Financial Policy and Corporate Strategy

Financial Policy and Corporate Strategy Page 1
Financial Policy and Corporate
Strategy
Chapter 1

Question: Define strategic financial management and its functions? Also, discuss the
importance of strategic management in today’s scenario?
Answer: Strategic financial Management can be defined as :
 application of various strategic decisions of financial techniques
 in order to help the decision maker or the investors to achieve their objectives
i.e. wealth maximization and
 to allocate limited funds between alternatives uses in such as manner that the
organization can sustain its investors as well.
Strategic financial management helps in dealing with the 3 fundamental elements
of business i.e.
 A clear and realistic strategy
 The financial resources, controls and systems to see it through and
 The right management team and processes to make it happen
Thus, it can be summarized as Fundamentals of business = Strategy + Finance +
Management.
Strategic financial management combines the backward-looking, report-focused
discipline of (financial) accounting with the more dynamic, forward-looking
subject of financial management.
5 functions of Strategic Financial Management
• Continual search for best investment opportunities;
• Selection of the best profitable opportunities;
• Determination of optimal mix of funds for the opportunities;
• Establishment of systems for internal controls; and
• Analysis of results for future decision-making
4 Importance of Strategic Management
• Strategic management intends to run an organization in a systematized
manner by developing a series of plans and policies such as strategic plans,
functional policies, structural plans and operational plans.
• It is a systematic approach which deals with organization vision, mission and
objectives and strategies to achieve that objective.
• It helps in continuous identification of uncertain areas of business and
environment and tries to reduce the impact of same through continuous
review of the whole planning and implementation process.
• Thus, it is helps an organization in long run survival and command over the
market by giving emphasis on critical resources of the firm and to create such
processes that are holistic, periodic, futuristic, intellectual and creative and
ultimately saves the organization from myopic vision.

Question: Define Agency Theory or Discuss key decisions of financial management?
or
How to deal with strategic problem for financial management i.e how limited
funds are allocated between alternative uses?
Answer: Since capital is the limiting factor, the strategic problem for financial management
is how limited funds are allocated between alternative uses. This can be done by
using agency theory.
According to Agency theory, strategic financial management is the function of 4
major components based on the mathematical concept of expected NPV (net
present value) maximization, which are:
1. Financing decisions – These decisions deal with the mode of financing or mix
of equity capital and debt capital.
2. Investment decisions – Theses involve the profitable utilization of firm's funds
in long term projects. These projects are evaluated in relation to expected risk
and return.
3. Dividend decisions – These decisions determine the division of earnings
between payments to shareholders and reinvestment in the company.
4. Portfolio decisions – These decisions involve evaluation of investments based
on their contribution to the aggregate performance of the entire corporation
rather than on the isolated characteristics of the investments themselves.
Question: Define Strategy and Explain the different levels of strategy?
Answer: Strategy means  the long term direction and scope of an organization  to
achieve competitive advantage  through the configuration of resources  within
a changing environment  for the fulfilment of stakeholder’s aspirations and
expectations.
Strategies at different levels are the outcomes of different planning needs. There
are basically three types of strategies:
Corporate Level Strategy:
Corporate level strategy fundamentally is concerned with selection of businesses
in which a company should compete and with the development and coordination
of that portfolio of businesses. It is concerned with 3 questions:
 Suitability i.e. Whether the strategy would work for the accomplishment of
common objective of the company
 Feasibility i.e. Determines the kind and number of resources required to
formulate and implement the strategy
 Acceptability i.e. It is concerned with the stakeholders’ satisfaction and can be
financial and non-financial

Business Unit Level Strategy
It is the managerial plan for achieving the goal of the business unit. At the
business unit level, the strategic issues are about
 Practical coordination of operating units and internal function activities and
 Developing and sustaining a competitive advantage for the products and
services that are produced.
Functional Level Strategy
It is the low level plan to carry out principal activities of a business. Functional
level strategies in R&D, operations, manufacturing, marketing, finance, and
human resources involve the development and coordination of resources through
which business unit level strategies can be executed effectively and efficiently.
Ultimately,
Functional strategy must be consistent with the business strategy, which in turn
must be consistent with the corporate strategy
Question: Define Financial Planning? What are the Basic Issues addressed under Financial
Planning?
Answer: Financial planning is the backbone of the business planning and corporate
planning.
Financial planning is a systematic approach whereby the financial planner helps
the customer to maximize his existing financial resources by utilizing financial
tools to achieve his financial goals.
It helps in defining the feasible area of operation for all types of activities and
there by defines the overall planning framework.
Outcomes of the financial planning are the financial objectives, financial decision-
making and financial measures for the valuation of the corporate performance.
There are 3 major components of Financial planning i.e.
 Financial Resources (FR)
 Financial Tools (FT)
 Financial Goals (FG)
Thereby,
Financial Planning: Financial Resources + Financial Tools = Financial Goals
4 Basic Issues addressed under Financial Planning are:
 Profit Maximization versus Wealth Maximization i.e. organization must focus
on maximization of wealth instead of maximization of profit as it suffers from
limitations. Wealth maximization can reflect the business efficiency without
any scope for ambiguity.
 Cash Flow: It deals with the movement of cash and surplus of internally
generated funds over expenditures.

 Credit Position: It describes organization strength in mobilizing borrowed
money. In case the internal generation of cash position is weak, the firm may
exploit its strong credit position to go ahead in the expansion of its activities.
 Liquidity Position of the Business: It describes the extent of idle working
capital. It measures the ability of the firm in handling unforeseen
contingencies.
Question: Explain the Interface of Financial Policy and Strategic Management?
or
Explain briefly, how financial policy is linked to strategic management?
Answer: The success of any business is measured in financial terms. At every stage of its
operations including policy-making, the firm should take strategic steps with
value-maximization objective in order to maximise shareholders wealth. This is
the basis of financial policy being linked to strategic management.
The interface of strategic management and financial policy is based on the fact
that the starting and end point of an organization is money.
Therefore, no organization can run an existing business and promote a new
expansion project without a suitable internally and externally mobilized financial
base.
The interface can be seen in respect of many business decisions of an
organization. For Example:
 Manner of raising capital as source of finance and capital structure are the
most important dimensions of strategic plan. The money can be raised
through ownership capital (like equity or preference shares) and or borrowed
capital (like issuing debentures, accepting public deposits, loans etc.)
 Along with the mobilization of funds, policy makers should decide on the
capital structure which varies from industry to industry. Like: debt equity ratio
of 1:1 is acceptable in public sector while 2:1 is acceptable in private sector as
per industry norms.
 Investment and fund allocation by different business units is another
important dimension of interface of strategic management and financial
policy. Such investment proposals can be divided into 3 groups:
 Addition of a new product
 Increase the level of existing product operation
 Cost reduction and efficient utilization of resources through new
approach
Project evaluation and project selection are the two most important jobs
under fund allocation. Planner’s task is to make the best possible allocation
under resource constraints.

 A dividend policy decision is another area which deals with the extent of
earnings to be distributed and the extent of earnings to be retained for future
expansion scheme of the firm.
To arrive at the right dividend policy, following are considered
 Investment opportunities
 financial needs of the firm and
 shareholders preference for dividend against capital gains resulting out
of share
 Alternatives like cash dividend and stock dividend
Conclusion
Therefore, Financial policy of a company cannot be worked out in isolation of
other functional policies. It has a wider appeal and closer link with the overall
organizational performance and direction of growth.
Further, each factor is interdependent in the financial policy framework.
Question: Write a short note on Balancing Financial Goals vis-a-vis Sustainable Growth?
Answer: • Sustainable growth is concerned with distribution of resources in such a
manner that future stakeholders can also take benefit.
• The concept of sustainable growth can be helpful for planning healthy
corporate growth.
• Managers are required to consider the financial consequences of sales growth
and to set their goals consistent with the operating and financial policies of
the firm to avoid future conflicts that could emerge due to inconsistency with
the value of organization sustainable growth.
• Organization shall adopt suitable financial policy initiative to make sure
enterprise growth speed close to sustainable growth ratio and have
sustainable healthy development.
• The sustainable growth rate (SGR) of a firm is the maximum rate of growth in
sales that can be achieved, given the firm's profitability, asset utilization, and
desired dividend payout and debt ratios.
SGR = ROE x (1- Dividend payment ratio)
• The SGR is a measure of how much a firm can grow without borrowing more
money. After the firm has passed this rate, it must borrow funds from another
source to facilitate growth.
• Sustainable growth model is based on assumption that business wants to
1) maintain a target capital structure without issuing new equity;
2) maintain a target dividend payment ratio; and
3) increase sales as rapidly as market conditions allow

• Sustainable growth achievement requires growth strategy and growth
capability.
• Mature firms often have actual growth rates that are less than the sustainable
growth rate where management's principal objective is finding productive
uses for the cash flows that exist in excess of their needs.
• Growth can come from 2 sources: increased volume and inflation. Inflation
increases the amount of external financing requirement and increases the
historical cost based debt-to-equity ratio.
Example w.r.t SGR
Suppose a company has an ROE of 15% and a dividend payout ratio of 40%. Then SGR will be
9% (15%*60%).
This implies that the company can safely grow at a rate of 9% using its current resources and
revenue without incurring additional debt or issuing equity to fund growth.
If company wants to accelerate the growth rate say 12%, and then company would likely need
additional financing.
Question: What makes an organisation financially sustainable?
Answer: To be financially sustainable, an organisation must
• have more than one source of income;
• have more than one way of generating income;
• do strategic, action and financial planning regularly;
• have adequate financial systems;
• have a good public image;
• be clear about its values (value clarity); and
• have financial autonomy
Question: What makes an organisation sustainable?
Answer: To be sustainable, an organisation must
• have a clear strategic direction;
• be able to scan its environment or context to identify opportunities for its
work;
• be able to attract, manage and retain competent staff;
• have an adequate administrative and financial infrastructure;
• be able to demonstrate its effectiveness and impact in order to leverage
further resources; and
• get community support for, and involvement in its work

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