AEC6 (Financial Management)

August 9, 2019

The Nature, Purpose and Scope of Financial Management

Financial Management
- also referred to as managerial finance, corporate finance, and business finance.
- is a decision making process concerned with planning, acquiring and utilizing funds
in a manner that achieves the firm’s desired goals.
- the process for and the analysis of making financial decisions in the business
context.
- focuses on decisions relating to how much and what types of assets to acquire, how
to raise the capital needed to purchase assets, and how much to run the firm so as
to maximize its value.

Goal of Financial Management

The goal of financial management is to maximize the current value per

share of the existing stock or ownership in a business firm.

Scope of Financial Management

The traditional view of Financial Management looks into the following functions that a financial
manager of a business firm will perform.

1. Procurement of short-term as well as long-term funds from financial institutions.

2. Mobilization of funds through the financial instruments such as equity shares, preference
shares, debentures, bonds, notes, and so forth.
3. Compliance with legal and regulatory provisions relating to funds procurement, use and
distribution as well as coordination of the finance function with the accounting function.

Important business trends that gave Financial Management a much greater significance:

a. Globalization of business
b. Ever-improving technology
c. Corporate governance

In view of the modern approach, the Finance Manager is expected to analyze the business firm
and determine the following:

1. The total funds requirements of the firm;

2. The assets or resources to be acquired; and
3. The best pattern of financing the assets.

Types of Financial decisions

1. Investment decisions – determining how scarce or limited resources in terms of funds of

the business firms are committed to projects.
2. Financing decisions – assert that the mix of debt and equity chosen to finance
investments should maximize the value of investments made.
3. Dividend decisions – determination of the quantum of profits to be distributed to the
owners, the frequency of such payment and the amounts to be retained by the firm.

Significance of Financial Management

 Broad applicability
the principle of finance is applicable wherever there is cash flow.
financial management is equally applicable to all forms of business (sole
proprietorship, partnership and corporation) and to non-profit organizations
(trusts, societies, government organizations, public sectors)

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  Reduction of chances of failure
finance function is treated as primordial which enables the other functions like
production, marketing, purchase, and personnel to be effective in the
achievement of the organizational goal and objectives.

 Measurement of Return on Investment

financial management studies the risk-return perception of the owners and the
time value of money.
financial management considers the amount of cash flows expected to be
generated for the benefit of owners, the timing of these cash flows and the risk
associated to these cash flows.

Relationship between Financial Management and Accounting

Financial management is a separate management area. It is something more than an art

of accounting and bookkeeping. Accounting function discharges the function of systematic
recording of transactions to the firm’s activities in the book of accounts and summarizing the
same for the presentation in the financial statements. The finance manager will make use of the
accounting information in the analysis and review of the firm’s business position in decision
making.

Strategic Financial Planning – involves financial planning, financial forecasting, provision of

finance and formulation of finance policies which should lead the firm’ survival and success. It
should enable the firm to:
judicious allocation of funds
capitalization of relative strengths
mitigation of weaknesses
early identification of shifts in environment
counter possible actions of competitor
reduction in financing costs
effective use of funds deployed
timely estimation of funds requirement
identification of business and financial risk

The financial policy requires the development of firm’s resources for achieving the corporate
strategic objectives. The financial policy should align with the company’s strategic planning. The
finance manager should take investment and finance decisions in consonance with corporate
strategy.

Short-term and Long-term Financial Objectives of a Business Organization

Among the primary financial objectives of a firm are the following:

Short and Medium-term

 Maximization of return on capital employed or return on investment.
 Growth in earnings per share and price/earnings ratio.
 Minimization of finance charges.
 Efficient procurement and utilization of short-term, medium-term, and long-term funds.

Long-term
 Growth in the market value of the equity shares through the maximization of the firm’s
market share and sustained growth in dividend to shareholders.
 Survival and sustained growth of the firm.

Competing viewpoints concerning what the primary financial objectives of the business firm
should be:

1. Owner’s perspective (maximize shareholder or owner’s wealth)

2. Stakeholder’s perspective (social responsibility over profitability)

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Decisions in finance (Financial Objectives)

1. Investing – deals with managing the firm’s assets. This task requires both the mix and
type of assets to hold. Examples of investing decisions are:

evaluation and selection of capital investment proposal

determination of the total amount of funds that a firm can commit for investment
prioritization of investment alternatives
funds allocation and rationing
determination of the levels of investments in working capital
determination of fixed assets to be acquired
asset replacement decisions
purchase or lease decisions
restructuring, reorganization, mergers, and acquisition
securities analysis and portfolio management

2. Financing - concerned with the ways in which the firm obtains and manages the
financing it needs to support its investments. Examples of financing decisions are:

determination of the financing pattern of short-term, medium-term and long-term

funds requirements
determination of the best capital structure or mixture of debt and equity financing
procurement of funds through the issuance of financial instruments such as
equity shares, preference shares, bonds, long-term notes, and so forth
arrangement with bankers, suppliers, and creditors for its working capital,
medium-term and other long-term funds requirement
evaluation of alternative sources of funds.

3. Operating – working capital management. Managing working capital is a day-to-day

responsibility of that ensures that the firm has sufficient resources to continue its
operations and avoid costly interruptions. Examples of operating decision are:

the level of cash, securities and inventory that should be kept on hand
the credit policy
source of short-term financing
financing purchase of goods

Functions in Finance

Financial Manager’s role in achieving the primary goal of the firm

Financial Manager Makes

Decisions Involving

Analysis and Acquisition of Utilization of

Planning Funds Funds

Impact on Risk and

Return

Affect the Market Price

of Common Stock

Lead to Shareholder’s
Wealth Maximization

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 The financial management function is usually associated with a top officer of the firm
such as Vice-President for Finance or Chief Financial Officer. The Vice-President for Finance
coordinates the activities of the treasurer and controller.

Controllership is the traditional management accounting and it focuses on the areas of

planning and controlling. The seven functions of a controller are:
1. Planning and controlling
2. Reporting
3. Evaluation
4. Government relations
5. Protection of assets
6. Economic appraisal
7. Tax administration

Treasurership deals with money, cash, or wealth of an organization. The functions of a

treasurer are:
1. Provision of capital
2. Investor relations
3. Short-term borrowings
4. Banking and custodianship
5. Credit and collection
6. Investments
7. Insurance

Corporate Governance – process of monitoring managers and aligning their incentives with
shareholders goals. The monitors inside a public firm are the Board of Directors, who are
appointed to represent shareholders’ interest.

The monitors outside the firm include

a. External auditors – examines the firm’s accounting systems and comment on

whether the financial statements fairly represent the firm’s financial position.
b. Investment analysts – keep track of the firm’s performance, conduct their own
evaluations of the company’s business activities, and report to the investment
community.
c. Investment banks – help firms to access capital markets.
d. Credit analysts – examine a firm’s financial strength for its debt holders.
e. Government – monitors business activities through the SEC, BIR, BSP and other
government agencies.

Forms of Business Organization

1. Proprietorship – business owned by a single person who has complete control over his
business.

Advantages:
 Ease of entry and exit
 Full ownership and control
 Tax savings
 Few governmental regulations
Disadvantages
 Unlimited liability
 Limitations in raising capital
 Lack of continuity

2. Partnership – legal arrangement in which two or more persons agree to contribute

capital or services to the business and divide the profit and losses that may be derived
therefrom.

Advantages
 Ease of formation
 Additional source of capital

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  Management base
 Tax implication
Disadvantages
 Unlimited liability
 Lack of continuity
 Difficulty in transferring ownership
 Limitations in raising capital

3. Corporation – artificial being created by law and is a legal entity separate and distinct
from its owners.

Advantages
 Limited liability
 Unlimited life
 Ease of transferring ownership
 Ability to raise capital
Disadvantages
 Time and cost of formation
 Regulation
 Taxes

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