CHAPTER

AN INTRODUCTION TO FINANCIAL MANAGEMENT I What is Finance?

Finance is the study of how individuals, institutions, governments, and businesses acquire, spend, and manage money and other financial assets. Financial Environment encompasses the financial system, institutions, markets and individuals that make the economy operate efficiently. The Three (3) Areas of Finance Comprising the Financial System in the Financial Environment: 1. Financial institutions and financial markets 2. Investments 3. Financial Management Financial Institutions are system operate efficiently individuals, businesses, and physical assets (inventories, organizations or intermediaries that help the financial and transfer funds from savers and investors to governments that seek to spend or invest the funds in buildings, and equipment.)

Financial Markets are physical locations or electronic forums that facilitate the flow of funds amongst investors, businesses, and governments. Investments involve the sale or marketing of securities, the analysis of securities, and the management of investment risk through portfolio diversification. Financial Management involves financial planning, asset management, and fund raising decisions to enhance the value of businesses. Entrepreneurial Finance is the study of how growth-driven, performance-focused; early-stage firms raise financial capital and manage operations and assets.

Personal Finance is the study of how individuals prepare for financial emergencies, protect against premature death and property losses, and accumulate wealth over time. Financial System is the interaction among policy makers, a monetary system, financial institutions, and financial markets to expedite the flow of financial capital from savings into investment. Financial management is concerned with the maintenance and creation of economic wealth. Thus, the preferable goal of the firm should be maximization of shareholder wealth by which we mean maximization of the price of the existing common stock rather than profit maximization. Why not Profit Maximization as goal of the firm? Profit maximization stresses the efficient use of capital resources, but is not specific with respect to the time frame over which profits are to be measured. Profit maximization ignores uncertainty and risk. Profit maximization ignores the relationships between risk and expected return. Profit maximization ignores timing of the projects returns. Profit maximization ignores the cost of capital.

Forms of business organization:

Sole Proprietorship a business owned by a single individual. Partnership an association of two or more individuals joining together as coowners to operate a business for profit. Corporation an entity that legally functions separate and apart from its owners.

Objectives of Income Taxation: 1. The provision of revenues for government expenditures; 2. The achievement of socially desirable goals; and

3. Economic stabilization. Marginal Tax Rate the tax rate that would be applied to the next peso of income. Other Tax Considerations: 1. 2. 3. 4. The The The The dividend income exclusion for corporations; effects of depreciation on the firms taxes; tax treatment of operating losses; and recognition of capital gains and losses.

Dividend Exclusion refers to tax exemption of a corporation on certain percentage of the dividend income received from other corporation. Depreciation the means by which an assets value is expensed over its useful life for income tax purposes. Net Operating Loss Carryback and Carryforward a tax provision that permits the taxpayer first to apply the loss against the profits in the three prior years (carryback). If the loss has not been completely absorbed by the profits in these three years, it may be applied to taxable profits in each of the fifteen following years (carry forward).(U.S. Taxation Law) Net Operating Loss Carryover (RP Taxation Laws) - a tax provision that permits the taxpayers net operating loss to be carried forward to the next three (3) years. Capital Gain or Loss - a gain or loss resulting from the sale or exchange of a capital asset. Ten Axioms that Form the Basics of Financial Management: Axiom #1 The Risk-Return Tradeoff We wont take on additional risk unless we expect to be compensated with additional return. Axiom #2 - The Time Value of Money A dollar received today is worth more than a dollar received in the future. Axiom #3 Cash Not Profits Is King. Axiom #4 Incremental Cash Flows Its only what changes that count. Axiom #5 The Curse of Competitive Markets Why its hard to find exceptionally profitable projects. Axiom #6 Efficient Capital Markets The markets are quick and the prices are right. Axiom #7 The Agency Problem Managers wont work for the owners unless its in their best interest. Axiom #8 - Taxes Bias Business Decisions. Axiom #9 - All Risk Is Not Equal Some risk can be diversified away, and some cannot. Axiom #10 - Ethical Behavior Is Doing the Right Thing, and Ethical Dilemmas Are Everywhere in Finance.