DM 2 223 FINANCIAL MANAGEMENT Lecture 5

INTRODUCTION TO 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.
➢ It is also described as the process for and the analysis of making financial decisions in the business
context. It is a part of larger discipline called FINANCE which is a body of facts, principles, and theories
relating to raising money by individuals, businesses, and governments.

THE 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.”

➢ The stated goal considers the fact that the shareholders in a firm are the residual owners. By this, we
mean that they are entitled only to what is left after employees, supplier, creditors and anyone else with
legitimate claim are paid their due. If any of these groups go unpaid, the shareholders or owners get
nothing.
➢ This goal does not imply that the financial manager should take illegal or unethical actions in the hope of
increasing the value of the equity in the firm. The financial manager should best serve the owners of the
business by identifying goods and services that add value to the firm because they are desired and
valued in the free market place.

SCOPE OF FINANCIAL MANAGEMENT

➢ Traditionally, financial management is primarily concerned with acquisition, financing and management
of assets of business concern in order to maximize the wealth of the firm for its owners.
➢ The basic responsibility of the Finance Manager is to acquire funds needed by the firm and investing
those funds in profitable ventures that will maximize the firm’s wealth, as well as generating returns to
the business concern.

Briefly, 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 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 and distribution
as well as coordination of the finance function with the accounting function

TYPES OF FINANCIAL DECISIONS

The three major types of decisions that the Finance Manager of a modern business firm will be
involved in are:
1. Investment decisions
2. Financing decisions
3. Dividend decisions
All these decisions aim to maximize the shareholders’ wealth through maximization of firm’s wealth.

1. Investment Decisions
➢ Those which determine how scarce or limited resources in terms of funds of the business firms
are committed to projects.
➢ Generally, the firm should select only those capital investment proposals whose net present
value is positive and the rate of return exceeding the marginal cost of capital.
➢ These decisions also consider the profitability of the firm and lead to the creation of wealth.

2. Financing Decisions
➢ Those which assert that the mix of debt and equity chosen to finance investments maximize the
value of investments made.
➢ The finance decisions should consider the cost of finance available in different forms and the
risks attached to it.
➢ If the cost of capital and minimization of risks in financing will lead to the profitability of the
organization and create wealth to the owner.

Instructor: Danica M. Almario, CPA 1

DM 2 223 FINANCIAL MANAGEMENT Lecture 5

3. Dividend Decisions
➢ Those which is concerned with the determination of quantum of profits to be distributed to the
owners, the frequency of payments and the amounts to be retained by the firm.
➢ The dividend distribution policies and retention of profits will have ultimate effect on the firm’s
wealth.
➢ The business firm should retain its profits in the form of appropriations or reserves for financing
its future growth and expansion schemes.

SIGNIFICANCE OF FINANCIAL MANAGEMENT

The importance of financial management is known for the following aspects:

1. Broad Applicability
Any organization whether motivated with earning profit or not having cash flow requires to be
viewed from the angle of financial discipline. The concept of cash flow is one of the central elements of
financial analysis, planning, control, and resource allocation decisions.
Cash flow is important because the financial health of the firm depends on its ability to generate
sufficient amounts of cash to pay its employees, suppliers, creditors and owners.

2. Reduction of Changes of Failure

A firm having latest technology, sophisticated machinery, high caliber marketing and technical
experts, and so forth may still fail unless its finances are managed on sound principles of financial
management.
The strength of business lies in its financial discipline. Therefore, finance function is treated as
primordial which enables the other functions like production, marketing, purchase and personnel to be
effective in the achievement of organizational goal and objectives.

3. Measurement of Return on Investment

Anybody who invests his money will expect to earn a reasonable return on his investment. The
owners of business try to maximize their wealth. Financial management studies the risk-return
perception of the owners and the time value of money.
It considers the amount of cash flows expected to be generated for the benefit of owners, the
timing of these cash flows and the risk attached to these cash flows. The greater the time and risk
associated with the expected cash flow, the greater is the rate of return required by the owners.

RELATIONSHIP BETWEEN FINANCIAL MANAGEMENT AND ACCOUNTING

Just as marketing and production are major functions in an enterprise, finance too is an independent
specialized function and is well knit with other functions.
Financial management is a separate management area. In many organizations, accounting and finance
functions are intertwined and the finance function is often considered as part of the functions of the
accountant. Financial management is however, something more than an art of accounting and bookkeeping.

➢ 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.

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:
1. Statement of Financial Position
2. Statement of Financial Performance
3. Statement of Changes in Equity
4. Cash Flow Statement

Instructor: Danica M. Almario, CPA 2

DM 2 223 FINANCIAL MANAGEMENT Lecture 5

FOUR BASIC FINANCIAL STATEMENTS

1. Statement of Financial Position (Balance Sheet) – shows the financial position – assets, liabilities and
owner’s equity of the firm on a particular date.
2. Statement of Financial Performance (Income Statement) – represents the result of operations –
revenues, expenses, net profit or loss for the accounting period.
3. Statement of Changes in Equity – summarized the changes in a company’s equity for a period of time
(generally one year).
4. Cash flow statement – provides information about the cash inflows and outflows from operating,
financing and investing activities during an accounting period.

RELATIONSHIP BETWEEN FINANCIAL MANAGEMENT AND ECONOMICS

The finance manager must be familiar with the microeconomic and macroeconomic environment
aspects of business.

1. Microeconomics
It 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, cost-volume-profit analysis, dividend
distribution decisions, and so forth.

2. Macroeconomics
It looks at the economy as a whole 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.
The finance manager should look into rate of inflation, real interest rates, market competition,
foreign exchange rates, growth of economy, banking system, unionization of labor and so forth.

Instructor: Danica M. Almario, CPA 3