INTRODUCTION TO

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FINANCIAL MANAGEMENT

Financial Management is mainly concerned with using

efficiently the important economic resources of a firm like its capital
funds. It is immediately associated with accounting which is a
common mistake that most individuals make. Financial
management focuses more on what is the interpretation of the
accounting data presented and on how to implement a strategy for
the data presented. It is more concerned with what to do with a
firm’s capital funds. It answers questions such as “how to raise
capital?”, “how to allocate available funds”, and “what strategy
can be adapted?”.

In today’s business environment, financial managers have

been assigned various and changing roles. The modern financial
manager has now a very crucial role in the effective management of the company. He must have a broader
knowledge of the financial environment to take financial decisions or any corrective measures, concerning the
firm's operation. This is contrary to the traditional role of mainly being in charge of the procurement of cash,
maintaining accurate records, and preparing reports that cater to the company’s current financial condition
and performance.

Financial Management differs from Financial Accounting in that the latter mainly focuses on gathering
data by the applicable standards. The former is being able to apply the provisions of certain accounting
standards in reporting data while also being able to apply strategies that would address issues about the
interpretation of those data. In simple terms, Financial Management is the application of decision-making
skills in interpreting the data provided by Financial Accounting. The field of Financial Management makes a
huge impact in determining what kind of investors will have and the direction of the company in the future.

This module will allow the learners to have a grasp of what Financial Management is about and its
applications in the real world.

Definitions of Financial Management

Since Financial Management has become popular in the business world over the past couple
of years, there are many definitions coined by different people to explain the subject matter. The
definitions listed below should give a deeper sense of reflection on what Financial Management is
about.
"It is concerned with the efficient use of an important economic resource namely, capital
funds".

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 "Financial Management deals with procurement of funds and their effective utilization in the
business”.
Howard and Upton: Financial management "is an application of general managerial principles
to the area of financial decision-making”.
Weston and Brigham: Financial management “is an area of financial decision-making,
harmonizing individual motives and enterprise goals”.
Joseph and Massie: Financial management “is the operational activity of a business that is
responsible for obtaining and effectively utilizing the funds necessary for efficient operations”.
Richard A. Brealey: "Financial management is the process of putting the available funds to
the best advantage from the long-term point of view of business objectives."
Still another definition states that Financial Management is the efficient and effective
planning and controlling of financial resources to maximize profitability and ensure a lion individual
called personal finance), government (called public finance and for prof organization/firm (called
corporate or managerial finance).

Main Features of Financial Management

The main characteristics presented in financial management may be inferred from the
definitions presented in this module.
1. Analytical Thinking- Under financial management financial problems are analyzed and
considered. A study of the trend of actual figures is made and ratio analysis is done
2. Continuous Process- previously financial management was required rarely but now the
financial manager remains busy throughout the year.
3. Basis of Managerial Decisions- All managerial decisions relating to finance are taken after
considering the report prepared by the finance manager. Financial management is the base
managerial decisions
4. Maintaining Balance between Risk and Profitability- Larger the risk in the business the
larger the expectation of profits. Financial management maintains a balance between risk
and profitability.
5. Coordination between Processes- There is always coordination between various processes
of the business.
6. Centralized Nature- Financial management is of a centralized nature. Other activities can be
decentralized but there is only one department for financial management.

Importance of Financial Management

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 As you have learned earlier, financial management is more than just accounting. Accounting
primarily focuses on recording business transactions and everyday activities whereas Financial
Management takes on the role of actually interpreting the data being reported. This involves
decision-making about the firm. The right mix of fund allocation also a vital role in financial
management since having expertise in this area, will allow businesses to thrive in terms of their
cash management and cash flow.
Another important function of Financial Management is the ability of a firm to conduct Asset
Management. This involves the efficient allocation of available resources within a firm. Many
organizations rely not on the quantity and extent of the assets but rather on how these assets are
managed within the organization. A handful of organizations reached the pinnacle of their success
even with very few assets. A big part of this success is their ability to efficiently manage the available
resources they have procured. On the other hand, some firms may also experience some turbulence
in their businesses like bankruptcy and liquidation despite them having large amounts of resources
available for their disposable. This may be linked to poor financial management decisions by their
top executives.
Financial Management is important in today’s business world as it is proven to be a vital part
of an organization’s structure. Right from the recording of financial transactions to the preparation
of financial statements, the organization has to make sure that proper procedures have been
followed. This is because the organization has to ultimately depend on that information for future
planning and forecasting and decision-making.

Relationship with other business functions

Other organizational
functions are closely tied to
Financial Management and in one
way or another, are affected by
the decisions made by financial
managers. The following are
some of the notes about other
business functions.

1. Financial Management and Economics

Economics provides a structure for decision-making in such areas as risk analysis, pricing
theory through supply and demand relationships, comparative return analysis, and many
other important areas. Economics also provides a broad picture of the economic environment
in which corporations must continually make decisions. In this regard, Financial Management
is related to economics in the sense that the decision of a financial manager must also be
taking into consideration the economic environment in which the business exists.

2. Financial Management and Accounting

Financial Management, as discussed earlier is the interpretation of the data presented in
accounting. Interpretation gives color to the somewhat vague numbers presented in financial
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 reports. The firm’s finance and accounting activities are closely related and generally overlap.
Accounting is sometimes said to be the language of finance because it provides financial data through
income statements, balance sheets, and the statement of cash flows. The financial manager must
know how to interpret and use these statements in allocating the firm's financial resources to
generate the best return possible in the long run.

3. Financial Management and Mathematics

Modern approaches to financial management apply a large number of mathematical and
statistical tools and techniques. They are also called econometrics. Economic order quantity, time
value of money, cost of capital, capital structure theories, dividend theories, ratio analysis, and
working capital analysis are used as mathematical and statistical tools and techniques in the field of
financial management.

4. Financial Management and Production Management

The profit of the concern depends upon the production performance. Production
performance finance, because the production department requires raw materials, machinery,
wages, operating expenses, etc. Important production decisions like make or buy can be taken only
after financial implications have been considered.

5. Financial Management and Marketing

Marketing is another vital part of a firm’s profitability that is linked with financial
management. Marketing strategies such as holding inventories to provide uninterrupted service to
customers to increase sales are a cost of a firm that needs the area of financial management.
Managers need to know whether to spend much on these marketing strategies since they bring
about large chunks of their sales or just to forfeit these marketing strategies. Spending on
advertisement is also what financial managers keep an eye on depending on its relationship with the
company’s sales data.

6. Financial Management and Personnel

The provision of wages, salary, remuneration, commission, bonus, pension, and other
monetary benefits has become a major financial decision in the area of human resource
management. Should the firm give out a bonus to its employees? Or how much should a firm give as
a bonus to its top-performing manager? These are some questions that might be answered by
financial management.

7. Financial management and Top Management

Strategic planning and management control are two important functions of top management. The
finance function provides the basic inputs needed for undertaking these activities.

8. Financial Management and Quantitative Methods

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 Quantitative methods such as linear programming, probability, discounting techniques,
present value techniques, etc. are useful in analyzing complex financial management
problems.

9. Financial Management and Costing

Cost efficiency is a major strategic advantage to a firm, and will greatly contribute to its
competitiveness, sustainability, and profitability. A finance manager has to understand, plan and
manage costs, through appropriate tools and techniques including Budgeting and Activity-based
Costing.

10. Financial Management and Law

Sound knowledge of the legal environment, corporate laws, business laws, Import Export
guidelines, international laws, trade and patent laws, commercial contracts, etc. are again finance
executives in a globalized business scenario.
11. Financial Management and Taxation
Sound knowledge of taxation, both direct and indirect, is expected of a finance manager, as
all financial decisions are likely to have tax implications. Tax planning is an important function of a
finance manager. Some of the major business decisions are based on the economics of taxation. A
finance manager should be able to assess the tax benefits before committing funds.

12. Financial Management and Treasury Management

Every finance manager should be well grounded in treasury operations, which is considered
a profit center. It deals with optimal management of cash flows, judiciously investing surplus cash in
the most appropriate investment avenues, anticipating and meeting emerging cash requirements,
and maximizing the overall returns. In banks, it includes the design of new financial products from
existing products.

13. Financial Management and Banking

Every finance manager must be up to date on the changes in services & products offered by
the banking sector including several foreign players in the field. Thanks to Government's liberalized
investment norms in this sector, the banking system has essentially been an important consideration
in financing decisions.

14. Financial Management and Insurance

Evaluating and determining the commercial insurance requirements, choice of products, and
insurers. analyzing their applicability to the needs and cost-effectiveness, techniques, ensuring
appropriate and optimum coverage, claims to handle, etc. fall within the ambit of a finance
manager's scope of work & responsibilities.

15. Financial Management and Information Technology

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 A finance manager needs to know how to integrate finance and costing with operations
through software packages. Now more than ever, the difficult job of valuation of financial
instruments in the past is made easier with the aid of better information technology.

Scope of Financial Management

The scope of financial management includes the following A’s.

1. Anticipation
- In financial management, estimation of a firm’s needs is important as well as
estimating the amount of income that may enter the company or the amount of
expense that a company has to incur. Anticipation involves finding out how
much finance is required by a company.
2. Acquisition
- Once the required capital or finance is determined by the company, then the
company must find out how these finances will be procured from different
sources.
3. Allocation
- The collection of a firm’s finances will now be determined by where it will be
spent. Will it be spent to purchase a fixed asset? Or will it be used to purchase
inventories to increase sellable products?
4. Appropriation
- Upon earning profits, appropriation means the decision of the firm to determine
the division of profits among shareholders, credit holders, or whether it will be
part of a firm’s reserved capital.
5. Assessment
- This controls the financial activities of a company.

Functional Areas of Financial Management

1. Determining Sources of Funds

In a business, there are different ways in which it can procure funds. Investors/Owners
can be the easiest source of funds as they have a direct stake in the company’s financing.
Another source of funds would be from the sales of the company. Externally, a company
can also tap the resources of a third-party such as a bank to finance its operations and
acquisitions.

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 2. Financial Analysis

The financial data reported to a company must be interpreted by financial managers and
analysts for them to determine where a firm performs best or slacks. It is the evaluation and
interpretation of a firm's financial position and operations and involves the comparison and
interpretation of accounting data. The financial manager has to interpret different
statements. He is required to measure the company's liquidity, determine its profitability, and
assess overall performance in financial terms.

3. Optimal Capital Structure

Using the basic accounting equation of “Assets = Liabilities + Equities”, a firm may be able to
determine what level of its capital structure must be achieved for it to perform at a high
level. A firm may either have more debt than it has equity or the other way around. Or a
more balanced firm may opt to have its debt and equity at an equal level. The financial
manager has to establish an optimum capital structure and ensure the maximum rate turn
on investment. The financial manager should have adequate knowledge of different
empirical studies on the optimum capital structure and find out whether, and to what extent,
he can apply their findings to the advantage of the firm.

4. Cost-Volume-Profit Analysis

This is popularly known as the 'CVP relationship'.

The financial manager has to ensure that the
income for the firm will cover its variable costs.
This will further be discussed in more advanced
management accounting subjects. What is
important to know is that the cost and volume of
a product/service have a direct effect on its
profit and this is what financial managers need to
understand to gain an edge in their company.

5. Profit Planning and Control

Profit planning ensures the attainment of stability and growth. Profit planning is an important
responsibility of the financial manager. Profit planning and control is a dual function that
enables one to determine costs it has incurred, and revenues it has earned during a
particular period.

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 6. Fixed Assets Management

The acquisition of fixed assets involves capital expenditure

decisions and long-term commitments of funds. Because of this
long-term commitment of funds, decisions governing their
purchase, replacement, etc., should be taken with great care
and caution. Financial managers need to know that funds used in fixed assets won’t be
available anymore to be used in their current operations.

7. Capital Budgeting

Capital budgeting decisions are most crucial; for they have long-term implications. They
relate to the judicious allocation of capital. Current funds have to be invested in long-term
activities in anticipation of an expected flow of future benefits spread over a long period.
Capital budgeting forecasts returns on proposed long-term investments and compares the
profitability of investments and their cost of capital. It results in capital expenditure
investment. The financial analyst should be able to blend risk with returns to get the current
evaluation of potential investments.

8. Working Capital Management.

This involves the working capital equation of “Working Capital = Current Assets - Current
Liabilities”. Working capital is rightly an adjunct of fixed capital investment. It is a financial
lubricant that keeps business operations going. It is the lifeblood of a firm.

9. Dividend Policies

Dividend policies constitute a crucial area of financial management. While owners are
interested in getting the highest dividend from a corporation, the Board of Directors may be
interested in maintaining its financial health by retaining the surplus to be used when
contingencies arise. A firm may try to improve its internal financing so that it may avail itself
of the benefits of future expansion. However, the interests of a firm and its stockholders are
complementary, for the financial management is interested in maximizing the value of the
firm, and the real interest of stockholders always lies in the maximization of this value of the
firm; and this is the ultimate goal of financial management.

10. Acquisitions and Mergers

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 Firms may expand externally through cooperative arrangements, by acquiring other
concerns, or by entering into mergers. Acquisitions consist of either the purchase or lease of
a smaller firm by a bigger organization. Mergers may be accomplished with a minimum cash
outlay, though these involve major problems of valuation and control.

11. Corporate Taxation

Corporate taxation is an important function of financial management, for the former has a
serious impact on the financial planning of a firm.

Explain the activity: As a student studying Bachelor of Science in Accountancy/Management

Accounting, explain why you should know about Financial Management. Limit your
explanation to five to ten sentences.

Elaborate activity: Through an infographic portray the relationships of financial management

with the other business functions.

Evaluate activity (Assignment #1) This should be done after reading all of Module 1: Using the
Ten Axioms of Financial Management, create a reflection paper that details your
understanding of these axioms.

Financial Management Process

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 Financial
Financial Planning Financial Control Decision-Making
- Create Budgets -Control Cash Flows -Investment
and Forecasts - Control Cash Decisions (Where
- Determine the Acquisitions and do you invest
sources of funds Expenditures scarce resources?)
-Addresses whether - Financing
company assets are Decisions (Where
being used should the needed
efficiently capital be sourced
out?)
- Dividend Decisions
(How much of the
profit should be
reinvested or
returned?)
- Liquidity Decisions
(How should the
working capital be
managed?)

Jobs in Financial Management

Different career paths may be undertaken when Financial Management is the area
of expertise to study. A detailed discussion of Jobs in Finance is further discussed in Chapter
1 of Brigham’s Fundamentals of Financial Management.

Investment Banking Jobs are generally involved working with corporations,

government, and other large institutions giving them strategic advice. Hedge Fund Jobs are
among the most sought-after jobs in the financial world. Depending on the firm and the level
of the trader, these jobs can involve taking orders from portfolio managers or using discretion
on what to buy and sell. Financial Advisory Jobs is perhaps the most familiar to the general
public and is primarily focused on providing financial services to retail investors. The term
"financial advisor" encompasses a variety of jobs whose practitioners have often been
referred to as stockbrokers, although the industry has tried to move away from that term.
Financial Media Jobs incorporate knowledge of finance and economics with the ability to
write or speak intelligently about the markets. Individuals interested in these jobs should
possess superior communication skills as well as market savvy. Analyst Jobs are among the
most common in the financial industry and can encompass a variety of different job
descriptions. Portfolio Management Jobs are some of the prestigious roles in the finance
industry and involve directly managing institutional and retail client portfolios. Trading jobs
are found at a variety of institutions including commercial and investment banks, asset
management firms, and hedge funds.

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 There are a variety of certifications that apply to Financial Management as well such
as Certified Financial Planner, Chartered Financial Analyst, Certified Fund Specialist, and
Certified Management Accountant.

TEN AXIOMS THAT FORM THE BASICS OF FINANCIAL MANAGEMENT

1. The Risk-Return Trade-off

- We won’t take on additional risk unless we expect to be compensated with an
additional return
2. The Time Value of Money
- A dollar received today is worth more than a dollar received in the future. (This is
further discussed in a separate module)
3. Cash Flows is King
- This states that Cash flow and not profit is king in terms of financial management
4. Incremental Cash Flows
- Only the cash flows that changes are the ones that count
5. The Curse of Competitive Markets
- Why it’s hard to find exceptionally profitable projects
6. Efficient Capital Markets
- The markets are quick and the prices are right
7. The Agency Problem
- Managers will not work for the owners unless it is in their best interests
8. Taxes Bias Business Decisions
- In evaluating projects, income taxes play a significant role in the decision-
making
9. All Risks are Not Equal
- Some risks can be diversified away and some cannot
10. Ethical Behavior is Doing the Right Thing
- Ethical dilemmas are everywhere in finance

GOAL AND OBJECTIVE OF THE FIRM

Objectives of Financial Management may be broadly divided into:
1. Profit Maximization
2. Wealth Maximization

Profit maximization is a single-period or, at most, a short-term goal, to be achieved

within one year; it is usually interpreted to mean the maximization of profits within a given
period. A corporation may maximize its short-term profits at the expense of its long-term
profitability. In contrast, stockholder wealth maximization is a long-term goal, since
stockholders are interested in future as well as present profits.

Wealth maximization is generally preferred because it considers (1) wealth for the long
term, (2) risk or uncertainty, (3) the timing of returns, and (4) the stockholders' return. Timing
of returns is important; the earlier the return is received; the better, since a quick return,
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 reduces the uncertainty about receiving the return, and the money received can be
reinvested sooner.

Generally speaking, a firm must set its goals into maximizing its wealth rather than its
profits for it to have sustainability in the long run.

Reference: Notes as compiled by the Faculty of the Department of Accountancy, Saint Louis
University, Contributed By: Gabriel Santos

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