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Module I

Financial Strategy and Planning

Learning Objectives
Meaning of strategy and strategic planning process Environmental factors influencing business Strategic Financial Management and its importance Meaning and techniques of Financial Forecasting Financial Planning as to External funds requirement Computation of Internal Growth Rate and Sustainable Growth Rate Steps in Financial Planning process Steps in decision making and Problem solving process Financial Sector reforms Agency theory of Employment in relation to Strategic Financial Management Meaning and benefits of Limited Liability Partnership Definition, meaning and tests of Corporate Governance History of WTO

Strategic Approach to Financial Management


Strategy is defined as where the organization wants to
go to fulfill its purpose and achieve its mission, it provides the framework for guiding choices which determine the organizations nature and direction and these choices relate to the organizations products and services, markets, key capabilities, growth, return on capital and allocation of resources.

Strategic Planning is a systematic analytical approach


which reviews the business as a whole in relation to its environment with different objectives.

Strategic Planning Process


Define Process Internal Appraisal Set Objectives Analyze existing strategies Define strategic issues Develop new or revised Strategies Determine critical success factors Prepare Plans Implement plans Monitor External Appraisal

Economic Environment of Business


Factors influencing at International level: Foreign Exchange rates, interest rates, wage rates of different countries Economic and trade agreements Entry barriers of different countries Globalization and liberalization of trade Balance of payments of different countries Monetary and economy policies of different countries Political situation of different countries

Contd.
Factors influencing at national level: Inflation rate Growth rate of GDP Tax rates Exchange rate of national currency Monetary and economic policy of government Government incentives and subsidies Rate of unemployment Availability of skilled manpower and technology

Contd.
Factors influencing at Organizational level: Nature and size of business Expected and market rate of return Asset and liability structure of the firm Efficiency of the management and its commitment Ownership pattern Technology adopted Attitude of the stakeholders over firm

Strategic Financial Management


Strategic financial planning involves financial planning, financial forecasting, provision of finance and formulation of finance policies for firms survival and success. The finance function of any organization has following objectives: - Forecasting: demand and sales volume, cash flows, inflation rates, prices, inventory requirements etc. - Organizing: financial relation, accounting system - Planning: investment planning, manpower planning, development process, marketing strategies. - Coordination: linking finance with other functions, with national budget and five year plans, with labor union policies and media - Control: Financial charges, overall monitoring of the system, equilibrium in the capital.

Financial Forecasting
Financial forecasting is to prepare projected financial statements. Which helps making decisions like; - capital investment, - annual production level, - operational efficiency required, - requirement of working capital, - assessment of cash flow, - raising of long term funds, - estimated growth in sales etc.

Techniques of Financial Forecasting


Days sales method: its a traditional technique used to forecast the sales by calculating the number of days sales and establishing its relation with the balance sheet items to arrive at the forecasted balance sheet. Percentage of sales method: according to this method percentage change in sales have impact on different items of balance sheet and according to that the projected statements are prepared. Simple linear regression method: in this method sales is taken as independent factor and with it the other items of assets and liability are forecasted. Multiple regression method: in this financial forecasting it is assumed that sales are a function of several variables.

Contd.
Projected funds flow statement: the projected fund flow statement shows the future sources of funds and its possible application. Projected cash flow statement: it is a detailed projection of income to be realized and cash expenses as well expenditure. Projected income statement and balance sheet: the projected income statement is prepared on the basis of forecast of sales and expenses. The projected balance sheet is also drawn based on the future estimation of raising or repayment of long term funds and acquisition or disposal of fixed assets and estimation of working capital.

Benefits of financial forecasting


It provides basic and necessary information for setting up of objectives of the firm and for preparation of its financial plans. It acts as a control device for firms financial discipline. It provides necessary information for decision making of all functions in an organization. It monitors the optimum utilization of firms resources. It projects the funds requirement and utilization of funds in advance. It alarms the management when the events of the concern going out of control. It enables the preparation and updation of financial plans according to the changes in economic environment and business situations. It provides the information needed for expansion plans of business and future growth needs of the organization.

Financial Forecasting Techniques


1. External Funds Requirement (EFR): EFR = (A/S L/S) S MS1 (1-D) Where,
A/S = Total assets/sales L/S = Current liabilities and provision/sales S = sales of the current year S1 = Projected sales of the next year S = Expected increase in sales over current year (S S1) M = Net Profit Margin D = Dividend payout ratio

Contd.
2. Internal Growth Rate (IGR):
IGR is the maximum growth rate a firm can achieve without going for external financing. All the financing requirements are met internally from the internal accruals. IGR = ROA*b / 1 (ROA*b)

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

Contd.
3. Sustainable Growth Rate (SGR):
SGR is the maximum growth rate which can be achieved using both internal accruals and external debt without increasing the financial leverage. SGR is the maximum sales that can be achieved in a year based on target operating debt and dividend payout ratio.

b(NP/S) (1+ D/Eq) SGR = (A/S) [b (NP/S) (1+ (D/Eq)]


Where, b = Retention ratio, NP/S = Net profit / sales, D/Eq = Debt equity ratio

A/S = Asset to sales ratio, S = Annual sales

Financial Planning Process


Clearly defined Mission and Goal Determination of Financial Objectives: short and long term 3. Formulation of financial policies: ratios, minimum balances, inventory consumables etc. 4. Designing financial procedures: capital budgeting, cash flow control system, financial forecasting techniques etc. 5. Search for opportunities 6. Identifying possible course of action: business strategies for different functions of the firm 7. Searching for alternatives 8. Assembling information 9. Evaluation of alternatives and reaching a decision 10. Implementation, monitoring and control 1. 2.

Decision Making and Problem Solving process Recognize problem Collect information Identify causes Specify problem \allocate priorities Examine resources Search for alternative Evaluation of alternatives Select best course of action Implement decision Results and control

Agency theory of employment


What is agency theory? Agency costs:
- Expenditure to structure the organization in such a way to minimize dishonesty of managers. - Expenditures to managers actions by internal audit. - Opportunity cost of lost profits

Constituents of Agency theory:


Value Maximization Management Risk Monitoring Motivation through incentives

Corporate Governance
Corporate Governance is the system by which business corporations are directed and controlled. It is a process or a set of systems and processes to ensure that a company is managed to suit the best interests of all. Corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation and spells out the rules and procedures for making decisions on corporate affairs to achieve company objectives and in monitoring its performance.

Tests to analyze CG
Whether the company funds have been deployed for the main objectives of the firm? Whether the company has the core competence to effectively manage its diversification? Whether the personal properties of the directors have been let out at very high rent to the company? Whether the Companies Act, FEMA, Factories act are complied properly? Whether the internal controls in place are effective? Whether there is transparent financial reporting and audit practices and the accounting practices adopted by the company are in accordance with the accounting standards?

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