Answer the following
1. Analyze the role of money and banking in an economy
2. Discuss the key components of the Philippine financial system
and their roles in supporting economic growth
3. Discuss the importance of financial management in businesses
and organizations
4. Evaluate the role of financial markets and institutions in
facilitating economic growth
5. Explain the concept of the time value of money (TVM) and its
significance in financial decision-making
INTRODUCTION TO BASIC
FINANCE
FINANCE
Studies money and its management
Explores the allocation of resources
- in a world of uncertainty
Investors, portfolio managers, and corporate financial managers may
take actions to help manage risk, but risk still exists and is a major
component in the study of finance,
Divisions of finance
Financial Institutions
Concerned with institutional aspect of discipline which encompass the creation of
financial assets, the markets for trading securities, and regulation of financial markets
Investments
Concerned with the analysis of individual assets and the construction of well-
diversified portfolios encompassing financial planning, specifying the investor’s
financial goals, analyzing various securities the the individual may acquire
Business finance
Emphasizes the role of the financial manager – must make certain that the firm can
meet its obligation, determine the best sources of financing, and allocate the firm’s
resources among competing investment alternatives
Key Financial Concepts
Sources of Risk and Financial
Finance Return Leverage
Valuation Assumptions
The Role of
Financial Markets
and Financial
Intermediaries
The role of money
Money is anything that is generally accepted in
payment for goods and services or for the
retirement of debt.
Measures of the Supply of Money
Several measures of the composition of money supply
Total amount of money in circulation
Sum of coins, currency, and demand deposits
Sum of coins, currency, demand deposits, savings accounts, and small
certificate of deposits
Money is crucial to an advanced economy
It facilitates the transfer of goods and resources
An advanced economy could not exist without something to
perform the role of money
The role of interest rates
Money and interest are often used together
Interest rates help allocate scarce credit among competing uses for the funds.
Higher interest rates increase the cost of credit and should discourage
borrowing, so that the scarce credit is directed toward its best usage
Financial
markets and
the transfer of
savings
One of the basic methods that exist for
transferring funds from savers to users is
the Direct investment
Occurs when starting a business and invest savings in the operation
A direct transfer also occurs when securities are initially sold to
investors in the “primary” market.
One of the important purposes of financial
markets is the creation of markets in
existing securities
Transfer ownership of securities among various investors
Indirect transfer through financial intermediaries
When new securities are issued funds are directly transferred from
savers to firms. While the ultimate effect is the same, the transfer
through financial intermediaries create claims on themselves
When a saver deposits funds in a financial intermediary such as a bank,
that individual receives a claim on the bank and not on the firm to
whom the bank lends the funds.
If the saver had lent the funds directly to the ultimate users and they failed, the
saver would sustain a loss. This loss may not occur if the saver lends the money
to a financial intermediary. If the financial intermediary makes a bad loan the
saver does not sustain the loss unless the financial intermediary fails. Even then
the saver may not sustain a loss if the deposits are insured.
The Role of Financial
Management
DEFINITION
The term financial management has been defined by Solomon, “It is concerned with
the efficient use of an important economic resource namely, capital funds”.
The most popular and acceptable definition of financial management as given by
S.C. Kuchal is that “Financial Management deals with procurement of funds and
their effective utilization in the business”.
Howard and Upton : Financial management “as 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”.
Joshep 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.
What is Financial
Management?
Concerns the acquisition,
financing, and
management of assets with
some overall goal in mind.
Financial management is an
integral part of overall
management.
It is concerned with the duties of
the financial managers in the
business firm.
Financial Management is mainly
concerned with the effective funds
management in the business. In simple
words, Financial Management as
practiced by business firms can be
called as Corporation Finance or
Business Finance.
SCOPE OF
FINANCIAL
MANAGEMENT
1.Financial Management and Economics
Economic concepts like micro and macroeconomics are directly applied with the financial
management approaches. Investment decisions, micro and macro environmental factors are closely
associated with the functions of financial manager. Financial management also uses the economic
equations like money value discount factor, economic order quantity etc. Financial economics is
one of the emerging area, which provides immense opportunities to finance, and economical areas
2. Financial Management and Accounting
Accounting records includes the financial information of the business concern. Hence, we can
easily understand the relationship between the financial management and accounting. In the
olden periods, both financial management and accounting are treated as a same discipline and
then it has been merged as Management Accounting because this part is very much helpful to
finance manager to take decisions. But nowaday’s financial management and accounting
discipline are separate and interrelated
3. Financial Management or Mathematics
Modern approaches of the financial management applied large number of mathematical and statistical
tools and techniques. They are also called as econometrics. Economic order quantity, discount factor,
time value of money, present 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
Production management is the operational part of the business concern, which helps to multiple the
money into profit. Profit of the concern depends upon the production performance. Production
performance needs finance, because production department requires raw material, machinery, wages,
operating expenses etc. These expenditures are decided and estimated by the financial department and
the finance manager allocates the appropriate finance to production department. The financial
manager must be aware of the operational process and finance required for each process of production
activities.
5. Financial Management and Marketing
Produced goods are sold in the market with innovative and modern approaches.
For this, the marketing department needs finance to meet their requirements. The
financial manager or finance department is responsible to allocate the adequate
finance to the marketing department. Hence, marketing and financial management
are interrelated and depends on each other.
6. Financial Management and Human Resource
Financial management is also related with human resource department, which provides
manpower to all the functional areas of the management. Financial manager should carefully
evaluate the requirement of manpower to each department and allocate the finance to the
human resource department as wages, salary, remuneration, commission, bonus, pension and
other monetary benefits to the human resource department. Hence, financial management is
directly related with human resource management.
FUNCTIONS OF FINANCE MANAGER
FUNCTIONS OF FINANCE MANAGER
IMPORTANCE OF FINANCIAL
MANAGEMENT
IMPORTANCE OF FINANCIAL
MANAGEMENT
IMPORTANCE OF FINANCIAL
MANAGEMENT
TYPES OF FINANCIAL
DECISIONS
Major types of decisions that finance
manager of modern business:
1. Investment decisions
2. Financing decisions
3. Dividend decisions
All of these decisions aims to maximize shareholders’ wealth
through maximization of the firm’s wealth
Investment Decisions
Most important of the three
When it comes to value
decisions. creation
ØWhat is the optimal firm size?
ØWhat specific assets should be acquired?
ØWhat assets (if any) should be reduced or
eliminated?
Assume this is a manufacturing company’s
balance sheet
Financing Decisions
Determine how the assets will be
financed
üWhat is the best type of financing?
üWhat is the best financing mix?
üWhat is the best dividend policy (e.g.,
dividend-payout ratio)?
üHow will the funds be physically acquired?
Asset Management
Decisions
ØHow do we manage existing assets
efficiently?
ØFinancial Manager has varying degrees
of operating responsibility over assets.
ØGreater emphasis on current asset
management than fixed asset
management.
DIVIDEND DECISIONS
What is the Goal
of the Firm?
Maximization of
Shareholder Wealth!
Value creation occurs when we
maximize the share price for current
shareholders.
OBJECTIVES OF
FINANCIAL
MANAGEMENT
q Profit maximization
q Wealth maximization
PROFIT MAXIMIZATION
1. Profit maximization is also called as cashing per share maximization. It leads to maximize the
business operation for profit maximization.
2. Ultimate aim of the business concern is earning profit, hence, it considers all the possible
ways to increase the profitability of the concern.
3. Profit is the parameter of measuring the efficiency of the business concern. So it shows the entire
position of the business concern.
4. Profit maximization objectives help to reduce the risk of the business.
Main aim is earning profit.
Profit is the parameter of the business
Favorable operation.
Arguments for Profit reduces risk of the business
concern.
Profit
Maximization Profit is the main source of finance.
Profitability meets the social needs
also.
Profit maximization leads to exploiting
workers and consumers.
Unfavorable
Arguments Profit maximization creates immoral
for Profit practices such as corrupt practice, unfair
trade practice, etc.
Maximization
Profit maximization objectives leads to
inequalities among the sake holders
such as customers, suppliers, public
shareholders, etc.
It is vague: In this objective, profit is not defined
precisely or correctly. It creates some unnecessary
opinion regarding earning habits of the business
concern.
Drawbacks of
It ignores the time value of money: Profit maximization
Profit does not consider the time value of money or the net
present value of the cash inflow. It leads certain
Maximization differences between the actual cash inflow and net
present cash flow during a particular period.
It ignores risk: Profit maximization does not consider
risk of the business concern. Risks may be internal or
external which will affect the overall operation of the
business concern.
Wealth maximization is one of the modern
WEALTH approaches, which involves latest innovations
and improvements in the field of the business
MAXIMIZATION concern. The term wealth means shareholder
wealth or the wealth of the persons those who
are involved in the business concern.
Wealth maximization is also known as value
maximization or net present worth
maximization. This objective is an universally
accepted concept in the field of business.
qWealth maximization is superior to the profit
maximization because the main aim of the
Favorable business concern under this concept is to
improve the value or wealth of the shareholders.
Arguments q Wealth maximization considers the comparison
of the value to cost associated with the business
concern. Total value detected from the total cost
for Wealth incurred for the business operation. It provides
extract value of the business concern.
Maximization qWealth maximization considers both time and
risk of the business concern.
qWealth maximization provides efficient
allocation of resources.
qIt ensures the economic interest of the society.
Shortcomings of Alternative
Perspectives
Profit Maximization
Maximizing a firm’s earnings after taxes.
Problems
ØCould increase current profits while harming
firm (e.g., defer maintenance, issue common
stock to buy T-bills, etc.).
ØIgnores changes in the risk level of the firm.
Strengths of Shareholder
Wealth Maximization
ØTakes account of: current and future profits and
EPS; the timing, duration, and risk of profits and
EPS; dividend policy; and all other relevant factors.
ØThus, share price serves as a barometer for
business performance.
Social Responsibility
ØWealth maximization does not preclude
the firm from being socially responsible.
ØAssume we view the firm as producing
both private and social goods.
ØThen shareholder wealth maximization
remains the appropriate goal in
governing the firm.
Corporate Governance
qCorporate governance: represents the
system by which corporations are
managed and controlled.
qIncludes shareholders, board of
directors, and senior management.
qThen shareholder wealth maximization
remains the appropriate goal in
governing the firm.
Board of Directors
✓Typical responsibilities:
✓ Set company-wide policy;
✓ Advise the CEO and other senior executives;
✓ Hire, fire, and set the compensation of the CEO;
✓ Review and approve strategy, significant investments, and
acquisitions; and
✓ Oversee operating plans, capital budgets, and financial
reports to common shareholders.
✓CEO/Chairman roles commonly same person in US, but
separate in Britain (US moving this direction).
Sarbanes-Oxley Act of 2002
ØSarbanes-Oxley Act of 2002 (SOX): addresses corporate
governance, auditing and accounting, executive
compensation, and enhanced and timely disclosure of
corporate information
Ø Imposes new penalties for violations of securities
laws
Ø Established the Public Company Accounting
Oversight Board (PCAOB) to adopt auditing,
quality control, ethics, disclosure standards for
public companies and their auditors, and policing
authority
Ø Generally increasing the standards for corporate
governance
Organization of the Financial
Management Function
Board of Directors
President
(Chief Executive Officer)
Vice President VP of Vice President
Operations Finance Marketing
Organization of the Financial
Management Function
VP of Finance
Treasurer Controller
Capital Budgeting Cost Accounting
Cash Management Cost Management
Credit Management Data Processing
Dividend Disbursement General Ledger
Fin Analysis/Planning Government Reporting
Pension Management Internal Control
Insurance/Risk Mngmt Preparing Fin Stmts
Tax Analysis/Planning Preparing Budgets
Preparing Forecasts
