Strategic Financial Management

1
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.
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
Strategic Financial Management
Strategic Financial Management
refers to both, financial implications or
aspects of various business
strategies, and strategic management
of finances.
 Strategic Financial Decisions
Strategic Financial Management Deals with:
1. Investment decisions
 Long Term Investment Decisions
 Short Term Investment Decision
2. Financing Decisions
 Best means of financing- Debt Equity Ratio
3. Liquidity Decisions
 Organization maintain adequate cash reserves or
kind such that the operations run smoothly
4. Dividend Decisions
 Disbursement of Dividend to Share holder and
Retained Earnings
5. Profitability Decisions
 Strategic Financial Decisions
Strategic Financial Management also Deals with:
1. Valuation of the firm
2. Strategic Risk Management
3. Strategic investments analysis and capital budgeting
4. Corporate restructuring and financial aspects
5. Strategic financial evaluation
6. Strategic capital restructuring
7. Strategic international financial management
8. Strategic financial engineering and architecture
9. Strategic market expansion planning
10.Strategic compensation planning
11.Strategic innovation expenditure
12.Other business challenges
 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
 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
 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.
 Dividend Decisions
Two alternatives are available in dealing with
the profits of a firm.
(1)They can be distributed to the shareholders
in the form of dividends or
(2)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
 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.
 Working Capital Decision
Gross working capital (GWC)
GWC refers to the firm’s total investment in
current assets.
Current assets are the assets which can be
converted into cash within an accounting year
(or operating cycle) and include cash, short-
term securities, debtors, (accounts receivable
or book debts) bills receivable and stock
(inventory).

12
 Concepts of Working Capital
Net working capital (NWC).
NWC refers to the difference between current
assets and current liabilities.
Current liabilities (CL) are those claims of
outsiders which are expected to mature for
payment within an accounting year and
include creditors (accounts payable), bills
payable, and outstanding expenses.
NWC can be positive or negative.
Positive NWC = CA > CL
13 Negative NWC = CA < CL
 Concepts of Working Capital
GWC focuses on
-Optimization of current investment
-Financing of current
assets
-Liquidity
NWC position
focuses on of the firm
-Judicious mix of short-term and long-tern
financing

14
 Operating Cycle
Operating cycle is the time duration required
to convert sales, after the conversion of
resources into inventories, into cash. The
operating cycle of a manufacturing company
involves three phases:
- Acquisition of resources such as raw material, labour,
power and fuel etc.
-Manufacture of the product which includes conversion
of raw material into work-in-progress into finished goods.
- Sale of the product either for cash or on credit. Credit
sales create account receivable for collection.
15
 Working Capital Management
Receivables Management
Investment in receivable
• volume of credit sales
• collection period
Credit policy
• credit standards
• credit terms
• collection efforts

Cash Management
 Working Capital Management
Inventory Management
Stocks of manufactured products and
the material that make up the product.
Components:
• raw materials
•work-in-process
• finished goods
•stores and spares (supplies)
 Working Capital Management
Cash Management
Cash management is concerned with the
managing of:
- cash flows into and out of the firm,
-cash flows within the firm, and
-cash balances held by the firm at a point of
time by financing deficit or investing
surplus cash
Functions of Financial Manager
1. Financial Forecasting and
Planning
2. Acquisition of funds
3. Investment of funds
4. Helping in Valuation Decisions
5. Maintain Proper Liquidity
 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.
 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).
 Strategic planning
Strategic planning is the formal consideration of an

organization's
All future course.
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?".
.But this approach is more about defeating competitors than
about excelling.
 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.
 Characteristics of Strategic planning
Successful Strategic planning constitutes
the following features. It should:
1. Exhibit impacts in daily routine
2. Facilitate dynamic, forward and backward thinking process
3. Counters repetitive patterns of mistakes, especially human
tendencies
4. Remain clear and simple
5. Ensure planning is complete only when it is properly
implemented
6. Designate a core planning team with a level of autonomy
7. Constitute collective leadership and involvement of key
stakeholders in decision making
 Mission and Vision
Mission: Defines the fundamental purpose
of an organization or an enterprise,
BREIFLY describing why it exists and what
it does to achieve its Vision
A Vision statement outlines what the
organization wants to be, or how it wants
the world in which it operates to be. It
concentrates on the future. It is a source of
inspiration. It provides clear decision-
making criteria.
 Finance Functions
Investment or Long Term Asset Mix
Decision
Financing or Capital Mix Decision
Dividend or Profit Allocation Decision
Liquidity or Short Term Asset Mix
Decision

26
 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
 Strategic Financial Planning
It formulates the method by which financial
goals are to be achieved.
There are two dimensions:
1. 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.
 Strategic Financial Planning
Scenario Analysis
Each division might be asked to prepare three
different plans for the near term future:
1. A Worst Case- This plan would require making the worst
possible assumptions about the companies products and
the state of the economy
2. A Normal Case- This plan would require making the most
likely assumptions about the company and the economy
3. A Best Case- Each divisions would be required to work out
a case based on optimistic assumptions. It could involve
new products and expansion.
 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.
 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.
 Objectives and Goals
Goal: The Financial Goal of the firm
should be shareholder’s wealth
maximization, as reflected in the market
value of the firm’s share.
Firms’ primary objective is maximizing the
welfare of owners, but, in operational terms,
they focus on the satisfaction of its
customers through the production of goods
and services needed by them
 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.
 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.

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

36
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.
37
 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
38
 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.
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 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
40
and risk premium for risk.
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.
 Financial Goals and Firm’s Mission
and Objectives
Firms’ primary objective is maximizing the welfare
of owners, but, in operational terms, they focus on
the satisfaction of its customers through the
production of goods and services needed by them
Firms state their vision, mission and values in broad terms
Wealth maximization is more appropriately a decision
criterion, rather than an objective or a goal.
Goals or objectives are missions or basic purposes of a
firm’s existence

42
 Financial Goals and Firm’s Mission and
Objectives
The shareholders’ wealth maximization is the
second-level criterion ensuring that the
decision meets the minimum standard of the
economic performance.
In the final decision-making, the judgement
of management plays the crucial role. The
wealth maximization criterion would simply
indicate whether an action is economically
viable or not.
43
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.
Strategic Planning Process
 Strategic Planning
Strategic Planning relates to planning
in advance for a long period of time.
This facilitates predicting the future
and devising a course of action well
in advance.
It deals with future course of action
consistent with the business
environment changes.
Components of Strategic Planning
1. Vision- Organization visualizes what it would like to in
future
2. Mission- Deals with distinctive purpose which an
organization is striving for. It declares the main
concerns or priorities and principles of the business
firm.
3. Goals - They are concrete aims which enhance the
motivation of organization teams which prepare
themselves in specific aspects.
4. Objectives- intend to put forward in precise terms
what an organization wants to achieve, where it
wants to be in future, what are the tasks that needs
to be achieved in short spans of time.
 Process of Strategic Planning
1.Visualizing ideal future
2.Identifying critical success factors
3.Analyzing the present status of the company both
internal and external
4.Identifying core areas and core competencies and
opportunities available in the environment
5.Focusing on core areas and devising strategy
accordingly
6.Designing of long-range plan
7.Implementing plans and transition management
8.Reviewing and redesigning and updating and checking
discrepancies
9.Achieving desired outcomes
 Benefits of Strategic Planning
1. Development and articulation of the vision into
mission
2. Standardization and innovation in the dimensions get
included for the analysis for decision making
3. More acceptance throughout the organization and
from stakeholders
4. Results into a more tolerant, enduring and dynamic
organization
5. Opportunities in external environment can be tapped
6. Identifies competitive position and enables
competitive advantage through growth and sustenance
 Benefits of Strategic Planning
7. Cross functional approach integrates the systems for
implementation
8. Flow of vision and its orientation to all levels and
departments in an organization
9. Well-directed inputs to reduce wastage are
encouraged
10. Facilities prioritization and utilization of resources
11.Empowerment leads to commitment and contribution
of ideas at all levels
12. The broad view of strategic level is transferred to
narrower levels of the organization
 Financial Planning Model:
The Ingredients
1. Sales forecast
2. Pro forma statements
3. Asset requirements
4. Financial requirements
5. Plug
6. Economic assumptions
 1. Sales Forecast
 All financial plans require a sales
forecast.
 Perfect foreknowledge is impossible
since sales depend on the uncertain future
state of the economy.
 Businesses that specialize in
macroeconomic and industry projects can
be help in estimating sales.

3-52
 2. Pro Forma Statements
 The financial plan will have a forecast
balance sheet, a forecast income
statement, and a forecast sources-and-
uses-of-cash statement.
 These are called pro forma statements
or pro formas.

3-53
 3. Asset Requirements
 The financial plan will describe
projected capital spending.
 In addition it will the discuss the
proposed uses of net working capital.

3-54
 4. Financial Requirements
 The plan will include a section on
financing arrangements.
 Dividend policy and capital structure
policy should be addressed.
 If new funds are to be raised, the plan
should consider what kinds of securities
must be sold and what methods of
issuance are most appropriate.

3-55
 5. Plug
 Compatibility across various growth targets will
usually require adjustment in a third variable.
 Suppose a financial planner assumes that
sales, costs, and net income will rise at g.1 Further,
suppose that the planner desires assets and
liabilities to grow at a different rate, g.2 These two
rates may be incompatible unless a third variable is
adjusted.
For example, compatibility may only be reached if
outstanding stock grows at a third rate, g3

3-56
 6. Economic Assumptions

The plan must explicitly state the

economic environment in which the firm
expects to reside over the life of the
plan.
Interest rate forecasts are part of the
plan.

3-57
Strategic Planning Model
 9S Model of SFM
Nine S Model combines the quantitative and
qualitative skills of a strategist.
1.Sanctity
2.Selectivity
3.System
4.Strategic Cost Management
5.Sensitivity
6.Sustainability
7.Superiority
8.Structural Flexibility
 9S Model of SFM
1. Sanctity refers to the ‘ethical economics’ of
business. This approach offers a long-term,
sustainable ‘brand-equity’ to the enterprise
which ultimately reduces every cost at every
stage of a product life cycle.
2. Selectivity refers to the most appropriate
business choices based on an enterprise's
core competence. SFM should concentrate on
building up a most flexible core competence
together with strategic cost mangement.
 9S Model of SFM
3. System- emphasizes the need for a supportive
mechanism to make ‘SFM’ a continued success. It
refers to the technological, accounting, information
and operational systems of an enterprise.
4. Strategic Cost Management- is the micro-level
strategic analysis of various cost-structure and cost
implications. Some of costing methods are; Activity
Based Costing (or Objective Based Costing), Life
Cycle Costing, Notional Cost Benefit Analysis, Cost
analysis for establishing the validity of a certain
value-chain of an enterprise, etc.
 9S Model of SFM
5.Sensitivity- It is to know the strategic use of
every piece of information. It convert
technical data into commercial data.
Sensitivity depends on the capacity to
transform ‘x’ information into ‘y’ in minimum
possible amount of cost and time.
6. Sustainability- of performance is a matter of
long-term strategic planning. Strategic plan
requires a very careful combination of ‘business
strategy ‘ and ‘business funding strategy’. It also
means ‘managing new competitors’ with extra
cost on sustenance’.
 9S Model of SFM
7. Superiority- refers to the position of
‘Leadership’ that an enterprise must attain in the
market. SFM should aim at maintaining both
positions in the same market and little
paradoxical.
8. Structural Flexibility- It is the sum total of the
qualitative and quantitative adaptability and
adjustability of an organization. Sunk cost,
Committed cost, Engineered cost, Capacity
Cost, Burden costs and corrective cost could be
huge if structural flexibility is absent.
 9S Model of SFM
9. Soul Searching- It is based on continuous
bench marking and requires a tremendous
amount of financial alertness, innovation and
total exposure to new variables and parameters.
It also refers to establishing new heights of
achievement and newer core-competences.
The 9 references of SFM ultimately aim for,

‘Wealth Maximization through the

accelerating Effect’.
 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.
 Strategic planning
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, Informatics,
Social, Technological, Economic and Legal).
 Strategic planning
Strategic planning is the formal consideration of an

organization's
All future course.
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.
 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.
 Characteristics of Strategic planning
Successful Strategic planning constitutes the following
features. It should:
1. Exhibit impacts in daily routine
2. Facilitate dynamic, forward and backward thinking
process
3. Counters repetitive patterns of mistakes, especially
human tendencies
4. Remain clear and simple
5. Ensure planning is complete only when it is properly
implemented
6. Designate a core planning team with a level of
autonomy
7. Constitute collective leadership and involvement of key
stakeholders in decision making
 Components of
Strategic planning or
Strategic Intent

Vision Mission Goals Objectives

Components of Strategic Planning
1. Vision- Organization visualizes what it would like to in
future
2. Mission- Deals with distinctive purpose which an
organization is striving for. It declares the main
concerns or priorities and principles of the business
firm.
3. Goals - They are concrete aims which enhance the
motivation of organization teams which prepare
themselves in specific aspects.
4. Objectives- intend to put forward in precise terms
what an organization wants to achieve, where it
wants to be in future, what are the tasks that needs
to be achieved in short spans of time.
 Vision
A Vision statement outlines what the
organization wants to be, or how it
wants the world in which it operates to
be. It concentrates on the future. It is a
source of inspiration. It provides clear
decision-making criteria.
Every organization visualizes what it would
like to be in future.
Vision describes a wishful long-term desire of
the company with out mentioning the steps or
plans to be used in order to set the target.
 Mission
Mission: Defines the fundamental
purpose of an organization or an
enterprise, describing why it exists and
what it does to achieve its Vision.
Mission deals with a distinctive Purpose
which a organization is striving for. A
well defined mission statement declares
the main concerns or priorities and
principles of the business firm
 Objectives
Objectives intend to put forward in
precise terms what an organization
wants to achieve where it wants to be in
future, what are the tasks that needs to
be achieved in short spans of time to
achieve the future objectives and goals.
 Goals
Goals are the concrete aims or targets
which enhance the motivation of the
organizational teams which prepare
themselves in specific aspects.
Goals provide the benefit of breaking
down or fragmenting the broader
mission into more concert and clear
tasks that are understandable, and
responsibilities are allocated to
individuals and teams in the
organization.
 Financial Objectives and
Goals
Goal: The Financial Goal of the firm
should be shareholder’s wealth
maximization, as reflected in the market
value of the firm’s share.
Firms’ primary objective is maximizing the
welfare of owners, but, in operational terms,
they focus on the satisfaction of its
customers through the production of goods
and services needed by them
 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.
 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.

1-78
 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
79
 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
 Strategic Financial Planning
It formulates the method by which financial
goals are to be achieved.
There are two dimensions:
1. 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.
 Strategic Financial Planning
Scenario Analysis
Each division might be asked to prepare three
different plans for the near term future:
1. A Worst Case- This plan would require making the worst
possible assumptions about the companies products and
the state of the economy
2. A Normal Case- This plan would require making the most
likely assumptions about the company and the economy
3. A Best Case- Each divisions would be required to work out
a case based on optimistic assumptions. It could involve
new products and expansion.
 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.
 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.
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.
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 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
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 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.
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 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
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and risk premium for risk.
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.
 Financial Goals and Firm’s Mission
and Objectives
Firms’ primary objective is maximizing the welfare
of owners, but, in operational terms, they focus on
the satisfaction of its customers through the
production of goods and services needed by them
Firms state their vision, mission and values in broad terms
Wealth maximization is more appropriately a decision
criterion, rather than an objective or a goal.
Goals or objectives are missions or basic purposes of a
firm’s existence

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 Financial Goals and Firm’s Mission and
Objectives
The shareholders’ wealth maximization is the
second-level criterion ensuring that the
decision meets the minimum standard of the
economic performance.
In the final decision-making, the judgement
of management plays the crucial role. The
wealth maximization criterion would simply
indicate whether an action is economically
viable or not.
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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.
 Costs and Benefits
Financial executives do financial cost benefit
analysis. IRR is a method of cost analysis in
certain cases and Economic Rate of Return
(ERR) should replace the IRR for adequate and
rational appraisal of the same project in both
the economy.
Indicative Cost -Benefit-Analysis may be
useful for highly subjective decisions or
judgments.
The indicative or relative significance of
various variables deciding the ultimate
outcome of the decision making process can
be used for approximate cost benefit analysis.
 Costs and Benefits
Ongoing business processes require a
quick ‘incremental Cost-Benefit analysis’ for
quick conclusions.
As long as incremental profit exceeds
incremental costs, the project is worth
while.
Sustainable Net incremental Benefit is very
often a strategic decision. It also require a
lot of strategic analysis based on a long-
tem appraisal of the uncertainty involved.
 Costs and Benefits
The long term project will have to be
assessed with an average Cost Benefit
Analysis (CBA) for the project’s life cycle.
CBA with strategic perspective is of vital
significance.
Multi-product or multi-locational enterprises
always makes use of CBA in totality.
LIFE CYCLE COSTING (LCC) is
commonly used of the ‘life-cycle strategy
formulations of a project.
LIFE CYCLE COSTING (LCC)
LCC involve the analysis of the following
cost:
1.Cost of Launching
2.Cost of early corrections
3.Cost of take of
4.Cost of consolidation
5.Cost of leadership
6.Cost of Sustainance
7.Cost of Revival
8. Cost of withdrawal from market