Financial Strategy

What is financial strategy

A financial strategy is a written down plan or
guideline that deals with key elements in raising
funds, managing organisation funds and the
implementation of the organisation objectives
within the limited financial capabilities.
Financial strategies are very important for the
survival of any institution, because without good
financial strategies, organizations will run bankrupt.
What does a financial strategy involves?
Acquiring needed capital (source of finance)
Developing projected financial
statements/budgets
Management/usage of funds
Evaluating the worth of business
Financial Strategy
Sources of Funds Projected Financial
Statements/Budgets
Management of Funds Evaluating value of
business
Tangible Net Worth No of times of annual
profit
Market based apprach
Based of value of similar
firm
Based of P/E measure MP per share * shares
outstanding + premium
Economic Value Added
Few decisions that may require finance/
accounting policies:
To raise capital with short term debt, long term
debt, preferred stock or common stock

To lease or buy the assets

To determine dividend payout policies

To determine the amount of cash that is required in
hand etc
Source of funds
Business requires additional capital, besides net profit from operations and
sale of assets. Other sources of funds are Debt and Equity. (which determine
the capital structure of a firm)

Determining optimal mix of debt and equity in firm capital structure is vital.

Firm should have enough debt in its capital structure to boost ROI (if earning
is more than cost of debt).

In adverse situation high debt can lead to poor stockholders return and
jeopardize companys survival.

Fix debt obligations must be met regardless of the circumstances.

Issuances of stock can have issues like ownership, control of enterprise
which can lead to hostile takeovers, mergers and acquisitions.
2. 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 firms 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.

Budgets allows an organization to examine the expected results of various actions
(implementation decisions) and approaches.

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.
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Eg. Increase in promotion expenditure by 50%
(market development 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.
Management and 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. All this leads to optimum utilization of
funds.

Organizations that implements strategies of stability, growth, and
retrenchment cannot escape proper management of funds.
Evaluating the Worth of a 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 approaches to determination of business worth

1. The first approach is to determine tangible net worth or stock
holders 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.
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The second approach is measuring the value of firms based on future
benefits its owners may derive through net profits. Establish business
worth as five times the firms current annual profit. Note: Firms suppress
earnings in financial statement to minimize taxes.

The third approach is letting market determine a business worth.

1. Base the firms worth on selling price of similar company and make a
comparison.
2. Use price earning ratio where we divide the market price of common
stock by annual earnings per share and multiply this number by the firms
average net income for the past five years.
3. 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.
ContinueEconomic value added
In corporate finance Economic Value Added (EVA) is an
estimate of a firm's economic profit being the value
created in excess of the required return of
the company's investors (being shareholders and debt
holders).

EVA = NOPAT WACC(invested capital)

NOPAT = EBIT(1-t)
Invested capital = net working cap + net fixed assets Or
BV of long term debt + BV of equity.