Unit 1 Introduction to Financial Management PDF

Victor Ian C. Zoleta, CFIMS, CTP, MBA  What is Finance? Definition & Importance of Financial Management Goals, Objectives and Functions of Finance Finance in the Business World OUTLINE ofof OUTLINE...

Victor Ian C. Zoleta, CFIMS, CTP, MBA  What is Finance? Definition & Importance of Financial Management Goals, Objectives and Functions of Finance Finance in the Business World OUTLINE ofof OUTLINE Types of Business Organization The Financial Manager: Types, Role & Functions, DISCUSSION DISCUSSION Tools Ten Principles of Financial Management Agency Relationship Business Ethics and Corporate Governance Multinational vs. Domestic Firms Misconceptions about Financial Management  Latin word: finer (to end) or (to pay) Noun: management of money. Verb: to provide capital for a person OUTLINE Whatofis or enterprise. DISCUSSION Finance? Function of Finance 1. Allocation of available funds. 2. Acquisition of fund requirements. 3. Utilization of funds to achieve set goals.  FINANCE – concerned with decisions about money. Investors’ Preferences (All else equal..) 1. More value is preferred to less. 2. The sooner cash is received, the more OUTLINE Whatofis valuable it is. DISCUSSION Finance? 3. Less risky assets is more valuable than riskier assets. General Areas of Finance: 1. Financial Markets and Institutions 2. Investments 3. Financial Services 4. Managerial/Business Finance  FINANCIAL MANAGEMENT – concerned with raising, allocating and controlling the funds of the firm. – focuses on decisions relating to the amount and type of assets to acquire, raising the capital needed to buy assets and maximizing the value of OUTLINE of FINANCIAL the firm. DISCUSSION MANAGEMENT Importance of Financial Management: - Achieves the financial goals and objectives in the organization. - Helps the organization in financial planning and forecasting future events. - Interprets the decision-making process based on the results and figures. - Allocates and controls the sources of funds.  Shareholders’ Wealth Profit Maximization Maximization Obtain large amount of Achieve highest market OBJECTIVE profits. value of common stock. 1. Calculating profits is 1. The long term is easy. emphasized. 2. Determining link 2. Risk or uncertainty is GOALS,of OUTLINE ADVANTAGES between financial recognized. OBJECTIVES and decisions and profits 3. Timing of returns are DISCUSSION FUNCTIONS are simple. taken into account. 4. Stockholders’ return is considered. 1. The short term is 1. No clear relationship more emphasized. between financial 2. Risk or uncertainty is decisions and stock ignored. price. DISADVANTAGES 3. Timing of returns does 2. Management anxiety not matter. and frustration may be 4. Immediate resources experienced. are necessary.  How is Finance similar and different to the disciplines of Economics and Accounting? FINANCE in the business world Efficiency + Effectiveness = ? Efficiency – “Doing things right”. Effectiveness – “Doing the right things”. 1.Sole Proprietorship TYPES OF 2.Partnership BUSINESS 3.Corporation ORGANIZATION 4.One-Person Corporation 5.Cooperative*  Business owned by a single person. TYPES OF  Simplest form of legal organization. BUSINESS  No formal procedures to ease business. ORGANIZATION  Profit of the business is taxed as personal income of the owner.  ADVANTAGES DISADVANTAGES 1. Ease of formation. 1. Limited life. 2. Control over 2. Unlimited liability. operations. TYPES OF 3. No profit-sharing. 3. Difficulty in raising capital. BUSINESS 4. Sole decision- 4. Limitation of skills, ORGANIZATION maker. talents and capabilities. 5. Easy termination. 5. Inability to attract or retain good employees.  Composed of two or more persons who agree to contribute money, property or services for the purposes of dividing the profits between or TYPES OF among themselves. BUSINESS  Aggregate concept: Partnership as ORGANIZATION a collection of rights and responsibilities of partners and jointly liable for all the debts and obligations. Allows pooling of resources for some common purposes. Characteristics: 1. Mutual agency 2. Voluntary association TYPES OF 3. Based on contract BUSINESS 4. Limited life ORGANIZATION 5. Unlimited liability 6. Division of profits 7. Co-ownership of contributed assets.  ADVANTAGES DISADVANTAGES 1. Ease of formation. 1. Limited life. 2. Combined capital 2. Unlimited liability. TYPES OF resources. BUSINESS 3. Pooling of skills, 3. Mutual agency. expertise and ORGANIZATION experiences. 4. Less government 4. Difficulty in raising control, supervision capital. and intervention.  An artificial body or being organized in accordance with the provision of law in which ownership is divided into shares of stocks. TYPES OF An artificial body being created by BUSINESS the operation of law having the rights ORGANIZATION of succession and the powers, attributes, and properties expressly authorized by law or incident to its existence. (Corporation Code of the Philippines, Section 1). Characteristics: 1. Separate legal existence. 2. Created by operation of law. TYPES OF 3. Transferable units of ownership. BUSINESS 4. Limited liability of stockholders ORGANIZATION 5. Continuity of existence. 6. Centralized management by Board of Directors.  ADVANTAGES DISADVANTAGES 1. Limited liability. 1. Double taxation. 2. Indefinite life. 2. More government control. TYPES OF 3. No mutual agency. 3. Costly to organize. BUSINESS 4. Ease of obtaining 4. Involved in ORGANIZATION additional capital. decision-making process. 5. Ease of transfer of 5. Dilution of ownership interest. earnings and control. 6. Separate legal entity.  A corporation with a single stockholder.  Single stockholder plays as the sole incorporator, director and president. TYPES OF Offers the full control and authority of a BUSINESS sole proprietorship and limited liability of a corporation. ORGANIZATION  Required to designate a nominee and alternate nominee who shall be indicated in the Articles of Incorporation to replace the single stockholder in case something happens to him/her.  ADVANTAGES DISADVANTAGES 1. Limited liability. 1. Limited Membership to Natural Persons, Trusts, or Estates. TYPES OF 2. Perpetual Existence 2. Complexity 3. No minimum capital 3. Suitable only for small BUSINESS requirement. business. ORGANIZATION 4. Open to foreign investors. 4. No perpetual succession. (Line between the ownership and control is blurred which might result in unethical business practices. 5. Complete control of business.  Member-owned financial institution with a specific goal of meeting the needs of the members based on social, economic and cultural factors. TYPES OF  Must be at least five members and BUSINESS each of them must have equal voting ORGANIZATION rights. Registered with Cooperative Development Authority (CDA) which promulgates rules and regulations to govern all types of cooperatives.  ADVANTAGES DISADVANTAGES 1. Limited liability1. Limited capital. 2. Ease of formation. 2. Lack of managerial TYPES OF expertise. BUSINESS 3. Open membership. 3. Corruption 4. Democratic 4. Lack of interest ORGANIZATION management. 5. Tax concession  Chief Financial Officer (CFO) – oversees the entire financial activity and serves as the adviser in financial matters to the Board of Directors. TYPES OF Treasurer – handles external financing FINANCIAL matters; manages the corporate assets and liabilities, investment portfolio, plans MANAGER the finances, formulates credit policy. Controller – handles internal matters; most of which are financial and cost accounting, taxes budgeting and control functions.  The financial manager plays a crucial role in the goals, policies and success of any firm. 1. Investment Decision – most important of the three decisions when it comes to VALUE CREATION. - Investment serves as the firm’s life support ROLE AND FUNCTIONS system. OF FINANCIAL 2. Financing Decision – finding ways to provide MANAGER money for the activities of the firm (short-term or long-term debt or equity financing) - Finding the best possible financing mix or capital structure for the firm. 3. Dividend Policy Decision – dividend declaration reflects the profitable status of the firm. Finance in the Organizational Structure of the Firm 1. Financial Policy-making - Selecting financial goals, developing financial policies and designing the finance organization. 2. Financial Planning and Budgeting TOOLS OF - Blueprint to follow to reach the goals set. FINANCIAL - Forecasting: integral part of planning process. MANAGER - Financial Planning: sets the course to take to reach the set goals. 3. Financial Analysis - Process of evaluating business performance, projects, investment options and other finance- related activities to determine feasibility and profitability. Figure 1.1 Value of the Firm  The level of return to be earned from an investment should increase as the level of risk goes up. The higher the risk, the greater probability of higher return. 10 PRINCIPLES The lower the risk, the greater probability OF FINANCE of smaller return. Save and invest for future consumption. Investments should provide appropriate compensation for forgone consumption.  10 PRINCIPLES The amount of money today is different from what it will be in the future. OF FINANCE Critical consideration in financial and investment decisions. Helps individuals and firms determine how much money must be placed today to accumulate a future sum given an interest rate for a given period.  Cash is more valuable than any other form of investment. 10 PRINCIPLES Cash flows received can OF FINANCE be reinvested by the firm. More businesses fail for lack of cash flow than lack of profit.  Incremental cash flows are direct consequence of taking a specific course of action. Every investment involves a 10 PRINCIPLES comparison of alternatives. OF FINANCE  Project Evaluation VS. Value Creation : Investing for returns above same risk alternatives. Perfect market conditions:  No entry and exit restrictions. 10 PRINCIPLES  No one producer or buyer large OF FINANCE enough to affect prices.  Identical products are manufactured. How to find projects that create a wealth- competitive market? How can we make markets less competitive?  Price adjustments to new information are quick and correct. Current prices reflect all 10 PRINCIPLES information about the security. OF FINANCE Profit-driven investors. Arrival of information is random. Why should capital markets be efficient?  A potential conflict of interest between the stockholders and managers. (separation of ownership and management). oPrincipal – Shareholders 10 PRINCIPLES oAgents – Managers OF FINANCE Preference toward size over profitability. Attitudes towards risk. Will financial managers work in the shareholders’ best interest?  After-tax cash flows received can be reinvested. Favorable tax status for certain investments affects 10 PRINCIPLES decisions. OF FINANCE Financial leverage is affected by tax status – interest payments are tax-deductible expenses.  Diversification eliminates certain type of risk which creates offsets between good and bad results. Diversifiable: firm-specific; 10 PRINCIPLES unsystematic risk. OF FINANCE Non-diversifiable: market- specific; systematic risk. “Don’t put all your eggs in one basket.” ---- Why?  Doing something that is viewed right by many people. Unethical behavior might be 10 PRINCIPLES damaging and costly. OF FINANCE How does Ethics play an important role in the success of any business organization?  An agency relationship exists whenever a principal (an owner) hires an agent (management) to act on his or AGENCY her behalf. RELATIONSHIP An agency problem results when the agent (management) makes decisions that are not in the best interests of principals (owners).  Managers are naturally inclined to act in their own best interests. STOCKHOLDERS Mechanisms to motivate managers to act in vs. MANAGERS shareholder’s best interest Managerial compensation (incentives) Shareholder intervention Threat of takeover  Business Ethics: A company’s attitude and conduct toward its employees, customers, community, and stockholders (i.e., the firm’s BUSINESS ETHICS stakeholders). and CORPORATE Corporate Governance: The “set of GOVERNANCE rules” a firm follows when conducting business. Good corporate governance generally generates higher returns to stockholders. Some reasons firms “go international”: To seek new markets MULTINATIONAL To seek raw materials CORPORATIONS To seek new technology To seek production efficiency To avoid political and regulatory hurdles  Different currency denominations Economic and legal ramifications FACTORS: Domestic vs. Multinational Language differences Firms Cultural differences Roles of governments Political risk