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1. FINANCIAL MANAGEMENT 1
Reflection: Picture yourself as a potential financial manager three years from now, what should
you do now to equip yourself with the necessary tools? What do you think? Whatever your
answer is make it your goal.
GOALS OF FINANCIAL MANAGEMENT
The goals of financial management could be synonymous to the goals of the enterprise. One
may consider that the utmost aspiration of the company is to yield the highest possible profit for
the firm. If we accept this answer, then the company would be evaluating each decision it makes
based on the amount of income that would be flowing into the company. The highest income-
generating proposal would be the best choice. However, while this approach may be simple and
highly desirable, it has serious drawbacks or disadvantages.
Let us consider the first drawback. Changes in profit may also mean changes in risk. An
enterprise with an earnings per share (EPS) of say P150/share may be less acceptable if its EPS
would be P175/share. Deeper consideration of this would lead you to think that intrinsic risk or the
risk that goes with those two alternatives increases.
Now the second drawback of the maximizing profit approach is that it does not fully take into
account the timing when the profit/gain would be received. Consider the matrix below which shows
two alternatives as to which one would your firm consider investing into:
Earnings Per Share
Year 2010 Year 2011 Total
Nico Corporation's Ordinary Shares BOO P450 P750
Riel Corporation's Ordinary Shares 450 300 750
If the company's framework of mind is merely maximizing profit, one may say that they can
invest in either Nico or Riel Corporation since the yield is the same. However, Riel Corporation is
definitely a better choice. Why? Because Riel Corporation's benefits occur earlier. This means that
your company can reinvest the P150/share (Pi150-P300) difference in earnings a year earlier than
if you chose to invest in Nico Corporation. Get it?

2. The last drawback that one may experience using the maximizing the profit approach as the
main goal of the company is the accurate measuring of the key ingredient in this approach, which
is profit. Why? The reason is that this is virtually impossible to achieve. You may react by saying
"well we compute income all the time in our accounting courses." Yes, it's true but, the definition
of profit alone is many. There are various economic and accounting definitions for profit. Each
definition is subject to its own set of interpretations. Economic phenomena like inflation and
deflation and foreign exchange transaction variables complicate the matter. Although financial
accounting and reporting methods are continually evolving to solve these issues, many problems
remain adamant.
If yielding the highest profit is not the primordial goal of financial management or of the
company, then what is? The goal of financial management could be categorized as follows:
 Maximization pf the value of the firm (Valuation Approach)
 Maximization of Shareholder Wealth
 Social Responsibility and Ethical Behavior
VALUATION APPROACH
The discussion above is not meant to undermine the importance of profit. Let us just
emphasize that profit maximization is very important. However, this is not primordial. The
definitive gauge of performance is not the income yielded but more so how the yield are
valued by the owners of the company.
What does this mean? This means that the main goal of financial management is to
maximize not profit alone, but the maximization of overall value of the firm, thus it IS called
the Valuation Approach. j Therefore in considering investment proposals or decisions, .the
financial manager should not only consider profit, he/she must also consider among other
things the:
 Risk attached to the investment proposal or the company's operation.
 Time design as to when and how the profits will flow into the company.
This refers to as to when will the profits flow into the company and
furthermore, more when will there be an upsurge or decline of profit (refer
to example of Nico and Riel Corporation).
 The quality and reliability of the profits reported by the firm.
A wise financial manager should, therefore, take into consideration the impact of all these to
the company's overall valuation. If a decision brings about a status quo or augments the firm's
overall value then the decision is acceptable,

3. MAXIMIZATION OF SHAREHOLDERS' WEALTH
Maximization of the Shareholders' wealth is considered to be the expansive goal of the
firm, this, however is not an easy task, Managers have no direct control of the market value
of the firm's stocks. The market value of stocks may not necessarily be high even if the
company proves to be profitable and stable. This is specially the case when stock market
prices are declining as influenced by economic, political, and social factors in the financial
environment.
The main focus is not so much with the day-to-day movements of the stock market
price, but more so on the amplification of the long-term wealth of the shareholders. This,
again, is everything but simple. Why? Because the expectations and requirements made by
shareholders vary. In the 1950s to 1960s, the main focus was on increasing earnings. In the
1970s to 1980s the main concern became more conservative by focusing not so much on
income growth but on lowering risks and high current dividend payments.
What actions should a financial manager make in order to maximize the value of the
company's stock? Does it mean that maximizing profit results to maximizing the company's stock
values?
We just gave you two hanging questions on the previous paragraph. But for one to answer
the question, we need to consider the company's income or profits vis-a-vis earnings per share
(EPS). We suggest that you review your knowledge of EPS in your accounting subjects. To guide
us in finding the answer, let us consider the example below.
Example: Observe the data of Nico Corporation:
Shares outstanding Yr.-end Net Income
The year 2010 100,000 P500,OOO
The year 2011 200,000 P600,OOO
You own 100 shares of Nico Corporation.
Analysis:
EPS = Net Income / Shares Outstanding
Share of net
Earnings Per
2010
100 shs/100, OOO
shares = 1%
1% x P500,OOO =
P5,OOO
shs= P5/sh
2011
100 shs/200, OOO
shares = 0.5%
0.5% x P600,OOO =
P3,OOO
= P3/sh

4. Interpretation:
We can interpret, based on the data provided and the analysis made, that the company-
wide profit increased by PIOO, OOO in 2011. Your share of net income decreased by P2, 000.
The EPS decreased by P2/share in 2011. Furthermore you suffered with the other shareholders
an earnings dilution despite the increase in total corporate profit.
Conclusion:
Since profits increase by PIOO,OOO, your share of net income decreased by P2,OOO and
the company's earnings per share diminished by P2/share, we can therefore infer two things.
First, that profit maximization does not necessarily mean stock value maximization. And lastly,
considering other things being constant, if the company is truly concerned with the welfare of its
shareholders, it should focus on EPS rather than on total company profits.
SOCIAL RESPONSIBILITY
Social responsibility is an issue that needs to be considered. Can one reconcile the need
of the firm for wealth maximization and the need of the firm to be socially responsible? Stated
differently, can a firm be socially responsible while focusing on maximizing the shareholders'
wealth or maximizing the overall value of the firm?
In most cases, they can be reconciled. The firm by using measures that would maximize
wealth and company market value would be able to draw more capital, help diminish
unemployment, and give services to the community. However, this is not always the case.
Salary distribution, hiring practices, product safety, minority training, anti-pollution measures,
and pricing of products sold may sometimes be inconsistent with maximizing company value.
Installing expensive pollution control devices is not considered profitable. So the question is
should companies stop using these devices? A big fat NO.
It's easy to say no. But to resolve issues like these, companies belonging to the same
industry must make a concerted effort to be socially responsible. Why concerted? Concerted
because, if only one company opts to be socially responsible that "martyr" would not survive.
For instance, if only Company X opts to acquire the anti-pollution device which is costly, the
price of the products sold by Company X needs to be increased. Company Y and Company
Z, both without the anti-pollution device, can sell their products at a lesser price. Company X
will be at a disadvantage. But will companies be willing to voluntarily participate in this
concerted effort? Not always.
So a more acceptable solution to this is to allow certain cost-augmenting measures to
be compulsory rather than voluntary to guarantee that the burden falls uniformly on all
businesses. Relating this to the anti-pollution example, the cost of putting an anti-pollution
device will now be carried by Companies X, Y, and Z, thus making the cost less burdensome.

5. But who will make this compulsory? Answer— Government agencies. A coordinated effort
between the industry and the government can make this solution more feasible.
Some corporations who have chosen to follow the "enlightened" path of being socially
responsible, argue that socially responsible measures and actions may not necessarily be too
costly, since they advertise heavily. The costs are offset by the increase in income generated
by the increase in sales revenue because customers tend to buy more from companies that
are socially responsible.
FUNCTIONS OF FINANCIAL MANAGEMENT
The functions of financial management are actually the topics we shall cover in this book,
financial management involves the prudent allotment and spreading of company funds to current
assets and non-current assets. An effective and efficient financial management entails the creation
of a well-balanced blend of financing activities and to formulate the suitable Some of these general
functions are carried out on a daily basis like cash management, inventory management, credit
management, and fund receipt; and disbursement management. menu. Other activities not done
on a daily basis but rather irregularly would include company stock and bond issuance, capital
budgeting and creating dividend policies.
It is important to note that while daily and irregular activities are managed, the financial
manager must be able to balance making income and considering the inherent risks on decisions
made. This balancing act between income and risk is referred to as risk-return trade-offs. The
financial manager must strike a balance between the highest possible incomes with the most
reasonable amount of risk. This balancing act requires expertise that is gained through studying
and experience.
All these activities plus the balance of the risk-return trade-off are done to achieve the
primordial goal financial management, which is to maximize the shareholders' wealth.
FINANCIAL MANAGER'S RESPONSIBILITIES
The responsibilities of a financial manager are closely linked with the function of financial
management. The particular activities inherent to a financial manager's job would be:
1. Forecasting and Planning. The financial manager does not function alone. His/her must
be able to work together with other managers in formulating strategic as well as
operative plans necessary to form the company's desired position.
2. Making Crucial Investment & Financing Decisions. Increasing sales or increasing demand
for services from companies require investing money for acquisition of property, plant
and equipment (PPE), and inventory. The financial manager must help decide on the
appropriate amount of PPE to be acquired and determine the sources of funds to
finance such acquisitions.

6. 3. Coordinating and Controlling. It is very important for managers, financial or otherwise, to
coordinate with each other, As mentioned in number one, the financial manager works and
coordinates with other executives to guarantee efficient operation of the firm. All business
decisions made by other executives [n the firm have financial implications. For instance,
proposals made by marketing managers on improving sales of a product line may entail
acquisition of new equipment, which in turn entails cash disbursements. Therefore,
marketing managers must carefully take into account how their decisions and actions affect
other factors like fund availability, inventory requirements, and plant acquisition, capacity
and utility.
4. Trading in Financial markets. It is crucial for financial managers to have their "hands on
dealings" with the financial markets. These markets are those involved in the trading of
debt and equity securities. Financial managers are often task to trade the equity
securities of the firm in the financial market. In doing so, the firm is affected and at the
same time affecting other firms. The effect is that investors are either making or losing
money in trading.
5, Risk Management, No business entity is ever free from risks. The risk may come in terms
of financial risks where prices of commodities, currency exchange rates and interest rates
fluctuate; or the risk may even come in terms of natural calamities like floods, fires, and
earthquakes. A well-skilled financial manager however,
Can deter the effects of these risks by availing of the appropriate and adequate
insurance for the firm, or by hedging in the derivatives market. In addition to this, the
financial manager is also accountable for the entity's risk management policies and
programs that involve the detection of the risks. Risks that the entity should efficiently
hedge itself against.
ALTERNATIVE FORMS OF BUSINESS ORGANIZATION
There are three basic forms of business organizations. These are: (1) sole proprietorships;
(2) partnerships; and (3) corporations.
Sole Proprietorship. This considered as the oldest, most common, and simplest form of
business organization. This is a form of business entity, where there is only one owner, hence the
word sole. The customary feature of a sole proprietorship is that the owner is inseparable from the
business. One may say that they are the same entity. (Reconcile this with the separate entity
concept you have learned in your basic accounting).
This type of entity offers a number of benefits. First of which is simplicity in decision making,
since only one person makes all the major decisions. Other advantages would be that it is easy
and inexpensive to form, subject to few government regulations. An aspect of the "same entity/'
concept is that taxes on a sole proprietorship are determined at the personal income tax rate of the

7. owner. In other words, a sole proprietorship does not pay taxes separately from the owner. It is not
subject to corporate income taxes.
However, there are drawbacks to this form of business organization. Due to its very Nature, it
would be difficult for a single proprietor to come up with a sizable amount of capital. Another aspect
of the "same entity/' concept is that the owner of a sole proprietorship has complete control over
the business, its operations, and is financially and legally responsible for all debts and legal actions
against the business. This "same entity" aspect of the sole proprietorship invariably creates
another drawback. The proprietor has unlimited personal liability for the payables or financial
obligations of the firm. This means that the owner is liable to pay with his personal properties,
liabilities not covered by their assets. Lastly, the life of the company is limited to the life of the
proprietor.
Partnership. This exists when two or more persons combine their resources to conduct
business, earn profit, and distribute among themselves the results of their operations. The contract
evidencing its existence is called the articles of partnership.
The main advantage of a partnership would be its low cost and ease of formation. The
disadvantages are similar to a sole proprietorship: unlimited liability, limited life, difficulty of
Transferring ownership since this would lead to dissolution of the partnership, difficulty of
Amassing a large amount of capital.
As mentioned in the previous paragraph, partnerships are typically unlimited. This would
mean that the partners are liable to pay obligations beyond their contributions. Just like a sole
proprietorship, a partnership has unlimited liabilities, The partners are obliged to pay the company
debts with their personal properties not covered by the investments made by the owners or not
covered by the assets of the company. These partnerships are called general or unlimited liability
partnerships.
Partnership firms are common but not limited to professionals like doctors, lawyers, and
accountant’s architects and other
Corporation. This is a legal business entity created by the government. This does not follow
the same entity concept, it is considered as separate and distinct from its owners and executives.
The contract evidencing the existence of a corporation is called articles of incorporate ration. The
articles of incorporation present the rights and limitations of the entity.
This form of business entity has a number of advantages. First of which, is unlimited Changes
in ownerships or death of owners do not dissolve the corporation. Another advantage is ease of
transferability of ownership. Unlike a partnership where the consent of the partners are required
for the admission of an incoming partner(s), the corporation transfers ownership through the selling
and buying of shares of stocks. The last advantage would. Since the owners are separate and
distinct from the corporation, the owners are not obliged to pay financial obligations not covered by
company assets using their personal properties

8. Hybrid Forms of Organization
Typically, partnerships are considered general better known as unlimited liability
partnerships. This was discussed previously. However another type of partnership exists, the
limited liability partnership (LLP). Under this type, the partnership is composed of at least one
general partner and the rest are limited partners. In this scenario, the limited partners do not have
control over company operations. As the name indicates, the limited partners are liable only for the
amount of their investments. This specific characteristic makes the I-LP a hybrid because although
the firm is a partnership, it has the benefit of a corporation-like firm where the owners are not
obliged to pay company debts with their personal properties.
AGENCY RELATIONSHIPS
Whenever a person or a group of persons (principal) employs another person or group of
persons (agency), to render service(s) and at the same time delegate decision-making authority to
the agent, an agency relationship exists. In financial management parlance, agency relationships
exist between the company's shareholders and managers and between creditors and owners.
Agency Conflicts
We know for that a shareholder's primary goal is wealth maximization here could be a conflict
of interest if the manager is also a partial owner of the same firm. The manager's primary goal is
to maximize the size of the firm, and by doing so he stabilizes job security for himself and for all
the employees of the firm, and ultimately, increases his position, status, perquisites and salary,
thus the shareholder's primary goal of wealth maximization might be set aside. It can be argued
that since there are managers owning a small portion of the corporate share they are hungry for
salary increases and perquisites at the cost of shareholders that are not managers.
Agency Costs
There are means by which managers can be persuaded to maximize the company's stock
price or maximize wealth and act for the shareholders' best interest. However, this would entail
costs. The costs could come in terms of audit costs which is geared towards monitoring managerial
actions, and restructuring the company that would regulate undesirable managerial actions. The
more control measures employed by management gearing towards stockholders' benefits, the
higher would be the agency costs.
It is therefore crucial, that the amount of costs to be spent in assuring that managerial actions
are for the benefit of shareholders, be viewed and assessed just like any other investment decision

9. made by the company. Make sure that agency costs should not exceed the return or yield that the
company will gain from implementing the control measures.
Control Mechanisms
There are a number of ways to encourage managers to perform for the interest of
shareholders. Some of them are:
1. Provide Performance-based Incentive Plans.
There are ways by which performance based incentives may be given to
Managers. One way is by providing managers with executive stock options. Under this scenario,
managers are given the privilege to acquire the company's share at a fixed price. Performance
shares may also be given to managers as incentives. Performance shares are given to managers
based on their effectiveness in achieving company goals. The relevant criteria for effective
performance could be in terms of achieving high EPS, high return on assets (ROA), or high return
on equity (ROE). Another relevant criteria for providing incentives would be the economic value
added (EVA), this is another way by which an entity's profitability is measured. EVA is derived by
subtracting the cost of all capital (interest expense among other things) from the net income after
tax. If the EVA is positive, it can be interpreted that management is adding or making added value
for shareholders. In other words the higher the EVA, the more wealth is being created by
management for its shareholders. If EVA is negative, it can be interpreted that management is
ruining value.
2. Straight Involvement by Shareholders (Institutional).
In the late 1990s, almost half of the shares in the United States were owned by
institutions like insurance companies, pension funds, and mutual funds. This being so,
they developed a significant influence over the entity's operations. They can provide suggestions
to management in running the business. During that time it became a practice that when a
shareholder owns stocks of at least one thousand dollars for at least one year, the said
shareholder could sponsor a proposal that must be voted on at the annual shareholder's meeting,
regardless of management's approval,
3. Takeovers.
Shareholders in some cases do hostile takeovers, in this situation, managers of firms
acquired by the shareholders are terminated. Those managers, who are "lucky" to be
retained, lose their independence and autonomy, thus "twisting," so to speak, the manager's
arm to perform measures that would maximize the company's share prices and ultimately
maximize the firm's wealth.

10. ACTIVITY FOR WEEK 1
On Goal Maximization, discuss:
1. What is meant by goal maximization of the shareholders' wealth?
2. What are the functions of financial management?
3. What are the financial manager's responsibilities?
4. On the forms of business organizations, thoroughly discuss:
A. Compare and contrast the different forms of business organizations.
B. Why is a corporation more suitable for large organizations?
C. What are hybrid forms of organizations?
On Agency Relationships, discuss:
1. What issues does agency theory examine?
2. What control mechanisms may be employed to encourage managers to
perform in the interest of shareholders?
CONCEPT MAP DESIGNS
Using your creativity, draw a concept map or paradigm that illustrates the concepts of:
1. Goals of Financial Management.
2. Agency Relationships.
3. Functions of Financial Management.
4. Responsibilities of Financial Managers.
5. Agency Relationships.