An Analysis Of Different Strategy Formations Finance Essay
It seems that’s people have practiced strategy since the beginning of time. The great Chinese military theorist, Sun Tzu, described his principles of war as early as 500 BCE. It is also said that the strategy concept
Strategic Financial Issues
The financial manager must ascertain the best sources of funds, uses of funds, and control of funds. Cash must be raised from internal or external (local and global) sources and allocated for different uses. The flow of funds in the operation of the organization must be monitored. To the extent that a corporation is involved in international activities, currency fluctuations must be dealt with to ensure that profits aren’t wiped out by the rise or fall of the dollar verus, the yen, euro or other currencies. Benefits in the form of returns, repayments, or products and services must be given to the sources of outside financing. All these tasks must be handled in a way that complements and supports overall corporate strategy. A firm’s capital structure (amounts of debt and equity) can influence its strategic choices. For example, increased debt tends to increase risk aversion and decrease the willingness of management to invest in R&D.
The mix of externally generated short-term and long- term funds in relation to the amount and timing oh internally generated funds should be appropriate to the corporate objectives, strategies, and policies. The concept of financial leverage (the ratio of total debt to total assets) is helpful in describing how debt is used to increase the earnings available to common sharehoders. When the company finances its activities by sales of bonds or notes instead of through stock, but fewer shareholders share the profits than if the company had sold more stock to finance its activites. The debt, however, does raise the firm’s break-even point above what it would have been if the firm had financed from internally generated funds only. High leverage may therefore be perceived as a corporate strength in times of prosperity and ever-increasing sales, or as a weakness in times of a recession and falling sales. This is because leverage acts to magnify the effect on earning per share of an increase or decrease in dollar sales. Research indicated that greater leverage has a positive impact on performance for firms in stable environments, but a negative impact for firms in dynamic environments.
Capital budgeting is the analyzing and ranking of possible investments in fixed assets such as land, buildings, and equipment in term of the additional outlays and additional receipts that will result from each investment. A good fiancé department will be able to prepare such apital budgets and rank them on the basis of some accepted criteria or hurdle rate (for example, years to pay back investment, rate of return, or time to break-even point) for the purpose of the strategic decision making. Most firms have more than one hurdle rate to vary it as a function of the type of project being considered. Projects with high strategic significance, such as entering new markets of defending market share, will often have low hurdle rates.
Financial Strategy examines the financial implications of the corporate and business-level strategic options and identifies the best financial course of action. It can also provide competitive advantage through a lower cost of funds and a flexible ability to raise capital to support a business strategy. Financial strategy usually attempts to maximize the financial value of the firm.
The tradeoff between achieving the desired debt-to-equity ratio and relying on internal long-term financing via cash flow is a key issue in financial strategy. Many small and medium-sized company try to avoid all external sources of fund in order to avoid outside entraglements and to keep control of the company within the family. Many financial analysts believe, however, that only by financing through long-term debt can a corporation use financial leverage to boost earnings per share, thus raising stock price and the overall value of the company. Reseaarch indicates that higher debt level not only debt takeover by other firms (by making the company less attractive), but also leads to improved productivity and improved cash flows by forcing management to focus on core businesses.
Research reveals that a firm’s financial strategy is influenced by its corporate diversification strategy. Equity financing, for example, is preferred for related diversification while debt financing is preferred for unrelated diversification. The recent trend away from unrelated to related acquisitions explains why the number of acquisitions being paid for entirely with stock increased from only 2% in 1988 to 50% in 1998.
A very popular financial strategy is the leveraged buy out (LBO). In a leveraged buy out, a company is acquired in a transaction financed largely by debt – usually obtained from a third party, such as an insurance company or an investment banker. Ultimately the debt is paid with money generated from the acquired company’s operations or by sales of its assets. The acquired company, in effect, pays for all its acquisition! Management of the LBO is then under tremendous pressure to keep the highly leveraged company profitable. Unfortunately the huge amount of debt on the acquired company’s books may actually cause its eventual decline by focusing management’s attention on short-term matters. One study of LBOs (also called MBos – Managements buy outs) revealed that the financial performance of the typical LBO usually falls below the industry average in the fourth year after the buy out. The firms declines because of inflated expectations, utilization of all slack, management burnout, and a lack of strategic management. Often the only solution is to go public once again by selling stock to finance growth.
The management of dividends to shareholders is an important part of a corporation’s financial strategy. Corporations is fast-growing industries such as computers and computer software often do not declare dividends. They use the money they might have spent on dividends to finance rapid growth. If the company is successful, its growth in sales and profits is reflected in a higher stock price – eventually resulting in a hefty capital gain when shareholders sell their common stock. Other corporations that do not face rapid growth must support the value of their stock by offering generous and consistent dividends.
A recent financial strategy being used by large established corporations to highlight a high-growth business unit in a popular sector of the stock market is to establish a tracking stock. A tracking stock is a type of common stocl tied to one portion of a corporation’s business. This strategy allows established companies to highlight a high-growth business unit without selling the business. By keeping the unit as a sudsidiary with its common stocl separately identified, the corporation is able to keep control of the subsidiary and yet allow the subsidiary the ability to fund its own growth with outside money. It goes public as an IPO and pays dividends based on the unit’s performance. Because the tracking stock is actually an equity interest in the parent company (not the subsidiary), another company cannot acquire the subsidiary by buying its shares.
Financial management is the process of financial – decisions. There are three types of financial decisions:
Financial Decisions: such decisions involve estimating the requirement of funds, deciding about leverage, evaluating various sources of finance and finally raising the finance in such a way that the cost of capital is minimum and the risk is at optimum level.
Investment Decisions: Such decisions involve investments in working capital and fixed assets and evaluating the projects under consideration. The management should be guided by getting the maximum return by keeping the risk at optimum level.
Dividend Decisions: Such decisions involve the consideration of profit, liquidity, shareholder requirements, tax aspect and need of the funds for reinvestment purposes. The management has to decide about retaining the fund for further investment plans without compromising the various income requirements of innumerable shareholders.
The aim of a company is to create value for its shareholders. Although the other stale holders are also important, the shareholder is the most important stake holders. The overall objective of the financial management is to apply the financial management policies and principles for maximizing the wealth of the shareholders in the long run. This can be achieved by maximizing the EPS and keeping the risk at optimum levels.
The shareholders expect a rate of return based on the risk they perceive. By maximizing their wealth we mean providing better
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