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The Fundamentals of Financial Management

This document discusses the role and scope of financial management. It covers the following key points: 1. Financial management involves financial planning, cash management, and raising funds. This includes tasks like cash budgeting, raising money through stock/bond sales, and borrowing. 2. Cash budgeting is important for maintaining adequate cash flow and avoiding insolvency. Financial executives must plan investment and inventory to promote economic stability. 3. Raising funds can be done through partner/shareholder investment, borrowing through notes/bonds, or leasing property instead of purchase. Short and long-term leasing and borrowing are discussed.

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0% found this document useful (0 votes)
33 views32 pages

The Fundamentals of Financial Management

This document discusses the role and scope of financial management. It covers the following key points: 1. Financial management involves financial planning, cash management, and raising funds. This includes tasks like cash budgeting, raising money through stock/bond sales, and borrowing. 2. Cash budgeting is important for maintaining adequate cash flow and avoiding insolvency. Financial executives must plan investment and inventory to promote economic stability. 3. Raising funds can be done through partner/shareholder investment, borrowing through notes/bonds, or leasing property instead of purchase. Short and long-term leasing and borrowing are discussed.

Uploaded by

Nicole Lasi
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© © All Rights Reserved
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Chapter 1

Introduction
THE FUNDAMENTALS OF FINANCIAL MANAGEMENT
ROLE of Financial
Management
1. In the past,To secure funds needed by the business enterprise.
2. Present important developments have changed that. The recognition thath business and industry
must operate within highly competitive atmosphere necessited management to use it resources
economically and effciently. One source is financial.

Financial Management
- Is charged with important and significant tasks and responsibilities
The Financial executives An Overview
Members of the Financial Executives Institute have major financial responsibilities in their companies.

01
Chairman of the Finance
Committee of the board of Financial Executives have a wide range of
Directors responsibilities .His function and activities are in the
pursuit of company goals and objectives. Among

02 Vice President of
Finance
these is the concerted effort to achieve an
optimum financial scheme of things for the firm
to maximize the welfare price of shares

03
combined with their risk-aversion
Controller characteristics. This involves decision regarding
the optimum structure of assets and the style
financing which is the best available methods by
which capital is secured ,allocated and adjusted.

04 Chief Financial
Officer
Expanding Role of Financial
Management
The expanding role of the financial executive and his contributions to the success of many large corporations is
very evident. We shall not dwell at lenghth on the functions of the Vice President of Finance, trhe Chief Financial
Officer and the Treasurer .We will see them all as Financial executives.

The Controller
as a financial executive is applied to various accounting positions, the duties
of which vary from one company to another.

in Smaller firms -the controller is nothing more then a glorified senior book keeper
in Bigger firms -the controller is a key executive. In most firms, the controller is between two extremes. In
this book , he or she is the chief management accounting executive and as one of the financial executives
decides and recommends objectives, set goals and involves himself heavily with these goals.
• The function of top and financial management is manage a business which can achieve its
objectives within the exixting framework of the economy and the objective of the nation’s
economy.
The following statements express this :
• “The decisions made by business, when added together ,are crucial for making the economy
stable or unstable. The individual businessmean should do everything he can to make the
economy more stable ,consistent with his responsibility for economic efficiency and
expansion.”
• First of all, the businessman can improve the things he does.He can develop new products to
satisfy new demands, wants and needs .He may improve his production methods to cut costs
and bring more products.He can improve his selling techniques.
• For instance, he can plan his investment with more attention to prospects for the long range
growth of the economy. He can keep hi inventory down to the minimum level needed for
efficient operations and avoid speculation.
• Extreme inventory fluctuations have been a major factor in past economic instability. He can
Build up his financial strength during good timrd for recession times.
SCOP
E
OF
Financial
mangement
The following finance function in business make up the broad areas of
financial management :
01 financial Planning
Includes the preparation and transition of the short and long-term plans and programs of a business enterprise
into terms of the funds needed to consummate such plans and programs. It also determines the most desirable and
economical way to acquire funds and the control over the expenditure of such funds, and the appraisal of the
results of these expenditures. It includes:

A.Cash budgeting
A major responsibility of financial management is to maintain an adequate cash position to enable the business to
meet possible contingencies. This is composite reflection of all the operating budgets in terms of Cash Receipts and
Disbursements .Its main objective is to determine the remaining cash resources that will be available
during the period. This will help the company know if they can carry the program by obtaining additional
capital or invest its excess funds.
A.Cash budgeting
In the same manner ,the financial executive may able to foresee through cash budget if he will have
sufficient funds to repay its loan.

A profitable business, as indicated by its PROFIT or LOSS STATEMENT may be starved for cash and
may in fact be in danger of TECHNICAL INSOLVENCY OR TEMPORARY INSOLVENCY . A
state of technical insolvency exists when a business enterprise is unable to meet cash payments due on
contractual obligations. The lack of cash to meet payments of accounts payable, wages, taxes and depts
retirement will constitute technical insolvency although the business enterprise may have substantial and
adequate value of assets.

On the other hand, LEGAL INSOLVENCY exist when assets amount to less than its recorded
liabilities as brought by successive losses. This creates a deficiency in the owners equity account
and renders it incapable of supporting the business enterprise’s legal liabilities. The business
enterprise may be liquid and current with its bills, but it can be legally solvent may types of
financial institutions, legal insolvency forces the enterprise into immediate bankruptcy status.
b.Raising money
Raising cash may partake of two ways:

One is raising money directly from the owners. With partnerships, the partners have to
pool additional funds to meet the growing needs of the businesses. The limitation to this method of
financing is when the partners suffer from a dearth of financial resources and are unable to invest
additional funds. To get out of this predicament, credit facilities, principally banking institutions are
to be availed of. This may mean that partners have to pay interest for the use of money. With respect
to corporations, is the sale of shares of ownership interest in the form of common and
preferred stocks is one way of raising money for the business use. This is a common method of
financing. Like any other method, it suffers from the limitation in that the corporation cannot issue
additional shares of stocks in excess of the authorized capital unless permission is first obtained
from the State.
BORROWING
C. FUNDS
This can be in long-term or short-term. This method of financing shall be the subject of a
detailed discussion in the later part of this book.

d.Raising Funds Through the Sale of Notes and Bonds


When funds are needed for long-term finance are described as “secured promissory notes of the
issuing corporation regardless of the time of maturity “, while notes include “all unsecured secured
promises to pay. Another distinction between the two Is that a debt due less than one year from date of
issue is usually called a note.
e. Leasing Property is another alternative to buying it and raising funds
to finance the purchase.

The use of a lease has become an important method by which a corporation may
expand its sale of operations without acquiring title to the needed sate Both as means of
expansion of single corporation and as method of combining properties of two or more
companies for operating purposes, the lease plays a significant role in business finance.
The Short-term lease is used by small businesses for renting of offices stores and some
factories. A short-term lease may be inconvenient for the tenant since the rent is subject to
change upon renewal. Long-term leases cover the use of buildings, factories, real
estate, mining and others: Long-term leases generally include an option that permits the
lessee to purchase the leased property.
02 Cash MAnagement
Profit is the prime object of any business. Whether it is able to achieve this goal or not depends on a
number of important factors, one of which is the manner by -which the working capital is used.
Management of the money resources of a business covering cash and marketable securities - include
functions such as:

A.Handling Cash Receipts


Cash receipts from operations consist of cash sales and collections of receivables representing sales on credit terms.
The distribution of cash receipts from sales throughout the budget depends upon the following: 1 )the regularity of
sales 2) the proportions of cash and credit sales 3) the terms of sales 4) the amount collected from receivables
Business on cash basis only are affected by the regularity of total sales. Some business enterprises enjoying a
stable income are also affected by seasonal influence. This is proven in the case of textbooks. Their sales coincide
with the beginning of the school semester.
B.Cash, Disbursements for Operations
The most important group of disbursements from business operations are developed
from the sales estimates. In small businesses, it is possible to arrive at disbursements for
operation even in the absence of complex budgetary system. However, in larger business
concerns, each major item of disbursement is itself the result of subsidiary or
departmental budget. In certain respects, estimated cash disbursements for operations are
easier to allocate to specific budgetary. periods than are cash receipts. The payroll must be
met on definite dates and others, such as discounts on purchases on account, should be
taken advantage of
c.Custody of Petty Cash Funds
Even though the business policy is to make all payments by checks, there are
occasions when it is necessary to pay cash. For example, payments for office supplies that
must be procured immediately in order not to impede the work Now in the office. The
special funds that are set up in a company to make up for such kinds of payment are
described as "petty cash funds". The financial executive or manager is responsible for
setting up and supervising the administration of petty cash funds, which entail the use of
some system for purposes of controlling disbursements of petty cash. One common
method is the use of pre-numbered vouchers. In all instances, the petty cash vouchers
must be approved by the appropriate official for each disbursement.
D.Responsibility for Bank Deposits
Good financial handling demands that in the selection of a bank, consideration
must be made with respect to safety of deposits and services rendered. Financial
officers are aware of the importance of dealing with sound banks although all
members of the Philippine Deposit Insurance Corporation insure each individual
depositor to the maximum amount of P23,000. Factors other than safety must
also be considered such as prompt service, accessibility in location, and the grant
of loans whenever a need arises principally through the grant of a line of credit.
Investing Funds Not Needed
e. Immediately
It is a sound and Wise policy-to-channel funds that are not needed immediately into
investments that will yield commensurate returns with an adequate degree of safety.

Two concepts are equally important in understanding how firms choose


investments.
The first method pertains to the measure of expected rate of return. The second
method is relative to investing in blue chip stocks, which assures the investor a maximum
degree of safety on his investments as compared to highly speculative stocks as in the
case of mining and oil stocks
f. Custody of Marketable Securities
The financial manager's responsibilities with respect to the custody of different types of
securities are described here. These instruments of finance are classified as stocks
and funded debts including bonds and notes, The former represents the
owner's interest in business. The latter represents the creditors' claims upon the company.
Under each group of securities, numerous classifications and sub-classifications may be
made, They may be traded in the stock exchange market, custody of which is the
responsibility of thè financial executive. When they fall into wrong hands, they may pose
as a problem to the company. In the case of coupon bonds, claims of ownership over such
securities may be transferred by the simple process of delivery,
03 Management of Receivables
A joint responsibility with the marketing department is developing and carrying out credit policies, which
include the following:

Determining Who Shall Be Granted


A. Credit
The use of credit may be abused. The recipient of credit may be unable to pay on time and therefore throws chaos
into the business enterprise. The company is denied the use of a vital resource funds that are invested in the
merchandise sold on credit. Creditors are eager to expand their business but they find themselves demanding
protection when some consumers or debtors prove unable to handle their debts. At issue is a fundamental question,
Who shall be grant-ed credit? Limiting the grant of credit to a selected few eliminates risk buy at the same time
limits the company's volume of sales.
b.Determining the Amount
Companies which grant credit generally impose certain credit limits. Such credit
limits may be of two kinds quantitative and temporal.
Quantitative credit limits means the minimum amount of credit permitted to
remain outstanding on an account. This amount is determined through a proper analysis of
the C's of credit and is not to be extended. Instead of imposing a ceiling on the amount of
credit which a debtor may be able to use, temporal limits impose certain requirements that
dally crud must be complied with if purchases on credit are to be allowed.
Temporal credit limits is defined as that type of credit limit which does not lessen
the amount of credit to which a prospective borrower or debtor may avail himself, provided certain
stipulated requirements are accordingly met and complied with. The adoption of credit limits is to the
advantage of the creditors, as for instance there is a reduction in operational costs. Credit limits serve
as a safety valve against reckless buying and extravagance on the debtor part.
C.Bill Collection Granting
credit is one thing. Collecting bills due the company is another. The extension of
credit demands the operation of an effective collection department and machinery
regardless of its worthiness of the risks. If the collection of obligations cannot be enforced
effectively, it amounts to having ex- tended credit to very poor credit risks.
04
Determining Policies on Investments in
Inventories and Fixed assets
Large inventories do not help the economy. In fact, if could precipitate the onset of recession. Therefore,
sound policies on investment in inventories are both compelling and important:
Establishing Policies on Investment in
A.Every progressive company; must notInventory
only concern itself with current operations. It should also direct its
attention to the future. It should have policies with respect to long-term investments on productive use, which
generate income. It should do no less with respect to investments in inventory.
One way of controlling investment in inventories is through the cash budget, which will show any deviation
from budgeted amounts/ Another is through the use of ratios. The ratio of sale to inventory should be figured
regularly to determine any inventories getting out of Iine. Since items in too large a supply may be balanced by
items in short supply, the best procedure is to figure sales-inventory ratios by products. One factor, which needs
careful study in controlling the investment in inventories, is the emergency stock of each item. A balance must be
struck between the levels needed to be sure of never running out. The investment in the added inventories must be
balanced against the costs incurred in running out of stock and the possible loss of employee goodwill it forces a
shutdown. There is definitely a loss of customer goodwill if goods are not delivered on time as promised.
Relationship of Inventories and Fixed
B. Assets
This relationship to the finance function is somewhat different from that of
receivables. Inventories take longer to be converted into cash since goods will remain in
stock for a period of time. Those goods sold on credit will not be received until payment
is due. Fixed assets are converted into cash even more slowly since they are written off
only through a period of years. However, this is not the basic distinction between cash,
marketable securities, or receivables. The total amount of funds invested in fixed assets is
important since it must be financed, but of equal or of greater im- portance is the
suitability of the various types of assets for the production function they are to perform.
This is a primary responsibility of those in charge, of the production of a business. In the
same way, the types of goods to be *kept in inventory and the amounts of each are a basic
part of the sales function. The total amount invested is of high significance in as much as
funds must be supplied to finance inventory and fixed assets. The detailed planning for
capital assets and inventories and the day-to-day activities are not.
05 Controlling the Finance of a
Business
As one of the members of top management, the Financial Officer must participate in planning
general policies that are designed to control expenses. He is more directly interested in overall control
of financial expenses because he is responsible for carrying out financing and control in this area; The
internal expenses of the finance department are controlled just like other expenses, that is, by com-
paring actual and budgeted expenditures. When total amounts paid are out of line with the budget, it is
a general index that the total amount of financing is out of line and as such should be con- trolled
directly. The financial executive should make regular checks to be sure his interest rate or preferred
dividend rate is not out of line. He can do this by instituting a comparison of his rates with average
rates and checking the relationship over a period of time. Any tendency for rates paid by a business to
become higher in relation to average rates needs checking into and should be stopped if this could be
done.
Participation in Determining
06 Policies on Dividends
In developing a dividend policy, It is necessary to observe and benefit from the practices of
reputable firms. The dividend policies of most mature firms, that are considered permanent as a result
of their continuous operations through the years, can be classified in one or two ways. Some firms,
especially those with stable income and profits, attempt to pay regular dividends for purposes of re-
warding investors (stockholders) and generate good public relations. Sometimes this policy is carried
out even during less prosperous years. During prosperous periods, the company may declare "extras",
which are not to be considered regular dividends. This type of policy tends to elevate the respectability
of the stock toward the class of blue chips. The second kind of dividend policy consists of paying a
relatively constant percentage of earnings. While such a policy does not allow a company to move into
the blue-chip category, it does not tend to avoid excessive market repercussions of changing dividends
as earnings change.
Participation in Determining
06 Policies on Dividends
Some companies pay cash dividends. Others pay stock dividends to their stockholders. At this
point, one should not over. Took the fact that several factors determine the amount of each dividend
which a company should pay. The firm's stages in its life cycle is an important factor that must be
considered very careful- lye A new and growing business will back all or a large part of earnings,
where a mature company may choose to pay out a large pro. portion of earnings in dividends. À stock
dividend may be paid regularly out of the current years. In other instances, a larger stock dividend may
be paid from time to time when it becomes evident that part of the retained earnings will be kept in the
business permanently. Stock dividends are generally not considered for tax purposes.
Participation in Determining
06 Policies on Dividends
As a passing observation, financial management is a multi- faceted finance function. It consists of
activities and responsibilities joined together, which make an effective business operation from the
financial standpoint, Such activities and responsibilities are distributed among subordinate officials
under the supervision and control of the financial executive, who is placed in an enviable position that
he is afforded the opportunity to contribute his knowledge of financial operation to the organization's
decision making progress. The financial executive's goal appears quite clear to use these opportunities
to gain the maximum adoption of sound financial management skills throughout the organization. No
matter how capable and competent the financial executive is, alone he cannot be a success. He needs
assistance and cooperation from those around him.
TRAINING AND
DEVELOPMENT
OF
FINANCIAL
EXECUTIVES
Qualified staff will help the company achieve its objectives. The more
competent the executives are, the more likely they are to train and
develop well the people in the company
retired Controller for the financial analysis of Johns-Manville
W. Joseph Littlefield Corporation said: An effective. program for training, and
developing financial executives has three major objectives :

First, it will reduce the number of occasions where an executive who has grown up in the
company has a wealth of knowledge about the company's organization. He knows the
personalities, attitudes and idiosyncrasies of his associates. No executive brought in from outside
the company is as knowledgeable in this respect, although his past experience is very helpful and
important.
Second, an effective program will help to retain in the company those who appear to be most
likely to quality for higher responsibility. This means that the best will be available, when needed,
to fill top management positions.
Third, it will be a means of training all employees in the company so that they will be better
qualified to carry out their tasks
Qualities Desired of Financial Executives
Successful financial executives exhibit certain desirable qualities which they have developed to their great
advantage through a program of training and development. Among such qualities found to be most useful are :

A.Aptitude for Mathematics


In as much as a financial executive cannot escape using numbers in his job, it is necessary and
helpful for him to excel in figures. Such ability will enable him to read and understand a report quickly,
and detect errors in data or calculations without much effort.

B.Ability to Think Straight


A good financial executive must not only have good judgment but also have the skill to rea- son
logically. With such skills, it is easier for him to identify financial problems and provide sound bases
for sound conclusion
Qualities Desired of Financial Executives
c.Ability to Express Thoughts with Clarity
The inability to express one's thoughts and ideas to others is very frustrating to the staff. An
executive may know what he is doing, but if he can- not impart his knowledge to his staff, he provides
limited training and understanding of the job.

D.Ability to Visualize
Successful people are those who are able to visualize things and have a foresight of events.
Sometimes, the so-called intuition helps, although some may think of this as steaming up their crystal
ball. Intuition exists in the most conventional of minds. It is a way of thinking one knows what he is
doing.
Qualities Desired of Financial Executives
Ability and Willingness to Absorb New
e. Ideas
No company should be an entrepreneurial or "one-man" company, where there is only one Now
of ideas - from the top down. An accepting attitude of top management, in this case the financial
executive, creates commitment from employees since it is their ideas that are being introduced

f.Ability to Deal with People


As indicated in a foregoing discussion, a financial executive cannot perform all the tasks involved
in financial management by himself. Rather, he needs the cooperation of others who work with him. In
order to be a success in this regard, he must be a good exponent of public relations, There is only one
rule to remember at all times: the Golden Rule.
thank you

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