Fin man mod lectures

Introduction to Financial Management

Finance is the lifeline of a business entity. But finances, like most other resources, are always
limited. It is important for a business to manage its finances efficiently. As an introduction to financial
management, consider the nature, scope, and significance of financial management, along with
financial decisions and planning.

Definitions:
Financial management is the activity concerned with planning, raising, controlling and
administering of funds used in the business.” – Guthman and Dougal

“Financial management is that area of business management devoted to a judicious use of capital
and a careful selection of the source of capital in order to enable a spending unit to move in the
direction of reaching the goals.” – J.F. Brandley

“Financial management is the operational activity of a business that is responsible for obtaining
and effectively utilizing the funds necessary for efficient operations.”- Massie

Financial management : Importance, Nature, and Scope

Financial Management is an organic function of any business. Any organization needs finances to
obtain physical resources, carry out the production activities and other business operations, such
as pay salaries and wages to employees, payment to the suppliers, utilities, and communications .
There are many theories around financial management:

Financial management is all about providing funds needed by a business on terms that are most
favorable, keeping its objectives as company’s thrust. Therefore, this approach concerns
primarily with the procurement of funds which may include instruments, institutions, and practices
to raise funds. It also involves the legal and accounting relationship between an enterprise and
its source of funds.

1. Some businesses believe that finance is all about cash. Since all its transactions involve
cash, directly or indirectly, finance is concerned with everything that concern transactions
done by the business.
2. And finally, financial management includes the procurement of funds and their effective
utilization.
3. For example, in the case of a manufacturing company, financial management must ensure
that funds are available for installing the production plant and machinery and procurement of
raw materials and other cost of production when operations begins. reover, it must also
ensure that the profits adequately compensate the costs and risks borne by the business.
Forms of business organizations
a. Sole proprietorship
b. Partnership
c. Corporation

Sole Proprietorship
Owned by one individual running the business.

Advantages
1. Easily and inexpensively formed
2. Few government regulations
3. The owner pay the business taxes

Limitations
1. Difficult to obtain large amount of capital
2. Unlimited personal liability for the business’s debts
3. Life of the business is limited to the life of the owner

Partnership
Two or more persons bind themselves to contribute money,
property, and industry to a common fund with the intention
of dividing the profits among themselves.

Advantages
1. Easier and inexpensive to organize
2. More personal and informal
3. Combines special skills, expertise, and experience of the partners.

Disadvantages
1. Easily dissolved
2. Mutual agency
3. unlimited liability
4. Difficulty of raising large amount of capital

Corporation
an artificial being created by operation of law having right of succession,the powers, attributes,
and properties expressly authorized by law or incident to its existence.

Advantages
1. Legal capacity and limited liability
2. Continuity of existence
3. Transferability of shares
4. Board of directors as central management
5. Greater ability to acquire funds

Disadvantages
1. Complicated in formation and management
2. Greater degree of government control and supervision
3. High cost of formation and operation
4. Subject to heavier taxation
Business Regulations

a. Secure business permit from LGU (barangay, municipality, city)

b. DTI Registration
c. BIR Registration
d. Securities and Exchange Commission (for partnership and Corporation)

Financial Statements and Reports

Financial statements are annual reports and formal records of the financial activities and position of
a business economic entity. Financial information is presented in a structured manner and in a form
which is complete and understandable.
a. Balance Sheet or Statement of Financial Position
b. Income Statement
c. Statement of Cash Flow
d. Statement of Owner’s Equity
e. Footnotes (part of financial statements) ;

Sample template – Balance Sheet or Statement of Financial Position

It is a statement of firm’s financial position at a given date.

Assets
Are resource controlled by the enterprise as a result of past events that provide future economic
benefits expected to flow to the entity.
Examples:
Cash, Accounts Receivable, Inventories, and Prepaid Expense, Property and Equipment
( Furniture, Fixtures, Equipment, Land, Building)
Current Assets
Its realizable, intends to sell, use, consume it and within the normal operating cycle
Non-Current Assets
Tangible assets held by enterprise to be used in the production of goods and services.
Liabilities
Are obligations that have resulted from past events that give up resulted upon settlements.
Examples:
Accounts Payable, Accruals, Notes Payable (short-term), Bonds Payable

Current liabilities
It’s a present obligations that can be settled within one year.
Long term liabilities
These are obligations that can be settled more than one year.

Owner’s Equity
Residual interest in the assets of the enterprise after deducting the liabilities.

Capital = Sole proprietor

Partner’s Capital = Partnership
Shareholder’s Equity = Corporation
ash Flow Statement

Is a statement showing how much cash the firm is generating and spending.

2 methods of cash flow statement

a. direct

b. indirect

Direct method – shows major class of gross cash receipts and gross cash payments.

Indirect method- profit or loss is adjusted for the effects of noncash items and changes in
operating assets and liabilities.
Components of cash flow statement
operating activities
Investing activities
Financing activities

Operating activities

Normal course of operations:

Ex. Sales - cash received from customer
payment of expenses

Investing activities
Ex. purchase of new assets
sale of old equipment

Financing activities
Ex. Investment by owner
Withdrawals
Long-term borrowings

Footnotes to Financial Statements

Is a summary of additional information that helps explain the company’s operations and
financial position and it is also part of the financial [Link] contains the accounting
methods, principles and systems applied during the accounting year.

FINANCIAL STATEMENT (RATIOS) ANALYSIS

Financial statements provide information about a firm’s position at a specific point in time, as its
operations over some past period.

Investor’s standpoint

a. A. Predicting the future of the entity

b.

Management’s standpoint

B. Future conditions and as a starting point for planning actions that influence the firm’s future
course events.

Uses and limitation of ratio analysis

1. 1. Difficult to develop a meaningful set of industry average for comparative purposes.

2. 2. Most firms want to be better average, so attaining average performance is not good.
3. 3. Focus on industry average leader’s ratios.
4. 4. Inflation distorts balance sheet
5. 5. Seasonal factors can distort a ratio analysis
6. 6. Window dressing
7. 7. Different accounting practices can distort comparisons.
8. 8. Difficult to generalize whether a particular ratio is good or bad
9.
Ratios Analysis
Categories
1. Liquidity ratios -it shows the firm’s ability to pay off debts that are maturing within a year.
2. Asset management ratios – it shows how efficiently he firm is using its assets.
3. Debt management ratios- it shows how the firm has financed its assets as well as the firm’s
ability to repay its long term debt.
4. Profitability ratios – it show how profitability the firm is operating and utilizing its assets.
5. Market value ratios- this brings the stock price and shows what investors think about the firm
and its future prospects.

Liquidity ratios
Liquid Assets – assets that can be quickly converted into cash without having to reduce the
assets price.

a. Current ratio

This is the primary ratio and is calculated ;

Current assets

Current liabilities

Current assets include cash, marketable securities, accounts receivable, and inventories.

Current liabilities consist of accounts payable, accrued wages and short term notes payable to
the bank all of which are due within one year,.

b. Quick or Acid test ratio

The second liquidity ratio which is calculated as

Current asset - inventories

Current liabilities

Inventories are the least liquid of a firm’s current assets; and if sales slowdown, they might not
be converted into cash as expected.

Asset Management ratios

a. Inventory turnover ratio

This show how many times the particular asset is “turned over” during the year, thus.

Cost of goods sold

Inventories

b. Days sales Outstanding also known as Average Collection Period shows how many days
sales are tied up in receivables.

Receivables

Average sales per day

To get ; Average sales per day = annual sales divide by 365 days

c. Fixed assets turnover

Measure’s how effectively the firm uses its plant and equipment.

sales

net fixed assets

to get fixed assets = fixed assets minus depreciation

d. Total assets turnover ratio

Measures the turnover of all of the firm’s assets.

 Sales

Total assets

Debt Management ratios

a. Total debt to total assets

Known also as debt (liabilities) ratio measures the percentage of funds provided by creditors.

Total debt

Total Assets

b. Times-Interest-Earned ratio, thus ;

EBIT

Interest Charges

Earnings before interest and taxes (EBIT)

Profitability ratios

It shows the combined effects of liquidity management,

asset management, and debt management on operating results.

Operating margin = Operating income (EBIT)

Profit margin

Return on total assets = net income

total assets

Return on common equity = net income

common equity

Market Values ratios

Price/earnings ratio

Shows how much investors are willing to pay per peso of reported profits. It is calculated as;

Price per share

Earnings per share

Market/Book ratio

The ratio of stock market to its book value shows an indication of how investors regard the
company.
 Book value per share = Common equity

Shares outstanding

Trend Analysis

An analysis of a firm’s financial ratios over time; used to estimate the likelihood of improvement
or used to estimate the likelihood or deterioration in its financial condition.

The DuPont Equation

A formula that shows that the rate of return on equity can be found as the product of profit
margin, total assets turnover and the equity multiplier . It shows the relationship among asset
management, debt management and profitability ratios.

Financial analysis
It involves using financial data to assess the overall company’s performance and make
recommendation to management on how to improve the operation for the future. It refers to an
assessment of the viability, stability, and profitability of a business. These are reports using
ratios and other techniques, that make the information taken from financial statements and other
reports useful to top management as one of their bases in decision making.
Financial analysis (also referred to as financial statement analysis or accounting analysis
or Analysis of finance) refers to an assessment of the viability, stability, and profitability of a
business, sub-business or project. It is performed by professionals who prepare reports using
ratios and other techniques, that make use of information taken from financial statements and
other reports. These reports are usually presented to top management as one of their bases in
making business decisions. Financial analysis may determine if a business will:

 Continue or discontinue its main operation or part of its business;

 Major purchase of materials in the manufacture of its product;
 Acquisition or rent/lease machinery and equipment use in the production.
 Issue stocks or bank loan for working capital;
 investing or lending capital;

Horizontal analysis of financial statements

It involves comparison of a financial ratio, a benchmark, or a line item over a number of

accounting periods. This method of analysis is also known as trend analysis. Horizontal
analysis allows the assessment of

relative changes in different items over time. It also indicates the behavior of revenues,
expenses, and other line items of financial statements over the course of time.