FINANCIAL MANAGEMENT

Presented by:
Dr. Velissa C. Rubaya

Finance Management or Financial Management

Financial Management is the strategic planning and managing of an individual or organization’s finances
to better align their financial status to their goals and objectives.

Purpose of Financial Management

To guide businesses or individuals on financial decisions that affect financial stability both now and in the
future.

Types of Financial Management

1. Financing

o Acquiring funds, managing debt, and assessing risk when borrowing money for
purchases or to build a company.

o Raising capital.

2. Investment

o Choose where to invest, what to invest in, and how to invest.

3. Dividend

o Create dividend disbursement plan and policy and implement it.

o Suggest modifications when needed and monitor payouts if and when they occur.

Financial Management Cycle

1. Planning and Budgeting - Setting financial goals and creating a plan to allocate resources.

2. Resource Allocation - Distributing funds to prioritize projects or activities.

3. Operations and Monitoring - Implementing plans and tracking financial activities

4. Evaluation and Reporting - Assessing performance and sharing financial results with
stakeholders.

Source

Assignment: August 30, 2024

1. What are the ways on Shareholder’s Wealth Maximization?

2. Assignment Topic/s for Reporting Docs:

Shareholder wealth maximization is the idea that the main goal of a business's managers should be to
increase its stock price as much as possible.
Source

Shareholder wealth maximization means that a company’s primary goal is raising its stock price.

 Shareholder wealth maximization can be a good thing because it gives a firm's managers a clear
objective that builds value.

 However, shareholder wealth maximization can be negative if it encourages questionable

behavior and decisions at the expense of society, the environment, and the company's own long-
term sustainability.

How Shareholder Wealth Maximization Works?

Shareholder wealth maximization is a principle of corporate governance that sets one primary goal for
business managers.

Role of Business Managers

 Why are business firms not seeking profit rather than an increase in share price?

 One reason is that profit maximization does not take the concepts of risk and reward into
account as shareholder maximization does.

 The goal of profit maximization is, at best, a short-term goal of financial management.

Example of Maximizing Shareholder Wealth

For instance, a company that governs itself under the guiding principle of creating a company with
unending intrinsic value would be maximizing its shareholders' wealth.

 Every action it takes would be dedicated to increasing the share price, which makes the company
and its shares ever more valuable to those who invested in it.

 The goal of increasing stock price would supersede all other business goals, not to mention
social and environmental goals.

Ethics of Shareholder Wealth Maximization

There is an idea that businesses focused on money are greedy and don't care about social issues or that
socially responsible businesses can't increase stock values. But a company can be both profitable and
socially responsible.

 Consider the 2008 Great Recession and one of its main causes, the subprime mortgage crisis.
These banks were more concerned about their investment portfolios instead of properly loaning
money to customers, which is their charge.

 Those investment portfolios were filled with toxic assets, which eventually compromised the
operations of many financial institutions and caused the failure of several big banks.
  As a result, their share prices fell right along with them. In this case, greed and a lack of social
concern led to their downfall.

On the other hand:

 After almost failing during the Great Recession, automaker GM turned itself around,
strengthened its ability to withstand future recessions, and developed "greener" vehicles.

 As a result, it realized an increase in its share price.

Note:

 Business firms cannot exist and profit in the long run without being socially responsible.

How do you measure shareholder wealth maximization?

 You can measure shareholder wealth maximization by finding the value of the company's
common stock.

 Measure progress on a per-share basis by seeing how much the company's stock price has
increased, although you must account for any stock splits (or reverse stock splits).
Why is shareholder wealth maximization important?

 Shareholder wealth maximization is important because it provides a guiding objective (subject to

laws and ethical norms) upon which a firm's managers can base their decisions.

 This goal gives the managers clear direction in the face of otherwise competing interests and
priorities.

 It has become one of the most common norms in corporate governance.

GROUP 1
B. Financial Management Environment

1. The economic environment for business

o The economic environment refers to external factors such as economic growth, inflation,
interest rates, and fiscal policies that influence a business's operations and decision-
making processes.

2. The nature and role of financial markets and institutions

o Financial markets facilitate the buying and selling of financial instruments, while
financial institutions like banks and stock exchanges provide services to support these
transactions. They enable capital flow, risk management, and liquidity.

3. The nature and role of money markets

o Money markets deal with short-term borrowing and lending, providing liquidity to
businesses and governments. They facilitate the management of cash flow and short-
term investment needs.

GROUP 2
C. Working Capital Management

1. The nature, elements, and importance of working capital

o Working capital represents a firm's short-term assets and liabilities, critical for
maintaining liquidity and operational efficiency. It includes cash, accounts receivable,
and inventory.

2. Management of inventories, accounts receivable, accounts payable, and cash

o Effective management involves optimizing inventory levels, ensuring timely collection of

receivables, delaying payable payments without penalties, and maintaining sufficient
cash for operations.

3. Determining working capital needs and funding strategies

o Working capital requirements depend on the operating cycle and business nature,
funded through short-term loans, trade credit, or internal cash reserves.

GROUP 3
D. Investment Appraisal

1. Investment appraisal techniques

o Common methods include net present value (NPV), internal rate of return (IRR), payback
period, and accounting rate of return (ARR).
 2. Allowing for inflation and taxation in DCF

o Discounted Cash Flow (DCF) incorporates inflation by adjusting future cash flows and
taxation by accounting for tax impacts on earnings.

3. Adjusting for risk and uncertainty in investment appraisal

o Techniques include sensitivity analysis, scenario analysis, and risk-adjusted discount

rates.

4. Specific investment decisions

o These include lease vs. buy decisions, asset replacement analysis, and prioritizing
projects under capital rationing.

GROUP 4
E. Business Finance

1. Sources of, and raising, business finance

o Businesses finance operations through equity, debt, retained earnings, and hybrid
instruments. Sources include banks, capital markets, and venture capital.

2. Estimating the cost of capital

o Cost of capital is calculated as a weighted average of the costs of equity and debt,
considering risk and return expectations.

GROUP 5
Continuation of E. Business Finance
3. Sources of finance and their relative costs

 Equity financing is more expensive due to dividend expectations, while debt is cheaper but
increases financial risk.

4. Capital structure theories and practical considerations

o Theories include Modigliani-Miller, trade-off theory, and pecking order theory, focusing
on debt-equity mix optimization.

5. Finance for small and medium-sized entities (SMEs)

o SMEs rely on trade credit, bank loans, government grants, and crowdfunding for
financing due to limited access to capital markets.

GROUP 6
F. Business Valuations

1. Nature and purpose of the valuation of business and financial assets

o Valuation determines the worth of assets for mergers, acquisitions, taxation, and
investment decisions.
 2. Models for the valuation of shares

o Popular models include the Dividend Discount Model (DDM) and Price/Earnings (P/E)
ratio.

3. The valuation of debt and other financial assets

o Debt is valued based on present value of future cash flows, while financial assets
consider market prices and intrinsic values.

4. Efficient market hypothesis (EMH) and practical considerations in the valuation of shares

o EMH suggests share prices reflect all available information, influencing valuation based
on market efficiency.

GROUP 7
G. Risk Management

1. The nature and type of risk and approaches to risk management

o Risks include financial, operational, and market risks, managed through diversification,
insurance, and hedging.

2. Causes of exchange rate differences and interest rate fluctuations

o Exchange rates are affected by trade balances, inflation, and geopolitical events, while
interest rates depend on monetary policy and economic conditions.

GROUP 8
Continuation of G. Risk Management
1. Hedging techniques for foreign currency risk

 Techniques include forward contracts, options, and currency swaps.

2. Hedging techniques for interest rate risk

o Interest rate risks are hedged using futures, options, and interest rate swaps.

GROUP 9
H. Employability and Technology Skills

1. Use of computer technology to efficiently access and manipulate relevant information

o Tools like spreadsheets, databases, and accounting software improve data analysis and
decision-making.

2. Work on relevant response options, using available functions and technology, as would be
required in the workplace

o Tasks include generating financial reports, evaluating options, and leveraging software
for problem-solving and communication.
Financial Management: Definition, Types, Functions & Example

29 May, 2024- By Hoang Duyen

Financial management is a cornerstone of any successful organization. It involves planning, organizing,

controlling, and monitoring financial resources to maximize value and ensure stability. Understanding
financial management is essential for businesses of all sizes, as it influences every aspect of an
organization's operations and growth.

In this article, we will delve into the fundamental aspects of financial management, exploring its
importance, core functions, and the three main types that define its scope. Additionally, we will illustrate
these concepts with a practical example, providing a comprehensive overview of how financial
management supports organizational success.

What is financial management?

Financial management is the process of planning, organizing, directing, and controlling financial
activities within an organization or individual setting. Its primary goal is to manage the financial
resources efficiently to achieve the organization's objectives and maximize value. This field includes a
range of activities such as budgeting, forecasting, investment analysis, managing cash flow, and ensuring
financial stability and growth.

Here's a breakdown of what financial management entails:

 Individuals: Financial management involves budgeting, saving, investing, and making sound
financial decisions to achieve personal financial goals like buying a house, saving for retirement,
or paying down debt.
  Organizations: Financial management is concerned with managing the company's finances to
maximize profit, ensure financial stability, and make good investment decisions. It involves tasks
like financial planning, capital budgeting, and risk management.

In general, financial management is about taking control of your money and using it strategically to reach
your financial objectives.

Effective financial management is essential for the sustainability and growth of any organization. It
ensures that financial resources are used efficiently, financial risks are managed, and financial goals are
achieved.

Importance of financial management

Financial management is crucial for the sustainable development of both organizations and individuals.
Here are key reasons highlighting its importance:

Efficient Resource Utilization

Financial management ensures that financial resources are used effectively. It involves planning and
controlling financial activities to optimize resource allocation, minimize waste, and maximize value.

Financial management ensures that the most critical and high-return projects receive the necessary
funding, supporting organizational priorities and growth.

Financial Stability and Growth

Financial management allows for the identification of potential financial issues and the development of
strategies to address them.
Companies need to manage costs and optimize revenue. Financial management helps them in
maximizing profits. It involves cost control measures, efficient pricing strategies, and identifying
profitable investment opportunities.

Effective financial management helps you weather unexpected events and emergencies. An emergency
fund can act as a buffer for job loss, medical bills, or other unforeseen circumstances. Financial stability
brings peace of mind and allows you to focus on other aspects of your life.

Investor Confidence

Strong financial management practices enhance investor confidence. Transparent financial reporting
and efficient management of financial resources reassure investors about the organization’s financial
health and ability to generate returns.

In summary, financial management is fundamental to the effective operation of any organization. It

provides the framework for decision-making, supports strategic planning, ensures regulatory
compliance, and enhances overall financial health and performance.

Functions of Financial Management

Financial management translates financial objectives into actionable steps through a variety of functions.
Here are some key functions that financial managers perform:

Planning and Forecasting

The scope of financial management is broad and integral to the overall success of an organization. It
creates financial roadmaps, budgets, and projections to ensure the organization or individual has enough
funds to meet short- and long-term goals.
Financial management plays a vital role in strategic planning. It involves setting long-term financial goals
and developing strategies to achieve them, aligning financial planning with the organization’s overall
strategic objectives.

Dividend Policy

For organizations, financial management includes determining how much profit to distribute to
shareholders as dividends and how much to retain for reinvestment in the business. This decision
impacts shareholder value and the organization’s capital structure.

Financial Analysis and Reporting

Financial statement analysis is the process of evaluating, quantifying, and making judgments about the
financial performance of a business based on the information available in its financial statements.
Financial reports include three main parts:

 Balance sheet: Provides information about a business's assets, liabilities, and equity at a certain
time.

 Business performance report: Summary of a business's revenue, costs, and profits.

 Cash flow statement: Shows the business's cash inflow and outflow.

Purpose of financial statement analysis:

 Evaluate the current financial situation of the business.

 Identify the strengths, weaknesses, opportunities, and threats of the business.

 Compare your business's financial performance with other businesses in the same industry.

 Predict a business's future financial performance.

 Support decision-making for investment, lending, business, etc.

Sustainability

Financial management plays a key role in helping businesses develop sustainably. A reasonable financial
strategy not only focuses on short-term profits but also ensures long-term, stable, and responsible
development for stakeholders.

Long-term financial strategies need to be consistent with the sustainable development goals of the
business, including financial and non-financial goals, and be adjusted promptly according to changes in
the business environment. Integrating environmental, social, and governance (ESG) factors into financial
strategies will help businesses develop sustainably and be responsible to society and the environment.

Risk Management

Financial management involves identifying, assessing, and managing financial risks. It includes managing
market risk, credit risk, and operational risk, thereby protecting the organization from potential financial
losses and ensuring long-term viability.
Financial management helps you create a plan to manage and pay off debt effectively. So, it can save you
money on interest payments and free up resources for other financial goals.

Decision Making

In a complex business environment, financial management plays an important role in supporting

businesses in making strategic decisions. Specifically, financial management can help businesses with the
following decisions:

 Investment: Financial management provides an analysis of the benefits and risks of investment
projects. Businesses can make decisions on whether to invest in new projects, expand
operations, or upgrade infrastructure.

 Risk management: By assessing and managing financial risks, financial management helps
businesses understand and minimize risks that can affect the financial stability of the business,
from choosing appropriate co-insurance to capital structure optimization.

 Capital matters: Financial management provides information and analysis on how to optimize a
business's capital structure, including the management of debt, equity, and cash flow.

 Financial strategy: Financial management supports businesses in determining and implementing

financial strategies consistent with current business goals and conditions. Making decisions
about capital structure, cost of capital, and cash policy depend on thorough analysis from
financial management.

 Mergers & Acquisitions (M&A): In M&A transactions, financial managers play an important role
in assessing the value and risk of target companies, as well as determining how financing
supports the integration process, consolidation, or acquisition.

In short, financial management is part of a business's daily operations and a prominent source of
information to support strategic decisions and sustainable development.

These functions are interrelated and work together to achieve the overall objectives of financial
management. Financial managers should constantly monitor and adapt these functions based on
changing market conditions, business needs, and individual circumstances.

What Are the Three Types of Financial Management?

Financial management can be broadly categorized into three main types, each focusing on different
aspects of managing financial resources within an organization. These three types are:

Capital Budgeting

Capital budgeting is the process businesses use to evaluate potential long-term investments, such as
new machinery, building a new factory, or launching a new product line. It's essentially deciding whether
a project is worth the financial commitment. The primary goal is to allocate resources to projects that
will maximize the company's value and generate the highest returns over time.

Key activities in capital budgeting involve assessing the potential returns and risks associated with
investment opportunities. Techniques such as Net Present Value (NPV), Internal Rate of Return (IRR),
and Payback Period are used to evaluate projects. Based on these evaluations, decisions are made on
whether to pursue or reject investment projects, ensuring they align with the company’s long-term
strategic objectives.

The Capital Budgeting Process:

 Project Identification: Identifying potential investment opportunities that align with the
company's overall strategy.

 Cash Flow Estimation: Forecasting the project's expected cash inflows (revenue from the
project) and outflows (initial investment, ongoing costs).

 Risk Assessment: Evaluating potential risks associated with the project, such as market
fluctuations or technological advancements.

 Capital Budgeting Techniques: Applying various methods to analyze the project's financial
viability. Common techniques include:
- Net Present Value (NPV): Calculates the present value of all future cash flows from the project. A
positive NPV indicates the project is expected to generate profit.

- Internal Rate of Return (IRR): The discount rate at which the NPV equals zero. If the IRR is higher than
the company's minimum acceptable rate of return (MARR), the project is considered acceptable.

- Payback Period: The time it takes for the project's cash inflows to recover the initial investment. A
shorter payback period is generally preferred.

 Project Selection: Based on the analysis, the company decides whether to accept, reject, or
modify the project.

Capital Structure

Capital structure focuses on how a business finances its operations and growth. Financial managers
determine the optimal mix of debt and equity financing. Debt financing involves borrowing money, while
equity financing involves issuing stock. There are two primary components of capital structure:

 Equity: Equity financing involves raising funds by selling ownership shares in the company,
typically through issuing stocks or shares. Shareholders invest in the company in exchange for
ownership rights and potential dividends. Equity does not need to be repaid but entitles
shareholders to voting rights and a share of profits.

 Debt: Debt financing involves borrowing funds from external sources, such as banks, financial
institutions, or bondholders, with the promise of repayment with interest over a specified
period. Debt instruments may include loans, bonds, or other forms of borrowing. Debt financing
allows companies to leverage their assets and operations without diluting ownership, but it
increases financial leverage and requires regular interest payments.

Factors Affecting Capital Structure:

 Industry: Different industries have different risk profiles and typical capital structures. For
example, utilities might rely more on debt because their cash flows are predictable.

 Profitability: Companies with a history of stable profits are more likely to qualify for favorable
debt terms, making debt financing more attractive.

 Growth Stage: Startups may rely more on equity financing, while established companies may
have a mix of debt and equity.

 Tax Considerations: In some cases, interest payments on debt are tax-deductible, making debt
financing more appealing.

The main capital structure aims to minimize the cost of capital and maximize the company’s value by
finding the right balance between debt and equity.

Key activities include analyzing the cost of various financing options, such as equity, debt, and hybrid
instruments, and evaluating their impact on the company's risk profile and overall financial health.

This type of financial management involves making decisions on issuing new equity, taking on debt, or
restructuring existing financing arrangements to maintain an optimal capital structure.
Working Capital Management

Working capital management is an important aspect of corporate financial management, ensuring the
company has enough resources to maintain daily operations and meet short-term obligations.

Key Components of Working Capital Management:

 Current Assets: These are resources that can be readily converted into cash within a year. They
include:

- Inventory: Raw materials, work-in-progress, and finished goods a company holds for sale.

- Accounts Receivable: Money owed by customers for goods or services purchased on credit.

- Cash and Cash Equivalents: Highly liquid assets such as cash in hand, bank deposits, and short-term
investments.

 Current Liabilities: These are short-term financial obligations that must be paid within a year.
They include:

- Accounts Payable: Money owed to suppliers for goods or services purchased on credit.

- Short-Term Loans: Borrowings from banks or other financial institutions that need to be repaid within a
year.

- Accrued Expenses: Expenses incurred but not yet paid, such as salaries or utilities.

Strategies for Effective Working Capital Management:

 Managing Inventory Levels: Maintaining optimal inventory levels to avoid stockouts while
minimizing storage costs and the risk of obsolescence.

 Collecting Debts Promptly: Implementing efficient credit control practices to ensure timely
payments from customers and reduce the amount of outstanding receivables.

 Optimizing Payment Terms: Negotiating favorable payment terms with suppliers to extend
payment deadlines and improve cash flow.

 Managing Short-Term Financing: Utilizing short-term loans or lines of credit strategically to

bridge temporary cash flow gaps.

Worthy financial management will reduce risks such as insufficient cash to meet financial obligations,
customers not paying on time or not paying, inventory being obsolete, damaged, or lost, or changes in
interest rates affecting the cost of working capital loans.

 The optimal capital structure is not only a combination of debt and equity but must also be
consistent with the strategic goals and financial capabilities of the business. Managing capital
structure flexibly and prudently will help businesses optimize capital costs, maintain liquidity,
and achieve sustainable growth.

 Managing short-term assets and liabilities is an important factor that helps businesses maintain
solvency and operate effectively. At the same time, short-term debt management requires
 adjusting payment terms with suppliers to optimize cash flow and selecting suitable short-term
loan sources with reasonable loan conditions and interest rates. Financial indicators such as the
current ratio, quick ratio, and cash conversion cycle need to be closely monitored to evaluate the
solvency of the business.

 Ensuring sufficient liquidity to meet an organization's immediate and future cash needs is an
important task in corporate financial management. Liquidity is a business's ability to convert
assets into cash quickly to meet short-term financial obligations. To maintain liquidity, businesses
need to perform accurate cash flow forecasting, ensuring enough cash to cover daily operating
expenses and debts due. Businesses should manage payables well, negotiate favorable payment
terms with suppliers, and make the most of payment terms to maintain stable cash flow. They
can use financial tools such as bank credit and short-term loans to boost liquidity.

Example of Financial Management

Let's consider a mid-sized manufacturing company, ABC Manufacturing, which produces electronic
components. The company is looking to expand its operations by opening a new production facility to
meet increasing demand.

Capital Budgeting Example

ABC Manufacturing plans to invest in a new production facility. The management team needs to evaluate
the feasibility of this investment.

 Identifying Investment Opportunities

ABC Manufacturing has observed a significant increase in demand for its products in the market. This
surge in demand may be due to various reasons, such as changing consumer preferences, emerging
market opportunities, or increased sales efforts.
ABC Manufacturing wants to capitalize on this demand and maintain its competitive position, so it must
scale up its production capabilities.

 Estimating Cash Flows

The financial team estimates the initial investment required, including land purchase, construction costs,
machinery, and initial working capital. Let's say the total investment required is $10 million.

They forecast future cash inflows from increased production and sales. They estimate annual net cash
inflows of $2 million for the next 10 years.

 Evaluating Investment

The financial team evaluates the project by using capital budgeting techniques like Net Present Value
(NPV) and Internal Rate of Return (IRR).

- NPV Calculation: Assuming a discount rate of 10%, the NPV of the project is calculated. If the NPV is
positive, the project is considered viable.

- IRR Calculation: The IRR is calculated to compare it with the company’s required rate of return. If the
IRR exceeds the required rate, the project is considered attractive.

 Decision Making

Based on the positive NPV and an IRR of 15%, which is above the required return, the management
decides to proceed with the investment.

Capital Structure Management Example

To finance the construction of the new production facility, ABC Manufacturing must carefully evaluate
and determine the optimal mix of debt and equity financing. This decision involves weighing the
advantages and disadvantages of each financing option and considering various factors such as the
company's financial position, risk tolerance, cost of capital, and future cash flow projections.

 Assessing Financing Options

The financial team evaluates different financing options: issuing new equity, taking a loan, or a
combination of both.

They analyze the cost of debt, which is the interest rate on loans, and the cost of equity, which is the
expected return by shareholders.

 Determining Optimal Mix

They decide to finance 60% of the project through debt and 40% through equity.

Debt Financing: ABC Manufacturing secures a loan of $6 million at an interest rate of 5%.

Equity Financing: They issue new shares to raise $4 million.

 Impact Analysis
The financial team assesses the impact of this financing decision on the company’s balance sheet and
overall financial health.

They ensure the company maintains a healthy debt-to-equity ratio, balancing financial risk and cost of
capital.

Working Capital Management Example

With the new production facility, ABC Manufacturing needs to manage its short-term assets and
liabilities effectively.

 Managing Cash Flow

The financial team at ABC Manufacturing plays a crucial role in ensuring the company's financial stability
and liquidity by carefully managing cash flow.

The financial team develops a detailed cash flow forecast that projects the company's expected cash
inflows and outflows over a specified period, typically monthly or quarterly.

This forecast takes into account various sources of cash inflows, such as sales revenue, investments, and
financing activities, as well as cash outflows, including operating expenses, debt repayments, and capital
expenditures.

 Inventory Management

They implement inventory management techniques to optimize stock levels, reducing holding costs
while ensuring sufficient inventory to meet production needs.

Techniques like Just-In-Time (JIT) inventory are considered to minimize excess inventory.

 Accounts Receivable and Payable

The financial team establishes credit policies to manage accounts receivable, ensuring timely collection
of payments from customers.

They negotiate favorable payment terms with suppliers to manage accounts payable effectively,
balancing cash flow needs.

Outcome

ABC Manufacturing successfully expands its operations by effectively managing capital budgeting, capital
structure, and working capital. The new production facility increases capacity, meeting market demand
and enhancing profitability. The optimal financing mix reduces the cost of capital, and efficient working
capital management ensures smooth operational performance.

This example illustrates how different aspects of financial management are integrated to support
strategic decision-making and achieve the company's growth objectives.

Conclusion

Financial management is essential for the effective use of financial resources, playing a critical role in
supporting strategic planning, driving business growth, and ensuring long-term financial health. By
understanding and implementing sound financial management practices, organizations can ensure
financial health, strategic success, and long-term value creation for their stakeholders.

Financial management skills are essential not only for businesses but also for individuals. You can
practice your Financial Skills when participating in Skilltrans courses here!