TYBBA SEM 5

506: STRATEGIC FINANCIAL MANAGEMENT

Chapter 1. Introduction to Strategy and Financial Management (10%)

Introduction:

Strategic decisions made at the corporate level and that have long term implications on
shareholder value include those related to investment opportunities, corporate
restructuring, dividend policy, and capital structure.

With respect to investment opportunities, it is important to recognize that shareholder

value is 'created' where the return achieved on the project exceeds the required rate of
return given the risks inherent in the project. In addition to traditional discounted cash flow
analysis, and the calculation of net present value, the analysis of investment opportunities
often is aided by measures such as the profitability index (the ratio of net present value to
initial investment) and discounted payback period.

Companies frequently seek to restructure their operations in an attempt to enhance

shareholder value. The restructuring decision should flow from a corporation's strategy, and
should be based on the profitability of a particular business segment, as well as the assets
and financial resources required in order to generate that level of profit. In addition to
examining each business segment on a stand-alone basis, the implications of changes to
other segments of the organization also should be considered.

Dividend policy normally is viewed as an extension of the capital structure decision.

Dividends represent a transfer of wealth from the company to the shareholder. In theory, a
company should pay dividends where its investment opportunities are not expected to
generate a rate of return that is at least as high as its cost of capital. However, the dividend
policy decision also is influenced by shareholder expectations, and management's
reluctance to cut dividends once established given the potential negative consequences.

Capital structure argues that managers actively seek to direct the firm's capital structure to
support the firm's overall long term strategic goals.

Meaning of Strategic Financial Management :

Strategic financial management can be defined as being the application to strategic

decisions of financial techniques in order to help in achieving the decision-maker's
objectives.

The process of managing the finances of an organisation, corporation, or business is known

as strategic financial management. in order to meet the long-term goals of the organisation
In order to build a long-term strategy, it is a management approach that employs a variety
of tactics and financial instruments. It guarantees that the strategy is carried out in order to
meet the desired outcome.

The expression strategic financial management' refers to an approach, which being focused
on long-term financial health, offers a solution to this short-termism. Given that the
maximization of short-run accounting profits is inappropriate, the best starting point is with
the question of what constitutes an appropriate financial objective.

Strategic financial management integrates the financial management function into business
strategy and every other part of an organizations operation. Applying strategic financial
management knowledge and skills improves an organization's effectiveness and efficiency.
In today's highly competitive business environment, both private and government
organizations are increasingly putting more emphasis in this area to achieve their objectives.

Strategy + Finance + Management : The fundamentals of business

Strategic Financial Management assesses the complex decision-making necessary at the

higher levels of management, including evaluating and setting up reward systems for
subordinates and other personnel, evaluating expansion opportunities, mergers and
acquisitions, spin-offs and sales of existing assets, and making decisions on complex
investment opportunities and managing risk. It helps to develop the financial know-how,
necessary for senior management to skillfully guide any organization toward success.

Strategic financial management is defined as the application of financial techniques to

strategic decisions in order to help achieve the decision-maker's objectives'. Strategic
decisions are those which affect the whole organization, take into account factors in the
external environment and refer to the longer-term (five years or more) direction of an
organization. Strategic financial management requires the existence of objectives and
acknowledges that financial techniques are an integral part of policy making and control:

1) Strategy: A course of action including the specification of resources required, to

achieve a specific objective. Financial strategy is the aspect of strategy which falls
within the scope of financial management, which will include decisions on
investment, financing and dividends.

2) Strategic Financial Management: The identification of the possible strategies

capable of maximizing an entity's net present value, the allocation of scarce capital
resources among the competing opportunities and the implementation and
monitoring of the chosen strategy so as to achieve stated objectives.

Characteristics of Strategic Financial Management:

Some of the most important characteristics of Strategic Financial Management are as
follows:
• It manages to be both organized and adaptable at the same time.
• It is concerned with the administration of the fund over the long term, taking a long-term
perspective.
• When dealing with factual information, it employs analytical financial tools in conjunction
with qualitative and quantitative judgment to arrive at a conclusion.
• As a result, it contributes to the long-term growth, profitability, and survival of the
organization as well as the maximization of shareholder value.
• It aids in the formulation of appropriate strategies as well as the ongoing monitoring of
action plans to ensure that they are in line with long-term objectives and objectives.
• It entails approaching problem solving with an inventive, creative, and multifaceted
approach in order to identify solutions.
• While assessing the challenges in the context of the organization, strategic financial
management can identify a number of potential solutions that can be implemented.
• This approach is distinguished by the use of result-oriented resource combination,
particularly in the case of financial and economic resources.
• In order to achieve its strategic financial objectives, the business must adopt and update
strategies on a regular basis, which is a developing and ongoing process.
• The primary goals of the organization are the maximization of profit and wealth for its
shareholders.

Significance of Strategic Financial Management:

Strategic financial management is important because its study enables the finance manager
to:
1) Understand the limitations of traditional accounting models in an increasingly dynamic
and fast-changing world.
2) Contribute more effectively to corporate strategy by taking a more proactive and forward
looking approach.
3) React to conditions of rapid change through enhanced awareness, anticipation and
adaptation.
4) Understand and use alternative expressions of profit that start with recognition of the
impact on cash flow of the various stakeholders in a company.
5) Understand the different relationships between profits, expansion and cash flow model in
the traditional accounting and financial management models.

Strategic Planning:

Meaning of Strategic Planning:

Strategic planning is concerned mainly with the designing of business. Strategic planning
provides a means to deal explicitly and systematically with matters of fundamental
importance. Business planning is, "the process of selecting an organization's goals,
determining the policies and strategic programs necessary to achieve specific objectives en-
route to the goals and establishing the methods necessary to assure that the policies and
strategic programs are achieved". Thus, business planning is derived from strategic planning
and strategy.

Definition of Strategic Planning:

According to Scott, "long range business planning is a systematic approach to decision-

making about issues, which are fundamental and of crucial importance to its continuing
long-term effectiveness".
Strategic Planning is concerned with:
i) The direction in which the company should move.
ii) The implementation of the plan for the subsequent period,
iii) The alternatives, which are to be sacrificed, if the plan is accepted and implemented.
Strategic planning involves more than one strategy. In other words, the strategies relating to
different functional areas are involved business planning. An activity rather than a form of
organization, is at the core of business planning.

According to Alfred Chandler, strategic planning is "concerned with the determination of

the basic long-term goals and objectives of an enterprise and the adoption of courses of
action and allocation resources necessary for carrying out these goals".

According to William Glueck, "Strategic Planning is a stream of decisions and actions, which
lead to the deployment of an effective strategy or strategies to help achieve corporate
objectives, decisions and actions, which determine whether an enterprise excels, survives or
dies".

FINANCIAL PLANNING:

Meaning of Financial Planning:

Planning includes attempting to make optimal decisions, projecting the consequences of
these decisions for the firm in the form of a financial plan and then comparing future
performance against that plan.

Definition of Financial Planning:

According to William King, "Planning is the process of thinking through and making explicit
the strategy, actions, and relationships necessary to accomplish an overall objective".
"The financial plan of a corporation has two-fold aspects; it refers not only to the capital
structure of the corporation but also to the financial policies which the corporation has
adopted or intends to adopt".
Usually, a company creates a financial plan immediately after the vision and objectives have
been set. The Financial Plan describes each of the activities, resources, equipment and
materials that are needed to achieve these objectives, as well as the timeframes involved.

Financial Planning is the task of determining how a business will afford to achieve its
strategic goals and objectives.

According to Walker and Baughn, "Financial planning pertains to the function of finance and
includes the determination of the firm's financial objectives, financial policies and financial
procedures".

The Financial Planning activity involves the following tasks:

1) Assess the business environment
2) Confirm the business vision and objectives
3) Identify the types of resources needed to achieve these objectives
4) Quantify the amount of resource (labor, equipment, materials)
5) Calculate the total cost to create a budget
6) Identify any risks and issues with the budget set.

Performing Financial Planning is critical to the success of any organization. It provides the
business plan with rigor, by confirming that the objectives set are achievable from a
financial point of view. It also helps the CEO to set financial targets for the organization and
reward staff for meeting objectives within the budget set.

Need of Financial Planning:

Financial planning is one of the prerequisites for the success of an enterprise. As a short-
term measure, it ensures a timely and balanced flow of funds to all the segments of the
organization. As a long-term aspect, it is one of the basic tools for efficient use of financial
resources.

The need for financial planning arises due to the following reasons:
1) Timely availability of sufficient funds of cash to meet the various expenses, emergencies
and contingencies.
2) To ensure liquidity of funds throughout the year.
3) To outline the points of time where and when the funds will be required and how much.
4) To indicate whether there is likelihood of surplus resources available for expansion and
investment.
5) To anticipate future requirements of funds, if any.
6) To generate confidence in the minds of suppliers of funds by adopting prudent financial
policies.
7) The environment under which business firms operate constantly changes. There is cut
throat competition and the consequent narrow margin of profit. Financial planning is one of
the tools for filling-up the gap between the existing and desired situation (goals).
Besides the aforesaid, the financial planning also offers the advantages of conservation and
provision of finance for replacement of assets, reduce uncertainly, optimize cost of capital,
and effective utilization of funds, and consequently improved profitability and balancing the
cost, control and risk-larger gradually and steadily. In a later case, their expansion or
diversification may be financed to some extent by internal generation of funds also.
7) Government Polices and Control: In preparing a financial plan, promoters have to
invariably take into account government policies, including monetary and fiscal policies, and
other instruments of government control over a business.

Financial Planning Process:

For the purposes of financial planning, an organization should take the following steps:

1) Laying-Down Financial Objectives: In order to make an effective financial plan, first of all
the financial objective of the corporation should be laid down. The financial objectives of a
business help in determining policies and procedures. In the changing circumstances, the
business must determine its short term and long-term objectives in present times. Short-
term objectives should be determined in a manner that they help in the achievement of
long-term objectives.
1. Laying-Down Financial Objectives
2. Formulating Financial Policies
3. Developing Financial Procedures
4. Preparation of Financial Plan
5. Reviewing of Financial Planning
6. Steps in Financial Planning

The objectives should be clear and definite so that they can be used as guidelines by the
executives and the activities of the organization could be performed in an organized and co-
ordinate manner. The long-term financial objective of business should stress the maximum
and economical use of the financial resources so that value of assets could be maximized.
The liquidity of funds is maintained only when the adequate cash for each transaction is
maintained. For this purpose, there is need for effective management of working capital.

2) Formulating Financial Policies: The formulation of policies is the second step in financial
planning. These policies act as guidelines for the procurement of funds, their utilization
and control. These help in achieving the financial goals. Policies should be based on
predetermined objectives and practicable so that they can be implemented easily and
effectively. The policies should be determined at the top level of management. Normally
the advice of financial manager is sought in determining the policies and his role is
decisive. These policies can relate to determination of capital structure, capitalization,
sources of funds, realization of debt, management of capital, distribution of profit,
management of working capital management of inventory, etc.
3) Developing Financial Procedures: To implement the policies, it is necessary that detailed
financial procedures be determined which explain all rules and sub-rules. The
subordinates will come to know what work they have to do and how they have to do it.
Performance can be determined effectively. It will increase the efficiency of the
employees and their tasks can be co-ordinated. In order to implement the pre-
determined objectives, policies and programmes and to control the deviations, financial
controls are essential under the financial plan. For this purpose, budgetary control and
cost control system is adopted. Under it, standards are determined for financial
performance. Actual performance is compared with the standards to ascertain
deviations and their causes. Efforts are made to prevent the deviations.

4) Preparation of Financial Plan: Under this process, total capital requirement is

determined. It is called capitalization. To determine the capitalization, fixed assets,
current assets, preliminary expenses and other expenses are determined to make
correct estimate of necessary funds. After determining the total fund requirements, it is
determined in what proportion the funds will be raised from different sources. It is
called capital structure.

5) Reviewing of Financial Planning: Financial planning is a continuous process of business.

The financial objectives, policies, procedures, capitalization and capital structure should be
modified according to the changing internal and external circumstances.
Financial Forecasting:
Meaning of Financial Forecasting:
Financial forecasting describes the process by which firms think about and prepare for the
future. The forecasting process provides the means for a firm to express its goals and
priorities, and to ensure that they are internally consistent. It also assists the firm in
identifying the asset requirements and needs for external financing
Financial forecasting is that process in which the future financial condition of the firm is
shown on the basis of past accounts, funds flow statements, financial ratios and economic
conditions of the firm and industry. The projection of future plan of management in terms
of finance is financial forecasting. Financial forecasting shows financial planning activities of
a firm for specific period of time.
For example, the principal driver of the forecasting process is generally the sales forecast.
Since most Balance Sheet and Income Statement accounts are related to sales, the
forecasting process can help the firm assess the increase in current and fixed assets which
will be needed to support the forecasted sales level. Similarly, the external financing which
will be needed to pay for the forecasted increase in assets can be determined.

Benefits of Financial Forecasting:

1) Serves as an Advance Warning System: When prepared and presented early in the
budget planning process, forecasting future revenues and expenditures can alert elected
and appointed officials of the financial limitations under which the next year's budget (and
future years) is developed. This helps elected officials understand the financial situation,
eliminates surprises and provides time for them to take the necessary preventive actions.

2) Improves the Policy Development and Budget Preparation Process: Financial forecasting
can provide information about potential changes in services, new demands for service,
anticipatory revenues and any expected surplus or deficits. Early forecasts give local elected
officials an opportunity to provide policy direction, set budge: priorities and establish budget
guidelines based on this information. This direction can be incorporated into more detailed
budget instructions given to departments to aid in budget request preparation. This saves
considerable time and effort in preparing budget requests, Budget priorities may be
program oriented by indicating a preference for increased spending in one program or
service over another. Priorities may also be resource oriented, by indicating a priority for
taxes over user fees and charges.

3) Evaluate Alternative Financial Plans: Financial forecasting can illustrate the immediate
and longer-term fiscal implications of various economic and policy scenarios.