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ACC08/FMS01 LECTURES

ACC08/FMS01
LECTURES
Financial Management Part 1

This course is an introduction of financial management and provides the students an


understanding of the financial management methods used for analyzing the benefits of various
sources of finance. At the beginning of this course, the function of finance in different types of
organization is identified. The economic and strategic frameworks of financial management
are also discussed prior to financial statements analysis; financial forecasting, planning, and
budgeting; management of current assets; working capital policy and sources of short-term
financing. This first course of financial management synthesizes financial policy into a grand
strategy that comes from the integration of organizational purpose and goals.

Overview of Financial Management1


ACC08/FMS01 LECTURES

Gems

ACC08/FMS01
That is what
LECTURES learning is. You
suddenly
Financial Management Part 1 understand
something
Overview of Financial Management you've
understood all
Topical Objectives
your life, but in
At the end of this section, you are expected to :
1. Recall the characteristics of the different types of business
organizations; a new way .
2. Identify financial objective(s) of organizations; -Doris Lessing
3. Identify the various decision areas of organization
management that requires finance knowledge;
4. Gain familiarity to the functions of the finance department and
the Chief Financial Officer in an organization; and FINANCIAL
5. Review the fundamental concepts of finance. MANAGEMENT

Types of Business Organizational Structures


Is the management
and control of money and
In the Philippines, the major business structures are: money-related operations
1. Sole Proprietorship in a business
2. Partnership Refers to financial
3. Corporation (or Company) input into business
decisions
In the next page, a matrix that shows attributes of each of the three Involves oversight
business structures just mentioned is presented. responsibility on money
matters
In other countries, they also register companies with the structure
of S-Type of Corporation and Limited Liability Companies. They
are hybrid of partnerships and corporations. The corporate
attributes of limited liability and ease of transfer but the income of
owners are taxed together with the individuals income.

In the Philippines, what business structure is


closest to this S-Type Corporation set-up?

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ACC08/FMS01 LECTURES

Comparison Sole proprietorship (SP) General Partnership (GP) General Stock


Factors1
Description A business owned by an A business owned by two or more Regular corporation
individual who is solely individuals who agreed to combine
responsible for all aspects of resources for the purpose of
the business, and where the division of profits.
business and its owners are
thus considered the same
entity.
Business Easy and cheapest to form An Agreement between two or Required to file
formation (and dissolve) more parties. Partnership formation document
(dissolution) agreement should be created with the Filing agency.
SEC requires annual
meetings and bylaws
Size of the Dependent on the wealth of Can easily avail of financing Easiest to acquire
business owner compared sole proprietorship financing
Taxation Business income of the owner Unless registered as a general Corporations and their
is taxed once with the rest of professional partnership, business owners are separated
the reported profits income of the owners is taxed taxable entities
separately according to tax laws
for corporations
Length of Sole proprietorship either Depending upon partnership Perpetual
Existence ceases doing business or dies, agreement. Typically death or
but continues when sold to withdrawal of a partner dissolves
another individual entity
Liability Owner has unlimited liability General Partners are equally liable Shareholders are
and can lose personal assets or less the partnership agreement typically not liable for
states otherwise the debts of the
corporation. Some
officers can be held
liable if there is fraud
or severe
mismanagement
Operational Easiest with few legal Typically GPs have few legal Annual meetings,
Procedures requirements requirements filings, and reporting
required. Board of
Directors and Officers
must be maintained
Motivation of
managers is necessary

Organizations Financial Objectives


Considering a corporate set-up with its numerous owners, the shareholders elect a Board of Directors
to decide on matters affecting the affairs of the company. Among the board members, people are
elected to fill important positions.

1
www.suncorpfilings.com/documents/EntityComparison chart.pdf

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ACC08/FMS01 LECTURES

Chairman of the board Chief financial officer (CFO)


Chief executive officer (CEO) Vice presidents
Chief operating officer (COO) Treasurer
President Secretary
The shareholders may not have a direct operational capacity but they continue to hold rights over
dividend/ asset distribution, election of board members, and new/subsequent issuances of shares.
Looking at the two groups in the company, the Management and the Owners, there have been some
noted financial objectives of organizations stated in references2:
1. Maximization of business revenues and profit
2. Maximizing firm size
3. Maximization of the market value of shareholders equity (Peirson and Brown, 2009)
4. Maximization of the market value of the firm (Aswath Damodaran, 2007)

The first objective is identified to result to two types of the agency problem3. The third one focuses on
the increase in the market price of the shares owned by its owners and it has been favored because of
its impartiality and inkling to serve social responsibility. The fourth is similar to the second, however
does not focus on stock price alone.

2Aswath Damodaran cited in his lectures of the Classic Viewpoint: Van Horne: "In this book, we assume that the objective of the firm is
tomaximize its value to its stockholders" Brealey & Myers: "Success is usually judged by value: Shareholders aremade better off by any
decision which increases the value of their stake in thefirm... The secret of success in financial management is to increase value."
Copeland & Weston: The most important theme is that the objective of thefirm is to maximize the wealth of its stockholders." Brigham
and Gapenski: Throughout this book we operate on the assumptionthat the management's primary goal is stockholder wealth
maximizationwhich translates into maximizing the price of the common stock.

3Sen Jaya indicates the following as possible ways to reduce type 1 agency problem:1) Tie management compensation to stock price
performance2) The threat of firing through the board of directors3) Hostile takeovers by other firms motivate managers to prevent share
prices from falling4) Shareholders sponsoring resolutions at the annual shareholders meeting

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ACC08/FMS01 LECTURES

Challenge to the Financial Manager

Into

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ACC08/FMS01 LECTURES

Finance Decisions in Organizations


The following financial decision areas are common to The second direction of expansion [of financial
management] involves the role and function of financial
business organizations:
management within firms. Historically, financial managers
1. Investment analysis* (Desired vs. Optimal) were told how much money their companies needed for
2. Financing and Capital Structure* particular projects, and they went outside in pursuit of those
3. Business Organization decisions* funds. They had little to do with deciding how much was
4. Working Capital Management needed or what was done with the money after it was raised.
5. Dividend policy Today, financial managers are deeply involved in those
6. Risk management related decisions. (Lasher, 2011)

The areas above are responded to with knowledge in


accounting, economics, marketing, quantitative methods, and production management.

Functions of the Finance Department and the Chief Financial Officer

The following chart shows a sample of the functions found under the Finance Division

Fundamental Concepts of Finance


Basic Tenets of Money and Banking (STRIM)4
1. Stability improves welfare

4
Money, Banking and Financial Markets. Cecchetti 2e

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ACC08/FMS01 LECTURES

2. Time has value


3. Risk requires compensation
4. Information is the basis for decisions
5. Markets determine prices and allocation resources

Factors Affecting Market Value of Shares5

5
Moyer, 2010

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ACC08/FMS01 LECTURES

Basic concepts in Finance


1. Market value of a company6
2. Nominal and real amounts
3. Derivative securities
4. Arbitrage
5. Agency relationships7
Appendix

A Modification by Aswath Damodaran

In the next module


Business Environment
Putting economics in the
picture. The following diagram Business Strategy
justifies the study of the business
environment before the financial Organizational Architecture
objective of the organization.
Decision-Right Assignment
(Zimmerman, Advanced
Performance Evaluation
Managerial Accounting) Reward System

Incentives and Actions

Firm Value

6
Affected by amount, timing, and uncertainty of cash flows
7
Agency costs include: Corporate governance ; Management compensation; Threat of takeover; Annual audit by accounting
firm

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