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Financial Management Course Notes

  • Learning Outcomes (Financial Management Course)

    • 1) Apply the conceptual foundations of financial management to formulate decisions that can create value for the firm.
    • 2) Evaluate financial decisions made by existing corporations or entities to think analytically and independently before making financial decisions.
    • 3) Perform analysis on corporate cases and operations to resolve business problems for evaluating company performance and advising clients.
    • 4) Exhibit competence in financial decision making and tackle business challenges whose decisions and strategies are valued by colleagues and other businesses.
    • 5) Demonstrate a sense of responsibility to carry out research that can be utilized by businesses.

  • Course Introduction

    • Designed for students pursuing a career in Financial Management and in the corporate world.
    • Aims to deepen understanding of analytical tools, financial concepts, and mathematical frameworks of financial management.
    • Covers principles, foundations, and working capital management of a company.
    • Includes computations on time value of money, interests, profit planning, and simple analysis tools.
    • Premise: value-based management, where value creation should guide financial and operating decisions.

  • Module 1: An Overview of Financial Management

    • Learning Objectives:
    • 1) Define and comprehend the meaning of Finance.
    • 2) Determine and understand the three major areas of Finance.
    • 3) Identify the different fields of Finance.
    • 4) Define financial management.
    • 5) Differentiate the legal forms of business enterprises, their advantages and disadvantages.
    • 6) Understand the 10 Axioms that form the foundations of Financial Management.
    • Engage/Explore: Reflect on what comes to mind about Financial Management; watch the video “Financial Manager Career Video” at the provided link.

  • Explain: Evolution and Scope of Finance

    • Finance emerged and developed to answer financial questions for individuals, businesses, and government; decision-oriented in resource allocation.
    • Finance as the transfer of money among individuals, businesses, and governments (process, institutions, markets, instruments).
    • Evolution highlights:
    • Early focus on preservation of capital, liquidity, reorganization, bankruptcy (1930s).
    • 1950s: decision-oriented process for long-term real capital; expanded to cash/inventory management, capital structure, dividend policy.
    • Shift toward creating value for the firm; focus on risk-return relationships and maximizing return for a given risk.
    • Nobel Prize context: Markowitz and Sharpe (risk-return and portfolio management); Miller (capital structure theory).
    • Finance continues to be increasingly analytical and mathematical; hedging products to reduce risk from interest rate and FX changes.

  • What is Finance?

    • Finance is a branch focused on the allocation, procurement, and efficient management of funds to maximize profit, increase firm value, and fulfill social responsibility.
    • It involves estimating and obtaining capital from alternative sources at favorable terms for profitable deployment in operations.
    • Finance is both an art and a science of managing money; aims to attain growth, stability, profitability, and liquidity; determines fund requirements and uses funds to increase firm value and contribute to economic welfare.

  • Major Areas of Finance

    • Three major areas (see Figure reference): 1) Financial Management (Corporate Finance or Business Finance): decisions within a firm; asset selection, financing, cash management, credit, acquisitions; primary goal: maximize firm value.
      • Focuses on what assets to acquire, how to raise capital, and how to run the firm to maximize value.
        2) Financial Institution and Market: banks and intermediation, loans, cash management, interest rates, regulation; capital markets determine interest rates and prices of stocks/bonds; institutions that supply capital include banks, investment banks, brokers, mutual funds, insurance companies; regulators include Bangko Sentral ng Pilipinas and SEC.
        3) Investments: analysis from investors’ viewpoint; security valuation, portfolio construction, performance measurement; sub-activities include security analysis, portfolio theory, and market analysis; behavioral finance as part of market analysis; interconnections exist among banking, capital markets, and corporate finance.

  • Fields of Finance (Five Specialized Areas)

    • 1) Public Finance: government money management, taxation, and policy-guided fund use.
    • 2) Securities and Investment Analysis: buying/selling securities, risk/return techniques, evaluating risk, forecasting performance; analyze legal/investment characteristics, measure risk.
    • 3) International Finance: cross-border money flows, currency restrictions, exchange rates, and international regulatory issues.
    • 4) Institutional Finance: financial institutions (banks, insurance, pension funds, credit unions) and their roles in aggregating and allocating savings.
    • 5) Financial Management: the firm’s problems with funds acquisition, optimal financing mix, and dividend policy within firm objectives; day-to-day and capital markets activities.
    • Note: Despite categorization, these areas are interrelated; e.g., a bank loan requires understanding corporate finance; a treasurer must understand banking; a security analyst benefits from corporate finance knowledge.

  • Major Decisions by a Financial Manager (Three Pillars)

    • a) Allocation (Investment Decision / Capital Budgeting): allocate funds to long-term assets; evaluate prospective profitability and measure return and risk.
    • b) Financing Decision: identify sources of funds and optimal debt/equity mix (capital structure); aim for best financing mix.
    • c) Dividend Decision: decide profit distribution vs retention; relate to working capital and day-to-day liquidity management.
    • Working capital management: ensuring sufficient resources for operations and avoiding interruptions.
    • Note: These decisions relate to both long-term asset decisions and daily financial operations.

  • Finance vs Economics and Accounting; Finance within an Organization

    • Finance grew from economics (future cash flows determine asset value) and accounting (information on cash flow sizes).
    • In organizations, finance interacts with marketing, production, management, accounting, etc.; finance looks forward and evaluates decisions by value impact; accounting provides historical data.
    • Organizational chart basics: Board of Directors (top), Chair (often also CEO), CEO, COO/President, CFO (senior vice president responsible for accounting, financing, credit policy, asset decisions, investor relations). Public firms require CEO and CFO to certify SEC reports; inaccuracies could lead to penalties.

  • Finance and Other Business Functions: Relationships

    • Finance interfaces with marketing (evaluate marketing ROI and profitability), production (evaluate investments in plants/equipment, processes, materials, and manpower), and accounting (historical vs forward-looking data).
    • Finance applies economic principles to manage money; uses accounting data for decision-making; focuses on forward-looking goals rather than solely historical numbers.

  • Modern Finance Function (Four Key Roles)

    • Steward: controls assets and ensures compliance to mitigate risks.
    • Operator: creates strategic framework to monitor finance processes for cost effectiveness.
    • Strategist: acts as strategic advisor to align goals with performance measurement and interpretation of financial information.
    • Catalyst: implements and monitors necessary changes to achieve strategic objectives and support stewards/operators/strategists.

  • A. Treasury Functions and Jobs in Finance

    • Finance prepares students for jobs in banking, investments, insurance, corporations, and government; non-finance majors also need finance knowledge for cross-functional decisions.
    • Example: Marketing programs are evaluated by finance for profitability; management decisions are evaluated in terms of impact on firm value.
    • Career paths (illustrative list): capital budgeting analyst/manager, cash manager, credit manager, financial analyst, treasurer, pension fund manager, benefits officer, project finance manager, property manager (corporate).

  • B. Financial Services: Banking Roles

    • Loan Officer: evaluates credit, manages relationships, negotiates terms, cross-sells services, acts as financial advisor.
    • Credit Analyst: evaluates applications, forecasts cash flows, analyzes financial condition, interacts with lenders.
    • Trust Officer: manages investment portfolios for individuals/institutions.
    • Branch Manager: oversees branch operations (accounts, loans, foreign exchange, customer problems, safes).

  • Securities Sector Roles

    • Financial Planner: advises clients on budgeting, securities, insurance, taxes, retirement, and estate planning; devises comprehensive plans.
    • Investment Banker: underwrites and markets new issues; advises on financing strategies and new financing vehicles.
    • Securities Analyst: studies stocks/bonds, industry-specific, analyzes economic impacts on firms/industries.
    • Stockbroker: acts as agent for buyers/sellers; provides quotes and analyst reports to clients.

  • Real Estate Sector Roles

    • Mortgage Banker: arranges financing for real estate projects; liaises with lenders and borrower to structure terms.
    • Real Estate Lender: construction lenders vs permanent lenders; funds for construction vs long-term financing post-construction.
    • Real Estate Appraiser: estimates market value and conducts cost analyses/feasibility studies.
    • Real Estate Asset Manager: manages real estate assets; negotiates leases; plans capital improvements; controls operating costs.

  • Insurance Sector Roles

    • Insurance Agent/Broker: sells policies; interviews prospects; handles claims and premiums.
    • Underwriter: assesses risks for insurance; evaluates applications and actuarial studies; commercial underwriting for assets.
    • Actuary: uses statistics and math to price policies and assess risk.
    • Loss Control Specialist: identifies hazards to minimize losses; workplace safety programs.
    • Risk Manager: identifies and mitigates risks; may involve employee benefit plans and risk reduction measures.

  • Financial Certifications (Professional Credentials)

    • Certified Financial Planner (CFP) • Chartered Financial Consultant (ChFC) • Chartered Financial Analyst (CFA) • Certified Investment Management Analyst (CIMA) • Certified Management Accountant (CMA) • Chartered Market Technician (CMT)

  • Financial Management: Core Concepts and Decisions

    • Financial Management focuses on how organizations create and sustain value; decisions range across investing, financing, and managing (managerial) aspects.
    • Three core decisions: Investing (capital budgeting), Financing, and Managerial (operational management of finances).
    • These decisions influence the firm’s asset mix and growth, financing strategy, and overall operational efficiency.

  • The Financial Manager’s Responsibilities

    • 1) Forecasting and planning: coordinate with executives to lay out enterprise plans achieving objectives.
    • 2) Major investment and financing decisions: select asset types, efficient asset use, financing to maximize growth potential.
    • 3) Coordination and control: align investments with other executives; monitor financial implications of decisions.
    • 4) Dealing with financial markets: borrowing and trading assets to create or lose value; growth aims benefit customers and employees.

  • Forms of Business Organization

    • Four main forms: (1) Sole Proprietorship, (2) Partnership, (3) Corporation, (4) Limited Liability Company (LLC) / Limited Liability Partnership (LLP).

  • Proprietorships

    • Advantages: easy/cheap to form; few regulations; lower income taxes than corporations.
    • Disadvantages: unlimited personal liability; limited life tied to owner; difficulty raising large capital.
    • Common path: small businesses start as proprietorships and may convert to corporations when growth outweighs advantages of sole proprietorship.

  • Partnerships

    • Similar ease of setup and pro rata income allocation taxed at individual level.
    • Disadvantages: unlimited personal liability for partners; if one partner cannot meet obligations, others are at risk.

  • Corporations

    • Legal entity separate from owners; limited liability for stockholders; easier to transfer ownership; unlimited life.
    • Major drawback: double taxation (corporate earnings taxed; dividends taxed to stockholders).
    • Formation: file articles of incorporation; adopt bylaws; form a board of directors; board appoints officers.

  • LLCs and LLPs

    • LLC: hybrid between partnership and corporation; taxed like a partnership; limited liability; ownership stakes carry voting rights; popular for non-professional firms.
    • LLP: similar to LLC but typically used by professional firms (accounting, law, architecture); taxed like partnerships; partners have liability protection.
    • Comparison: large corporations often still prefer C-corporation status due to capital-raising advantages, liquidity, and broader investor base.

  • Assessment #1 (Practice Task)

    • Write down 5 advantages and 5 disadvantages of each business form: 1) Sole Proprietorship 2) Partnership 3) Corporation.

  • Ten Axioms that Form the Foundations of Financial Management (Axioms 1–10)

    • Axiom 1: The Risk-Return Trade-off – We won’t take on additional risk unless we expect to be compensated with additional return.
    • Example: If you have Php 100,000 in a savings account earning 1.5%, you won’t switch to a risky asset unless the expected return exceeds the opportunity cost plus risk.
    • Axiom 2: The Time Value of Money – A dollar today is worth more than a dollar tomorrow.
    • Concept: money has time value; today’s money can be invested to earn returns; future benefits should be discounted to present value when evaluating projects.
    • Practical implication: present value and future value calculations are used to evaluate projects; decide based on whether benefits exceed costs when brought to present value.
    • Generic representation (conceptual): PV = rac{FV}{(1+r)^t} where r is the discount rate and t is time.
    • Axiom 3: Cash – Not Profits – Is King
    • Focus on cash flows rather than accounting profits; cash in hand can be invested or paid as dividends, whereas profits may not be immediately realized as cash.
    • Axiom 4: Incremental Cash Flows – It’s Only What Changes That Counts
    • Incremental CF = CFwithproject − CFwithoutproject.
    • Used to decide whether to accept a project by comparing the incremental cash flow impact.
    • Axiom 5: The Curse of Competitive Markets – It’s Hard to Find Exceptionally Profitable Projects
    • In competitive markets, large profits attract entrants; sustainable excess profits are difficult; differentiation and cost advantages help create barriers.
    • Axiom 6: Efficient Capital Markets – Prices Reflect All Available Information
    • In an efficient market, stock prices reflect all known information, aligning market value with intrinsic value; true vs perceived values may differ; equilibrium occurs when price equals intrinsic value, marginal investors set prices.
    • Axiom 7: The Agency Problem – Managers Won’t Work for Owners Unless Aligned
    • Separation of ownership and control can lead to managers pursuing their own interests; alignment via monitoring, compensation structures (stock options, bonuses) and governance.
    • Axiom 8: Taxes Bias Business Decisions
    • After-tax incremental cash flows matter; taxes influence investment choices; government incentives (e.g., tax credits) can stimulate R&D and other activities.
    • Axiom 9: All Risk Is Not Equal – Diversification Can Reduce Some Risks
    • Diversification across assets can reduce risk; not all risk is diversifiable; some systemic risk remains.
    • Axiom 10: Ethical Behavior Is Doing the Right Thing, and Ethical Dilemmas Are Everywhere in Finance
    • Ethics and CSR matter; unethical behavior can harm reputation and value; cases include Enron, WorldCom, Merck Vioxx; organizations should have codes of ethics and training; dilemmas require consideration of broader societal impact.

  • Balancing Shareholder Value and the Interests of Society

    • Primary goal of a corporation is to maximize owner value, yet firms must consider social responsibilities to employees, customers, communities, and environment.
    • Example contrasts:
    • Larry Jackson (proprietor) prioritizes personal goals and relationships; shareholders’ perspective vs proprietor’s perspective differ.
    • Linda Smith (public company CEO) must balance shareholder value with social responsibilities; neglecting societal interests can incur costs (reputational damage, regulatory pressure, boycotts).
    • The finance function evaluates decisions by their impact on stock price and shareholder wealth, while recognizing societal constraints and CSR.
    • Stock prices reflect the present value of expected cash flows, which depend on managerial actions, economy, taxes, and political conditions.
    • True vs market vs intrinsic value concepts; intrinsic value is an analyst’s estimate of true value; market price reflects marginal investor perceptions; prices tend to converge to intrinsic value over time.

  • Important Business Trends

    • Globalization: growing cross-border reach; real-time data, global operations (e.g., Walmart, Coca-Cola, IBM); globalization continues to expand.
    • Information Technology (IT) Advancements: improved data collection and analytics reduce risk in investments; historical data informs site selection, market predictions, etc.
    • Corporate Governance: shifts in governance structures; active investors can influence management; proxy access and oversight have evolved (e.g., SEC rules on shareholder access to nominating directors).

  • Business Ethics and Governance

    • Due to financial scandals, there is emphasis on ethics and codes of conduct; ethics influence reputation and long-term value.
    • Examples of ethical issues: balancing transparency vs competitive advantage; handling product risks (Merck Vioxx case) and disclosure timing.
    • Consequences of unethical behavior include bankruptcies (Enron, WorldCom) and reputational damage; governance mechanisms include internal monitoring and external audits.
    • Guidance for employees: consider ethical implications of actions; whistleblowing may be necessary in some cases; consequences of not speaking up can be severe.

  • Conflicts Among Stakeholders: Managers, Stockholders, and Bondholders

    • Managers vs Stockholders: managers may pursue self-serving goals (e.g., excessive salaries); remedies include reasonable compensation, removal of underperforming managers, and the threat of hostile takeovers; compensation should align with long-run stock performance (stock options phased in, performance-based).
    • Stockholders vs Bondholders: stockholders benefit from upside risk while bondholders prefer security; high leverage increases risk to bondholders; covenants are used to limit debt and protect bondholders.
    • Market dynamics: institutional investors have significant influence; shareholder proposals and proxy rules affect governance; hostile takeovers act as checks on management underperformance.
    • Valuation framework: intrinsic value vs market price; managers use valuation models to compare action alternatives; aim for value-based management that aligns with shareholders’ and society’s interests.

  • Intrinsic Value, Market Price, and Information

    • The firm’s actions, economy, taxes, and politics influence cash flows and risk, shaping stock price movements.
    • The stock’s intrinsic value is an estimate by analysts with best data; market price is the actual price determined by marginal investors with imperfect information. Over time, prices tend to converge toward intrinsic value as events unfold.
    • Practical implication: value-based management should focus on long-run intrinsic value rather than short-run price fluctuations.

  • Important Model and Theory References (Conceptual)

    • The asset value is the present value of expected cash flows: V = ext{PV}ig( ext{cash flows}ig) = ext{PV}ig(C1, C2,

    ig).

    • The degree to which information is reflected in prices is central to efficiency; beware of price manipulations that do not affect cash flows.

  • Summary: Why Finance Matters for Exams

    • Finance integrates economics, accounting, and governance concepts to evaluate decisions by their impact on value.
    • Understanding cash flows, risk, markets, and ethical constraints is essential for integrating strategy with financial outcomes.

  • Equations and Key Formulas (LaTeX)

    • Incremental cash flows:
      ext{Incremental CF} = CF{ ext{with}} - CF{ ext{without}}.
    • Present value concept (time value of money):
      PV = rac{FV}{(1+r)^t}.
    • Asset valuation (present value of cash flows):
      V = ext{PV}ig(C1, C2, \, \dots, CT\big) = \sum{t=1}^{T} \frac{C_t}{(1+r)^t}.
    • Axioms 1–4 use basic relationships such as: return, opportunity cost, and risk compensation (conceptual inequalities may be stated as needed).

  • Practical Takeaways for Exam Preparation

    • Be able to explain the three major areas of finance and provide examples for each.
    • Describe the three major decisions of a financial manager (investing, financing, managerial/working capital decisions) and how they relate to the balance sheet.
    • Compare forms of business organizations (sole proprietorship, partnership, corporation, LLC/LLP) including advantages/disadvantages and implications for liability, taxation, and capital raising.
    • Recall the Ten Axioms and be prepared to explain each with an example.
    • Understand the real-world tensions among managers, stockholders, and bondholders and how governance mechanisms address those tensions.
    • Recognize the importance of ethics and CSR in finance and how it affects long-run value and reputation.

  • Quick Reference Links (as provided in the transcript)

    • Financial Manager Career Video: https://www.youtube.com/watch?v=8ATMziMJ1fw
    • Regulatory and market bodies referenced: Bangko Sentral ng Pilipinas (regulates banks) and SEC (regulates securities markets)