chap 1 financial strategy & planning

8/3/2019 Chap 1 Financial Strategy & Planning

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Financial Strategy and

Planning

By, Ashok Bantwa

Chapter1


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Strategic Approach to Financial

Management


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Strategic Approach to Financial

Management

Strategic Planning

Economic environment of business

Strategic financial management


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Thinking Strategically:

The Three Big Strategic Questions

1.Whats the companys present situation?

2. Where does the company need to go from here?

3. How should it get there?


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Strategy

A strategy is Managements action planto

Grow the business

Attract and please customers

Compete successfully

Conduct operations

Achieve target levels of organizational performance


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Strategic Planning

The main objective of strategic planning is to

create a viable link between the organizations

objectives and resources and its environmental

opportunities


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Strategic Planning

Five competitive forces for formulating and

implementing business strategy

Threat of new entrants

Threat of substitute products or services

Bargaining power of buyers

Bargaining power of supplier

Rivalry among the competitors

l


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Strategic Planning Process

Define Mission

Set Objectives

Analyze Exiting Strategies

Define Strategic Issues

Define new and Revised

Strategies

Determine Critical Successfactors

Prepare Plans

Implement Plans

Internal

Appraisal

(Strength andWeakness)

External

Appraisal

(Opportunities

and Threats )

Monitor


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Economic Environment of Business

The factors that influence the economic

environment of business are studied under the

following three heads,

International Factors

Factors influencing at national level

Factors influencing at organization level


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Strategic Financial Management

Strategic financial planning involves financial

planning, financial forecasting, provision of

finance and formulation of finance policies which

should lead the firms survival and success.


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Strategic financial planning involves financial

planning, financial forecasting, provision of

finance and formulation of finance policies which

should lead the firms survival and success.


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Strategic financial planning should enable thefirm to,

Judicious allocation of funds

Capitalization of relative strengths

Mitigations of weaknesses

Reduction in financing costs

Effective use of funds Timely estimation of fund requirements

Identification of business and financial risk etc.


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Five main objectives of finance function:

1. Forecasting

Demand and sales volume

Cash flows

Prices

Inflation rates

Labor union behavior

Technology changes

Inventory requirements


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2. Organizing

Financial relation

Liaison with financial institutions and clients

3. Planning

Investment planning

Manpower planning

Development planning

Marketing Strategies


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4. Coordination

Linking finance function with other areas

Linking with national budget and five year plans

Linking with labor union policies Liaison with media

5. Control

Financial charges Achievement of desired objectives

Overall monitoring of the system

Equilibrium in the capital


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Financial Forecasting


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Financial Forecasting

Meaning of forecast

Meaning and techniques of forecasting

Benefits of financial forecasting


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Meaning of Forecast

A forecast is a prediction of what is going to

happen as a result of given set of circumstances.

Forecasting is essential for planning

Forecasting is needed to prepare the budget


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Meaning of Forecast While forecasting both micro and macro

economic factors (like inflation, monsoon, price,

competition, technology etc.) should be taken

into consideration

Forecasting aims at reducing the area of

uncertainty that surround management

decisions related to costs, profit, pricing, capital

investment and so forth

While forecasting about future, the past data

must be analyzed.


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Meaning and techniques of financial

forecasting

In financial forecasting future estimates are madethrough the preparation of statements like

projected income statement, projected balance

sheet , projected cash flow statement, cashbudget etc.


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Techniques of financial forecasting

Days sales method: Used to forecast the sales by calculating number of

days sales and establishing its relation with balancesheet items to arrive at forecasted balance sheet

Percentage of sales method:

based on the premise that most Balance Sheet andIncome Statement Accounts vary with sales

Financial requirement is forecasted on the basis offorecast of sales

Balance sheet items are forecasted as specificpercentage of sale


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Simple linear regression method:

Forecast is made by identifying one variable as an

independent variable (Sales) and other variables

(Balance sheet items ) as dependent variables.

Multiple linear regression method:

This method is applicable when behavior of one

variable is dependent on more than one factor.


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Projected fund flow statement:

It is statement of sources and application of funds

analyzing the changes taking place between two

balance sheet dates. Projected cash flow statement:

Projected cash flow statement focus on the cash

inflows and outflows of various items represented in

income statement and balance sheet.

Projected income statement and balance sheet


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Benefits of Financial Forecasting

Provides basic information for setting up of

objectives of the firm and for preparation of its

financial plan

Acts as a control device for firms financial discipline

Provides necessary information for decision making

of all functions in an organization

Monitors the optimum utilization of firms financial

resources

It projects funds requirement and utilization in

advance


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Financial Forecasting techniques

External Fund Requirement (EFR)

Where

A/S = Total Assets (Fixed+Current) / Sales

L/S = Current Liabilities and provisions / Sales

S = Sales of current year

S1 = Projected sales of the next year

S = Expected increase in sales over the current year

M = Net profit margin

D = Dividend pay out ratio

)1(1

DMSSS

L

S

AEFR


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Internal Growth Rate (IGR)

Internal growth rate is the maximum growth rate afirm can achieve without going for external financing.

Where

ROA = Return on Assets (PAT / Total Assets)

b = Retention Ratio (1 Dividend Payout Ratio)

)(1 bROA

bROAIGR


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Sustainable Growth Rate (SGR)

Sustainable growth rate is the maximum growth ratethat can be achieved by using internal accruals as well

as external debt without increasing financial leverage.

q

q

ED

SNPb

SA

E

D

S

NPb

SGR

1

1


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Sustainable Growth Rate (SGR)

Where :

b = Retention Ratio

NP/S = Net Profit Margin

D/Eq = Debt to Equity Ratio

A/S = Assets to sales Ratio

S = Annual Sales

q

q

E

D

S

NPb

S

A

E

D

S

NPb

SGR

1

1


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Financial Planning Process


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Steps Financial Planning Process

Clearly Define Mission and Goal:

Top management should decide organizations

mission, goal and objectives

Determination of financial objectives:

While determining financial objectives firm must

consider its mission, goal and objectives

Classified as short term and long term objectives


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Formulation of financial policies: A company can frame following financial policies to

achieve its financial objectives

To decide the standard level of debt equity ratioand current asset ratio

Level of minimum cash balance to be maintained

Minimum and maximum level of inventory

Equity to be raised by issue of equity shares

Divisions in which profitability center is to be

implemented


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Designing financial procedures: Helps financial manager in day to day functioning by

following predetermined procedures.

Search for opportunities: Search for opportunities which are compatible with

firms objectives

Identifying possible course of action: Identify the possible course of action which are

needed to achieve the objectives


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Screening of alternatives: Each alternative need to b screened with respect to

resources required, expected return and risk involved

Assembling of information: The cost benefit trade off must be kept in view while

gathering the information

Evaluation of alternatives and reaching decision

Implementation monitoring and control


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Decision Making and Problem SolvingProcess


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Recognize

Problem

Collect

Information

Identify

Causes

Specify

Problem

Allocate

priorities

State Aims

Examine

Resources

Search For

Alternative

Course of

Action

Evaluate

Alternative

Courses of

Actions

Access

possible

adverse

consequenc

es

Select Best

Course of

Action

Control

Results

Implement

Decision

Problem Analysis

Decision Making


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Financial Sector Reforms


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Framing guiding policies in structuring financialsystem of country

Framing policies, rules and regulations for having

thorough check on financial intermediaries andtheir liquidity

Framing policies and check points for primary and

secondary securities market Maintaining the solvency and liquidity of financial

intermediaries by fixing SLR and CRR


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Liking the growth of financial sector and growthof economy

Development of financial instruments the need of

economy Regulating the foreign exchange market

Fixation of roles and responsibilities of apex

bodies like RBI, SEBI, IRDA etc.

Development of screen based trading of

securities etc.


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Agency Theory of Employment

Agency theory models a situation in whichprincipal (Owner) delegates the decision making

authority to an agent (Managers) who receives

reward in return for performing some activities ofprincipal.

Conflict between the interest of owners and

managers results in agency problem. Shareholders can maximize their wealth by giving

appropriate incentives to the managers and by

proper monitoring of managers


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Agency Costs: Management is considered as an agent of

shareholders and if it does not act in the best interest

of shareholders it leads to following agency costs Expenditure to structure the organization in such a

way so as to minimize the dishonesty of managers

Expenditure to monitor the managers actions by

doing internal audits

Expenditure to protect the owners from the

mischief of managers


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Constituents of agency theory: Value maximization

Shareholders seek to maximize their wealth , whereas

management put its own interest above that ofprincipal

Management risk

Managements errors in decision making give rise to

management risk

Monitoring

Control mechanism designed by the principal to

monitor the actions of agent


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Constituents of agency theory:

Motivation through incentives

Appropriate incentive contracts can motivate

mangers to act in best interest of shareholders

For e.g. performance based payment


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Limited Liability Partnership (LLP)

Limited Liability Partnership


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Limited liability is the key attribute of limited

company incorporated under companies act1956.

The LLP is a separate legal person liable to third

parties independent of other partners Combines the features of company and

partnership firm

It is a body corporate incorporated under the LLPact

Law relating to partnership is generally notapplicable to LLP

Li it d Li bilit P t hi


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Limited Liability Partnership Change in partners does not affect the existence,

rights and liabilities of LLP

A written agreement is entered into between the

partners of LLP

Partners are not liable for the acts of LLP / Liability of

partners is limited

LLP can own and hold the property, employ people

and enter into contract in its own name

An LLP has members but no directors and

shareholders

Has complete flexibility as to its internal structure

Li it d Li bilit P t hi


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Benefits of LLP

No limit on the maximum number of members

Boon to the members of professions which do not

allow formation of limited company

Partners get the benefits of limited liability Its existence is not affected by the entry and exit of

members

Flexibility in terms of internal structure Less formal requirement than a company

No double taxation as in case of companies


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Corporate Governance


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Corporate governance is a set of systems orprocesses to ensure that a company is managed

to suit the best interest of all of its stakeholders

Concerned with maintaining high level oftransparency while running the business

It is system of making the management

accountable to the shareholders for effectivemanagement of company


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Good corporate governance means, Maximizing long term shareholders value

Making the managers accountable to the owners

High level of transparency Compliance with all rules and regulation and

guidelines

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