Lesson 1:

Introduction to Financial
Management
Chapter Objectives:
 Define Finance and Financial Management
 Enumerate the functions of business finance
 Describe who are responsible for financial management
within an organization
 Identify the major roles of financial managers.
 Describe how the financial manager helps in achieving the
goal of the organization
 Describe the role of financial institutions and markets.
SELF-REFLECTION
Finance in Everyday Life
 What were the things that you incur daily?
 Are you able to save even a small amount out of your
allowance? Do you have any savings or excess cash?
 What did you do with your excess money?
 What did you do if you were short of cash?
 Where did you get additional funds? What other cash
sources do you know?
BASIC KNOWLEDGE:
Finance Defined:
Finance and Financial Management
Finance is the science and art of managing money.
 It addresses matters regarding the management, creation, and
study of money and investments.
 It involves activities such as investing, borrowing, lending,
budgeting, saving and forecasting.
 It involves the use of credit and debt, securities, and investment
to finance current projects using future income flows.
 It can be broadly divided into three categories: public finance,
corporate finance, and personal finance.
Financial Management
Financial Management is the process of managing financial
resources, including management decisions concerning
accounting and financial reporting, forecasting and budgeting.
 It deals with decisions that are supposed to maximize the
value of shareholder’s wealth.
 The goal of Financial Management is to maximize the value
of shares of stocks.
 It has 2 core processes: finance operations and resource
management operations.
 Proper handling of the monetary resources of a business
organization is vital and since cash is the most liquid asset, it
has to be managed efficiently.
Objectives of Financial Management
 Maximizing profits: Provide insights on, for example, rising costs of
raw materials that might trigger an increase in the cost of goods sold.
 Tracking liquidity and cash flow: Ensure the company has enough
money on hand to meet its obligations.
 Ensuring compliance: Keep up with state, federal and industry-
specific regulations.
 Developing financial scenarios: These are based on the business’
current state and forecasts that assume a wide range of outcomes
based on possible market conditions.
 Manage relationships: Dealing effectively with investors and the
boards of directors.
Functions of Financial Managers
1. Raising Capital - this is the most important role of finance which includes making
decisions on how to raise capital for the organization. The financial manager helps to
raise capital economically to ensure that surplus funds do not remain idle or any
shortage of funds does not impede the business operations.
2. Working Capital Management - finance develops a plan to ensure a company’s
smooth daily financial operations. It involves monitoring and controlling the company’s
cash flow, accounts receivable, and inventory and liabilities. The objective is to keep an
optimal balance in order to meet operational demands without tying up excess capital.
3. Investing Capital – the finance team evaluates various investment opportunities to
invest the capital and allocate it to the different streams to generate revenue and make
the organization more profitable. In doing this, they also assess potential risks and
returns.
Functions of Financial Managers
4. Safeguarding Investment – since uncertainty is always prevalent in any organizations,
it is the role of business finance to protect its capital investments. They need to keep
monitoring the investment to maximize profits and lower risks.
5. Risk Mitigation - in today’s era, markets are volatile therefore, risk mitigation plays a
crucial role. Business finance managers ensure the strong financial health of the
company. To enable this, it is important to invest wisely, take calculated risks and
constantly monitor the market. If the financial health of the organization is maintained,
companies need to find alternate ways to raise funds such as refinancing the business,
loan restructuring, and so on.
Functions of Financial Managers
6. Cost Minimization & Profit Maximization – a business finance role is to minimize
the cost of funds to maximize shareholders’ wealth which involves examining all
alternative sources of financing. Measures need to be in place in order to maximize
the firm’s overall profits. Firms may decide to issue bonds instead of stock since
bonds are riskier than stocks; but bonds also cost less than stocks. So, then the firm
accepts the risk of borrowing in exchange for a lower cost of funds.
7. Financial Planning - Financing planning includes confirming the vision and
objectives of the business and drawing a financial plan to achieve these objectives.
To achieve this, the business finance function sets budgets, identifies risks involved
with created budgets. Therefore, financial planning needs to be taken cared of to
ensure the company adapts to changing financial needs. It also involves securing
and managing the current assets of the company.
Budgeting
Budgeting is the act of estimating income and expenses over
a period of time and involves continuous checking of
expenses.
Importance of Budgeting
1. Setting of Goals: Budgeting involves planning. It serves as
a roadmap to achieve the end goal of an individual or an
entity. It prioritizes the objectives and provides a strategy to
allocate the available resources accordingly. A goal can be
to expand the business, save, generate more revenue, etc.
2. Financial Stability: Preparing a well-planned budget helps
in better planning and contributes to the overall financial
stability of the business. A structured budget suggests a
strategy to spend the money which reduces the financial
stress of the business and provides a sense of security.
Importance of Budgeting
3. Decision-Making: As said earlier, a budget is a roadmap to
achieve the goal of the business, it also helps to make
informed decisions according to the end goal of the
business. Entities will sometimes be faced with large
decisions that will impact their inflow and outflow of cash.
With a budget, it would be easy to make better decisions.
4. Identify Income and Expenses: Identifying all the sources
of income and categorizing all expenses ensures that a
business has a comprehensive view of its financial inflows
and outflows. It helps in determining the area where the
spending needs to be controlled.
Importance of Budgeting
5. Coordination: It encourages managers to build
relationships with the other parts of the organisation and
understand how the various departments interact with each
other. This maintains coordination among various
departments in an organisation.
Financial Institutions, Financial Instruments and Financial Markets
Financial institutions are intermediaries that channel the savings of individuals,
businesses, and governments into loans or investments. Examples of financial
institutions/Intermediaries:
 Commercial Banks - Individuals deposit funds at commercial banks, which use
the deposited funds to provide commercial loans to firms and personal loans to
individuals, and purchase debt securities issued by firms or government
agencies.
 Insurance Companies - Individuals purchase insurance (life, property and
casualty, and health) protection with insurance premiums. Insurance companies
pool these payments and invest the proceeds in various securities until they have
funds needed to pay off claims by policyholders. Because they often own large
blocks of a firm’s stocks or bonds, they frequently attempt to influence the
management of the firm to improve the firm’s performance, and ultimately,
the performance of the securities they own.
Financial Instruments, Financial Institutions and Financial Markets
 Mutual Funds - Mutual funds owned by investment companies that enable
small investors to enjoy the benefits of investing in a diversified portfolio of
securities purchased on their behalf by professional investment managers.
When mutual funds use money from investors to invest in newly issued debt
or equity securities, they finance new investment by firms. Conversely, when they
invest in debt or equity securities already held by investors, they are transferring
ownership of the securities among investors.
 Pension Funds - Financial institutions that receive payments from employees and
invest the proceeds on their behalf. Examples are SSS and GSIS.
Financial Institutions, Financial Instruments and Financial Markets
Financial instruments - is a contract that gives rise to a financial asset of one entity
and a financial liability or equity instrument of another entity. They are monetary
contracts between parties that can be created, traded, modified and settled.
When a financial instrument is issued, it gives rise to a financial asset on one
hand and a financial liability or equity instrument on the other.
1. Financial asset
2. Financial liability
3. Equity instrument
4. Debt instrument
Financial Institutions, Financial Instruments and Financial Markets
Financial Asset : is any asset that is:
 Cash
 An equity instrument of another entity
 A contractual right to receive cash or another financial asset from another entity.
 A contractual right to exchange instruments with another entity under conditions that are
potentially favorable.
 Examples: Notes Receivable, Loans Receivable, Investment in Stocks, Investment in Bonds
Financial Liability : is any liability that is a contractual obligation:
 To deliver cash or other financial instrument to another entity.
 To exchange financial instruments with another entity under conditions that are
potentially unfavorable.
 Examples: Notes Payable, Loans Payable, Bonds Payable
Financial Institutions, Financial Instruments and Financial Markets
Equity Instrument is any contract that evidences a residual interest in the assets of an
entity after deducting all liabilities. It generally has varied returns based on the
performance of the issuing company.
 Preferred Stock has priority over a common stock in terms of claims over the
assets and cash dividend declaration of a company. If a company has liquidated
and its assets have to be distributed, all claims to preferred stockholders are given
first prior to distribution to common stockholders. Likewise, dividends to preferred
stockholders are usually in a fixed rate. No cash dividends are given to common
stockholders unless all the dividends due to preferred stockholders are paid first.
 Common Stock on the other hand are the real owners of the company. If the
company’s growth is encouraging, the common stockholders will benefit on the
growth. Moreover, during a profitable period for which a company may decide to
declare higher dividends, preferred stock will receive a fixed dividend rate while
common stockholders receive all the excess.
Financial Institutions, Financial Instruments and Financial Markets
Debt Instruments generally have fixed returns due to fixed interest rates.
 Treasury Bonds and Treasury Bills are issued by the Philippine government.
These bonds and bills have usually low interest rates and have very low risk of
default since the government assures that these will be paid.
 Corporate Bonds are issued by publicly listed companies. These bonds usually
have higher interest rates than Treasury bonds. However, these bonds are not risk
free. If the company which issued the bonds goes bankrupt, the holder of the
bonds will no longer receive any return from their investment and even their
principal investment can be wiped out.
Financial Institutions, Financial Instruments and Financial Markets
Financial Market – is an organized forums in which the suppliers and users of various types of
funds can make transactions directly. It refers to a marketplace where creation and trading of
financial assets (shares, bonds, derivatives, currencies, etc.) take place.
Financial Market Classifications:
1. Primary vs Secondary Markets
 To raise money, users of funds will go to a primary market to issue new securities (either
debt or equity) through a public offering or a private placement.
 The sale of new securities (bonds or stocks) to the general public is referred to as a public
offering. The first offering of stock is called an initial public offering. The sale of new
securities directly to an individual or group of investors is called a private placement.
 Securities holders may decide to sell the securities that have been previously purchased.
This takes place in a financial market in which preowned securities (those that are not new
issues) are traded. These are referred to as secondary markets.
 The Philippine Stock Exchange (PSE) is both a primary and secondary market.
Financial Institutions, Financial Instruments and Financial Markets
2. Money vs Capital Markets
 Money market is a financial relationship created between suppliers and users of
short-term funds. It is a venue wherein securities with short-term maturities are
sold. They are created because some individuals, businesses, governments, and
financial institutions have temporarily idle funds that they wish to invest in a
relatively safe, interest-bearing asset.
 Capital market is a market that enables suppliers and users of long-term funds to
make transactions. Securities with longer-term maturities are sold in Capital
markets. The key capital market securities are bonds (long-term debt) and both
common stock and preferred stock (equity, or ownership).
Financial Institutions, Financial Instruments and Financial Markets

Overview of the Financial System