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Chapter 1: FINANCIAL POLICY AND CORPORATE
STRATEGY
STRATEGIC FINANCIAL DECISION MAKING FRAMEWORK
All businesses need to have the following three fundamental essential elements:
A clear and realistic strategy,
The financial resources, controls and systems
The right management team and processes
Strategy + Finance + Management = Fundamentals of Business
Meaning of Strategic Financial Management
Strategic financial management combines the backward-looking, report focused
discipline of (financial) accounting with the more dynamic, forward-looking subject
of financial management.
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.
The key decisions falling within the scope of financial strategy are as follows:
1. Financing decisions: These decisions deal with the mode of financing or mix
of equity capital and debt capital.
2. Investment decisions: These decisions involve the profitable utilization of
firm's funds especially in long-term projects (capital projects).
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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
STRATEGY AT DIFFERENT HIERARCHY LEVELS
Corporate Level Strategy: Corporate level strategy fundamentally is concerned
with selection of businesses. Corporate level strategy should be able to answer three
basic questions:
Suitability
Feasibility
Acceptability
Business Unit Level Strategy: At the business unit level, the strategic issues are
about practical coordination of operating units and developing.
Functional Level Strategy: The functional level is the level of the operating divisions
and departments. The strategic issues at this level are related to functional business
processes and value chain. Functional level strategies in R&D, operations,
manufacturing, marketing, finance, and human resources involve the development
and coordination of resources.
FINANCIAL PLANNING
There are 3 major components of Financial planning:
Financial Resources (FR)
Financial Tools (FT)
Financial Goals (FG)
Financial Planning = FR + FT + FG
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INTERFACE OF FINANCIAL POLICY AND STRATEGIC MANAGEMENT
The interface of strategic management and financial policy will be clearly
understood if we appreciate the fact that the starting point of an organization is
money and the end point of that organization is also money. No organization can
run an existing business and promote a new expansion project without a suitable
internally mobilized financial base or both i.e. internally and externally mobilized
financial base.
Sources of finance and capital structure are the most important dimensions of a
strategic plan. The need for fund mobilization to support the expansion activity of
firm is very vital for any organization.
Another important dimension of strategic management and financial policy
interface is the investment and fund allocation decisions.
Dividend policy is yet another area for making financial policy decisions affecting
the strategic performance of the company.
Thus, the financial policy of a company cannot be worked out in isolation of other
functional policies.
BALANCING FINANCIAL GOALS VIS-A-VIS SUSTAINABLE GROWTH
The concept of sustainable growth can be helpful for planning healthy corporate
growth. This concept forces managers to consider the financial consequences of
sales increases and to set sales growth goals that are consistent with the operating
and financial policies of the firm. Often, a conflict can arise if growth objectives are
not consistent with the value of the organization's sustainable growth.
Sustainable growth is important to enterprise long-term development. Too fast or
too slow growth will go against enterprise growth and development, so financial
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should play important role in enterprise development, adopt suitable financial
policy initiative to make sure enterprise growth speed close to sustainable growth
ratio and have sustainable healthy development.
What makes an organisation financially sustainable?
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
Sustainable Growth Rate
The sustainable growth rate (SGR), concept by Robert C. Higgins, 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 (financial
leverage) ratios. The sustainable growth rate is a measure of how much a firm can
grow without borrowing more money.
SGR = ROE x (1- Dividend payment ratio)
Sustainable growth models assume that the business wants to:
maintain a target capital structure without issuing new equity;
maintain a target dividend payment ratio; and
increase sales as rapidly as market conditions allow.
What makes an organisation sustainable?
In order to be sustainable, an organisation must:
have a clear strategic direction;
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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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