Finance Basics

What is Strategic Finance?

Strategic finance, also known as strategic financial management, provides long-term planning for ongoing growth and development. At times, this can come at the expense of shorter-term gains, such as enacting asset reductions or policy changes that public stakeholders may not agree with initially.

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From tactical to strategic

Business practices like budgeting, risk management, and self-evaluation permeate throughout every level of an organization. This affects both tactical, short-term decisions and the company’s long-term strategy.

When looking at financing options, management might consider its short-term assets (inventory, accounts receivables) and its long-term assets (property, plants, equipment) to identify what can be leveraged or liquidated to fund a business acquisition. The decision may adversely impact a company’s short-term performance, but will ultimately increase its long-term gains.

For example, in 2013, McDonalds decided that a stock buyback was a worthwhile investment because the market price was optimal. By buying back more than 18 million publicly-available shares, McDonald’s lowered the book value of their share price, yet increased their ownership stake at a reasonable market value. This, in tandem with other tactical maneuvers, increased the earnings over time for each shareholder and bolstered the total value of the company.

The influence of financial managers

Strategic financial managers are not only responsible for the identification of available or potential resources, but creating the plan for leveraging these resources to achieve the overarching objectives as well. Further, a financial manager must ensure the long-term profitability and financial health of the company. A 10% year over year (YOY) growth rate means little if you can’t successfully position the business to effectively utilize the expanded resource pool or remain resilient during down periods.

Good financial managers will coordinate the balance sheet, income statement, and cash flow to accurately monitor the well-being of the company while optimizing assets. In doing so, they will need to answer a range of questions regarding how investment decisions today will impact the organization moving forward.

Some of these questions include:

  • What is the right mix of short- and long-term assets that will ensure the company can both maximize profitability while maintaining adequate liquidity (net working capital)?
  • How will we finance upcoming projects?
  • What are the capital requirements and how will we balance debt and equity? Will these funders come from owners or lenders?
  • How can we overhaul older assets so that they generate earnings in the future?

Beyond such questions, managers must monitor the level of risk in a company’s portfolio. Risk management involves identifying and quantifying key factors that increase or decrease a company’s financial exposure. Managers will use a variety of financial instruments and vehicles, such as options, futures, and securities, to augment profitability while operating within an acceptable level of risk tolerance.

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Keeping investors happy

In addition to tracking and improving financial performance, strategic financial managers must also decide the best way to compensate shareholders. Aside from buying shares back, this compensation typically comes in the form of dividends. Dividends are the net profit payouts to shareholders following a period of gain.

The company dividend policy dictates whether profits are to be paid as dividends or retained and reinvested directly back into the business. If dividends are the decision, what percentage of profits is to paid? To effectively strike a balance between growing the business and maintaining happy shareholders, managers must understand their company’s market position and accurately project future earnings.

Evaluation and evolution

Ultimately, the success of a financial strategy is determined by its continued long-term value and stability. Even the strongest companies can’t maintain torrid growth paces, and strategies should account for this. In many ways, a company’s ability to honestly evaluate itself through monitoring day-to-day operating expenses, performance snapshots, resource waste, and overall efficiency will provide answers as to how it can thrive through both growing and receding economic conditions. Processes should be established and modified based on continuous data analysis, as well as variations between projections and results.

As a company grows, decisions regarding development and resource allocation multiply. For example, when considering a potential expansion, a financial manager may be forced to decide whether it is wiser to purchase a new facility or invest in a new capability. The solution can take many forms. That manager can buy in a new property, hire employees, or upskill their current labor force. An additional option (for larger companies) is to acquire a smaller company that already possesses the required assets.

Regardless of the specified function, strategic finance is a dynamic process. Expenditures, revenues, and economic conditions influence how a company must align its resources. This may require a workforce reduction or liquidation of fixed assets to lower operating expenses. Conversely, it may necessitate mergers or acquisitions to support expansion into new markets.

Sound financial strategy identifies new challenges and opportunities. New problems open the door for new solutions. Identifying these problems and solutions is one of the central roles of a financial manager.