TYBAF/SEMVI/unitI.SFM

1          Meaning of strategic financial management

Strategic financial management refers to study of finance with a long term view considering the strategic goals of the enterprise. Financial management is nowadays increasingly referred to as "Strategic Financial Management" so as to give it an increased frame of reference.

?                What do you understand by strategic financial management? How strategic management is related to financial management?

Strategic management intends to run an organization in a systematized fashion by developing a series of plans and policies known as strategic plans, functional policies, structural plans and operational plans. It is a systems approach, which is concerned with where the organization wants to reach and how the organization proposes to reach that position. Thus, strategic management is basically concerned with the futurity of the current decisions without ignoring the fact that uncertainty in the system is to be reduced, to the extent possible, through continuous review of the whole planning and implementation process. It is therefore necessary for an organization interested in long run survival and command over the market, to go for strategic planning and the planning process must be holistic, periodic, futuristic, intellectual and creative with emphasis given on critical resources of the firm otherwise, the organization will fall in the traps of tunnelled and myopic vision

2          Financial policy and strategic management

?                Financial policy is linked to strategic Management,  Explain.

The inter face 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 again. Offer of the organization is only a vehicle that links up the starting point and the endpoint. No organization can run the existing business and promote a new expansion project without suitable internally mobilized financial base or both internally and externally mobilized financial base.

The success of any business is measured in financial terms. Maximising value to the shareholders is the ultimate objective. For this to happen, at every stage of its operations including policy-making, the firm should be taking strategic steps with value-maximization objective. This is the basis of financial policy being linked to strategic management.

The linkage can be clearly seen in respect of many business decisions. For example:

i.                    Manner of raising capital as source of finance and capital structure are the most important dimensions of strategic plan.

ii.                  Cut-off rate (opportunity cost of capital) for acceptance of investment decisions.

iii.                 Investment and fund allocation is another important dimension of interface of strategic management and financial policy.

iv.                Foreign Exchange exposure and risk management.

v.                  Liquidity management

vi.                A dividend policy decision deals with the extent of earnings to be distributed and a close interface is needed to frame the policy so that the policy should be beneficial for all.

vii.              Issue of bonus share is another dimension involving the strategic decision. Thus from above discussions it can be said that financial policy of a company cannot be worked out in isolation to other functional policies. It has a wider appeal and closer link with the overall organizational performance and direction of growth.

Hence, the financial policy of a company is closed linked with its corporate strategy. The corporate strategy establishes an efficient and effective match between its competences and opportunities and environmental risks. Financial policies of a company should be developed in the context of its corporate strategy. Within the overall framework of a company's strategy, there should be consistency between financial policies investment, debt and dividend.

Thus from above discussions it can be said that financial policies has a wider appeal and closer link with the overall organizational performance and direction of growth.

3          Interface of Financial Policy and Strategic Management

The interface of strategic management and financial policy will be understandable 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 internally and externally mobilized financial base.

1)      Sources of finance and capital structure are the most important dimensions of a strategic plan. The generation of funds may arise out of ownership capital and or borrowed capital. A company may issue equity shares and/or preference shares for mobilizing ownership capital.

2)      At the time of mobilization of funds, policy makers should decide on the capital structure to indicate the desired mix of equity capital and debt capital. There are some norms for debt equity ratio. Whereas this ratio in its ideal form varies from industry to industry. It also depends on the planning mode of the organization under study.

3)      Other important dimension of strategic management and financial policy interface is the investment and fund allocation decisions. A planner has to frame policies for regulating investments in fixed assets and for restraining of current assets. Investment proposals mooted by different business units may be addition of a new product, increasing the level of operation of an existing product and cost reduction and efficient utilization of resources through a new approach and or closer monitoring of the different critical activities.

On the basis of the aforesaid three types of proposals a planner should evaluate each one of them by making within group comparison in the light of capital budgeting exercise. Dividend policy is yet another area for making financial policy decisions affecting the strategic performance of the company. A close interface is needed to frame the policy to be beneficial for all. Dividend policy decision deals with the extent of earnings to be distributed as dividend and the extent of earnings to be retained for future expansion scheme of the firm

4          Functions of strategic financial management

Strategic Financial Management is the portfolio constituent of the corporate strategic plan-that embraces the optimum investment and financing decisions required to attain the overall specified objectives. In this connection, it is necessary to distinguish between strategic, tactical and operational financial planning. While strategy is a long-term course of action, tactics are intermediate plan, while operational are short-term functions. Senior management decides strategy, middle levels decides tactics and operational are looked after line management.

?                Explain functions of strategic financial management

Irrespective of the time horizon, the investment and financial decisions functions involve the following functions

1)      Continual search for best investment opportunities

2)      Selection of the best profitable opportunities

3)      Determination of optimal mix of funds for the opportunities

4)      Establishment of systems for internal controls

5)      Analysis of results for future decision-making

1          Financial planning

Financial planning is the backbone of the business planning and corporate planning. It helps in defining the feasible area of operation for all types of activities and thereby defines the overall planning framework.  Financial planning is a systematic approach whereby the financial planner helps the customer to maximize his existing financial resources by utilizing financial tools to achieve his financial goals.

Financial planning is simple mathematics. There are 3 major components:

• Financial Resources (FR)

• Financial Tools (FT)

• Financial Goals (FG)

We can say in Financial Planning: FR + FT = FG

In other words, financial planning is the process of meeting your life goals through proper management of your finances. Life goals can include buying a home, saving for your children's education or planning for retirement.

It is a process that consists of specific steps that help you to take a big-picture look at where you are financially. Using these steps you can work out where you are now, what you may need in the future and what you must do to reach your goals.

Financial objectives are to be decided at the very out set so that rest of the decisions can be taken accordingly. The objectives need to be consistent with the corporate mission and corporate objectives. There is a general belief that profit maximization is the main financial objective. In reality it is not. Profit maybe an important consideration but not its maximization. Profit maximization does not consider risk or uncertainty, whereas wealth maximization does.

1          Financial strategy

Financial strategy examines the financial implications at corporate and business levels to identify the best financial course of action. This can provide competitive advantage through lower cost of funds and flexibility to raise capital. This strategy normally helps in maximizing the financial value.

For the past few decades, researchers have attempted to model the strategic decision process and identify the major types or categories of strategic decisions. This is a difficult task since strategic decisions are often described as "unstructured", "unprogrammed", and "messy".

Mintzberg, Raisinghani, and Theoret (1976) provided an early attempt at modelling the process of strategic decision making and identified three major phases with subroutines or sub phases within each. These included the following:

I.                    The Identification phase

v  1. The Decision Recognition Routine: Opportunities, problems, and crises are recognized and evoke decisional activity.

v  2. The Diagnosis Routine: Information relevant to opportunities, problems, and crises is collected and problems are more clearly identified.

II.                 The Development phase

v  3. The search Routine: Organizational decision makers go through a number of activities to generate alternative solutions to problems.

v  4. The Design Routine: Ready-made solutions which have been identified are modified to fit the particular problem or new solutions are designed.

III.               The Selection Phase

5. The Screen Routine: This routine is activated when the search routine identifies more alternatives than can be intensively evaluated. Alternatives are quickly scanned and the most obviously infeasible are eliminated

2          Strategic financial decision making framework

Capital investment is the springboard for wealth creation.  In a world of economic uncertainty, the investors want to maximize their wealth by selecting optimum investment and financial opportunities that will give them maximum expected returns at minimum risk.

Since management is ultimately responsible to the investors, the objective of corporate financial management should be to implement investment and financing decisions which should satisfy the shareholders by placing them all in an equal, optimum financial position.

The satisfaction of the interests of the shareholders should be perceived as a means to an end –  maximization of shareholders’ wealth.

Since capital is the limiting factor, the problem that the management will face is the strategic allocation of limited funds between alternative uses in such a manner, that the companies have the ability to sustain or increase investor returns through a continual search for investment opportunities that generate funds for their business and are more favorable for the investors

Therefore, all businesses need to have the following three fundamental essential elements:

(1)   A clear and realistic strategy;

(2)   The financial resources, control and systems to see it through; and

(3)   The right management team and processes to make it happen

This is the long term direction and scope of an organization to achieve competitive advantage through the configuration of resources within a changing environment for the fulfillment of stakeholder’s aspirations and expectations.  In an idealized world, management is ultimately responsible to the investors.  Investors maximize their wealth by selecting optimum investment and financing opportunities, using financial models that maximize expected returns in absolute terms at minimum risk.

What concerns the investors is not simply maximum profit but also the likelihood of it arising: a risk-return trade-off from a portfolio of investments, with which they feel comfortable and which may be unique for each individual

Strategic financial management combines backward-looking, report-focused discipline of accounting with the more dynamic, forward-looking subject of financial management.

It is basically about the identification of the possible strategies capable of maximizing an organization’s market value.  It involves the allocation of scarce capital resources among competing opportunities.

It also encompasses the implementation and monitoring of the chosen strategy so as to achieve agreed objectives.

This is the portfolio constituent of the corporate strategic plan that embraces the optimum investment and financing decisions required to attain the overall specified objectives.

In this connection, it is necessary to distinguish between strategic, tactical and operational financial planning.

While strategy is a long-term course of action, tactics are intermediate plans, while operational are short-term functions.

Irrespective of the time horizon, the investment and financial decisions functions involve the following functions:

·         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

·         Analysis of results for future decision-making.