STRATEGIC FINANCIAL MANAGEMENT

How e SFM came into practice?

Five competitive forces

• The threat of new entrance

• The threat of substitute products or services

• The rivalry amongst existing organizations within e industry

• The bargaining power of suppliers

• The bargaining power of consumers.

SFMThe identification of the possible strategies capable

of maximizing an organization's net present value,

the allocation of scarce capital resources among the

competing opportunities, and the implementation

and monitoring of the chosen strategy so as to

achieve stated objectives

Need for SFM

• you will assess the complex decision making necessary at the higher levels of management, including evaluating and setting up reward systems for subordinates and other personnel.

• evaluating expansion opportunities.

• mergers and acquisitions, and sales of existing assets, and making decisions on complex investment opportunities and managing risk.

• You will develop the financial know-how necessary for senior management to skilfully guide any organisation toward success.

Overview of SFM

Forecasting:

• Demand and sales volume/revenues• Cash flows• Prices• Inflation rates• Labour union behavior• Technology changes• Inventory requirements

Organizing:

• Financial relation• Liaison with financial institutions and clients• Accounting system

Planning

• Investment planning• Manpower planning• Marketing strategies

Coordination

• Linking finance function with other areas• Linking with national budget and five year plans• Linking with labour union policies• Liaison with media

Control

• Financial charges• Achievement of desired objectives• Overall monitoring of the system

Financial forecasting:

Financial forecasting provides e basic infn on which sys png is based on. In financial forecasting, the future estimates are made through preparatin of statements like projected income stmt, pro b/s, pro cashflow and funds flow stmts.

Techniques of financial forecasting:

Days sales method: Traditional method used to forecast e sales by calculating e no of days sales and establishing its relation with e b/s items to arrive e forecasted b/s.

Regression method: Regression analysis provides estimates of values of the dependent variable from values of independent variable.

Projected fund flow statement

Projected cash flow statement

Projected income statement and balance sheet

Financial Planning Techniques

External Funds Requirement:

EFR = (A/S-L/S)ΔS-MS1(1-D)

Where A = Total AssetsL = Payables and provisionsS = Sales for current yearS1 = Projected sales for next yearΔS = Expected increase in salesM = Profit MarginD = Dividend payout ratio

Internal Growth Rate

IGR is e max growth rate a firm can achieve without going for ext financing. All e financing reqts are met internally.

IGR = (ROA*b)/1-(ROA*b)

Where ROA = Return on assets (PAT/Total assets)b=Retention ratio (1-Dividend payout ratio)

Assumptions: E Div payout ratio should be as per e targeted rate.E inc in sales will cause increase in assets of the concern in direct

proportion.For achieving IGR, e firm does not require to raise equity capital or

addl debt.To achieve IGR, e firm will finance its addl requirements only from

retained profitsE earnings after tax should be in direct proportion to sales.

Sustainable Growth Rate

SGR is e max growth rate which can be achieved by using both internal accruals, as well as, external debt without increasing e financial leverage. SGR is e max sales that can be achieved in a year based on target operating debt and dividend payout ratios.

SGR = b(NP/s)(1+D/EQ)/(A/s)-[b(NP/s)(1+D/Eq)]

Where b=Retention ratio or (1-b = Dividend payout ratio)NP/S = Net profit margin or Net profit/salesD/Eq =Debt-Equity ratio or long term debt/shareholders equityA/S = Assets to sales ratioS = Annual sales

SGR is a powerful png tool used for balancing of sales obj of e firm with its operating efficiency and financial resources.

Significance: Lower e ratio, e more efficient utilisation of assets.

Assumptions:

• Net Profit Margin Ratio – Net profit should be in constant proportion to sales achieved.

• Assets to sales Ratio – Assets of e firm will increase directly in proportion to increase in sales.

• Dividend payout ratio – It should be acc to target rate set for e firm.• Debt equity ratio – E firm has a target debt-equity ratio and it intend

to maintain capital structure acc to target set.• The firm does not intend to further equity since it is a costly source

of finance.

Ways to increase SGR:

Increase net profit marginDecrease in dividend payoutIncrease in debt component proportionate to equity

Process of financial planning:

Clearly defined mission and goal – Top mgt should realise e imp of setting e orgn mission,goal and obj.

Determination of fin objectives – long term obj – earning in excess over e targeted return on cap emp, inc in eps mkt value of share, max value for shareholders

Short term – liquidity, wking cap mgt, current ratio, operational efficiency.

Formulation of financial policies –

Debt equity ratio – 3:2, Current ratio 2:1Min cash bal Rs. 1 lakhEquity to be raised only by issue of e shares.Profitability centre concept to be implemented for all divisions in e orgn.

Designing Financial procedures: E financial procedures helps e FM in day to day functioning, by following e predetermined procedures. E financial procedures outline e cashflow control system, setting up of standards of performance, continuous evaluation process, capital expenditure authorizaiton procedures.

Search for opportunitiesE earlier opportunity is identified e greater should be e potential returns before competitors and imitators react.

Identifying possible course of action: This requires e devp of business strategies from which individual decisions emanate.

Screening of alternatives

Evaluation of alternatives and reaching a decision

Implementation, Monitoring and control

Capital Structure and Firm value

Two principal sources – Equity and debt

What should be e proportion of equity and debt in e cap structure of a firm?

E choice of a firm’s capital structure is a mkting problem.

It is concerned with how e firm divide its cash flows into two broad componenets

• Fixed component - obligation toward debt capital• Residual component – equity shareholders

What is e relationship b/w capital structure and cost of capital?

Value of e firm is maximised when e cost of capital is minimised and vice versa.

Some argue that there is no relationship whatsoever b/w capital structure and firm value. Some argue that there is a relationship b/w capital structure and firm value.

Assumptions:

• There is no income tax, corporate or personal.

• The firm pursues a policy of paying all of its earnings as dividends.

• The operating income is not expected to grow or decline over time.

• A firm can change its capital structure without incurring transaction costs.

Dividend Policy and Firm value

E dividend policy of a firm determines what proportion of earnings is paid to shareholders by way of dividends and what proportion is ploughed back in the firm for reinvestment purposes.

Models:

Most of e discussion on dividend policy and firm value assumes that e invt decision of a firm is independent of its dividend decision.

Walter model:

• E firm is an all equity financed equity. Further it will rely only on retained earnings to finance its future invts. This means that e invt decision is dependent on e dividend decision.

• The rate of return on investments is constant.• The firm has an infinite life.

Gordon Model:

Retained earnings represent e only source of financing for e firm.

E rate of return on e firm’s invt is constant.

E cost of capital for e firm remains constant and it is greater than e growth rate.

E firm has perpetual life.

Tax does not exist.