What is Finance and Financial Management?

Finance is always of great importance, be it in a business or in one's everyday life. It is

important to manage risks in business, it is equally important to manage risks in life
as well. Risk is nothing but an uncertain event that might damage your assets and
when it is financial risks, it creates loss of Finance. Some books define Finance as
the science and art of managing money. (Gitman & Zutter, 2012).

Financial Management deals with that decisions that are supposed to maximize the
value of shareholder’s wealth (Cayanan). These decisions will ultimately affect the
markets perception of the company and influence the share price. The goal of
Financial Management is to maximize the value of shares of stocks. Managers of a
corporation are responsible for making the decisions for the company that would lead
towards shareholder’s wealth maximization.

Organizational structure of the company is important especially in the financial aspect

of the business and the particular set of people, each play a role in the decision
making of the company. See diagram below:

From the diagram presented, emphasized that each line is working for the interest of
the person on the line above them. Since the managers of the company are making
decisions for the interest of the board of directors and the board of directors do the
same for the interest of the shareholders, it follows the goal of each individual in a
corporate organization should have an objective of shareholders wealth
maximization.

The roles of each position identified.

1. Shareholders: The shareholders elect the Board of Directors (BOD). Each
share held is equal to one voting right. Since the shareholders elect the BOD,
their responsibility is to carry out the objectives of the shareholders. Otherwise,
they would not be elected in that position. Ask the learners again, what
objective of the shareholders is, just to refresh.
2. Board of Directors: The board of directors is the highest policy making body in a
corporation. The board’s primary responsibility is to ensure that the corporation is
operating to serve the best interest of the stockholders. The following are among the
responsibilities of the board of directors:

a. Setting policies on investments, capital structure and dividend policies.

b. Approving company’s strategies, goals and budgets.
c. Appointing and removing members of the top management including the president.
d. Determining top management’s compensation.
e. Approving the information and other disclosures reported in the financial
statements (Cayanan, 2015).

3. President (Chief Executive Officer): The roles of a president in a corporation

may vary from one company to another. Among the responsibilities of a
president are the following:

a. Approving the information and other disclosures reported in the financial

statements. Overseeing the operations of a company and ensuring that the strategies
as approved by the board are implemented as planned.
b. Performing all areas of management: planning, organizing, staffing, directing and
controlling.
c. Representing the company in professional, social, and civic activities.

4. VP for Marketing: The following are among the responsibilities:

a. Formulating marketing strategies and plans. Directing and coordinating company
sales.
b. Performing market and competitor analysis.
c. Analyzing and evaluating the effectiveness and cost of marketing methods applied.
d. Conducting or directing research that will allow the company identify new
marketing opportunities, e.g. variants of the existing products/services already offered
in the market.
e. Promoting good relationships with customers and distributors. (Cayanan, 2015).

5. VP for Production: The following are among the responsibilities:

a. Ensuring production meets customer demands.
b. Identifying production technology/process that minimizes production cost and
make the company cost competitive.
c. Coming up with a production plan that maximizes the utilization of the company’s
production facilities.
d. Identifying adequate and cheap raw material suppliers. (Cayanan, 2015)
6. VP for Administration: The following are among the responsibilities:
a. Coordinating the functions of administration, finance, and marketing departments.
b. Assisting other departments in hiring employees.
c. Providing assistance in payroll preparation, payment of vendors, and collection of
receivables.
d. Determining the location and the maximum amount of office space needed by the
company. Identifying means, processes, or systems that will minimize the operating
costs of the company. (Cayanan, 2015).
The role of the VP for Finance/Financial Manager is to determine the appropriate
capital structure of the company. Capital structure refers to how much of your total
assets financed by debt and how much is financed by equity.
To be able to acquire assets, our funds must have come somewhere. If it has bought
using cash from our pockets, it has financed by equity. On the other hand, if we used
money from our borrowings, the asset bought has financed by debt.

What are the functions of Financial Managers?

1. Financing decisions- include making decisions as to how to finance long-term
investments and working capital-which deals with the day-to-day operations of
the company.

2. Investing Decisions- To minimize the probability of failure, long-term

investments have supported by a capital budgeting analysis.

3. Operating Decisions – deal with the daily operations of the company especially
on how to finance working capital accounts such as accounts receivable and
inventories.

4. Dividend Policies – Dividend is a part of profits that are available for

distribution, to equity shareholders. The Finance manager must decide whether
the firm should distribute all the profits or retain them or distribute a portion
and retain the balance.

The financial system links the savers and the users of funds. Savings can come from
households, individuals, companies, government agencies, or any other entity whose
cash inflows are greater than their cash outflows. The financial system through
financial intermediaries provides a mechanism by which these savings can be
channeled to users of funds, borrowers, and investors.

Some of the financial instruments issued by users of funds such as the shares of
stocks and corporate bonds of publicly listed companies and the debt securities issued
by the National Government have traded.
Difference of Financial instruments, financial institutions and financial
markets:

1. Financial institutions are companies in the financial sector that provide a broad
range of business and services including banking, insurance, and investment
management.
Identify examples of financial institutions/Intermediaries:

a. Commercial Banks - Individuals deposit funds at commercial banks, which

use the deposited funds to provide commercial loans to firms and personal
loans to individuals, and purchase debt securities issued by firms or
government agencies.

b. Insurance Companies - Individuals purchase insurance (life, property and

casualty, and health) protection with insurance premiums. The insurance
companies pool these payments and invest the proceeds in various securities
until the funds needed to pay off claims by policyholders. Because they often
own large blocks of a firm’s stocks or bonds, they frequently attempt to
influence the management of the firm to improve the firm’s performance, and
ultimately, the performance of the securities they own.

c. Mutual Funds - Mutual funds owned by investment companies that enable

small investors to enjoy the benefits of investing in a diversified portfolio of
securities purchased on their behalf by professional investment managers.
When mutual funds use money from investors to invest in newly issued debt or
equity securities, they finance new investment by firms. Conversely, when they
invest in debt or equity securities already held by investors, they are
transferring ownership of the securities among investors.

d. Pension Funds - Financial institutions that receive payments from employees

and invest the proceeds on their behalf. Other fifinancial institutions include
pension funds like Government Service Insurance System (GSIS) and Social
Security System (SSS), unit investment trust fund (UITF), investment banks,
and credit unions, among others.

2. Financial Instruments-is a real or a virtual document representing a legal

agreement involving some sort of monetary value. These can be debt securities like
corporate bonds or equity like shares of stock. When a financial instrument issued, it
gives rise to a financial asset on one hand and a financial liability or equity
instrument on the other.

a. Financial Asset is any asset that is:

• Cash
• An equity instrument of another entity
• A contractual right to receive cash or another financial asset from another
entity.
 • A contractual right to exchange instruments with another entity under
conditions that are potentially favorable. (IAS 32.11).

Examples: Notes Receivable, Loans Receivable, Investment in Stocks,

Investment in Bonds

b. Financial Liability is any liability that is a contractual obligation:

• To deliver cash or other financial instrument to another entity.

• To exchange financial instruments with another entity under conditions that
is potentially unfavorable. (IAS 32)
• Examples: Notes Payable, Loans Payable, Bonds Payable.

c. An Equity Instrument is any contract that evidences a residual interest in the

assets of an entity after deducting all liabilities. (IAS 32).

Examples: Ordinary Share Capital, Preference Share Capital.

d. Debt Instruments generally have fixed returns due to fixed interest rates.

Examples of debt instruments are as follows:

• Treasury Bonds and Treasury Bills issued by the Philippine government.

These bonds and bills have usually low interest rates and have very low risk of
default since the government assures that these have been paid.

• Corporate Bonds issued by publicly listed companies. These bonds usually

have higher interest rates than Treasury bonds. However, these bonds are not
risk free. If the company issued the bonds goes bankrupt, the holder of the
bonds will no longer receive any return from their investment and even their
principal investment has wiped out.

e. Equity Instruments generally have varied returns based on the

performance of the issuing company. Returns from equity instruments
come from either dividends or stock price appreciation.

The following are types of equity instruments:

•Preferred Stock has priority over a common stock in terms of claims over the assets
of a company. This means that if a company has liquidated and its assets have to be
distributed, no asset be distributed to common stockholders unless all the claims of
the preferred stockholders has given. Moreover, preferred stockholders have also
priority over common stockholders in cash dividend declaration. Dividends to
preferred stockholders are usually in a fixed rate. No cash dividends given to common
stockholders unless all the dividends due to preferred stockholders paid first.
(Cayanan, 2015).

• Holders of Common Stock on the other hand are the real owners of the company. If
the company’s growth is encouraging, the common stockholders will benefit on the
growth. Moreover, during a profitable period for which a company may decide to
declare higher dividends, preferred stock will receive a fixed dividend rate while
common stockholders receive all the excess.

3. Financial Market - refers to a marketplace, where creation and trading of

financial assets, such as shares, debentures, bonds, derivatives, currencies, etc. take
place.

Classification of Financial Markets:

Primary vs. Secondary Markets

To raise money, users of funds will go to a primary market to issue new securities
(either debt or equity) through a public offering or a private placement.

The sale of new securities to the public referred to as a public offering and the first
offering of stock named an initial public offering. The sale of new securities to one
investor or a group of investors (institutional investors) is referred to as a private
placement.

However, suppliers of funds or the holders of the securities may decide to sell the
securities that have purchased. The sale of previously owned securities takes place in
secondary markets.

The Philippine Stock Exchange (PSE) is both a primary and secondary market.

Money Markets vs. Capital Markets

Money markets are a venue wherein securities with short-term maturities (1 year or
less) are sold. They have created because some individuals, businesses, governments,
and financial institutions have temporarily idle funds that they wish to invest in a
relatively safe, interestbearing asset. At the same time, other individuals, businesses,
governments, and financial institutions find themselves in need of seasonal or
temporary financing.

On the other hand, securities with longer-term maturities sold in Capital markets. The
key capital market securities are bonds (long-term debt) and both common stock and
preferred stock (equity, or ownership).

The role of Financial Managers: make financing decisions that require funding from
investors in the financial markets.
APPLICATION:

How do we measure wealth maximization?

For example, Assume that Mr. Y bought 10 shares of Globe Telecom at PHP2, 510
each on September 9, 2010. This brings his investments to PHP25, 100. What
happens to the value of his investment if the price goes up to PHP2, 600 per share or
it goes down to PHP2, 300 per share?

Explanation: An increase of the share price to PHP2, 600 per share means that people
are willing to buy the shares for that amount. If the learners were to sell their shares
at this point, it will result to a profit of PHP90 per share or PHP900 on their whole
investment. Hence, the value of their investment increased from PHP25, 100 to
PHP26, 000. Therefore, there is an increase in shareholder’s wealth.

On the other hand, a decrease in the share price to PHP2, 300 per share means that
people are only willing to buy shares for PHP2, 300. If the learners were to sell their
investment at this point, they will receive PHP23, 000 which would result to a loss of
PHP2, 100. The decrease in value of their investment leads to a decrease in
shareholder’s wealth.
What have I learned? Answer the following questions and submit your answers to the
Mr. Andrew Nginsayan of the CBAA Department.

Directions: Write T if the statement is True and F if the statement is False. Write your
answer on the space provided:

______1. High cash flow is generally associated with a higher share price whereas
higher risk tends to result in a lower share price.

______2. The wealth of corporate owners has measured by the share price of the stock.

______3. When considering each financial decision alternative or possible action in

terms of its impact on the share price of the firm's stock, financial managers should
accept only those actions that expected to maximize shareholder value.

______4. Stockholders expect to earn higher rates of return on investments of lower

risk and lower rates of return on investments of higher risk.

______5. Financial markets are intermediaries that channel the savings of individuals,
businesses, and government into loans or investments.

______6. Commercial banks obtain most of their funds from borrowing in the capital
markets.

______7. The money market involves trading of securities with maturities of one year or
less while the capital market involves the buying and selling of securities with
maturities for more than one year.

______8. Primary and secondary markets are markets for short-term and long-term
securities, respectively.

______9. A mutual fund is a type of financial intermediary that obtains funds through
the sale of shares and uses the proceeds to acquire bonds and stocks issued by
various business and governmental units.

______10. Credit unions are the largest type of financial intermediary handling
individual savings.

NAME OF STUDENT:
SUBJECT: