Finance for Strategic Managers: A Complete Reference Guide

Why Financial Information Is Needed in Business

Business often turns on decision-making, and effective decisions require both financial and non-financial information. Financial information, which often derives 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).

"Risk" is the probability and extent of negative results arising from a decision. When a business manager makes a decision, he or she must weigh the possibility and degree of loss the business might suffer as a consequence. Because managers must often make decisions under uncertainty — with imperfect information about existing circumstances, future circumstances, or future results — many business decisions involve risk. One of the most significant types is financial risk. Financial risk involves possible financial losses 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, decisions must be made without knowing all current or future circumstances, which is inherently financially risky.

The financial information needed for strategic business decisions normally consists of information provided by three core statements: balance sheets, profit and loss accounts, and cash flow statements (Zager & Zager, 2006, p. 36).

A balance sheet is essentially a snapshot, consisting of Capital (source of money) + Liabilities = Assets (where the money currently is). It shows the individuals or 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 essentially 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 or 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 for the business to survive (Businessballs, 2016).

Published Financial Statements: Purpose, Structure, and Ratios

Published accounts are a company's financial records that have been prepared, audited, and sent to shareholders and other interested individuals or 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 and loss accounts, and cash flow statements, effective 31 December of each calendar year. These are readily available from a variety of sources, including CompanyCheck online (CompanyCheck Ltd., 2016).

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 or 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 made over the financial year; notes about the accounts; a director's report; and, depending on the company's 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 in relation to production, sales, profit before tax, and profit after tax; challenges faced by the company and steps taken or being taken to meet them; sources and uses of funds; product information; assets and liabilities; research and development progress; capital projects undertaken, continued, or completed; employee-management relations; the economic environment and its effects on performance; the company's social responsibilities; future prospects; commitments and liabilities for which no provision was made, and the reasons for that; details of any material liability arising after the balance sheet date and before the directors adopted the accounts; and utilisation of capacity and reasons for any under-utilisation.

A financial ratio is the comparative relationship between two designated numerical values taken from a company's financial statements, used to assist in evaluating the company's financial condition. Many financial ratios are used in accounting to judge a company's overall financial health. The financial ratios from the published accounts of Virgin Atlantic Ltd. include: pre-tax profit margin; current ratio; sales to networking capital; gearing; equity percentage; creditor days; liquidity/acid test; percentage return on capital employed; percentage return on total assets employed; current debt ratio; total debt ratio; percentage stock turnover ratio; and percentage return on net assets employed (CompanyCheck Ltd., 2016).

These are by no means exhaustive. There are approximately 30 relevant financial ratios that can be loosely organised into 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, capitalisation 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, price/earnings ratio, price/earnings-to-growth ratio, price/sales ratio, dividend yield, and enterprise value multiple (Loth, 2016).

Each financial ratio supports strategic decision-making by providing a more accurate picture of a company's condition, stand-alone performance, and competitive performance from a particular perspective. Using a variety of financial ratios to examine a company from multiple angles gives an increasingly accurate overall picture, helping the strategic decision-maker understand and account for possible financial benefits and risks. The more accurate the picture of the company's condition, the better equipped the strategic manager is to make optimal decisions (Loth, 2016).

Long- and Short-Term Financial Requirements and Cash Flow Management

A business's long-term financial requirements are its fixed capital requirements. These are needed from the earliest stage of the business and are "fixed" in the sense that production or service delivery does not consume them; rather, they have reusable value and are normally depreciated over a long period. Fixed capital requirements might include land, factories, office buildings, equipment, and any other requirement that is not repeatedly purchased in order to produce a good or service (Investopedia LLC, 2016). Short-term financial requirements are working capital requirements — sufficient short-term assets to meet short-term debts (Investopedia LLC, 2016).

Cash flow is the movement of cash into and out of a business. Its management is critical because cash is the fuel of the organisation, needed to perform basic functions, make investments, and pay business debts. Without healthy cash flow management, a business that appears profitable on paper can fail simply because it lacks sufficient liquidity to operate (Inc.com, 2016).

The goal of cash flow management is to achieve positive cash flow — a state in which the cash flowing into the business from sales, accounts receivable, investments, and similar sources is greater than the cash flowing out for accounts payable, monthly operating expenses, salaries, loan repayments, and so on. Cash flow management is approached through several techniques, including:

Constantly monitoring and tracking cash flow to understand precisely how much cash the business needs to operate and how much positive cash flow it has; collecting receivables more quickly to keep inflows from sales timely; tightening credit requirements for customers by carefully assessing the risk of extending credit; increasing sales by attracting new customers and selling additional goods or services to existing ones; offering pricing discounts for early payment and seeking similar discounts from suppliers; securing short-term loans, if necessary, to meet cash flow needs; and making wise investments in lucrative financial markets and operating subsidiaries (Inc.com, 2016).

Conclusion

Business often turns on decision-making, and effective decisions require financial and non-financial information, which collects and examines raw data and then converts it into usable information. When a business manager makes a decision, he or she must weigh the possibility and degree of loss the business might suffer because of that decision — often under conditions of uncertainty due to imperfect information, which introduces financial risk. The financial information needed for strategic business decisions normally consists of balance sheets, profit and 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 parties. Due to legal requirements, they are often structured as statutory accounts, including a balance sheet, a profit and loss account, notes about the accounts, a director's report, and — depending on the company's size — an auditor's report. A financial ratio is the comparative relationship between two designated numerical values taken from a company's financial statements, used to assist in evaluating its financial condition. Many such ratios are used in accounting to judge a company's overall financial health. Each ratio supports strategic decision-making by providing a more accurate picture of the company's condition, stand-alone performance, and competitive performance from a particular perspective.

A business's long-term financial requirements are its fixed capital requirements, while short-term financial requirements are working capital requirements — sufficient short-term assets to pay short-term debts. Cash flow is the movement of cash into and out of a business, and its management is critical because cash is the fuel of the organisation. Cash flow management techniques include: constantly monitoring and tracking cash flow; collecting receivables more quickly; offering pricing discounts for early payment; securing short-term loans if necessary; and making wise investments in lucrative financial markets and operating subsidiaries.

There are several possible business ownership structures, including sole proprietorship, partnership, limited partnership, limited liability company, and corporation, each operating according to differing accountability and government requirements. A corporation is the most formal, requiring government filings, and is a separate legal and tax entity from its investors while offering complete limitation of liability for those who own, control, and manage it. Corporate governance is the structure of rules, practices, and processes directing and controlling the corporation. Per the Companies Act of 2006, a corporation must file formation documents with the government and must annually file published accounts and corporate tax returns.

Finally, a business must rigorously appraise strategic capital and investment projects in a competitive, rapidly changing environment. Such projects might include expansion or modernisation, replacement decisions, and buy-or-lease decisions. The business should calculate and consider as many financial ratios as possible and should also follow five key steps: discerning the reliability of profit for each proposal; ranking proposals according to profitability; setting a cut-off rate; ranking proposals above or below that rate; and opting for the most profitable proposals within capital budget constraints. Following these rules makes it more likely that the business's investments will establish the best pattern of growth and profitability.

Boundless Management. (2016, May 25). Making decisions under conditions of risk and uncertainty. Retrieved from www.boundless.com.

Businessballs. (2016). Financial terms and ratios. Retrieved from www.businessballs.com.

CompanyCheck Ltd. (2016). Virgin Atlantic Ltd. Retrieved from companycheck.co.uk.

Dhiman, A. (2010, October 27). Sources of finance. Retrieved from www.slideshare.net.

Government of the United Kingdom. (2006). Companies Act of 2006. Retrieved from www.legislation.gov.uk.

Government of the United Kingdom. (2016). Prepare annual accounts for a private limited company. Retrieved from www.gov.uk.

Inc.com. (2016). How to manage cash flow. Retrieved from www.inc.com.

Investopedia LLC. (2016). Fixed capital. Retrieved from www.investopedia.com.

Investopedia LLC. (2016). Working capital. Retrieved from www.investopedia.com.

Laurence, B. (2016). Learn about business ownership structures. Retrieved from www.nolo.com.

Loth, R. (2016). Financial ratios. Retrieved from www.investopedia.com.

Open Learning World. (2011). Investment appraisal — methods and considerations. Retrieved from www.openlearningworld.com.

Zager, K., & Zager, L. (2006). The role of financial information in the decision-making process. Innovative Marketing, 2(3), 35–40. Retrieved from businessperspectives.org.