2. What does this involve?
• Raising finance
• Implementing profit centres
• Cost minimisation
• Allocating capital expenditure
3. Key terms
Financial strategy: the long term financial plan of action to achieve the
financial objectives of the business
Sources of finance: the range of options available to firms to fund
business operations including banks, venture capitalists and share
capital
Profit centres: a section of a business for which costs and revenues and
therefore profit can be identified
Capital expenditure: the purchase of assets that will remain in the
business in the medium to long term, accounted for in the balance
sheet.
4. Sources of finance
• Businesses need finance for short, medium and long-
term purposes
• Long term finance is normally needed to fund capital
expenditure
• Typically the largest source of finance is retained
profit
• If there is insufficient retained profit in a business an
alternative source of finance will be required
• There are 2 main types: equity share capital and debt
(loans)
5. Equity share capital Debt
• Exists for an unlimited term • Exists for a fixed term e.g. a 10 year
loan
• Carries a voting right
• Does not carry a voting right
• Dividends payable dependant upon
company performance • Interest payable regardless of company
performance
• Dividends paid after tax and therefor
do not affect tax liability • Interest paid before tax and therefore
reduces tax liability
• Ordinary shareholders are towards the
bottom of the list when payments are • Lenders are towards the top of the list
being made following the closure of a when payments are being made
company following the closure of a company
• Not secured • Will be secured against an asset
Contrasts between equity share capital and debt
6. Equity Share capital
• Unlike sole traders and partnerships, companies are able
to raise capital through the sale of shares
• A company will decide upon the maximum amount of
capital it is likely to need in the future from the sale of
shares
• Shares will then be issued to raise this predetermined
capital
• Additional share capital can be raised by releasing more
of the authorised share capital. This can be done through
a rights issue where existing shareholders are given the
right to buy a number of new shares. (normally offered
at a price below the market value)
7. Debt
• Finance obtained from banks and other institutions in the
form of a loan
• For the lender there is less risk than equity capital as the loan
is normally secured against an asset- if the company fails to
meet the terms of the agreement the asset can be seized.
• The risk to the company is greater due to interest payments-
these are compulsory regardless of the company's
performance.
• A company that relies heavily on debt capital is referred to as
being highly geared
8. Implementing profit centres
• In order to make strategic decisions it makes sense for a
business to identify the performance of individual subsections
within a company
• Profit centres involve devolving responsibility for profits to
identifiable subsections, not only does this help achieve
financial objectives but it also makes it easier to monitor
financial performance, allows for greater delegation and acts
to motivate.
• Helps a business gain a competitive advantage
• Profit centres are only appropriate when a subsection can
take responsibility for its own revenue as well as costs
9. Cost minimisation
• A strategy of cost minimisation will allow a business to
compete on price
• A business that has a high market share or is a market leader
will be in a position of power when it comes to negotiating
terms and conditions with suppliers
• It may therefore adopt a strategy which includes an aggressive
approach to negotiating prices for goods and services
• Lower input and processing costs can then be passed on to
customers
• Alternatively, a business may aim to reduce the cost of
managing resources through the adoption of a strategy
involving ‘just in time’
10. Allocating capital expenditure
• Capital expenditure is accounted for in the company’s balance
sheet allowing them to spread its cost over its useful life.
Expenditure on day to day items is called revenue
expenditure, this is accounted for in the income statement
• Large amounts of money can be involved in decisions
regarding expenditure, it is therefore taken very seriously
• ‘Sign off chain’- as the amount of money spent increases,
permission must be sought to make the purchase
11. Allocating capital expenditure
• Capital expenditure on new equipment/project is important to
maintain and increase shareholder wealth
• Benefits can be hard to measure as they may only be seen over a
long period of time. It therefore needs to be closely monitored
• Opportunity cost needs to be considered
12. Questions
1. What is meant by financial strategy? (3marks)
2. Explain why decisions about financial strategies
should be taken carefully (6marks)
3. Why might a chain of high street coffee shops,
such as Costa Coffee, choose a strategy of
operating each shop as a profit centre ?
(8marks)
