Strategic financial management

When making a financial strategy, financial managers need to include the following basic elements. More elements could be added, depending on the size and industry of the project.

Startup cost: For new business ventures and those started by existing companies. Could include new fabricating equipment costs, new packaging costs, marketing plan.

Competitive analysis: analysis on how the competition will affect your revenues.

Ongoing costs: Includes labour, materials, equipment maintenance, shipping and facilities costs. Needs to be broken down into monthly numbers and subtracted from the revenue forecast (see below).

Revenue forecast: over the length of the project, to determine how much will be available to pay the ongoing cost and if the project will be profitable.

For a financial manager in an organisation this will be mainly regarding the selection of assets which funds from the firm will be invested in. These assets will be acquired if they are proven to be strategically sound and assets are classified into 2 classifications:

• Long term assets - also known as Capital Budgeting for financial managers.
• Short term assets/current assets.
• Profitability Management.

Financial managers in this field must select assets or an investment proposals which provides a beneficial course of action, that will most likely come in the future and over the lifetime of the project. This is one of the most crucial financial decisions for a firm.

Important for short term survival of the organisation; thus prerequisite for long term success; mainly concerning the management of current assets that’s held on the company’s balance sheet.

As a more minor role under this section; it comes under investment decisions because revenue generated will be from investments and divestments.

Under each of the above headings: financial managers have to use the following financial figures as part of the evaluation process to determine if a proposal should be accepted. Payback period with NPV (Net Present Value), IRR (internal rate of return) and DCF (Discounted Cash Flow).

For a financial managers, they have to decide the financing mix, capital structure or leverage of a firm. Which is the use of a combination of equity, debt or hybrid securities to fund a firm's activities, or new venture.

Financial manager often uses the Theory of capital structure to determine the ratio between equity and debt which should be used in a financing round for a company.

The basis of the theory is that debt capital used beyond the point of minimum weighted average cost of capital will cause devaluation and unnecessary leverage for the company.

The equation of working out the average cost of capital can be found on the right.

Where:

Re = cost of equity

Weighted Average Cost Of Capital.[2]

Rd = cost of debt

E = market value of the firm's equity

D = market value of the firm's debt

V = E + D

E/V = percentage of financing that is equity

D/V = percentage of financing that is debt

Tc = corporate tax rate

The role of a financial manager often includes making sure the firm is liquid – the firm is able to finance itself in the short run, without running out of cash. They also have to make the firm’s decision in investing into current assets: which can generally be defined as the assets which can be converted into cash within one accounting year, which includes cash, short term securities debtors, etc.

The main indicator to be used here is the net working capital: which is the difference between current assets and current liabilities. Being able to be positive and negative, indicating the companies current financial position and the health of the balance sheet.

This can be further split into:

Which includes investment in receivables that is the volume of credit sales, and collection period. Credit policy which includes credit standards, credit terms and collection efforts.

Which are stocks of manufactured products and the material that make up the product, which includes raw materials, work-in-progress, finished goods, stores and spares (supplies). For a retail business, for example, this will be a major component of their current assets.

Concerned with the management of cash flow in and out of the firm, within the firm, and cash balances held by the firm at a point of time by financing deficit or investing surplus cash.

Financial managers often have to influence the dividend to 2 outcomes: The ratio as which this is distributed is called the dividend-pay out ratio.

• Distribute to the shareholder in the form of dividends
• Retain in the business itself

This is largely dependent on the preference of the shareholders and the investment opportunities available within the firm. But also on the theory that there must be a balance between the pay out to satisfy shareholders for them to continue to invest in the company. But the company will also need to retain profits to be reinvested so more profits can be made for the future. This is also beneficial to the shareholders for growth in the value of shares and for increased dividends paid out in the future. This infers that it is important for management and shareholders to agree to a balanced ratio which both sides can benefit from, in the long term. Although this is often an exception for shareholders who only wish to hold for the short term dividend gain.