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College of Business and Accountancy


Financial Management

Financial Management concerns the duties of the financial manager, who is responsible for making significant corporate
investment and/or financing decisions.

Goal of Financial Management

The goal is to maximize shareholders’ best interests by making decisions that maximize the market value per share of stock
rather than to maximize profit.

Role of Financial Managers

1. Financial analysis and planning

 Determining the proper amount of funds to employ in the firm through liquidity and profitability analysis of the
company’s FS. (Related topics: budgeting, FS analysis and additional funds needed)

2. Investment decisions
 Selecting the best projects in which to invest firm resources, based on consideration of risks and returns. (Related topic:
capital budgeting)

3. Financing and capital structure decisions

Outsourcing company funds (mix of debt and equity financing) to support firm’s operations and investment programs.
(Related topic: cost of capital)

4. Management of financial resources

 Managing the firm’s current assets and source of short-term credit in the most efficient manner. (Related topic: working
capital management)

5. Risk management
 Managing the firm’s exposure to all types of risk. (Related topic: leverage)

No single person is tasked for all the responsibilities of a financial manager. These tasks are dispersed throughout the firm. In
large firms, financial responsibilities are usually carried out by the treasurer, the controller, and the chief financial officer who usually
overseas the work of both treasurer and controller.

Basic principles in Managerial Finance

Most techniques and tools in finance are based on the following principles:

1. Risk-return trade-off
→ “We won’t take on additional risk unless we expect to be compensated with additional return”

2. Time value of money

→ a peso received today is worth more than a peso received in the future

3. Cash
→ not profit….is the king!!!

4. Incremental cash flows

→ it’s only what changes that counts

5. Tax Consideration
→ virtually all financial decisions are influenced by the effect of taxes.

6. Ethical Behavior
→ doing the right thing – is always relevant…

Working Capital Management

Working Capital Management involves managing the firm’s current assets and liabilities to achieve a balance between
profitability and risk that contributes positively to the firm’s value.

Trade-off between Risks and Returns

The management of working capital requires consideration for the trade-off between risk and returns. Holding more current
than long-term assets means greater flexibility and reduced liquidity risk. However, the rate of return will be less than with current
assets than with long-term assets. Long-term assets typically earn a greater return than current assets. Long-term financing has less
liquidity risk associated with it than short-term debt, but it also carries a higher cost. Consider the following:

Working Capital Policy

Conservative Aggressive
Level of Current Assets High Low
Reliance on Long-Term Financing High Low
Liquidity Risk Low High
Profitability and Returns Low High

Factors to Consider in Managing Working Capital

1. Appropriate Level This refers to Adequacy of working capital

 Consider: Nature of business and length of operating cycle
2. Structural Wealth This refers to composition of working capital
 Consider: Need for cash, accounts receivable and other current assets
3. Liquidity This refers to the relative transformation (and its rate) of current assets into more liquid current
assets (e.g., cash and marketable securities).

In general, sound working capital policy requires:

1. Managing cash and its temporary investment efficiently. (Cash and Marketable Securities Management)
2. Ensuring efficient manufacturing operations and sound material procurement. (Inventory Management)
3. Drafting and implementing effective credit and collection policies. (Receivable Management)
4. Seeking favorable terms from suppliers and other temporary creditors. (Short-Term Credit Financing)

Illustration: Working Capital

Given the following information of Saitama Company:

Cash P 12,000 Accounts payable P 10,000
Accounts receivable 18,000 Current tax liability 3,000
Inventory 20,000 Accrued payroll 7,000
Fixed assets 50,000 Bonds payable 80,000

The bonds will mature in 10 years. All amounts are correctly stated.

1. Net Working Capital 4. New Current Ratio (assuming all accounts payable are paid in cash)
2. Current ratio 5. New Current Ratio (assuming a P10,000 short-term loan is obtained
3. Acid-Test Ratio from a bank)

Turnover Ratios, Conversion Periods and Cash Conversion Cycle

Income statement account

Turnover =
Average balance sheet account

Average age/ Conversion No. of days in a year
periods Turnover

Cash Conversion Cycle is the average length of time a peso is tied up in current assets. It runs from the date the company makes
payment of raw materials to the date company receives cash inflows thru collection of accounts receivable. It is also known as the cash
flow cycle.

Objective: To shorten the cash conversion cycle without hurting operations. The longer the cash conversion cycle, the greater the need
for external financing; hence, the more cost of financing.

Working Capital Activity Ratios (Efficiency Ratios)

It is the time required to complete one collection cycle

Receivables turnover Net (Credit) sales from the time receivables are recorded, then collected,
Average receivables to the time new receivables are recorded again.

Average age of receivables 360 days It indicates the average number of days during which
(Average collection period) Receivables turnover the company must wait before receivables are
(Days’ sales in receivables) collected.

Cost of goods sold It measures the number of times that the inventory is
Inventory turnover Ave. merchandise inventory replaced during the period.

Average age of inventory It indicates the average number of days during which
(Inventory conversion period) 360 days the company must wait before the inventories are
(Days’ sales in inventory) Inventory turnover sold.


Makunochi Corporation purchases merchandise on 20-day term. Goods are sold, on the average, 15 days after they are received. The
average age of accounts receivable is 45 days. Makunochi pays its payable on due date. (Assume a 360-day year).

1. How long is the company’s normal operating cycle?
2. How long is the company’s cash conversion cycle?
3. What is the number of cash conversion cycles in one year
4. What is the accounts payable turnover ratio?
5. What is the inventory turnover ratio?
6. Assuming the average inventory amounts to P200,000, how much is the COGS?
7. What is the accounts receivable turnover ratio?
8. Assuming an average receivable balance of P700,000, how much is the net credit sales?


Cash Management involves the maintenance of the appropriate level of cash to meet the firm’s cash requirements and to maximize
income on idle funds.

Objective: To minimize the amount of cash on hand while retaining sufficient liquidity to satisfy business requirements (e.g., take
advantage of cash discounts, maintain credit rating, meet unexpected needs).

Reasons for Holding Cash: “Why would a firm hold cash when, being idle, it is a non-earning asset?”

1. Transaction Motive (Liquidity Motive)

 Cash is held to facilitate normal transactions of the business (daily operating requirements).

2. Precautionary Motive (Contingent Motive)

 Cash is held beyond the normal operating requirement level to provide for buffer against contingencies, such as slow-down
in accounts receivable collection, possibilities of strikes, etc.

3. Speculative Motive
 Cash is held to avail of business incentives (e.g., discounts) and investment opportunities.

4. Contractual Motive (Compensating Balance Requirements)

 A company is required by a bank to maintain a certain compensating balance in its demand deposit account as a condition of a
loan extended to it.

Optimal Cash Balance: Baumol Model

OCB = 2 x AD x CPT where: OCB = Optimum cash balance

OCR AD = Annual demand
CPT = Cost per transaction
OCR = Opportunity cost ratio

Total Costs of Cash Balance = Holding Costs + Transaction Costs

 Holding Costs = Average Cash Balance* x Opportunity Cost

 Transaction Costs = Number of Transactions** x Cost Per Transaction
* Average Cash Balance = OCB ÷ 2
** Number of Transactions = Annual Cash Requirement ÷ OCB

Illustration: Optimal Cash Balance

Eiji Corporation is expecting to have total payments of P1,800,000 for one year, cost per transaction amounted to P25, and the interest
rate of marketable securities is 10%.

1. What is the company’s optimal initial cash balance that minimizes total cost?
2. What is the total number of transactions (cash conversions) that will be required per year?
3. What will be the average cash balances for the period?
4. What is the total cost of maintaining cash balances?

Illustration: Minimum Cash Balance

Faith Corporation’s COGS per year is P4,860,000. Annual operating expenses are estimated at P1,200,000, inclusive of depreciation and
other non-cash expenses of P300,000.

Required: How much must the corporation’s minimum cash balance be if it is to be equal to 15 days requirement? (Use 360-day rear)

Cash Management Strategies

1. Accelerating collections (e.g., lockbox system)
2. Slowing disbursements (e.g., playing the floats)
3. Reducing precautionary idle cash (e.g., zero-balance accounts)

Float Management

Float is generally defined as the difference between the cash balance per BANK and the cash balance per BOOK as of a particular
period, primarily due to outstanding checks or other similar reasons.

Types of Float

1. Positive (Disbursement) Float: Bank balance > Book balance

Example: Outstanding checks issued by the firm that have not cleared yet.

2. Negative (Collection) Float: Book balance > Bank balance

1. Mail Float – Amount of customers’ payments that have been mailed by customers but not yet received by the seller-
2. Processing Float – Amount of customers’ payments that have been received by the seller but not yet deposited.
3. Clearing Float – Amount of customers’ checks that have been deposited but have not cleared yet.

Good cash management suggests that positive float should be maximized and negative float should be minimized.

Illustration: Float & Lockbox System

It typically takes Hope Corporation 8 calendar days to receive and deposit customer remittances. Hope is considering adopting a
lockbox system and anticipates that the system will reduce the float time to 5 days. Average daily cash receipts are P220,000. The rate of
return is 10 percent.

1. How much is the reduction of float in cash balances associated with implementing the system?
2. What is the amount of return associated with the earlier receipt of the funds?
3. If the lockbox costs P7,500 per month to implement, should the system be implemented?
a. Yes, savings is P24,000 per year c. No, loss is P14,500 per year
b. Yes, Savings is P82,500 per year d. No, loss is P24,000 per year


AR Management involves the determination of the amount and terms of credit to extend to customers and monitoring receivables from
credit customers.

Objective: To collect AR as quickly as possible without losing sales from high-pressure collection techniques. Accomplishing this goal
encompasses three topics: (1) credit selection and standards, (2) credit terms, and (3) collection and monitoring program

Consider this trade-off: Offering liberal and relaxed credit terms attracts more customers while it would entail more costs of AR as
collection, bad debts and interests (opportunity costs).

Factors to Consider for AR Policy

1. Who (customers) will be granted credit? How much is the credit limit?
Factors to consider in establishing credit standards – the Five C’s of Credit:
 Character – customers’ willingness to pay
 Capacity – customers’ ability to generate cash flows
 Capital – customers’ financial sources (i.e., net worth)
 Conditions – current economic or business conditions
 Collateral – customers’ assets pledged to secure debt.

2. Credit Terms – is the credit period and discount offered for customer’s prompt payment. The following costs associated with
the credit terms must be considered: cash discounts, credit analysis and collections costs, bad debt losses and financing costs.

3. Collection Program
Shortening the average collection period may preclude too much investment in receivable (low opportunity costs) and too
much loss due to delinquency and defaults. The same could also result to loss of customers if harshly implemented.

Illustration: Average Investment in Accounts Receivable

Heart Corporation sells on terms of 2/10, n/30. 70% of customers normally avail of the discounts. Annual sales are P900,000, 80% of
which is made on credit. Cost is approximately 75% of sales.

Required: Compute for the following:

1. Average balance of accounts receivable

2. Average investment in accounts receivable

Illustration: Accelerating Collection

Rose Corporation makes credit sales of P2,160,000 per annum. The average age of accounts receivable is 30 days. Management
considers shortening credit terms by 10 days. Cost of money is 18%.

Required: How much will the company save from financing charges? (Assume 360-day year)

Illustration: Discount Policy

Alone Company presents the following information:

Annual credit sales P 25,200,000 Collection period 3 months
Rate of return 18% Terms n/30

The company considers to offer a 4/10, n/30 credit term. It anticipates that 30% of its customers will take advantage of the discount
while sales would remain constant. The collection period is expected to decrease to two months.

Required: What is the net advantage (disadvantage) of implementing the proposed discount policy?

Illustration: Credit Policy – Relaxation

The Left Corporation reports the following information:

Selling price P 10 Annual credit sales 240,000 units

Variable cost per unit P8 Collection period 3 months
Total fixed costs P 120,000 Rate of return 25%

The Left Corporation, which has enough idle capacity, considers relaxing its credit standards (i.e., more liberal extension of credit). The
following is expected to result: sales will increase by 25%; collection period will increase to 4 months; bad debt losses are expected to be
5% on the incremental sales; and collection costs will increase by P40,000.

Required: Should the proposed relaxation in credit standards be implemented? Why?


Inventory Management Techniques

1. Inventory Planning – involves determination of the quality and quantity and location of inventory, as well as the time of
ordering, in order to minimize costs and meet future business requirements.
Examples: EOQ, Reorder Point, JIT System
2. Inventory Control – involves regulation of inventory within predetermined level; adequate stocks should be able to meet
business requirements, but the investment in inventory should be at the minimum.

Systems of Inventory Control

1. JIT Production System

2. Fixed Order Quantity System – an order for a fixed quantity is placed when the inventory level reaches the reorder point.
This is consistent with EOQ concept.

3. Periodic Review or Replacement System – orders are made after a review of inventory level has been done at regular

4. Optional Replenishment System – combination of fixed order and replacement systems.

5. Materials Requirement Planning (MRP) – MRP is designed to plan and control raw materials used in production based on a
computerized system that manufactures finished goods based on demand forecasts.

6. Manufacturing Resource Planning (MRP-II) – is a closed loop system that integrates various functional areas of a
manufacturing company (e.g., inventories, production, sales and cash flows). It is developed as an extension of MRP.

7. Enterprise Resource Planning (ERP) – integrates information systems of all functional areas in a company. Every aspect of
operations is interconnected as the company is connected with its customers and suppliers.

8. ABC Classification System – inventories are classified for selective control

A items – high value requiring highest possible control
B items – medium cost items requiring normal control
C items – low cost items requiring the simplest possible control

Economic Order Quantity (EOQ)

EOQ refers to the number of units that should be placed every order to economize on the sum of ordering costs and carrying

The EOQ answers two questions. First, how many units should be ordered? Second, when should these units be ordered?

The formula to compute EOQ is:


C = annual demand
N = ordering cost per unit
K = carrying cost per unit

Average inventory is computed as follows:

 No safety stock: EOQ/2
 With safety stock: EOQ/2 + safety stock
 If EOQ is not available: (Beginning inventory + Ending inventory) ÷ 2

Assumptions & Limitations of EOQ Analysis

1. Annual determinable demand for inventory is spread evenly throughout the year.
2. Lead time does not vary and each order is delivered in a single delivery.
3. The unit cost of the units ordered is constant; thus, there can be no quantity discounts.

Lead Time – is the time span from date of order to date required to receive the EOQ once an order is placed.

Safety Stock – sometimes called buffer stock, is the extra materials maintained to serve as insurance against possible delays.

Reorder Point – is the point in time a new order should be placed.

The Concept of Reorder Point

Order (Reorder) Point is the inventory level (in units) that automatically calls for placing a new order.

When is the perfect time to place an order?

“When to reorder” is a stock-out problem; the objective is to order at a point in time so as not to run out of stock before
receiving the inventory ordered but not so early that an unnecessary quantity of safety stock is maintained. When order point is
computed, there may be stock-out situation if:
 Demand is greater than expected during the lead time, or
 The order time exceeds the anticipated lead time.

LEAD TIME is the period from the time an order is placed until such time the order is received.
 Normal (Average) Lead Time – this refers to the usual delay in the receipt of ordered goods.
 Maximum Lead Time – this adds to normal lead time a reasonable allowance for further delay.

NORMAL LEAD TIME USAGE = normal lead time x average usage

SAFETY STOCK = (maximum lead time – normal lead time) x average usage

REORDER POINT (without safety stock) = Normal lead time usage

REORDER POINT (with safety stock) = Normal lead time usage + safety stock
Or; maximum lead time x average usage


The Handy Company has the following information available concerning one of its inventory items:

Cost of placing an order P 32.00

Unit of carrying cost per year P 4.00
Annual unit demand 5,625
Safety stock 100
Average daily demand 25
Normal lead time in days 10

1. What is the economic order quantity?
2. What is the frequency of placing an order?
3. What is the reorder point for the inventory item?
4. What is the maximum lead time?
5. What is the average number of orders made during the year?
6. How much is the total annual ordering costs?
7. How much is the average inventory?
8. How much is the total annual carrying costs?


1. A service enterprise's working capital at the beginning of January was P70,000. The following transactions occurred during
Performed services on account P 30,000
Purchased supplies on account 5,000
Consumed supplies 4,000
Purchased office equipment for cash 2,000
Paid short-term bank loan 6,500
Paid salaries 10,000
Accrued salaries 3,500

What is the amount of working capital at the end of January?

a. P80,500 b. P78,500 c. P50,500 d. P47,500

2. Colt Corporation has 100,000 shares of stock outstanding. Below is part of MFC’s Statement of Financial Position for the last fiscal
Colt Corporation
Statement of Financial Position – Selected Items
December 31, 2017

Cash P455,000
Accounts receivable 900,000
Inventory 650,000
Prepaid assets 45,000

Accrued liabilities 285,000

Accounts payable 550,000
Current portion, long-term notes payable 65,000

What is the maximum amount Colt can pay in cash dividends per share and maintain a minimum current ratio of 2 to 1? Assume
that all accounts other than cash remain unchanged.
a. P2.05 b. P2.50 c. P3.35 d. P3.80

3. Smile, Inc. has a total annual cash requirement of P9,075,000 which are to be paid uniformly. Smile has the opportunity to invest
the money at 24% per annum. The company spends, on the average, P40 for every cash conversion to marketable securities. What
is the optimal cash conversion size?
a. P60,000 b. P55,000 c. P45,000 d. P72,500

4. Newman Products has received proposals from several banks to establish a lockbox system to speed up receipts. Newman receives
an average of 700 checks per day averaging P1,800 each, and its cost of short-term funds is 7% per year. Assuming that all
proposals will produce equivalent processing results and using a 360-day year, which one of the following proposals is optimal for
a. A P0.50 fee per check c. A flat fee of P125,000 per year
b. A fee of 0.03% of the amount collected d. A compensating balance of P1,750,000

5. On an average day, a company writes checks totalling P1,500. These checks take 7 days to clear. The company receives checks
totalling P1,800. These checks take 4 days to clear. The cost of debt is 9%. What is the firm's disbursement float?
a. P10,500 b. P1,500 c. P1,800 d. None of the above

6. On an average day, a company writes checks totalling P1,500. These checks take 7 days to clear. The company receives checks
totalling P1,800. These checks take 4 days to clear. The cost of debt is 9%. What is the firm's net float?
a. P300 b. P3,300 c. P2,100 d. P1,200

7. Mr. S. Mart assumed the presidency of Riches Corp. He instituted new policies and with respect to credit policy, below is a
summary of relevant information:
Old Credit Policy New Credit Policy
Sales P1,800,000 P1,980,000
Average collection 30 days 36 days

The company requires a rate of return of 10% and a variable cost ratio of 60%. Using a 360-day year, the pre-tax cost of carrying
the additional investment in receivables under the new policy would be
a. P4,800 b. P2,880 c. P3,000 d. P4,080

For items 8 to 17:

Given the following data for Nika Corp.:

Annual units required = 4,800
Ordering costs = P30 per order
Carrying costs per unit = P1.25

On average, it takes 15 days for the supplier to deliver the order made by its customer.

Required: Determine the following:

8. EOQ
9. Number of orders made each year
10. Frequency of placing an order
11. Total ordering costs
12. Average inventory
13. Total carrying cost
14. Daily requirement
15. Reorder point
16. Reorder point (assuming there is a safety stock of 200 units)
17. Maximum lead time