysis is as follows:

Horizontal Analysis (Currency Change) = Comparison Period – Based Period

Horizontal Analysis (Percentage Change) = (Comparison Period – Based Period) ÷ Based Period

B. Vertical Analysis
- is a form of financial analysis where the line items on a company’s income statement or balance sheet is expressed as a
percentage of a base figure
- the formula for conducting vertical analysis is as follows:
Vertical Analysis (Income Statement) = IS Line Item ÷ Revenue
Vertical Analysis (Balance Sheet) = Balance Sheet Line Item ÷ Total Asset

C. Gross Profit Variation Analysis

- is a financial analysis technique used to evaluate the changes in gross profit over a specific period of time
- gross profit is the difference between revenue and the cost of goods sold (COGS) and represents the profitability of a
company’s core operations
Gross Profit Variance
GPV = GP (Actual or Current Period) – GP (Budget or Prior Period)

Sales Variance Cost of Sales Variance

Sales Price Variance (SPV) Sales Quantity Variance Cost Price Variance Cost Quantity Variance
(SQV) (CPV) (CQV)
= (USPTY - USPLY) Q STY = (QSTY - QSLY) USPLY = (UCPTY – UCPLY) QSTY = (QSTY – QSLY) UCPLY

where in:
USPTY = unit selling price THIS year)
USPLY = unit selling price LAST year
QSTY = quantity sold THIS year
QSLY = quantity sold LAST year

2 Way Variance Analysis 3 Way Variance Analysis

1. Indirect Approach - joint variance is included in the analysis on top of the
- spv + sqv = total 1 | cpv + cqv = total 2 basis price and quantity variance
- total 1 – total 2 = net increase/decrease - in computing for the sales price variance and cost price
2. Direct Approach variance, the last year ‘s unit sold is used
- spv – cpv = price variances | sqv – cqv = quantity var.

D. Cash Flow Analysis

- provides insight into a company’s liquidity, operating efficiency, and financial health
- it shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down
to operating, investing and financing activities

 Cash Flow from Operating Activities

- related to the core operations of the operations of the business, such as sales, revenue, expenses, and working capital
changes

Net Cash Flow from Operating Activities = Cash Inflows – Cash Outflows

Cash Inflows Cash Outflows

- cash received from customers - payment to supplies and employees
- interest received - payments for operating expenses
- dividends received - interest paid
- other operating expenses - income taxes paid

 Cash Flow from Investing Activities

-

Net Cash Flow from Investing Activities = Cash Received from Sales of Asset – Cash Paid for Purchase of Assets

Cash Received from Sales of Asset Cash Paid for Purchase of Asset
- includes cash inflows from selling long-term assets - includes cash outflows for acquiring long-term assets
such as PPE and other fixed assets
- this is recorded as a positive amount because it - this is recorded as a negative amount because it
represents a cash flow represents a cash outflow

 Cash Flow from Financing Activities

- cash flows related to borrowing, repaying loans, issuing equity and paying dividends

Net Cash Flow from Financing Activities = Cash Inflows from Financing – Cash Outflows from Financing

Cash Inflows Financing Activities Cash Outflows Financing Activities

- issuance of equity - repayment of debt
- issuance of debt - repayment of dividends
- repurchase of equity
E. Financial Ratios
- calculation where financial values are determined to get an insight into the overall financial health of a company and its
market position
- analyzing your company’s financial ratios can provide you with valuable insights into profitability, liquidity, efficiency and
more
- these ratios can help you visualize how your company has performed over a given period of time

Most Commonly Used Ratios

1. Liquidity Ratios
- used to measure a company’s capacity to pay off its short-term financial obligations with its current assets

Current Ratio Quick Ratio (Acid-Test Ratio)

- a widely used liquidity ratio that compares a - focuses on the most liquid assets that can be readily
company’s current assets to its current liabilities converted into cash to meet short-term obligations
- it indicates the company’s ability to pay off its short-
term debts using its short-term assets Quick Ratio = Cash and Cash Equivalents + Accounts
Receivable ÷ Current Liabilities
Current Ratio = Current Assets ÷ Current Liabilities

2. Profitability Ratios
- shows how successful a business is in earning profits over a period of time in relation to operation costs, revenue, and
shareholder’s equity

Gross Profit Margin Net Profit Margin

- the gross profit margin measures the percentage of - gives an overall view of a business profitability
revenue that remains after deducting the cost of - considers all financial aspects including cost of sales,
goods sold (COGS) operating expenses and non-operating expenses
- it indicates the profitability of a company’s core
operations Net Profit Margin (%) = Net Income ÷ Revenue
Gross Profit (%) = Gross Profit ÷ Revenue
Return on Assets Return on Investment
- measures how efficiently a company utilizes its - compares the net profits received at exit to the original
assets to generate profit cost of an investment, expressed as a percentage
- it indicates the company’s ability to generate
earnings from its total assets ROI = Net Income ÷ Cost of Investment

ROA = Net Income ÷ Average Total Asset Net Income = Income Before Tax – Income Tax
Income Tax = (Income Before Tax) (Tax Rate)
Or
Net Income = Before Tax (1 – Tax Rate)

3. Solvency Ratios / Leverage Ratios

- measures the extent to which assets cover commitments for future payments, the liabilities
- determines whether an entity has more ownership rather than debts

Debt-to-Equity Ratio Debt Ratio

- it indicates the extent to which a company relies on - tells what portion of a company’s total assets are
debt financing compared to equity financing financed by debt
- tells how much the company relies on borrowed - how much of the company is owned by creditors versus
money versus its own money the owners
D/E = Total Debt ÷ Total Equity Debt Ratio = Total Debt ÷ Total Assets
D/E Ratio < 1 D/E Ratio > 1 D/E Ratio = 1 Debt Ratio < 50% Debt Ratio > 50% Debt & Equity =
- equity has - debt has more - debt is equal - less than 50%, - greater than 50%
more weight weight than to equity assets are 50%, assets are - assets are
than debt equity financed more g=financed financed
by equity more by debt equally by debt
& equity
Rising Debt Ratio – the company resorts to more debt
and more interest expense
Falling Debt Ratio – the company is shifting more to
equity financing
Module 3: Financial Forecasting

Financial Forecasting
- the process of using past financial data and current market trends to make educated assumptions for future periods
- it is an important part of the business planning process and helps inform decision-making

How to Create a Financial Forecast

1. Set objectives 6. Forecast Cash Flows
2. Gather Historical Data 7. Monitor and Analyze Financial Ratios
3. Define Assumptions 8. Review and Refine
4. Develop a Sales 9. Document and Communicate
5. Project Expenses

Reasons Why Financial Forecasting is Beneficial

1. Planning and Goal Setting
- By projecting future financial performance, businesses can identify targets for sales, revenue, expenses, and profitability.
This allows for effective planning of resources, budgets, and strategies to reach those goals.

2. Budgeting and Resource Allocation

- Financial forecasting provides insights into expected cash flows, expenses, and revenue streams. It helps businesses allocate
resources effectively by identifying areas where additional investments may be required or where cost-saving measures can
be implemented.

3. Decision-Making and Strategy Development

- Financial forecasts assist in making informed decisions by providing a clear understanding of the potential financial outcomes
associated with various choices. It enables businesses to evaluate the feasibility and profitability of different strategies
before committing resources.

4. Performance Monitoring and Control

- By comparing actual results to forecasted figures, businesses can monitor their performance, identify variances, and take
corrective actions if necessary. This helps in maintaining financial control, identifying areas of improvement, and ensuring
that the business stays on track towards its goals.

5. Investor Relations and Stakeholder Communication

- It provides transparency and allows stakeholders to assess the company's financial health and potential returns on
investment. Accurate and well-documented financial forecasts can build investor confidence and strengthen relationships
with stakeholders.

6. Risk Management and Contingency Planning.

- By evaluating different scenarios and assessing the financial impact, businesses can develop contingency plans and risk
mitigation strategies. This enables them to proactively address potential challenges and make informed decisions to
navigate through uncertain times.

7. Business Valuation and Fundraising.

- It plays a crucial role in business valuation for mergers, acquisitions, or when seeking external funding. Investors and lenders
often assess a company's financial projections to evaluate its growth potential and profitability. Accurate financial forecasts
can help attract investors, secure financing, and support the valuation process.

Module 4: Planning and Budgeting

Budgeting
- is the process of creating a plan to spend your money
- spending plan is called a budget
- creating this spending plan allows you to determine in advance whether you will have enough money to do the things you
need to do or would like to do

How Budgeting Fits Into Financial Management

1. Planning
- Budgeting helps in the planning process by setting financial goals and objectives for the organization.

2. Resource Allocation
- A budget provides a framework for allocating financial resources to different departments, projects, or initiatives.
3. Expense Control
- By setting spending limits and tracking actual expenses against the budget, financial managers can identify areas of
overspending or potential cost savings.

4. Cash Flow Management

- By estimating cash needs and timing, businesses can anticipate potential cash shortfalls or surpluses.

5. Performance Evaluation
- By comparing actual results against budgeted figures, businesses can assess their financial performance, identify variances,
and take appropriate actions.

6. Decision-Making
- It provides financial managers with a framework for evaluating investment opportunities, assessing the financial viability of
projects, and making informed choices.

7. Forecasting and Projection

- Budgeting involves projecting future financial performance based on assumptions, market trends, and historical data.

8. Communication and Stakeholder Management

- Transparent and well-documented budgets help build credibility, gain support from stakeholders, and foster trust in the
organization's financial management.

Advantages of Budgeting Limitations of Budgeting

1. Forces managers to plan ahead a. Considerate time and cost are required
2. Provides a way of communicating management b. budgets are merely assumptions that require a judgment and
action plans across the organization may be altered or modified if required
3. it guides actions towards the attainment c. an effective budgetary system needs the collaboration of all
members of an organization
4. it defines objectives that serve as standards for the d. the budget program is simply a reference, not a replacement
assessment of future performance for strong management

The Master Budget

- this consists of all individual budgets for each section of the organization assessed in the consolidated form of a single overall
budget for the whole company

MASTER
BUDGET

OPERATING FINANCIAL CAPITAL INV.

BUDGET BUDGET BUDGET

Step in Developing a Master Budget

a. establish basic objectives and long-term corporate plans
b. prepare sale forecast
c. estimate the cost of sales of goods and operational cost
d. evaluate the effort of the budgeted operating revenues in the ALE accounts analysis
e. prepare the projected statement of revenue and the projected balance sheet

Module 5: The Role and Objective of Financial Management

Firm
- refers to a business entity or organization engaged in commercial activities with the goal of generating profits
- it can be a sole proprietorship, partnership, corporation, or any other legal structure established to carry out
economic activities.
 Objectives of a Firm
- profitability - operational efficiency
- growth and expansion - financial stability and risk management
- market leadership - corporate social responsibility
- customer satisfaction - employee satisfaction and development
- innovation and product development

Primary Goal of the Firm: Maximizing Shareholder Wealth

1. maximize sales or market share of the firm
2. maintain the highest quality product or service in the industry
3. maximize profits of the firm

THE PROBLEM WITH PROFIT MAXIMIZATION

Short-term Focus Neglecting Non-Financial Factors
- This may result in decisions that prioritize short-term - Profit maximization often places a primary emphasis
profits at the expense of long-term sustainability, on financial metrics, potentially overlooking other
investment in research and development, or strategic important factors such as ethical considerations,
initiatives that could enhance the company's social impact, environmental sustainability, and the
competitiveness and growth prospects in the future. well-being of stakeholders.

Determinants of Value
- Profitability and growth are basically considered as the major determinants of firm value. Corporate strategies
can be assessed on the basis of their expected effect on profitability, growth and firm value.

DETERMINANTS OF VALUE
Cash Flow Timing Risk
- A measure of how much cash a - The market value of a share of - Refers to the uncertainty or
business brought in or spent in stock is influenced not only by the potential for negative outcomes
total over a period of time. Cash amount of the cash flows it is that can impact financial
flow is typically broken down into expected to produce but also by performance or the achievement
cash flow from operating the timing of those cash flows. of objectives. It represents the
activities, investing activities, and Timing refers to the specific timing possibility of losses, deviations
financing activities on the or period in which cash inflows or from expected outcomes, or the
statement of cash flows, a outflows occur. failure to meet desired goals.
common financial statement.

Agency Problems (Principal-Agent Problems)

- The primary reason for the divergence of objectives between managers and shareholders has been attributed to
separation of ownership and control in corporations. The principals are the shareholders, and the agents are the
managers who are hired by shareholders to manage the business.

Mechanism to Reduce Managerial-Shareholder Conflicts

1. managerial compensation
2. monitoring by the board of directors
3. threat of takeovers

The Financial Management Function

1. President or the Chief Executive Officer (CEO)
2. Vice President of Finance or Chief Financial Officer (CFO)
› financial accounting
› cost accounting
› taxes
› data processing
 FINANCIAL MANAGEMENT AND OTHER DISCIPLINES
Accounting Economics
- Accountants are the scorekeepers. The financial - The typical firm is heavily influenced by the overall
manager refers to accounting data when making performance of the economy and is dependent upon
future resource allocation decisions, concerning long- the money and capital markets for investment funds.
term investments, when managing current Thus, financial managers should recognize and
investments in working capital and when making a understand how monetary policies affect the cost of
number of other financial decisions funds and the availability of credit.