FINANCIAL MANAGEMENT:

CHAPTER 1.

FINANCIAL MANAGEMENT – the process of planning decisions in order to maximize wealth, which is the
primary goal of a business enterprise. (purpose of financial management)
- Role is given to financial manager whose function: cash management, acquiring of
funds, raising and allocating of financial capital, manages the trade-offs between risks
and returns. (nature and scope of financial management).
- Adequate knowledge in accounting and financial data

Scope of Financial Management:

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

FUNCTIONS:
1. Record keeping
2. Performance evaluation
3. Variance analysis
4. Budgeting
5. Utilization of resources

GOALS:
1. Shareholders wealth maximization
2. Profit maximization
3. Managerial reward maximization
4. Behavioral goals
5. Social responsibility

Shareholders wealth maximization is the primary goal of the business because it increases the value of
the company’s share capital.

It mentions two views of maximization as goal of business:

Profit maximization:
- Short term goal normally one year or within a given period of time
- Large profits
- Easy to calculate
- Ignores risks and uncertainties
- Requires immediate resources or may mean postponement of long term goal to achieve
wealth maximization
Wealth maximization:
- Emphasizes wealth for the long term
(highest market value of share capital)
- Recognizes risk or uncertainty (shareholders expect greater returns from investments
with higher risk and they will demand a sufficiently large return to compensate for the
greater level of risk. This is called the risk-return trade off.
Risk refers to the variability of expected returns in terms of sales, earnings or cashflows
Typical forms of risk: economic risk(includes time value of money) , political
uncertainties, industry problems.
- Recognizes the timing returns (the earlier the return is received the better since a quick
return reduces the certainty about receiving the return and the money received can be
invested sooner
- Considers shareholders returns (it requires big or high returns of investment)

FINANCIAL MANAGEMENT has two fields of functions which help achieve its goals:
1. MANAGERIAL/MANAGEMENT ACCOUNTING which provides financial data to be used in making
decisions about the future of the business enterprise. It is future oriented and emphasizes
making right decisions today to ensure future performance. It is usually headed by a comptroller
or accounting manager which has the control features of the finance functions.

Role of a controller (internal nature):

1. Record keeping
2. Controlling and tracking the financial effects of prior and current operations
3. Taxes compliance
4. Controlling (internal control for check and balance)
5. Audit
6. Budgeting and forecasts
7. Asset and inventory management

2. FINANCIAL ACCOUNTING records the financial history of the business and involves the
preparation of reports for use of external parties like investors and creditors. It uses
information from management accounting to improve decisions affecting the business
enterprise wealth. It is usually headed by a financial manager or treasurer.

Role of financial manager (external nature):

1. Financial analysis and planning
2. Making investment decisions
3. Making financing and capital structure decisions
4. Managing financial resources
5. Managing risks
6. Credit and collections
Discuss briefly the typical finance organizational set up of a business enterprise CFO as head of finance
or VP-Finance

>The financial and operating environment wherein the business enterprise operates (in acquiring and
allocating/investing of funds) is the FINANCIAL MARKET.
FINANCIAL MARKET is where financial assets and financial liabilities are created. It is where the financial
manager obtains funds and at the same time invest fund surplus. This is regulated by BSP and SEC.
Its composistion:
1. Money markets are the markets for short term debt securities (maturities with less than one
year like treasury bills, commercial paper and negotiable certificate of deposit issued by the
government, in business and financial institutions.
2. Capital markets are the markets for long-term debt (with maturities of more than one year) and
corporate capital. The SEC which handles the share capital of large corporations is a prime
example of capital market.
a. Primary market- as the source of new securities for the secondary market (IPO or initial
public offering) where new issues of securities are traded
b. Secondary market- where previously issued securities are traded

The boundaries between the money markets and capital markets are blurred because most financial
institutions deal with both kinds of financial instruments.

Review the basic forms of business organization: single proprietorship, partnership and corporation –
its characteristics, advantages and disadvantages

CHAPTER 2 – FINANCIAL STATEMENTS

1. Statement of Financial Position - it summarizes the financial results of an organization at a
particular point or period of time. Its like taking a snapshot (freezing of an action) of a business
enterprise. The equation is Asset – Liabilities = Owners’ Equity.
2. Statement of Income – measures the operating performance or profitability of a company for a
specified period of time. It is referred to as the “motion picture” coz it tells you how a business
enterprise performed in preceding year and it serves as bridge between two statements of
financial position.
3. Statement of cashflows
4. Notes to the financial statements
- Unqualified opinion (signing CPA is satisfied in the conduct of audit)
- Qualified opinion when CPA has limitations in the conduct of audit particularly on
gathering of evidences and application of audit procedures
- Disclaimer of opinion when a CPA was unable to form an opinion on the fairness of the
FS and he believes the FS contain one or more significant departures from the GAAP.
 - Adverse opinion when the CPA believes the FS don’t present fairly and in conformity
with GAAP, the FS is misleading.
Provide example of audited financial statements for the students to see using audited 2011, then let
students answer the following:
1. What is your observation on the financial statements of the company?
2. What is your impression of the cashflow?
3. What you have noted in the notes to the financial statements which is relevant to the
financial reports?

Provide example of cashflow analysis using PAC internal FS of 2011 and let students provide analysis,
observations and recommendations.

CHAPTER 3- FINANCIAL STATEMENT ANALYSIS AND RATIOS

1. Discuss horizontal and vertical analysis & ratio analysis (ratio analysis is more effective)
2. Discuss different types of applicable ratios, meaning and importance.
3. Show sample of balance sheet, income statement, trend analysis and ratios analysis using PAC
2011 internal FS, showing vertical and horizontal type of analysis and groupings of ratios.

>Is high profitability would mean high cash?

- lesser cash may mean longer collections
- low profit may not mean low cash
- this may have non-cash components
- longer collection period
- more credit sales

>Users of financial statements – creditors, investors, management, regulatory agencies

Horizontal analysis – comparison of rwo or more years’ financial data concentrating on trends or the
account in peso value & % terms.

Vertical analysis – is the type of analysis using the common-size statements wherein a material item in
the FS is used as base value and all other accounts in the FS are compared to it.
Common size statement is a company’s financial statement that displays all items as percentages of a
common base figure

>Types of Ratios:
1. Liquidity is a business enterprise ability to satisfy maturing short-term obligations
- poor liquidity may mean the inability to pay bills, increase the cost of financing and unable to
pay dividends. Three basis measures: (a) net working capital (b) current ratio (c). quick or acid-test ratio
Net working capital is a measurement of the operating liquidity available for a company to use in
developing and growing its business.
2. Asset utilization or efficiency or activity/turn-over ratios – reflect the way in which a business
enterprise uses its assets to obtain revenue and profit.
a). Inventory turn-over = Cost of goods sold/Ave. inventory = this measures how quickly a
company is converting its inventory into sales, the bigger the ratios the better
b). Days in inventory = (Ave. inventory/Cost of goods sold) x 365 days = this measures how many
days the goods are held prior to sale, the lesser the better.
c). Accounts receivable turn-over
d). Days in accounts receivable
e). Asset turn-over
f). Operating cycle = Ave. collection period+Average age of inventory = is the number of days it
takes to convert inventory and receivables to cash
g). Net operating cycle or cash cycle
3. Leverage Ratios or Solvency and Debt Service Ratios= it is the business enterprise ability to satisfy
long-term debt as it becomes due.
Financial leverage is the size of debt in the business capital structure.
a). Debt to asset ratio
b). Debt to equity ratio
c). Interest coverage ratio = Income before interest and taxes/interest expense> tells you how
many times the business before tax earnings would cover interest
4. Profitability= ability to earn good profits and good returns of its investments
a). Gross profit margin
b). Net profit margin or profitability ratio
c). Return of investments (ROI) = measures how much profit is earned from investments
ROA – return on assets
ROE – return on equity
5. Market value or growth
EPS or earnings per share = how much profit is earned for every share invested by
owner
Book value per share = measures the present or current value of shares of the owners
RATIOS:
measures the ability of the company to pay its short term
1. Current ratio obligations. The higher the figure, the better.

indicates the ability of the company to pay its debt as it falls due.
This is more accurate than the current ratio as it does not consider
2. Quick (or acid test) ratio inventories. The higher the figure, the better.

this measures how much total assets covers total liabilities. The
3. Debt to asset ratio ideal ratio is less than 1.

this measures how much total equity covers total liabilities. The
4. Debt to equity ratio ideal ratio is less than 1.

5. Long-term debt to equity ratio this measures how much total equity covers long term debts. The
 ideal ratio is less than 1.

this measures the financial stability of the business. The higher

6. Capital ratio the ratio, the more sound is the business.

measures how effectively the total assets are used to generate

7. Total asset turnover sales

measures how effectively the fixed assets are used to generate

8. Fixed asset turnover sales

this is the ratio of the number of times the accounts receivable are
collected during the period. Low or declining ratio indicates
9. Accounts receivable turnover collection problem.

indicates the average number of days a company takes to collect

the receivables. This should be compared against the average
terms with the customers, if ratio is higher than the average terms,
10. Days receivables there is collection problem.

this measures the length of time that is needed for a company to

11. Payable turnover pay its suppliers

indicates the average number of days a company takes to pay for

12. Days payable its payables.

this indicates the number of days that a company can pay its
13. Days cash debts as they become due, out of current cash.

this is the number of days cash is kept in operation or will be

14. Cash cycle or Net operating available for other purposes. The shorter days, the better as it will
cycle show efficiency of the company in managing its working capital.

measures the operating efficiency of the company as against

15. Operating ratio sales. The lesser ratio, the better.

16. Operating profit margin measures profitability before interests and taxes

17. Net profit margin measures net profitability

18. Operating return on asset how effective are assets to generate profit

19. Return on assets how effective are assets to generate profit

20. Return on equity measures profit earned for every amount invested to the company

Provide sample of FS and ratios, trend analysis. Let students interpret and analyze the ratios and
trends versus the FS, then make/provide recommendations based on the analysis.
Provide an FS and require students to prepare ratio analysis (take CVI, Equate and PAC FS), then
provide recommendations based on the analysis
CORPORATE BUSINESS VALUATION
Purpose:
- To purchase a company
- To merge with other companies
- Sale
- Litigation
- Tax matter
- Expansion of the credit line
Valuation is normally based on the assumption that the entity is a “going concern” and is done thru due
diligence by looking at the entity on: nature of the business and its major operations, competition,
economic and political conditions, health of the industry, customer base, history of the business, degree
of risk, trend and stability of earnings, marketing factors, maturity of the business, financial status,
growth potential and quality of management.

Valuation methods:
1). Capitalization of earnings – this uses the net income, historical or using the weighted average.
- this also uses a multiplier t capitalize the earnings :
- for low risk business, between 5 or 6 but not more than 6
- for high risk business, between 1 or 2
- for average risk business, at 3

Two ways:
a). using the simple average by adding all the income and divide by the # of years
b). using the weighted average by using weights on years (current is equivalent to total years
used and the start of the year used in the data is equivalent to 1). Then, multiple each earnings by the
weight-years used and divide the total by the total weighted years.

2). Capitalization of excess earnings (using 5 years period)

Steps:
a). Determine the net tangible assets (total assets less the intangibles less the liabilities or also
the book value of the company) per year using a 5-year period.
b). Compute the weighted average of the net tangible assets
c). divide the total weighted amount by the total weighted average years
d). compute goodwill by:
- compute the excess earnings by deducting the normal return rate on weighted average
net tangible assets from the assumed weighted average net income for 5 years:
Assumed weighted average net income for 5 years Pxxx
Less: rate of return x item c xxx
------
Excess Pxxx
 ====
- Multiply excess by the assumed multiplier to get the goodwill
e). Add goodwill to the fair market value of assets to get the total valuation of the business.

3). Capitalization of cash earnings – using the weighted average cash for 5 years and multiplied by the
multiplier to get the valuation.

4). Present value discounted of future cashflows – this uses a cash in current year multiplied by the
estimated % growth. Each estimated cashflow in a year will be multiplied by a multiplier based on the
present value table using a discounted rate and for which year it is applied.
- add the present value of future cash earnings and the present value of selling price (the
expected selling price multiplied by rate in the present value table)

4). Book value – based on the recent book value of the net assets but not unrealistic coz it does not
consider current values.
5). Fair market value of assets – this will be determined by independent appraisal.
6). Gross revenue – using the gross revenue multiplied by the multiplier
7). Market value capitalization – the enterprise’s outstanding shares are multiplied by the market price
per share.
8). Comparable values of similar companies – market value of an enterprise on the same industry.
9). Combination of methods – determining the value by using two or more methods.

CHAPTER 4

Return on investment: DU PONT FORMULA (product of two factors):

NIAT _ or NIAT / Sales x Sales/Total Assets
Ave. Total Assets = Profitability Ratio x Total Assets turn-over

Or Return on Assets

Above is the Du Pont formula which uses the profitability ratio and the asset turn-over. This tells the
relationship between the funds tied up in assets, how much drag on the profitability and how excessive
expenses can be.

It is based on a thesis that business enterprise profitability is directly related to management’s ability to
manage assets efficiently and to control expenses effectively.

Enumerate the ways in reducing expenses (because high expenses means lesser profit)and strategies to
reduce assets (high assets versus sales is less in turn-over).

Per page no. 107, you can play around on reducing or increasing profit or reducing or increasing assets
by maintaining the rate on ROI.
The relationship is when there is decrease in profit and asset turn-over is constant or funds is tied up in
assets, the ROI is lesser. When profitability is maintained and assets are moved, the ROI will increase.
Moving the assets would likewise increase profitability and ROI. And to improve ROI when there is
decrease in profitability, one should move out the assets.

ROE
High level of ROI would mean to SH as high return of investment. But not at all times this will be the case
coz some businesses can generate above average level of returns from a below average performance
based on ROE thru borrowed funds. This is one way of improving returns to shareholders through
financial leverage.

ROE = NIAT/Ave Equity

To further relate this to other aspects:

a). ROI – NIAT/Ave. total assets
multiplied by
b). Ratio of assets to equity= total assets/SE

ROE measures the returns earned by both preference and ordinary shareholders investment. The
relationship between (a) & (b) would reflect the impact of the leverage on the shareholders return.

If you measure performance thru ROI, this would not mean a good indication that returns are high for
the shareholders because this includes liabilities. If you measure ROE only, this would result to a high
return giving way to the impression that financial leverage helps boosts in high performance.

Leverage has a tow-edged sword which means that it can help boost business by contributing to higher
returns or if assets do not earn a rate of return high enough to cover finance charges, then shareholders
suffer.

SUSTAINABLE GROWTH
This represents the rate at which business enterprise sales can grow without selling equity shares and by
just maintaining its financial ratios.

Growth can very well improve when business enterprise plows-back its returns to the business. This is
measured by the plowback ratio (this indicates the fraction of earnings that are reinvested or plowed
back into the business).

ECONOMIC VALUE ADDED (EVA)

This is the measure of economic profit wherein the cost of capital is deducted from NOPAT (EBIT less
corp tax). This means that equity capital has a cost because funds provided by shareholders could have
been invested elsewhere where these could earn a return. Shareholders give up the opportunity to
invest funds elsewhere when they provided capital to the business.

This cost of capital can be distributed as dividends.

So Eva means the measurement of an operations true profitability. It is also called the RESIDUAL
INCOME. It does not consider interest expenses because capital charge includes equity and long term
debts (which is accrued with interest).