Intoduction to Financial Management

Finance

Latin: finer meaning "to end" or "to pay". When a person pays his bill, the financial matter has ended

Financial Planning and Analysis

Most business decisions affect the financial resources of a company. The financial manager, therefore, takes part in corporate, strategic and operational planning in an enterprise. His knowledge of economics, particularly, managerial economics, enables him to make projections based on accumulated data and the different options open to management Projections may in the form of estimates of revenue, costs and expenses, required capital outlays, changes in company assets, liabilities and owner's equity and the resulting annual cash flows, payback period, rate of return on investments, earnings per share and similar ratios. Periodic results of operations and financial positions are analyzed to pinpoint areas of possible improvement.

Managing the Company's Liabilities and Owners' Equity

The items concerned in this activity are on the right-hand side of the balance sheet. The financial manager determines the mix of short-term and long-term financing, what particular source is best at a given point in time, and the level at which the debt/equity ratio should be maintained. These are very important because they will affect profitability and liquidity of the enterprise.

7. Proper risk management

Risk management is a task so important to the firm to weigh risks associated with certain business decisions. Buying stocks or investing in something needs risk analysis and assessment. In general, the riskier the project, the higher should be the return. Every management decision involves risk, more so every financial decision. Risk management is a primary task for the financial manager.

4. Effective inventory management;

Similarly, inventories need to be managed effectively. Overstocking is undesirable; it ties up capital. Understocking, likewise, is undesirable because the firm misses sales opportunities that could have increased profits. Purchasing the right inventory at the right time from the right sources gives the company an edge over its competitors. Disposing slow-moving inventories needs to be done, that is why some companies resort to barter in the barter exchanges where slow-moving inventories can be sold.

3. Money markets versus capital markets.

1. Money markets are the markets for short- term, highly liquid debt securities. The New York, London, and Tokyo money markets are among the world's largest. Capital markets are the markets for intermediate- or long-term debt and corporate stocks. The New York Stock Exchange, where the stocks of the largest U.S. corporations are traded, is a prime example of a capital market. There is no hard-and-fast rule, but in a description of debt markets, short-term generally means less than 1 year, intermediate-term means 1 to 10 years, and long-term means more than 10 years.

1. Physical asset markets versus financial asset markets.

1. Physical asset markets (also called "tangible" or "real" asset markets) are for products such as wheat, autos, real estate, computers, and machinery. Financial asset markets, on the other hand, deal with stocks, bonds, notes, and mortgages.

4. Primary markets versus secondary markets.

1. Primary markets are the markets in which corporations raise new capital. If GE were to sell a new issue of common stock to raise capital, a primary market transaction would take place. The corporation selling the newly created stock, GE, receives the proceeds from the sale in a primary market transaction. Secondary markets are markets in which existing, already outstanding securities are traded among investors. Thus, if Jane Doe decided to buy 1,000 shares of GE stock, the purchase would occur in the secondary market. The New York Stock Exchange is a secondary market because it deals in outstanding, as opposed to newly issued, stocks and bonds. Secondary markets also exist for mortgages, other types of loans, and other financial assets. The corporation whose securities are being traded is not involved in a secondary market transaction and thus does not receive funds from such a sale.

5. Private markets versus public markets.

1. Private markets, where transactions are negotiated directly between two or more parties, are differentiated from public markets, where standardized contracts are traded on organized exchanges. Bank loans and private debt placements with insurance companies are examples of private market transactions. Because these transactions are private, they may be structured in any manner to which the relevant parties agree. By contrast, securities that are traded in public markets (for example, common stock and corporate bonds) are held by a large number of individuals. These securities must have fairly standardized contractual features because public investors do not generally have the time and expertise to negotiate unique, non-standardized contracts. Broad ownership and standardization result in publicly traded securities being more liquid than tailor-made, uniquely negotiated securities.

2. Spot markets versus futures markets.

1. Spot markets are markets in which assets are bought or sold for "on-the-spot" delivery (literally, within a few days) Futures markets are markets in which participants agree today to buy or sell an asset at some future date. For example, a farmer may enter into a futures contract in which he agrees today to sell 5,000 bushels of soybeans 6 months from now at a price of $10.275 a bushel. To continue that example, a food processor that needs soybeans in the future may enter into a futures contract in which it agrees to buy soybeans 6 months from now. Such a transaction can reduce, or hedge, the risks faced by both the farmer and the food processor.

Goals of the Financial Manager

1. acquisition of funds with the least cost from the right sources at the right time; 2. effective cash management; 3. effective working capital management; 4. effective inventory management; 5. effective investment decisions; 6. proper asset selection; and 7. proper risk management.

8. Hedge funds

1. are also similar to mutual funds because they accept money from savers and use the funds to buy various securities, but there are some important differences. While mutual funds are registered and regulated by the Securities and Exchange Commission (SEC), hedge funds are largely unregulated. This difference in regulation stems from the fact that mutual funds typically target small investors, whereas hedge funds typically have large minimum investments (often exceeding $1 million) and are marketed primarily to institutions and individuals with high net worths. Hedge funds received their name because they traditionally were used when an individual was trying to hedge risks.

1. Acquisition of funds with the least cost from the right sources at the right time;

Acquiring funds from the right sources at the right time with the least cost provides an advantage toward goal attainment, Establishing the right connection or networking is important in this respect. Sources of funds include banks, financial institutions and financial intermediaries, insurance companies, mortgage and loan associations, and individual and corporate investors.

Utilization of Funds

1 wealth 2. the value of the company, and 3. the value of stakeholders,

Finance Functions

1. Allocating available funds, 2. Acquiring needed funds; and 3. Utilizing these funds to achieve set goals.

Saldana (1997)

added that finance, as a discipline, is concerned with identifying, evaluating, and managing sources and use of cash in order to increase the value of the business enterprise to its present owners. Saldana limited his definition to cash so we can replace it with funds, because if we acquire an asset on account, it is credit that we use to acquire the asset on account, it is credit that we use to acquire the asset and not cash. Credit, therefore, provides fund. By replacing "cash" with "funds", we can define finance as a discipline concerned with identifying, evaluating, and managing sources and use of funds in order to increase the value of the business enterprise to its present owners.

Allocation

determining where to use funds currently available to the firm.

Financial Decision Making

financial decisions require knowledge of economics. The financial manager must have proficiency in managerial economics, Cost benefit analysis is applied. The nature of data used varies depending on whether short-term or long-term financial decisions are being made.

6. Life insurance companies

take savings in the form of annual premiums; invest these funds in stocks, bonds, real estate, and mortgages; and make payments to the beneficiaries of the insured parties. In recent years, life insurance companies have also offered a variety of tax-deferred savings plans designed to provide benefits to participants when they retire.

Short-term Financial Decisions

the financial manager gives more emphasis on items that are affected by current operations such as current assets (cash, marketable securities, receivables, inventories, etc.), current liabilities (accounts and notes payable, current maturities of long-term debts, etc.), working capital, current ratio, net income, and variances between budgeted and actual results of operations. When two or more options are being evaluated, the financial manager applies cost-benefits analysis based on differential revenue costs and expenses and incremental cash inflows and outflows.

1. Investment Banks

traditionally help companies raise capital. They (1) help corporations design securities with features that are currently attractive to investors, (2) buy these securities from the corporation, and (3) resell them to savers. Because the investment bank generally guarantees that the firm will raise the needed capital, the investment bankers are also called underwriters.

Shetty et al (1995)

viewed finance as the operational or practical side of economics, the practical science of the production and distribution of wealth. Production is acquisition while distribution is utilization. Whereas, Webster defines economics as the science of production and distribution of wealth. According to Saldana (1997) , finance is the efficient allocation of scarce resources. So, we can say that finance is the efficient acquisition, distribution/ allocation, and utilization of scarce money/fund resources.

5. Effective investment decisions;

Determining where to invest funds to create additional income is making an investment decision. Too much cash lying in the bank or checking accounts that do not earn interest are not advisable. Any excess cash needs to be invested to earn income, either in the form of interest or dividends. Investing in the right assets is a must for successful management of a firm. Engaging in new projects and buying new assets are investment activities.

Types of Markets

Different financial markets serve different types of customers or different parts of the country. Financial markets also vary depending on the maturity of the securities being traded and the types of assets used to back the securities. For these reasons, it is useful to classify markets along the following dimensions: 1. Physical asset markets versus financial asset markets. 2. Spot markets versus futures markets. 3. Money markets versus capital markets. 4. Money markets versus capital markets. 5. Private markets versus public markets.

Financial Manager and his Primary Activities

(a) financial planning and analysis, (b) managing the firm's assets and (c) managing the firm's liabilities and owner's equity.

Financial Management

- otherwise called managerial finance, is concerned with the management of funds. It is the efficient and effective allocation, acquisition and utilization of funds. The acquisition of funds should always be at the least cost and such funds need to be channeled to fund projects or investments that will maximize benefits, including profit to the organization. - concerned with the maintenance and creation of economic value or wealth (Known et al 1998). At the same time management has social responsibility to all parties interested and affected by organizational decisions. Sometimes, this social responsibility will take priority over profit.

Director of Finance, VP for Finance, or Finance Manager.

- person in charge of the finance function - responsible for the allocation of the financial resources of a company, the acquisition of additional funds needed, and the utilization of these financial resources to attain organizational objectives.

7. Mutual funds

1. are corporations that accept money from savers and then use these funds to buy stocks, long-term bonds, or short-term debt instruments issued by businesses or government units. These organizations pool funds and thus reduce risks by diversification. They also achieve economies of scale in analyzing securities, managing portfolios, and buying and selling securities. Different funds are designed to meet the objectives of different types of savers. Hence, there are bond funds for those who prefer safety, stock funds for savers who are willing to accept significant risks in the hope of higher returns, and money market funds that are used as interest-bearing checking accounts. There are literally thousands of different mutual funds with dozens of different goals and purposes. Excellent information on the objectives and past performances of the various funds are provided in publications such as Value Line Investment Survey and Morningstar Mutual Funds, which are available in most libraries and on the Internet.

2. Commercial Banks

1. such as Bank of America, Citibank, BDO, BPI, PNB, Metrobank, and JP Morgan Chase, are the traditional "department stores of finance" because they serve a variety of savers and borrowers. Historically, commercial banks were the major institutions that handled checking accounts and through which the Federal Reserve System expanded or contracted the money supply. Today, however, several other institutions also provide checking services and significantly influence the money supply. Note too that the larger banks are generally part of financial services corporations as described next.

3. Effective working capital management;

Current assets and current liabilities are used in current operations Managing both current assets and current liabilities and maintaining the right combination (working capital management) allow the company to enjoy a good working capital position that enhances the firm's stability and liquidity, this favors the company in the eyes of creditors and suppliers.

Financial Institutions /Intermediaries

Direct funds transfers are common among individuals and small businesses and in economies where financial markets and institutions are less developed. But large businesses in developed economies generally find it more efficient to enlist the services of a financial institution when it comes time to raise capital. In the United States and other developed nations, a set of highly efficient financial intermediaries has evolved. Their original roles were generally quite specific, and regulation prevented them from diversifying. However, in recent years regulations against diversification have been largely removed; today, the differences between institutions have become blurred. Still, there remains a degree of institutional identity. Therefore, it is useful to understand the major categories of financial institutions. Keep in mind, though, that one company can own a number of subsidiaries that engage in the different functions described next. 1. Investment banks 2. Commercial banks 3. Financial services corporations 4. Credit unions 5. Pension funds 6. Life insurance companies 7. Mutual funds 8. Hedge funds

2. Effective cash management

Effective cash management needs a detailed cash flow budget so that the sources and uses of funds can be carefully planned. Taking advantage of cash discounts in paying trade payables, prioritizing the use of cash, and other similar strategies help in managing cash.

Financial Markets

People and organizations wanting to borrow money are brought together with those who have surplus funds in the financial markets. Note that markets is plural; there are many different financial markets in a developed economy such as that of the United States. We describe some of these markets and some trends in their development.

6. Proper asset selection;

Proper asset selection is important. Selecting the right machinery and equipment needed by a company in its operation is important to attain its production goal that creates sales. Deciding on buying a computer and the type of computer to buy will help the company attain improvement in organizational efficiency,

Managing the Assets of the Company

This activity concerns the left side of the balance sheet. Examples of assets are cash, marketable securities, receivables, inventories, plant, property and equipment. The financial manager determines the mix and type of assets that a business must have and sees to it that they are duly accounted for. "How much must be in the form of cash, receivables, inventories and other current assets?" "How much must be in plant, property and equipment? What are the fixed assets to be acquired?" "Which of the fixed assets already owned must be modified or replaced?" "Are assets duly safeguarded? Who are accountable for them? How effective is the internal control system in the company?"

4. Credit unions

are cooperative associations whose members are supposed to have a common bond, such as being employees of the same firm. Members' savings are loaned only to other members, generally for auto purchases, home improvement loans, and home mortgages. Credit unions are often the cheapest source of funds available to individual borrowers.

3. Finance services corporations

are large conglomerates that combine many different financial institutions within a single corporation. Most financial services corporations started in one area but have now diversified to cover most of the financial spectrum. For example, Citigroup owns Citibank (a commercial bank), an investment bank, a securities brokerage organization, insurance companies, and leasing companies.

5. Pension funds

are retirement plans funded by corporations or government agencies for their workers and administered primarily by the trust departments of commercial banks or by life insurance companies. Pension funds invest primarily in bonds, stocks, mortgages, and real estate.

Financial Manager

decides as to where to get financial resources like cash, inventories, equipment, and other assets needed by the firm in its operation.

Medina (2007)

defined finance as the study of the acquisition and investment of cash for the purpose of enhancing value and wealth.

Managerial Finance

management of funds

Long-term Financial Decisons

must be on items that reflect the long-term nature thereof such as fixed assets (plant, property and equipment), long term debt and owners' equity. The cost benefit analysis is applied considering the degree of risk involved, time value of money, mix of long-term sources of financing, debt/equity ratio and dividend policy

Acquisition

obtaining funds from the right sources at the right time. Utilization means using the funds. The definition will apply to persons and entities (private enterprises and the government) whether they are aiming for profit (increasing wealth) or not (non-profit organization). Funds are needed to finance operations of people and organizations.