1 - Financial Policy and Corporate Strategy - PPT (05-04-19)

05-04-2019
Chapter 1
FINANCIAL POLICY AND
CORPORATE STRATEGY
Learning Outcomes
• Strategic Financial Decision Making Frame
Work
• Strategy at different hierarchy levels
• Financial Planning
• Interface of Financial Policy and Strategic
Management
• Balancing Financial Goals vis-à-vis Sustainable
Growth
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Strategic Financial Decision Making

All businesses need to have the following three
fundamental essential elements:
• A clear and realistic strategy,
• The financial resources, controls and systems
to see it through and
• The right management team and processes to
make it happen.
Strategy
• Strategy may be defined as the long term
direction and scope of an organization to achieve
competitive advantage through the configuration
of resources within a changing environment for
the fulfilment of stakeholder’s aspirations and
expectations.
• What concerns the investors is not simply
maximum profit but also the likelihood of it
arising: a risk-return trade-off from a portfolio of
investments, with which they feel comfortable
and which may be unique for each individual.
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Strategy at Different Hierarchy

Levels
There are three levels of Strategy –
• Corporate Level;
• Business Unit Level; and
• Functional Level.
Corporate Level Strategy

Corporate level strategy fundamentally is
concerned with selection of businesses in which a
company should compete and with the
development and coordination of that portfolio of
businesses.
Suitability Whether the strategy would work for the
accomplishment of common objective of the company.
Feasibility Determines the kind and number of resources required

to formulate and implement the strategy.
Acceptability It is concerned with the stakeholders’ satisfaction and

can be financial and non-financial.
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Business Unit Level Strategy

• Business Level Strategies detail actions taken to
provide value to customers and gain a competitive
advantage by exploiting core competencies in specific,
individual product or service markets.
• Business-level strategy is concerned with a firm’s
position in an industry, relative to competitors and to
the forces of competition.
• At the business unit level, the strategic issues are about
practical coordination of operating units and
developing and sustaining a competitive advantage for
the products and services that are produced.
Functional Level Strategy

• Once higher level corporate and business strategies have
been developed, management need to formulate and
implement strategy for each of the functional areas of
business.
• Functional strategies are designed to help in the
implementation of corporate and business unit level
strategies.
• Strategies in functional areas including marketing, financial,
production, R & D and human resource management are
based on the functional capabilities of an organisation.
• For each functional area, first the major sub areas are
identified and then for each of these sub areas, content of
functional strategies, important factors, and their
importance in the process of strategy implementation are
identified.
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• Strategy may be defined as the long term

direction and scope of an organization to
achieve competitive advantage through the
configuration of resources within a changing
environment for the fulfilment of
stakeholder’s aspirations and expectations.
• Strategic Financial Management is application
of financial techniques to strategic decisions in
order to help achieve the decision-maker's
objectives.
• It involves the allocation of scarce capital
resources among competing opportunities.
Functions of Strategic Financial

Management
Strategic Long-term Senior
course of action management
decides strategy
Tactical Intermediate Middle level
plan decides tactics
Operational Short-term Operational are

functions looked after line
management
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Key Decisions within the scope of

Financial Strategy
1. Financing Decisions
2. Investment Decisions
3. Dividend Decisions
4. Portfolio Decisions
Financial Planning
• Financial planning is the backbone of the business
planning and corporate planning.
• Financial planning is a systematic approach whereby
the financial planner helps the customer to maximize
his existing financial resources by utilizing financial
tools to achieve his financial goals.
• There are 3 major components of Financial planning:
– Financial Resources (FR)
– Financial Tools (FT)
– Financial Goals (FG)
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Functions of Financial Decisions

• Continual search for best investment
opportunities;
• Selection of the best profitable opportunities;
• Determination of optimal mix of funds for the
opportunities;
• Establishment of systems for internal controls;
and
• Analysis of results for future decision-making.
Key Decisions within the Scope of

Financial Strategy
1. Financing decisions
2. Investment decisions
3. Dividend decisions
4. Portfolio decisions
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Interface of Financial Policy and

Strategic Management
The interface of strategic management and financial
policy will be clearly understood if we appreciate the fact
that the starting point of an organization is money and
the end point of that organization is also money.
Investment
Sources of Capital Dividend
and Fund
Finance Structure Policy
Allocation
Balancing Financial Goals vis-à-vis

Sustainable Growth
• Sustainable growth is important to enterprise long-
term development.
• Too fast or too slow growth will go against enterprise
growth and development, so financial should play
important role in enterprise development, adopt
suitable financial policy initiative to make sure
enterprise growth speed close to sustainable growth
ratio and have sustainable healthy development.
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Key Growth Rates

• Growth is often the central theme of corporate
planning as normally firms state corporate goals in
terms of growth rates.
• While firms may be interested in growth, they may be
reluctant to raise external equity.
• Keeping in view this reluctance it is useful to calculate
following two growth rates for long term financial
planning:
– The Internal Growth Rate
– The Sustainable Growth Rate
• The firm’s growth rate is higher when external finance
are used. It is lower when it uses internally generated
funds (retained earnings) only to finance its assets.
Internal Growth Rate

Internal Growth Rate is the maximum growth rate
that can be achieved with no external financing
whatsoever.
To determine the Internal Growth Rate we make
following assumptions:
– The assets of the firm will increase proportionately to
sales.
– The net profit margin (Net Profit to Sales) is constant.
– The dividend payout ratio is given.
– The firm will not raise external finance.
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Variables of IGR
Variables of IGR typically include
• The Net Profit Margin,
• The Asset Turnover Ratio (Ratio of Sales
Revenues to Total Assets), and
• The Retention Rate
Formula of IGR
Return on Assets (ROA) = Net Profit Margin x Asset
Turnover Ratio
ROA × Ploughback Ratio

IGR =
1- ROA × Ploughback Ratio
Or
ROA × (1- Dividend Payout Ratio)

=
[1- ROA × (1- Dividend Payout Ratio)]
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Sustainable Growth Rate (SGR)

• SGR is the maximum rate at which firm can grow by using
internal sources (retained earnings) as well as additional
external debt but without increasing its Financial Leverage
(Debt- Equity Ratio).
• Sustainable growth models assume that the business wants
to:
1) maintain a target capital structure without issuing new equity;
2) maintain a target dividend payment ratio; and
3) increase sales as rapidly as market conditions allow.
• To determine SGR the two additional assumptions are made:
(i) The firm has a target capital structure (D/E Ratio) which it wants to
maintain.
(ii) The firm does not intend to sell new equity shares as it is a costly
source.
Variables of SGR
Variables of SGR typically include
• The Net Profit Margin,
• The Asset Turnover Ratio (Ratio of Sales
Revenues to Total Assets),
• The Debt- Equity Ratio, and
• The Retention Rate
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Formula of SGR
• Return on Equity = Net Profit Margin x Asset
Turnover Ratio x (1+Debt Equity Ratio)
or
= Net Profit Margin x Asset Turnover Ratio x (Assets/
Equity)
ROE × Ploughback Ratio

• SGR =
1- ROE × Ploughback Ratio
Or = ROE × (1- Dividend Payout Ratio)

[1- ROE × (1- Dividend Payout Ratio)]
Questions
The following information is related to S Ltd:
Net Profit Ratio = 5%
Retention Ratio = 70%
Asset Turnover Ratio= 1
Asset to Equity = 2.4
What rate of Growth can be sustained without
resorting to external equity issue.
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Following Financial data are available for PQR

Ltd. for the year 2008:
(Rs. in lakh)
8% debentures 125
10% bonds (2007) 50
Equity shares (Rs. 10 each) 100
Reserves and Surplus 300
Total Assets 600
Assets Turnovers ratio 1.1
Effective interest rate 8%

Effective tax rate 40%
Operating margin 10%
Dividend payout ratio 16.67%
Current market Price of Share Rs. 14
Required rate of return of investors 15%
You are required to:

(i) Draw income statement for the year
(ii) Calculate its Internal Growth Rate of Earnings.
(ii) Calculate its sustainable growth rate of earnings
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Questions
Question
Explain the interface of Financial Policy and
Strategic Management. [May 2018] (NS) 4 Marks
Questions
• Explain the different levels of strategy.
• Explain briefly, how financial policy is linked to
strategic management.
• Write a short note on Balancing Financial Goals
vis-a-vis Sustainable Growth.
• What makes an organization sustainable? State
the specific steps.
• What makes an organization financially
sustainable.
• Explain various processes of strategic decision
making.
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Thank You
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05-04-2019

Strategic Financial Decision Making

Strategy at Different Hierarchy

Corporate Level Strategy

Feasibility Determines the kind and number of resources required

Acceptability It is concerned with the stakeholders’ satisfaction and

Business Unit Level Strategy

Functional Level Strategy

• Strategy may be defined as the long term

Functions of Strategic Financial

Operational Short-term Operational are

Key Decisions within the scope of

Functions of Financial Decisions

Key Decisions within the Scope of

Interface of Financial Policy and

Balancing Financial Goals vis-à-vis

Key Growth Rates

Internal Growth Rate

ROA × Ploughback Ratio

ROA × (1- Dividend Payout Ratio)

Sustainable Growth Rate (SGR)

ROE × Ploughback Ratio

Or = ROE × (1- Dividend Payout Ratio)

Following Financial data are available for PQR

Effective interest rate 8%

You are required to:

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