lecture 1 Strategic Financial Management.pptx

lecture 1 Strategic Financial Management.pptx

1. Strategic Financial Management Lecture No 1

2. Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch 1 - 2

3. Strategic Financial Management Strategic financial management refers to both, financial implications or aspects of various business strategies, and strategic management of finance. It is an approach to management that relates financial techniques, tools and methodologies to strategic decisions making to have a long-term futuristic perspective of financial well being of the firm to facilitate growth, sustenance and competitive edge consistently.

4. Strategic Financial Management The Chartered Institute of Management Accountants of UK (CIMA) defines strategic financial management as “the identification of the possible strategies capable of maximizing an organization’s net present value, the allocation of scarce capital resources between competing opportunities and the implementation and monitoring of the chosen strategy so as to achieve stated objectives

5. Strategic Financial Management An approach to management that applies financial techniques to strategic decision making. Definition: “the application of financial techniques to strategic decisions in order to help achieve the decision-maker's objectives” Strategy: a carefully devised plan of action to achieve a goal, or the art of developing or carrying out such a plan

6. Importance of Strategic Financial Management Traditional FP&A is broken. That is why more and more CFOs are embracing strategic finance;  50% believe  establishing finance and the CEO as business partners is necessary to tackle more challenging issues. Source:  McKinsey’s Pulse Survey -Executive views 2022

7. 7 Strategic Financial Management

8. Strategic Financial Decisions Strategic Financial Management Deals with: Investment decisions Long Term Investment Decisions Short Term Investment Decision Financing Decisions Best means of financing- Debt Equity Ratio Liquidity Decisions Organization maintain adequate cash reserves or kind such that the operations run smoothly Dividend Decisions Disbursement of Dividend to Share holder and Retained Earnings 5. Profitability Decisions

9. Strategic Financial Decisions Strategic Financial Management also Deals with: Valuation of the firm Strategic Risk Management Strategic investments analysis and capital budgeting Corporate restructuring and financial aspects Strategic financial evaluation Strategic capital restructuring Strategic international financial management Strategic financial engineering and architecture Strategic market expansion planning Strategic compensation planning Strategic innovation expenditure Other business challenges

10. Investment decisions The investment decision relates to the selection of assets in which funds will be invested by a firm. The assets which can be acquired fall into two broad groups: (a) long-term assets (Capital Budgeting) (b) short-term or current assets (Working Capital Management). (a) Long Term Investment Decisions Capital Budgeting Capital budgeting is probably the most crucial financial decision of a firm. It relates to the selection of an asset or investment proposal or course of action whose benefits are likely to be available in future over the lifetime of the project. Capital Budgeting decisions Use Pay Back period, NPV, IRR, etc. for evaluation

11. Investment Decisions (b)Short Term Investment Decision Working Capital Management  : Working capital management is concerned with the management of current assets. It is an important and integral part of financial management as short-term survival is a prerequisite for long-term success. Fixed Part of working capital –managed from long term funds Fluctuating Part of Working Capital –managed from short term funds

12. Financing Decisions The second major decision involved in financial management is the financing decision. The investment decision is broadly concerned with the asset-mix or the composition of the assets of a firm. The concern of the financing decision is with the financing-mix or capital structure or leverage. There are two aspects of the financing decision. First , the theory of capital structure which shows the theoretical relationship between the employment of debt and the return to the shareholders. The second aspect of the financing decision is the determination of an appropriate capital structure, given the facts of a particular case. Thus, the financing decision covers two interrelated aspects: (1) the capital structure theory, and (2) the capital structure decision.

13. Dividend Decisions Two alternatives are available in dealing with the profits of a firm. They can be distributed to the shareholders in the form of dividends or They can be retained in the business itself. It depends on the dividend-pay out ratio , that is, what proportion of net profits should be paid out to the share holders. It depends upon the preference of the shareholders and investment opportunities available within the firm

14. Profitability Management The source of revenue has to be pre-decided to obtain profits in future. It is closely related to investment decisions as revenue generation will be from operations, investments and divestments.

15. Financial Policy Criteria describing a corporation's choices regarding its debt/equity mix, currencies of denomination, maturity structure, method of financing investment projects, and hedging decisions with a goal of maximizing the value of the firm to some set of stockholders. Hedging: A strategy designed to reduce investment risk using call options, put options, short-selling, or futures contracts. Its purpose is to reduce the volatility of a portfolio by reducing the risk of loss.

16. FUNCTIONS OF STRATEGIC FINANCIAL MANAGEMENT: Financial Planning and Budgeting : Develops financial plans and budgets aligned with the company's strategy. Financial Analysis and Reporting : Analyzes financial data to inform strategic decisions and reports on financial performance. Capital Structure Management : Manages the company's capital structure to optimize financial performance. Investment Appraisal : Evaluates investment opportunities to ensure alignment with strategic objectives. Risk Management : Identifies and mitigates financial risks, including market risk, credit risk, and operational risk. Funding and Dividend Decisions : Makes decisions on funding requirements and dividend payments. Mergers and Acquisitions : Evaluates and executes mergers and acquisitions to achieve strategic objectives. Financial Modeling : Develops financial models to forecast financial performance and inform strategic decisions.

17. Role of Strategic Financial Management Aligns financial decisions with strategy : Ensures financial decisions support the company's overall strategy. Optimizes financial performance : Maximizes shareholder value through effective financial management. Manages financial risks : Identifies and mitigates financial risks that could impact the company. Provides financial insights : Analyzes financial data to inform strategic decisions. Fosters collaboration : Works with other departments to ensure financial considerations are integrated into strategic planning.

18. What are the benefits of strategic financial management?  1 . Better decision-making Constantly analyzing financial data and forecasting future financial performance enables businesses to make more informed decisions about their investments, operations, and other business activities. This also helps businesses identify new opportunities and avoid potential risks earlier, leading to increased profitability and financial stability. 2. Increased profitability A company can increase its profitability and financial stability by managing costs and maximizing revenue. This can be achieved through various strategies, such as cost-cutting measures, pricing changes, and marketing initiatives. 3. Improved investor relations  Strategic financial management allows transparent and accurate financial information to be provided to investors. This way, a company can build trust and confidence with its investors. 4. Better risk management Strategic financial management requires companies to identify and analyze any potential risks frequently. This way, a company can develop strategies to mitigate or avoid those risks. This protects the company's financial health in the long run and ensures its success.

19. 1- 19 Objectives Of Financial Management The term objective is used to in the sense of a goal or decision criteria for the three decisions involved in financial management The goal of the financial manager is to maximise the owners/shareholders wealth as reflected in share prices rather than profit/EPS maximisation because the latter ignores the timing of returns, does not directly consider cash flows and ignores risk. As key determinants of share price, both return and risk must be assessed by the financial manager when evaluating decision alternatives. The EVA is a popular measure to determine whether an investment positively contributes to the owners wealth.

20. 1- 20 Objectives Of Financial Management However, the wealth maximizing action of the finance managers should be consistent with the preservation of the wealth of stakeholders, that is, groups such as employees, customers, suppliers, creditors, owners and others who have a direct link to the firm.

21. 21 Finance Manager’s Role Raising of Funds Allocation of Funds Profit Planning Understanding Capital Markets Financial Goals Profit maximization (profit after tax) Maximizing Earnings per Share Shareholder’s Wealth Maximization

22. 22 Profit Maximization Maximizing the Rupee Income of Firm Resources are efficiently utilized Appropriate measure of firm performance Serves interest of society also

23. 23 Objections to Profit Maximization It is Vague It Ignores the Timing of Returns It Ignores Risk Assumes Perfect Competition In new business environment profit maximization is regarded as Unrealistic Difficult Inappropriate Immoral.

24. 24 Maximizing EPS Ignores timing and risk of the expected benefit Market value is not a function of EPS. Hence maximizing EPS will not result in highest price for company's shares Maximizing EPS implies that the firm should make no dividend payment so long as funds can be invested at positive rate of return—such a policy may not always work

25. 25 Shareholders’ Wealth Maximization Maximizes the net present value of a course of action to shareholders. Accounts for the timing and risk of the expected benefits. Benefits are measured in terms of cash flows. Fundamental objective—maximize the market value of the firm’s shares.

26. 26 Risk-return Trade-off Risk and expected return move in tandem; the greater the risk, the greater the expected return. Financial decisions of the firm are guided by the risk-return trade-off . The return and risk relationship: Return = Risk-free rate + Risk premium Risk-free rate is a compensation for time and risk premium for risk.

27. 27 Managers Versus Shareholders’ Goals A company has stakeholders such as employees, debt-holders, consumers, suppliers, government and society. Managers may perceive their role as reconciling conflicting objectives of stakeholders. This stakeholders’ view of managers’ role may compromise with the objective of SWM. Managers may pursue their own personal goals at the cost of shareholders, or may play safe and create satisfactory wealth for shareholders than the maximum. Managers may avoid taking high investment and financing risks that may otherwise be needed to maximize shareholders’ wealth. Such “satisfying” behaviour of managers will frustrate the objective of SWM as a normative guide.

28. What Will the Planning Process Accomplish? Interactions The plan must make explicit the linkages between investment proposals and the firm’s financing choices. Options The plan provides an opportunity for the firm to weigh its various options. Feasibility- The different plans must fit into the overall corporation objective of maximizing shareholder wealth Avoiding Surprises One of the purpose of financial planning is to avoid surprise.

29. Strategic planning Strategic planning is an organization's process of defining its strategy, or direction, and making decisions on allocating its resources to pursue this strategy, including its capital and people. Various business analysis techniques can be used in strategic planning, including SWOT analysis (Strengths, Weaknesses, Opportunities, and Threats ), PEST analysis (Political, Economic, Social, and Technological), STEER analysis (Socio-cultural, Technological, Economic, Ecological, and Regulatory factors), and EPISTEL (Environment, Political, Informatic, Social, Technological, Economic and Legal).

30. Strategic planning Strategic planning is the formal consideration of an organization's future course. All strategic planning deals with at least one of three key questions: "What do we do?" "For whom do we do it?" "How do we excel?" In business strategic planning, some authors phrase the third question as "How can we beat or avoid competition?". (Bradford and Duncan, page 1). But this approach is more about defeating competitors than about excelling.

31. Strategic planning In many organizations, this is viewed as a process for determining where an organization is going over the next year or - more typically - 3 to 5 years (long term), although some extend their vision to 20 years. In order to determine where it is going, the organization needs to know exactly where it stands, then determine where it wants to go and how it will get there. The resulting document is called the "strategic plan." It is also true that strategic planning may be a tool for effectively plotting the direction of a company; however, strategic planning itself cannot foretell exactly how the market will evolve and what issues will surface in the coming days in order to plan your organizational strategy. Therefore, strategic innovation and tinkering with the 'strategic plan' have to be a cornerstone strategy for an organization to survive the turbulent business climate.

32. Strategic Financial Planning A Financial Plan is statement of what is to be done in a future time. Most decisions have long lead times, which means they take a long time to implement. In an uncertain world, this requires that decisions be made far in advance of their implementation

33. Strategic Financial Planning It formulates the method by which financial goals are to be achieved. There are two dimensions: A Time Frame Short run is probably anything less than a year. Long run is anything over that; usually taken to be a two-year to five-year period. 2. A Level of Aggregation Each division and operational unit should have a plan. As the capital-budgeting analyses of each of the firm’s divisions are added up, the firm aggregates these small projects as a big project .

34. Strategic Financial Planning Scenario Analysis Each division might be asked to prepare three different plans for the near term future: A Worst Case- This plan would require making the worst possible assumptions about the companies products and the state of the economy A Normal Case- This plan would require making the most likely assumptions about the company and the economy A Best Case- Each divisions would be required to work out a case based on optimistic assumptions. It could involve new products and expansion.

35. Components of Financial Strategy Start-Up Costs A new business venture, even those started by existing companies, has start-up costs. An existing manufacturer looking to release a new line of product has costs that may include new fabricating equipment, new packaging and a marketing plan. Include your start-up costs in your financial strategy. Competitive Analysis Your competition affects how you make money and how you spend money. The products and marketing activities of your competition should be included in your financial strategy. An analysis of how the competition will affect revenue needs to be included in your planning.

36. Components of Financial Strategy Ongoing Costs These include labor, materials, equipment maintenance, shipping and facilities costs, such as lease and utilities. Break down your ongoing cost projections into monthly numbers to include as part of your financial strategy. Revenue In order to create an effective financial strategy, you need to forecast revenue over the length of the project. A comprehensive revenue forecast is necessary when determining how much will be available to pay your ongoing costs, and how much will remain as profit.