Financial Management

Module 01: Introduction

FINANCIAL MANAGEMENT
- Management of the finances of an organization in order to achieve the financial objectives of the
organization.
- Usual assumption: “that the objective of the company is to maximize shareholder’s wealth”

According to Guthmann and Dougall,

- “Business finance can be broadly defined as the activity concerned with the planning, raising, controlling
and administering the funds used in the business.”

In the words of Prather and Wert,

- “Business finance deals primarily with raising, administering and disbursing funds by privately owned
business units operating in non-financial fields of industry.”

Financial management is indispensable to any organization as it helps in:

1. Financial planning and successful promotion of an enterprise;
2. Acquisition of funds as and when required at the minimum possible cost;
3. Proper use and allocation of funds;
4. Taking sound financial decisions;
5. Improving the profitability through financial controls;
6. Increasing the wealth of the investors and the nation; and
7. Promoting and mobilizing individual and corporate savings.

The subject of finance has been traditionally classified into two classes:
● Public Finance
- Government Institutions
- State Governments
- Central Governments

● Private Finance
- Personal Finance
- Business Finance
- Finance of Non-Profit Organizations

Financial Planning
- The financial manager will need to plan to ensure that enough funding is available at the right time to
meet the needs of the organization for short, medium and long-term capital.

● Short term: funds may be needed to pay for purchases of inventory, or to smooth out changes in
receivables, payables and cash: the financial manager is here ensuring that working capital
requirements are met.
● IMedium or Long term: the organization may have planned purchases of non-current assets such
as plant and equipment: the financial manager must ensure that funding is available.

Note: The financial manager contributes to decisions on the uses of funds raised by analyzing financial
data to determine uses which meet the organization’s financial objectives.

FUNCTION OF FINANCIAL MANAGEMENT

● Estimation of capital requirement: A financial manager has to make estimation with regards to
capital requirements of the company. Depending upon expected costs and profits and future
programs and policies of a concern.
● Determination of capital composition: Once the estimation has been made, the capital
structure has to be decided. Involves short and long-term debt equity analysis.
 ● Choice of sources of funds: For additional funds to be procured, a company has many choices
like:
(a) Issue of shares and debentures
(b) Loans to be taken from banks and financial institutions
(c) Public deposits to be drawn like in form of bonds
(d) Choice of factor will depend on relative merits and demerits of each source and period
financing.
● Investment of funds: The finance manager has to decide to allocate funds into profitable
ventures so that there is safety on investment and regular returns
● Disposal of surplus: The net profits decision has to be made by the finance manager. This can
be done in 2 ways:
(a) Dividend declaration – It includes identifying the rate of dividends and other benefits like
bonus.
(b) Retained profits – The volume has to be decided which will depend upon expansional,
innovational, diversification plans of the company.
● Management of Cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries, payment
of electricity and water bills, payment to creditors, meeting current liabilities, maintenance of
enough stock, purchase of raw materials, etc.
● Financial controls: The finance manager has not only to plan, procure and utilize the funds but
he also has to exercise control over finance. This can be done through many techniques like ratio
analysis, financial forecasting, cost and profit control, etc.

THE CONTROL FUNCTION IN FINANCIAL MANAGEMENT

- Relevant for funding.

The following questions are needed to be answered in this aspect:

● Are the various activities of the organization meetings its objectives?
● Are assets being used efficiently?
To answer these questions, the financial manager may compare data on actual performance with forecast
performance.

Decisions involved in Financial Management

- The financial manager makes decisions relating to investment, financing and dividends. The
management of risk must also be considered. Investments in assets must be financed somehow.

● Investment decisions includes investment in fixed assets (called as capital budgeting)

● Financial decisions – They relate to the raising of finance from various resources which will
depend upon decision on type of source, period of financing, cost of financing and the returns
thereby.
● Dividend decision – The finance manager has to take decision with regards to the net profit
distribution. Net profits are generally divided into two:
(a) Dividend for shareholders – Dividend and the rate of it has to be decided.
(b) Retained profits – Amount of retained profits has to be finalized which will depend upon
expansion and diversification plans of the enterprise.

DIFFERENT TYPES OF INVESTMENT DECISIONS

Decisions internal to the business enterprise ● Whether to undertake new projects
● Whether to invest in new plant and
machinery
● Research and development decisions
● Investment in a marketing or advertising
campaign

Decisions involving external parties ● Whether to carry out a takeover or a merger

involving another business
 ● Whether to engage in a joint venture with
another enterprise

Disinvestment Decisions ● Whether to sell of unprofitable segments of

the business
● Whether to sell old or surplus plant and
machinery
● The sale of subsidiary companies

FINANCIAL OBJECTIVES IN RELATION WITH ORGANIZATIONAL STRATEGY

Financial strategy
- “The identification of the possible strategies capable of maximizing an organization’s net present
value, the allocation of scarce capital resources among the computing opportunities and the
implementation and monitoring of the chosen strategy so as to achieve states objectives.”
- Can be short term or long term, depending on the time horizon of the objective it is intended to
achieve. This definition also indicates that since strategy depends on objectives or targets, the
obvious starting point for a study of corporate strategy and financial strategy is the identification and
formulation of objectives.
- Corporate objectives are those which are concerned with the firm as a whole. Objectives should be
explicit, quantifiable and capable of being achieved. The corporate objectives outline the expectations
of the firm and the strategic planning process is concerned with the means of achieving the
objectives.

RESPONSIBILITIES OF FINANCIAL MANAGERS

MAIN FUNCTIONS OF FINANCIAL MANAGERS
Raising of Funds In order to meet the obligation of the business it is
important to have enough cash and liquidity. A
firm can raise funds by the way of equity and debt.
It is the responsibility of a financial manager to
decide the ratio between debt and equity. It is
important to maintain a good balance between
equity and debt.

Allocation of Funds Once the funds are raised through different

channels the next important function is to allocate
the funds. The funds should be allocated in such a
manner that they are optimally used.

Profit Planning Profit earning is one of the prime functions of any

business organization. Profit earning is important
for survival and sustenance of any organization.
Profit planning refers to proper usage of the profit
generated by the firm.

Understanding of Capital Markets It’s on the discretion of a financial manager as to

how to distribute the profits. Many investors do not
like the firm to distribute the profits amongst
shareholders as dividend instead invest in the
business itself to enhance growth. The practices
of a financial manager directly impact the
operation in capital market.

Module 03: The Role of Financial Statements

THE ROLE OF FINANCIAL STATEMENTS

- A financial statement is an official document of the firm, which explores the entire financial
information of the firm. The main aim of the financial statement is to provide information and
understand the financial aspects of the firm. Hence, preparation of the financial statement is
important as much as the financial decisions.
 - They are the reports the provide the detail of the entity’s financial information including assets,
liabilities, equities, incomes and expenses, shareholders’ contribution, cash flow, and other related
information during the period of time.

The Role of Financial Statement to Financial Managers

- Financial statements can be used by managers to track performance, budgets, and other metrics,
and as tools to make decisions, motivate teams, and maintain a big-picture mindset.

Ways Managers use Financial Statements are as follows:

1.) Measuring an Impact. As a manager, it’s important to have a method for tracking the impact
your efforts have on your company’s bottom line.
2.) Budget Determination. Financial statements are also useful when managing and planning
budgets. Because the financial landscape is ever-changing. An understanding of your company’s
financial health and history is necessary when budgeting.
3.) Cut unnecessary costs. Being able to see your company’s expenses line by line on both the
income and cash flow statements can highlight areas where it’s possible to cut costs.
4.) See things in macro level. Keeping the broader health of your organization in mind is vital when
managing your team. Analyzing the balance sheet, income statement, and cash flow statement
can allow you to understand the ins and outs of your company finances and give you
bigger-picture clarity to guide your goal-setting and decision making processes.
5.) Align Across Departments. Your company’s financial statements can be used to ensure multiple
departments are on the same page. When managers from each department have analyzed the
statements, discussions about goals and budgeting can center on a shared understanding of the
organization’s current financial health, and offer perspective into other manager’s goals and
motivations.
6.) Drive team motivation. When setting team goals, leverage financial statements to provide
context for why specific benchmarks were targeted and the thought process behind your plans for
reaching them.

THE OBJECTIVE OF FINANCIAL STATEMENTS

- According to Philippine Accounting Standards (PAS 1) the objective of Financial Statements is to
provide information about financial position, financial performance, and cash flows of an entity that is
useful for a wide range of users in making economic decisions.

Overall Considerations of Financial Statements

(a) Fair Presentation and Compliance with PFRS
(b) Going Concern
(c) Accrual Basis of Accounting
(d) Consistency
(e) Materiality and Aggregation
(f) Offsetting
(g) Comparative Information

The Components of Financial Statements

● Statement of Financial Position (balance sheet) at the end of the period. (ALOE)
- Helps to ascertain and understand the total assets, liabilities and capital of the firm. One can
understand the strength and weakness of the concern with the help of the statement of financial
position.

● Statement of Financial Performance (income statement) at the end of the period

- Also called as profit and loss account.
- Reflects the operational position of the firm during a particular period.
- Determines the entire operational performance of the concern like total revenue generated and
expenses incurred for earning that revenue.
 - Helps to ascertain the gross profit and net profit of the concern. Gross profit is determined by
preparation of trading or manufacturing a/c and net profit is determined by preparation of profit and
loss account.

● Statement of Changes in Equity for the period

- Reflects all changes in equity between the beginning and the end of the reporting period arising from
transactions with owners in their capacity as owners; reflecting the increase or decrease in net
assets in the period.
- Presents the user with information about each component of equity, including:
(a) A reconciliation between the carrying amount at the beginning and the end of the period of
each component of equity;
(b) The effects of retrospective application of accounting policies; and
(c) The effects of retrospective restatement of prior period errors.

- The consolidated statement of changes in equity (of a group that includes one or more partly-owned
subsidiaries) also provides information about the share of equity attributable to the owners of the
parent and that attributable to the non-controlling interests and information about changes in such
interests.

● Statement of Cash Flows for the period

- Summarizes the amount of cash and cash equivalent entering and leaving a company. The cash
flow statement (CFS) measures how well a company manages its cash position, meaning how well
the company generates cash to pay its debt obligations and fund its operating expenses.
- Complements the balance sheet and income statement.
- The main components of the cash flow statement are:
(a) Cash from operating activities
(b) Cash from investing activities
(c) Cash from financing activities

● Notes to Financial Statements

- Also called as footnotes
- Comprising a summary of significant accounting policies and other explanatory notes
- Provides additional information pertaining to a company’s operations and financial position and are
considered to be an integral part of the financial statements.
- Full disclosure principle
- Without these footnotes it would be exasperating for the shareholders, inventors and public to judge
the financial stability of the company.

Module 05: Financial Statement Analysis

THE NEED FOR FINANCIAL STATEMENT ANALYSIS

- Financial statements analysis involves the examination of both the relationship among financial
statement numbers and the trends in those numbers over time. One purpose of financial statement
analysis is to use the past performance of a company to predict how it will do in the future.
- Another purpose is to evaluate the performance of a company with an eye toward identifying
problem areas.
- In sum, financial statement analysis is both diagnosis – identifying where a firm has problems – and
prognosis – predicting how a firm will perform in the future.

Types of Financial Statement Analysis

● Materials Used Based:
(1) External Analysis
- Very much useful to understand the financial and operational position of the business concern
- Outsiders of the business concern do normally external analysis but they are indirectly involved in
the business concerns such as investors, creditors, government organizations and other credit
agencies.
 - Mainly depends on the published financial statement of the concern. This analysis provides only
limited information about the business concern.

(2) Internal Analysis

- The company itself disclose some of the valuable information to the business concern in this type of
analysis.
- Used to understand the operational performances of each and every department and unit of the
business concern.
- Helps to take decisions regarding achieving the goals of the business concern.

● Method of Operation Based

(1) Horizontal Analysis
- Financial statements are compared with several years and based on that, a firm may take decisions.
Normally, the current year’s figures are compared with the base year (consider as 100) and how the
financial information are changed from one year to another. This analysis is also called as dynamic
analysis.
- Involves analyzing financial data over time, such as computing year-to-year dollar and percentage
changes within a set of financial statements.

(2) Vertical Analysis

- Financial statements measure the quantities relationship of the various items in the financial
statement on a particular period.
- Static Analysis; this analysis helps to determine the relationship with various items appeared in the
financial statement. For example, a sale is assumed as 100 and other items are converted into sales
figures.
- Focuses on the relations among financial statement accounts at a given point in time.
- A common-size financial statement is a vertical analysis in which each financial statement account is
expressed as a percentage.

Techniques of Financial Statement Analysis

- Financial statement analysis is interpreted mainly to determine the financial and operational
performance of the business concern.
1.) Ratio Analysis
2.) Comparative Statement
(a) Comparative Income Statement Analysis
(b) Comparative Position Statement Analysis
3.) Trend Analysis
4.) Common Size Analysis
5.) Funds Flow Statement
6.) Cashflow Statement

FINANCIAL RATIOS AND METRICS

Liquidity Ratios
- Short-term Ratio
- Helps to understand the liquidity in a business in which is the potential ability to meet current
obligations.
Activity Ratio
- Turnover Ratio
- Measure the efficiency of the current assets and liabilities in the business concern during a particular
period. Helpful to understand the performance of the business concern.

Leverage Ratio
- Solvency Ratio
- Measures the long-term obligation of the business concern.
- Helps to understand how the long-term funds are used in the business concern.

Profitability Ratio
- Helps to measure the profitability position of the business concern.

Value Metrics
- Valuation metrics are comprehensive measures of a company’s performance, financial health and
prospects for future earnings.
SUMMARY of RATIOS

Ratio Formula

Gross Margin Percentage Gross Margin / Sales

Earnings per share (common stock) (Net Income - Preferred Dividends) / Average
Number of Outstanding Common Shares

Price-earnings Ratio Market price per share / Earnings per share

Dividend Payout Ratio Dividends per share / Earnings per share

Dividend Yield Ratio Dividends per share / Market price per share

Return on Total Assets (Net Income + [Interest Expense x (1 – Tax rate)])

/ Average Total Assets

Return on common stockholders’ equity (Net Income – Preferred Dividends) / (Average

total stockholders' equity – Average Preferred
Stock)

Book Value per share (Total stockholders’ equity – Preferred stock) /

Number of outstanding common shares

Working Capital Current Assets – Current Liabilities

Current Ratio Current Assets / Current Liabilities

Acid-test Ratio (Cash + Marketable Securities + Accounts

Receivable + Short-term Notes Receivable) /
Current Liabilities

Accounts Receivable Turnover Sales on Account / Average Accounts Receivable

balance

Average Collection Period 365 days / Accounts Receivable Turnover

Inventory Turnover Cost of Goods Sold / Average Inventory Balance

Average Sale Period 365 days / Inventory Turnover

Time Interest Earned EBIT / Interest Expense

Debt-to-Equity Ratio Total Liabilities / Stockholders’ Equity

Average Payment Period Accounts Payable / Average Purchases per day*

*Annual purchases on Credit / 365 days

Fixed Assets Turnover Sales / Net Fixed Assets

Debt Ratio Total Liabilities / Total Assets

Operating Profit Margin Operating Profit / Sales