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Financial strategy


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Formulation of Financial Strategy

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Financial strategy

  1. 1. Formulation of Functional Strategy: Financial Prof.PrashantMehta NationalLawUniversity,Jodhpur
  2. 2. Formulation of Functional Strategy: Finaincial Introduction Marketing Strategy Formulation Financial Strategy Formulation Production Strategy Formulation Logistics Strategy Formulation Research and Development Strategy Formulation Human Resource Strategy Formulation
  3. 3. Financial Strategy • Financial Strategy involves: • Acquiring Needed Capital / Source of Funds • Developing Projected Financial Statements / Budgets • Management / Usage of Funds • Evaluating the Worth of Business • Some examples of decisions that may require finance / accounting policies are: • To raise capital with short term debt, long term debt, preferred stock, common stock etc. • To lease or to buy fixed assets. • To determine appropriate dividend payout ratio. • To determine the amount of cash that must be kept in hand etc.
  4. 4. Sourcesof Funds • Business requires additional capital, besides net profit from operations, and the sale of assets the other sources of funds are Debt and Equity (Capital structure of Firm). • Determining optimal mix of debt and equity in firms capital structure is vital. • Firm should have enough debt in its capital structure to boost ROI (earning more than cost of debt). • In adverse situation high debt can lead to poor stockholders return and jeopardize companies survival. • Fix debt obligations must be met regardless the circumstances. • Issuance of stock can have issues like ownership, control of enterprise which can lead to hostile takeovers, mergers, and acquisitions.
  5. 5. Sourcesof Funds • The major factors for which strategies are to made are: • Capital Structure • Procurement of Capital • Working Capital Borrowings • Reserves and Surplus as source of Funds • Relationships with Lenders, Bank, and Financial Institutions • Source of Funds (External Borrowings or Internal Financing)
  6. 6. Projected Financial Statements / Budgets • Budgets allows an organization to examine the expected results of various actions (implementation decisions) and approaches. Eg. Increase in promotion expenditure by 50% (market development strategy), Salary increase by 25% (market penetration Strategy), R&D expenditure increase by 70% (Product Development) or to sell common stock to raise capital for diversification. • A pro forma income statement and balance sheet allow organization to compute projected financial ratios, compare them with prior years and industry averages under various strategy implementation scenarios. • Companies prepare projected financial statements to project future expenses and earnings more reasonably.
  7. 7. Projected Financial Statements / Budgets • A financial budget is the document that details how funds will be obtained and spent for a specified period of time. (annual budgets are more common). • Financial budgets are viewed as the planned allocation of firm’s resources based on forecasts of the future. The different types of budgets include cash budgets, operating budgets, sales budget, profit budget, factory budget, capital budget, expense budget, divisional budget, variable budget, flexible budget, fixed budget etc. These are important in guiding strategy implementation. • Financial budgets limitations are: Cumbersome to make, expensive, Over budgeting / under budgeting can cause problems, they can become substitute for objectives, budgets hides inefficiencies if based solely on precedence rather than periodic evaluation of circumstances. • Budgets are sometimes used as instruments of tyranny – frustration / resentment.
  8. 8. Managementand Usage of Funds • It deals with investments and Asset mix decisions. It involves decisions like capital investment, fixed asset acquisition, current assets, loans, advances, dividend decisions, and relationship with share holders. • Usage of funds is important since it relates to the efficiency and effectiveness of resource utilization in the process of strategy implementation. • Management of fund is important area of financial strategy and strategic decisions are made for the system of finance, accounting, budgeting, management control system, cash, credit, and risk management, cost control and reduction, tax planning and advantages. All this leads to optimum utilization of funds. • Organizations that implements strategies of stability, growth, and retrenchment cannot escape rigors of proper management of funds. • Financial plans and policies however present dilemma before management. The priorities of management may often conflict with those of share holders.
  9. 9. Evaluating the Worth of Business • Integrative, Intensive, Diversification strategies are implemented by acquiring other firms, and retrenchment may result in sale of division of organization. Here it is strategically important to establish financial worth / cash value of business. • There are three approaches to determination of business worth; • The first approach is to determine net worth or stock holder’s equity. Net worth is sum of common stock, additional paid in capital, and retained earnings. After this we add or subtract additional amount of goodwill, overvalued, and undervalued assets. The total obtained provides a reasonable estimate of firms monetary value. • I the firm has goodwill it will be listed in balance sheet as intangibles.
  10. 10. Evaluating the Worth of Business • The second approach is measuring the value of firms growth based largely on future benefits its owners may derive through net profits. Establish business worth as five times the firm’s current annual profit. Note: Firms suppress earnings in financial statement to minimize taxes. • The third approach is letting market determine a business worth. • Base the firm’s worth on selling price of similar company and make a comparison. • Use price earning ration where we divide the market price of common stock by annual earnings per share and multiply this number by the firm’s average net income for the past five years. • Outstanding shares method where we multiply number of shares outstanding by the market price per share and add a premium. The premium is simply a per share amount that a person or firm is willing to pay to control or acquire the company.
  11. 11. FinancialManagementStrategies Capital Acquisitions • Debt Leverage, Stock Sales, & Gains From Operations • Equity Financing Is Preferred For Related Diversification • Debt Financing Is Preferred For Unrelated Diversification • Leveraged Buyouts (Lbos) Make The Acquired Firm Pay Off The Debt Can We Grow By Relying On Only Internal Cash Flows? Do Stock Sales Dilute Ownership Control? Does A Large Debt Ratio Cripple Future Growth? Does Strong Leverage Boost Earnings Per Share? Does High Debt Deter Takeover Attempts? Resource Allocations • Dividends, Stock Price, & Reinvestment • Reinvest Earnings In Fast-growing Companies • Keeping The Stockholders Contented With Consistent Dividends • Use Of Stock Splits ( Or Reverses) To Maintain High Stock Prices • Tracking Stock Keeps Interest In Company, But Doesn’t Allow Takeover