In the current day, it is impossible to envision a world in which money is not used. Money, in reality, is the lifeblood of business in today’s world, as all of our economic operations are carried out through the use the techniques of strategic financial management. In order to do business, we require resources that are pooled in terms of financial resources. It is used for the acquisition of physical and material resources for the conduct of productive activities and commercial operations that have an impact on sales, as well as for the payment of compensation to resource providers, both physical and monetary. In this way, Nature of strategic financial management is regarded as an organic function of a company and has properly gained prominence as a critical function.
According to a number of expert’s strategic financial management, is simply the work of supplying money required by a business or enterprise on terms that are most advantageous in light of the business or firm’s overall objectives. As a result, the method is almost entirely focused with the procurement of money, although it may be broadened to encompass tools, institutions, and procedures that are used to generate funds.
In Depth Overview
It also includes the legal and accounting connection that exists between a corporation and the sources of cash that it draws upon. Strategic financial management is obviously more than just the acquisition of cash; there are a variety of additional duties and choices that must be made.
Thus, to be more specific, Strategic financial management is concerned with decisions about investment and finance, as well as dividend decisions, in connection to the company’s objectives. Such choices must be made with the best interests of the shareholders in heart. They are supported by the maximizing of shareholders’ wealth, which is dependent on the rise in the net value of the capital invested in the firm, as well as the reinvestment of earnings into the company’s growth and success. It is for these reasons that the market is willing to pay a lower or higher price for the shares of one firm than it is for the shares of another corporation. As a result, the characteristics of strategic financial management may be assessed through an examination of the nature of investment, financing, and dividend decisions.
Nature of Strategic Financial Management
The criteria for making investment choices and the criteria for making financing decisions in nature of strategic financial management can be examined separately under two different headings: investment decision criteria and financing decision criteria.
Decision on Investment
Investment is often defined as the use of money to generate profits or returns. This might be accomplished by the creation of physical assets with the money and the operation of a business, the purchase of shares or debentures in a corporation, or the purchase of a consumer durable such as a building, which is occasionally done incorrectly.
Depending on the projected earnings, money flows from one type of business to another in an economy. Similarly, assets of a company are acquired or sold in the capital market based on expectations of larger or fewer profits or gains. Nevertheless, inside a company, a finance manager determines where the firm’s resources should be channelled and who should be entrusted with making financial choices. A marketing manager may desire a new display room, a production manager may desire a new lathe, and a personnel management may desire better salaries for employees, all of which may result in more regular and efficient output in their respective departments. You can also read nature of financial management to get more knowledge on this chapter.
Above and beyond that, the senior management may choose to venture into a completely new field of manufacturing, such as a textile business branching out into electronics. All of them are business initiatives that have a good chance of increasing earnings. Resources, on the other hand, are limited. As a result, the dilemma of approving one proposal while rejecting another continues to exist.
Capital budgeting is a critical component of the decision-making process for large-scale investments. When it comes to the corporate sector, investment choices and capital budgeting are regarded to be identical. Investment choices are concerned with the question of whether increasing the value of capital assets now will result in increased income tomorrow that will be sufficient to cover expenditures.
As a result, investment choices are commitments of monetary resources made at various points in time with the anticipation of future economic returns. It is necessary to make a decision among the many resources and investment opportunities accessible. As a result, investment choices are concerned with the selection of real assets to be acquired over a period of time as part of a productive process.
When making such a decision, it is essential to take into account a number of variables, including the need for investment, factors influencing decisions, criteria for assessing investment decisions, and the selection of a specific alternative from among the numerous alternatives that are accessible. The choice to invest has, as a result, risen to become the most crucial element in a company’s overall decision making process. Such judgments are mostly taken after a thorough evaluation of the various offers in light of the company’s growth and profitability predictions.
The decision contributes to the achievement of the company’s long-term objectives, which include survival and expansion, the preservation of market share for its goods, and the retention of leadership in its manufacturing activity. The firm prefers to take advantage of the economic opportunities that arise as a result of investment decisions. As an nature of strategic financial management example:
- Expansion of the producing process in order to satisfy the current excessive demand in the local market, to take advantage of the global market, and to benefit from the advantages and economies of scale that come with increased output.
- Equipment selection generates the requirement for investment selections that are based on questions of quality and the most recent technological advances.
- In order to take advantage of technological advancements, it is important to replace old and worn-out equipment and buildings. This is done in order to reduce production costs by replacing obsolete and worn-out equipment and buildings and to increase productivity of labor.
Economic and financial engagement is required for all mergers, acquisitions, restructurings, and rehabilitation, and investment decisions control each of these activities.
- Another area of investment is the re-allocation of capital, which is necessary to guarantee that assets are allocated in accordance with the production policy.
- As a result, investment decisions cover a broad and complicated range of issues including the following areas: company development and contraction, including business failure and reorganization.
- assessing risk; purchasing, hiring, or leasing an item.
- Capital budgeting.
- Management of liquidity and current assets.
- Management of fixed assets.
- Capital expenditures (cost of capital).
The factors that influence investment decisions are, in essence, the components that go into making investment decisions. Capital is a rare resource with a high supply cost, making it difficult to get. In order to make the best possible investing selections, it is necessary to take into account the criteria listed above.
- The availability of capital as well as concerns of the cost of capital, with particular emphasis on financial analysis.
- A set of standards by which to select a project for implementation and to maximize returns therefrom, with particular emphasis on logic and arithmetic.
Decision on Financing
The decision on financing is the next stage in the nature of strategic financial management process for putting the investment choice into action once it has been made. Based on its balance sheet, a sample firm gets financing from shareholders, whether ordinary or preferred stockholders, bondholders on a long-term basis, financial institutions as long-term loans, banks and others as short-term loans, and other sources. The provisions regulating the issuance of preference shares, debentures, loan papers, and other types of securities differ from one another.
It is the determination of how much money to raise from among the many sources of funding available that is dealt with in financing choices (sometimes referred to as the financing mix or capital structure). Efforts are made to get the best possible financing combination for a certain company’s needs. In order to do this, the company’s financial structure as well as its short and intermediate term funding strategies must be investigated.
Capital budgeting, long-range planning, appraisal of alternative uses of money, and the development of measurable criteria of success in financial terms are all examples of how finance decisions have become completely integrated with top-management policy formation in more sophisticated firms.
Financial decision-making is becoming increasingly concerned with questions such as how to measure the cost of funds, how to evaluate proposals for capital-intensive projects, how far the financing policy influences the cost of capital, whether corporate funds should be committed to or withheld from certain purposes, and how to calculate the expected returns on projects.
The most efficient use of funds has emerged as a new issue for financial decision-makers, and senior executives in the business sector are more concerned with planning the sources and uses of funds as well as assessing results. New measuring techniques, which make use of computers, have made it possible to allocate capital more efficiently through finance decisions.
As an effective scope of strategic financial management in corporate units, both investment decisions and financial decisions are made in conjunction with one another. Certainly, the scope of these decisions is distinct, yet they are intertwined in their consequences. As previously stated, financial decisions include determining the appropriate proportion of equity capital to debt in order to establish an optimal capital structure and balancing the fixed and working capital requirements in the company’s financial structure.
This critical area of financial decision-making is concerned with maximizing returns on investment while avoiding risk, and it is extremely essential. The risk and return analysis is a typical technique for making investment and finance decisions, as well as for determining the best capital structure for a business division. It should be emphasized that debt increases the riskiness of a company’s capital structure.
This nature of strategic financial management is concerned with the study of a company’s earnings before interest and taxes, variable costs, and contribution to the stock market. A study of operational leverages is what it is formally known as. In addition, using the financial leverage approach, the earnings per share that will be distributed to shareholders is calculated and reported. When both of these elements are taken into consideration, this is referred to as combined leverage.
Decision By Dividends
Another important nature of strategic financial management is the determination of dividends. The strategic financial management must determine whether the company should share all earnings or keep them altogether, or if it should distribute a portion of the profits while keeping the rest. It should be based on whether the firm or its shareholders are in a better position to make better use of the money and to generate a greater rate of return on the funds, according to theoretical considerations.
The market price of the company’s stock, the trend of earnings, the tax position of its shareholders, cash flow position, the need for funds for future growth, and restrictions imposed by the Companies Act, among other factors, play an important role in determining the dividend policy of the business enterprise, as shown in the chart below. Besides making a judgement on the optimal dividend payout ratio, the finance manager is also responsible for making choices on incentive payments and interim dividends.
Criteria for Decision Making
In order to fulfill the aforementioned aims, a fair decision criterion should differentiate between acceptable and unacceptable suggestions and solve the challenge of selecting the best alternative from among the numerous choices accessible in a particular circumstance. You should also know the limitations of financial management on the same ground. Fair choice criteria should be based on the following two essential principles: (1) the “Bigger and Better” concept; and (2) the “Bird in Hand is Better than Two in the Bush” philosophy, to name a few examples. In accordance with the first principle, larger advantages are preferred over smaller ones, but the second principle implies that early benefits are preferred over later benefits.
Both of the aforementioned concepts are predicated on the premise that “all other factors are equal,” which is an uncommon occurrence in actual life. While this is true in theory, in fact, the decision-making process conforms extremely closely to these principles, especially in the areas of capital budgeting choices and assessing the cost of capital in project financing proposals.
Nature of strategic financial management must not only ensure that funds are available for the installation of plant and machinery at a reasonable cost, but it must also ensure that the additional profits generated by the project are sufficient to compensate the business for the costs and risks incurred during the project’s setup.