Basic Concepts of Financial Strategic Management

Finance -- Finance for Strategic Managers -- Stage I am a longstanding manager in a family firm which is a small but growing organisation. My responsibility is finance. A new member of the family has just joined the firm fresh from completing a post graduate (level 7) qualification at college. He is clear that in order to ensure the business's continued success he must develop the financial skills required to assess and manage finance within the business.

He wishes to begin by understanding the role of financial information in business strategy and given my experience he has asked for my advice. He intends to create a file on finance for strategic managers which he can use as an aide memoire. Body Section 1: An Assessment Of Why Financial Information Is Needed In Business Business often turns on decision making and effective decisions need financial and non-financial information.

Financial information, which often comes from accounting, serves management's decisions by collecting and examining raw data, and then converting that data into usable information (Zager & Zager, 2006, p. 35). b. An Identification Of The Business Risks Related To Financial Decisions "Risk" is the probability and extent of negative results from a decision. When a business manager makes a decision, he/she must weigh the possibility and degree of loss the business might suffer because of that decision.

Due to the fact that a business manager must often make decisions with uncertainty, having imperfect information about existing circumstances, future circumstances or future results, many business decisions involve risk. There are several types of risk involved in decision making, one of which is financial risk. Financial risk involves possible financial losses that could be caused by factors such as poor resource distribution, interest rate fluctuations, tax policy shifts, commodity price fluctuations or currency value fluctuations (Boundless Management, 2016).

Since a strategic manager cannot perfectly foretell the future, he/she must make decisions without knowing all current circumstances and or future circumstances/results, which is financially risky. c. Financial Information Needed For Strategic Business Decisions The financial information needed for strategic business decisions normally consists of the information provided by: balance sheets; profit & loss accounts; and cash flow statements (Zager & Zager, 2006, p. 36). A balance sheet is a "snapshot" basically consisting of Capital (source of money) + Liabilities = Assets (where the money is currently).

It shows individuals/entities owning company resources and exactly what they own, company assets, company debts, reserves, stock values, capital assets, cash on hand, and the value of shareholders' funds (Businessballs, 2016). A profit and loss account (P&L) is basically a trading description for a fixed period of time.

It shows how well a company has executed its trading activities, displaying profit performance through sales revenues, costs of sales/goods sold, a gross profit margin (or "contribution"), fixed overheads and/or operating expenses, and a profit before tax figure (PBT) (Businessballs, 2016). Finally, a cash flow statement displays the flow and availability of cash through and to the business during a specific period.

A cash flow statement, which often encompasses a full trading year, must be reliable, as cash must be available to pay suppliers, staff and other creditors in order to survive (Businessballs, 2016). 2. Section 2 -- Information on Published Financial Statements a. Example Of Published Accounts Published accounts are a company's financial records that have been prepared, audited and sent to shareholders and other interested individuals/entities.

Typically, a company's board of directors presents a copy of the profit and loss account, balance sheet, director's report and auditor's report before the company's annual general meeting. For example, Virgin Atlantic Ltd. openly publishes its key financial records, including its audited balance sheets; profit & loss accounts; and cash flow statements, effective December 31st of each calendar year. They are readily available at a variety of sources, including "CompanyCheck" online (CompanyCheck Ltd., 2016). b.

Purpose, Structure And Content Of Published Accounts Published accounts are professionally prepared, audited and published for the purpose of giving reliable information to stockholders, potential investors, government authorities, and other interested persons/entities.

Due to legal requirements, they are often structured as statutory accounts, including a 'balance sheet', which shows the value of everything the company owns, owes and is owed on the last day of the financial year, a 'profit and loss account', which shows the company's sales, running costs and the profit or loss it has made over the financial year, notes about the accounts, a director's report and depending on the company size, possibly an auditor's report (Government of the United Kingdom, 2016).

Their content includes reliable information for a reported period (usually a year) about: company performance, often in comparison with the prior year; performance possibly in relation to production, sales, profit before tax and profit after providing for tax; challenges faced by the company and steps the company took and/or is taking to meet the challenges; sources and uses of funds; product information; whatever the company owned and owed; research and development and their progress; capital projects undertaken, continued and/or completed by the company; employee-management relations; the economic scene and its effects on company performance; the company's role and actions in social responsibilities; the company's future prospects; commitments and liabilities for which no provision was made and the reasons for not making provisions; details of any material liability arising after the balance sheet date and before the directors adopted the accounts; utilization of capacity and reasons for under-utilization of capacity.

c. A Calculation Of The Financial Ratios From The Accounts A financial ratio is the comparative amounts of two designated numerical values taken from a company's financial statements that assist in evaluating the company's financial condition. Quite a few financial ratios are used in accounting to judge a company's overall financial condition.

The financial ratios from the published accounts of Virgin Atlantic Ltd., for example, include: pre-tax profit margin; current ratio; sales networking capital; gearing; equity in percentage; creditor days; liquidity/acid test; percentage of return on capital employed; percentage of return on total assets employed; current debt ratio; total debt ratio; percentage of stock turnover ratio; and percentage of return on net assets employed (CompanyCheck Ltd., 2016).

These are by no means exhaustive, as there are approximately 30 relevant financial ratios that can be loosely organized in six general categories: liquidity measurement ratios, including current ratio, quick ratio, cash ratio and cash conversion cycle; profitability indicator ratios, including profit margin analysis, effective tax rate, return on assets, return on equity and return on capital employed; debt ratios, including debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio, and cash flow to debt ratio; operating performance ratios, including fixed-asset turnover, sales/revenue per employee and operating cycle; cash flow indicator ratios, including operating cash flow/sales ratio, free cash flow/operating cash ratio, cash flow coverage ratio and dividend payout ratio; and investment valuation ratios, including per share data, price/book value ratio, cash flow coverage ratio, price/earnings ratio, price/earnings to growth ratio, price/sales ratio, dividend yield and enterprise value multiple (Loth, 2016).

d. An Explanation Of How They Support Strategic Decision-Making Each financial ratio supports strategic decision making by giving a more accurate picture of a company's condition, stand-alone performance and competitive performance from a certain perspective. The use of a variety of financial ratios examining a company from various perspectives gives an increasingly accurate picture of the company's overall condition, stand-alone performance and competitive performance, which helps the strategic decision-maker understand and account for possible financial benefits/risks while making his/her decisions.

The more accurate a picture of the company's condition, the better equipped is the strategic manager in making optimal strategic decisions (Loth, 2016). 3. Section 3 a. Clear distinction between long and short-term financial requirements for businesses A business's long-term financial requirements are fixed capital requirements. They are needed for the business, even at its earliest stage and are "fixed" in that production/service does not consume them; rather, they have reusable value and are normally depreciated over a long time.

Fixed capital requirements might include land, factories, office buildings, equipment and any other requirement that is not repeatedly purchased to produce a good/service (Investopedia LLC, 2016). Short-term financial requirements are working capital requirements, sufficient short-term assets to pay short-term debts (Investopedia LLC, 2016). b. Table Comparing Sources Of Long And Short-Term Finance (Dhiman, 2010) c. Examination Of Cash Flow Management Techniques And Assessment Of Why The Management Of Cash Flow Is So Important.

Cash flow is the movement of cash into and out of a business and its management is important because it is the fuel of the organization, needed to perform the organization's basic functions, invest and pay business debts. Without healthy cash flow management, a business that looks good on paper because of profits, for example, can fail because it does not have enough of its life's blood to operate (Inc.com, 2016).

The goal of cash flow management is to have positive cash flow, in which the cash flowing into the business from sales, accounts receivable, investments, etc., is greater than the cash flowing out of the business for accounts payable, monthly operating expenses, salaries, loan debts, etc.

Cash flow management to achieve positive cash flow is approached through several techniques, such as: constantly monitoring and tracking cash flow to see precisely how much cash the business needs to operate and how much positive cash flow it has; collecting receivables more quickly to keep cash flow from sales coming in; tightening credit requirements for customers by wise assessment of the risk of extending credit; increasing sales by striving to attract new customers and sell additional goods/services to existing customers; pricing discounts for customers who pay early and seeking the same types of discounts with suppliers and others to whom the business owes money; securing short-term loans, if necessary, to meet cash flow needs; and wise investments in lucrative financial markets and operating subsidiaries (Inc.com, 2016).

The object, of course, is to have enough blood in the form of cash flow pumping through the business' arteries and veins to keep functioning properly. 4. Section 4 -- Expansion a. Different Business Ownership Structures and Roles and Accountability of Owners and Managers in Making Decisions. There are several possible business ownership structures, including sole proprietorship or sole trader; partnership; limited partnership; limited liability company; and corporation (Laurence, 2016).

A sole proprietorship or sole trader is a single-person business requiring no formal filing and is essentially inseparable from the individual, who is responsible for all debts, judgments and taxes. A partnership is also a simple form of business owned by two or more individuals whose business arrangements, including profits and liabilities, are governed by contract between them; though a partnership is often deemed an equal division of profits/responsibilities, the division of responsibilities and accountability are actually spelled out by the contract.

A limited partnership is one in which one individual is the "general partner" who solicits investments from "limited partners" who share in profits/liabilities only according to their investments. Here, the general partner is responsible for the day-to-day operations and is accountable to limited partners only to the extent of their investments and the contractual terms.

A limited liability company is more complex, requiring formal filings with the government, creating a separate, independent legal and tax entity from its investors in most respects: Investors in the LLC have limited responsibility and personal liability for debts/claims but must pay taxes on their shares of the income through their personal tax returns. The LLC's management is accountable to the investors to the extent of their investments and according to the relationships spelled out in the corporate documents and Companies Act of 2006 (Government of the United Kingdom, 2006).

A corporation also requires formal filings with the government and is also a separate, independent legal and tax entity from its investors but offers complete limitation of liability for its debts/claims for the people who own, control and manage it. The corporation itself files tax returns and pays corporate tax while individual owners must pay personal income tax only on the money they have gained from the corporation by salary, bonus, stock dividend, etc. (Laurence, 2016).

In addition, as the Companies Act of 2006 indicates, corporate management is accountable to the government, shareholders, customers, suppliers, high-finance investors and the community (Government of the United Kingdom, 2006). b. Corporate governance Corporate governance is the structure of rules, practices and processes directing and controlling the corporation. It is the corporation's framework for achieving its goals and basically involves balancing the interests of all the corporation's stakeholders, including management, shareholders, customers, suppliers, high-finance investors, the government and the community. c.

Legal and Regulatory Requirements A corporation must adhere to a number of legal and regulatory requirements. Per the Companies Act of 2006, its very formation requires filing a series of documents with the government, including: an application for registration; the memorandum of association; a statement of capital and initial shareholdings; a statement of guarantee; a statement of proposed officers; and a statement of compliance with registration requirements (Government of the United Kingdom, 2006, pp. 3-6). If all documents are acceptable, the registrar of companies will issue a certificate of incorporation.

Thereafter, the company is required to annually file the published accounts mentioned above, including: audited balance sheets; profit & loss accounts; and cash flow statements (Government of the United Kingdom, 2006). Furthermore, the corporation is required to file corporate tax returns and pay taxes accordingly. A perusal of the Companies Act of 2006 shows that the government regulates most legal/regulatory aspects of a corporation, from political donations to meetings to removal of a member of the board of directors. d.

Evaluation Of Methods For Appraising Strategic Capital Or Investment Projects A business must appraise strategic capital and investment projects in a highly competitive, rapidly changing world that presents opportunities and threats to the organization. With constant changes in prices, supply, demand, technology and cash flows, painstaking evaluation of investment projects is vital to a company's survival and growth when those investments may involve large commitments of resources for such projects as expansion/modernization, replacement and buy/lease decisions.

A business would, of course, calculate and consider as many financial ratios as possible, including but not limited to: liquidity measurement ratios, including current ratio, quick ratio, cash ratio and cash conversion cycle; profitability indicator ratios, including profit margin analysis, effective tax rate, return on assets, return on equity and return on capital employed; debt ratios, including debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio, and cash flow to debt ratio; operating performance ratios, including fixed-asset turnover, sales/revenue per employee and operating cycle; cash flow indicator ratios, including operating cash flow/sales ratio, free cash flow/operating cash ratio, cash flow coverage ratio and dividend payout ratio; and investment valuation ratios, including per share data, price/book value ratio, cash flow coverage ratio, price/earnings ratio, price/earnings to growth ratio, price/sales ratio, dividend yield and enterprise value multiple (Loth, 2016).

In addition to calculating and assessing as many financial ratios as possible, a business deciding whether to commit a large amount of resources in proposed investments should also follow at least five steps. First, it should discern the reliable profitability of each proposal it is considering. Second, it should rank those proposals according to their expected profitability. Third, it should set a cut-off rate below which it will not further consider a proposal for investment. Fourth, it should rate each proposal above or below that cut-off rate.

Fifth, it should opt for the most profitable proposals, given the limits of the business' capital budget (Open Learning World.com, 2011). By following those basic rules, a company will not only consider likely costs and benefits, measure the expected rate of return (ROI) after tax but also establish an optimal pattern of investment for the company's profitability and growth. C. Conclusion Business often turns on decision making and effective decisions need financial and non-financial information, which collects and examines raw data, then converts it into usable information.

When a business manager makes a decision, he/she must weigh the possibility and degree of loss the business might suffer because of that decision, often in uncertainty due to imperfect information, which involves financial risk. The financial information needed for strategic business decisions normally consists of the information provided by: balance sheets; profit & loss accounts; and cash flow statements. Published accounts are a company's financial records that have been prepared, audited and sent to shareholders and other interested individuals/entities.

Due to legal requirements, they are often structured as statutory accounts, including a 'balance sheet', which shows the value of everything the company owns, owes and is owed on the last day of the financial year, a 'profit and loss account', which shows the company's sales, running costs and the profit or loss it has made over the financial year, notes about the accounts, a.