Financial Strategies for the Manager
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Thus by initially responding to product market forces and priorities of growth and diversification, the company becomes more dependent on the external capital market, and must then reemphasize ROI and shareholder benefit as the price of that dependency. After regaining self-sufficiency, the company can move again to a more conservative debt policy or increased dividend payout.
It will then become less dependent on the external capital market and the priority of its goals. Few companies can follow this path without a number of unexpected twists and turns. Nonetheless, this model helps point out how strategies evolve and how the priority of financial goals shifts in response to a changing corporate environment. Financial self-sufficiency is a natural and appropriate prerequisite for a high degree of managerial independence.
When all goes well, it assures a minimum of external financial discipline. Of course, freedom from external discipline is a matter of degree, but corporate financial management has as its implicit, if not explicit, objective decreased dependence on capital market uncertainty and interference. Another element in the achievement of corporate and managerial independence is diversification.
A number of corporate critics have questioned whether the recent spate of corporate diversification by acquisition or merger is appropriate. Such concern is not new. Most mature companies pursue diversification at some stage in their histories and inevitably suffer conflicts between the interests of stockholders and those of the organization and its professional managers. Though they often couch their motives for merger in terms of stockholder interest, managers pursue diversification because such a strategy:.
Such objectives are rational and justifiable. Society should value them. Diversification, however, can impose some cost on the community of professional investors by: reducing the number and variety of investment vehicles accessible to the individual portfolio, reducing the information available on individual corporate units, and at times placing resources in the hands of managers with inferior objectives or ability.
Strategic financial management
Nor is the investment community the only potential loser. A national commodity food producer and marketer embarked on an ambitious diversification strategy shortly after World War II. Its technology was simple and mature, the market highly competitive, profit margins narrow, and growth modest. New postwar management decided to undertake a radical change.
While rationalizing the production and distribution facilities of existing products, the company began aggressively to acquire food and related products for national or regional distribution. Over ten years, the company became highly diversified; the original product came to represent only a modest share of its sales. Though management admitted it had made some mistakes, it regarded the strategy as a success.
Not all diversification strategies are this successful; everybody won, from the organization and its managers to the original shareholders if they hung on long enough and sold out soon enough. The shareholders won, not because the company had reduced their risk by diversification but by its shrewd selection and good management. Instead of getting out of the original one-industry company and diversifying on their own, they stuck with management and took a chance that it would do a better job in the long run.
There was one loser: the members of the original product market constituency who lost bargaining power and influence. Previously they had held the power to dominate corporate priorities since their cooperation was essential to organizational survival. In the diversified company, that power was gone.
How to find the right financial strategy for your business - The Business Journals
Management could now, if it chose, abandon the original product market without seriously threatening the organization. Sometimes, diversified companies carry the goal of financial self-sufficiency—essential to the organization as a whole—indiscriminately down to the divisional or individual product market level. In fact, individual product market positions may appropriately function, at any given time, in surplus or deficit mode. The phase-out of a mature product position should ideally coincide with the phase-in of an entry-level position in a high-growth industry, which will operate at a deficit.
In practice, of course, the financial goals system is designed to motivate as well as discipline.
Like a parent, management often becomes impatient for its infant product positions to grow up and become self-sufficient, thus assisting in the support of the younger siblings. Heated debate has raged over which financial goals govern corporate management, whether they are imposed from without by myopic investors or developed from within by career managers , and whether they serve the best interests of the company and society.
I have found that the issue cuts deeper than the familiar question of whether short-term financial priorities distort the resource allocation process. Inevitably, they confront the reality of the existing corporate environment and established strategy.
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A serious inconsistency with that reality threatens the discipline of the system. In such cases, either management persistently rationalizes and ignores discrepancies between goals and performance or, worse, warps actions and reported results to meet expectations. In the near term, financial goals are largely set for—and not by—management. They may result from past strategic decisions that placed the company in a certain product market, involved it in a long-term lending arrangement with a particular institution, made certain contractual commitments, or designed a particular organizational structure to effect the strategy.
These things together determine an environment that imposes a set of specific and objective financial conditions of successful performance. These realities dominate the design of the goals system in the short term. Following naturally from the implementation of the existing competitive strategy, they remain in place as long as the strategy continues. Existing market forces outline required rates of growth and return as well as debt and dividend constraints. Competitive environments narrow the limits of choice. Much confusion often results, however, from the indiscriminate mingling of short- and long-term goals.
Implementation of the existing strategy in existing product markets determines short-term goals, while new strategic directions implicitly or explicitly map out new long-term priorities. The difference in time frame depends on the time necessary to implement strategic redirection in product or capital markets, organizational structure or staff. For companies whose current competitive environment satisfies long-term expectations, this issue represents a distinction without a difference.
The Importance of Financial Strategy
For managements or investors dissatisfied with near-term performance, however, it is important to keep the two horizons and their related goals systems separate. Short-term goals relate performance in the current industry setting to primary competitors. In defining long-term goals, managers are free—and indeed have the responsibility—to ignore the current environment and to set goals that meet or exceed the best performance in the country for companies in their risk class. Company B, referred to in Exhibit II, wanted to grow faster than GNP, thus outperforming the average industrial company in growth rate.
Such goals transcend existing competitive conditions.
To mix the two planning horizons in one planning document, as Company B did, is to create confusion among management rank and file. The long-term goal may be a cause for concern by those responsible for current performance, but the immediacy of short-term goals will drive the long-term goals out every time. A significant conflict of goals often occurs when companies quantify their ROI targets. In the broad sense, every company should try to find the highest sustainable ROI while maintaining a strong position in the market and a top-quality management team. Expressed in operational terms, that means equaling or exceeding company or industry performance.
A company bases the ROI required for self-sustaining growth on the dictates of the current business environment and competitive strategy. Management can properly describe it as a short-term goal related to existing strategy and the need for a balanced flow of funds. On the other hand, the corporate cost of capital tests individual against aggregate corporate performance. As judged by the capital markets in which the company competes for funds, the measure tests the need for—or the wisdom of—strategic redirection of resources, addresses long-term issues, and is properly described as a long-term goal.
Many companies commonly and, I believe, mistakenly use this measure in the capital-budgeting process as a short-term target or hurdle rate in the evaluation of ongoing investment projects. Knowing when to access credit that has a large return is an important aspect of managing cash flow. This becomes especially important when securing projects depends on accessing outside capital to fund the project without a long waiting period. Any purchases made through the business, particularly large purchases, should have detailed guidelines in the business plan.
This will determine which purchases will be made with cash, a line of credit and with a credit card. This strategy will also outline taking advantage of the terms of suppliers. For instance, if a supplier offers day terms, the business will wait until the end of the term to make a payment. In addition, the purchasing strategy should specify if approval is needed by a manager or board for purchases over a certain amount.
If the business is not properly managing its own receivable, it can be devastating to the financial health of the business. The financial strategy should detail the collections plan. This may include dedicating in-house staff to following up with overdue customers or turning them over to an outside agency.
It will also specify late fees and if deposits are due before products and services are delivered for new customers. Although a specific investment strategy may not be able to be detailed in a written plan, general guidance should be given to management. This includes a percentage of money invested in high-risk portfolios vs. Army arsenal property outside Boston planning to consolidate its headquarters operations into one location.
At the same time, the company spent heavily preparing to spin out several operating sections into the skyrocketing dot-com public market. The dot-com bubble burst. Property renovation costs soared, and ADL ran out of cash. Notes were called, and the year-old public company was put into bankruptcy. The point here is to emphasize the need to develop a sound finance strategy for where your company is and the importance of considering the benefits and risks of one financing path over another. For most companies, the competitive and financial environment is continuously changing. Developing some form of two- to five-year business strategy and finance strategy is required for smart adaption to an evolving competitive landscape:.
Smaller companies that are more reliant on one technology, business sector, customer or competitive advantage are more at risk when their underlying business model changes. Survival requires adapting to change. Developing strategy means taking the time to understand the fundamental dynamics within your business sector and where your company fits into the picture.
With these in hand, your chances for success will be greatly improved. At the core of a business strategy is the finance strategy. Delta Air Lines has a large inventory of aircraft. Every company needs a plan for financing its operations over the next several years reflecting its unique business model. Things to consider are:. Think of the finance strategy as a set of controlling principles under which the company operates. The finance plan is the tactical plan for access to the needed capital on the required schedule, at the projected cost and on terms acceptable to the company.
Strategy can be expressed in different measurements of financial requirements and performance:. But they also express a unifying concept for how the company competes and its unifying financial strategy.
Creative Pharma: This innovative drug development company will identify a new molecule and demonstrate that it could significantly reduce the symptoms of an important disease with fewer side effects.