A group of specialists believes that strategic financial management is just concerned with money. Because every commercial transaction includes the exchange of money, whether directly or indirectly, it is reasonable to believe that scope of strategic financial management is concerned with everything that occurs during the course of a firm. It is, without a doubt, overly broad.
There are organizations such as schools, associations, government agencies, and other organizations where funds are procured and used, according to the third group of people whose point of view is widely accepted, strategic financial management is defined as the procurement of funds and their effective utilization in the business by the third group of people.
Scope of Strategic Financial Management
As a self study you can read nature of strategic financial management for more knowledge. The decision criteria are determined by the goal that is to be attained via the use of the decision making process’s various instruments. One of the primary goals of every company organization is to maximize profits while keeping expenditures to an absolute minimum. As a matter of fact, the following are the scope of strategic financial management criteria have been used to develop these techniques
When deciding on this factor for investment selections, time is of the utmost importance. The choice is made on the basis of the investment’s ability to be repaid as quickly as possible. In simple terms, pay back is the amount of time it takes for cash flows generated by a project to repay the initial investment to a company’s account. On the basis of this criterion, projects with a shorter payback period will be given preference.
Unlike the concepts given out above, the payback choice criterion does not follow the principles of “the larger and better” or “bird in hand.” It fully disregards the first principle since it does not take into consideration the cash flows generated after the investment has been recovered. It also does not fully comply with the second principle since, upon the recovery of the money, it gives zero value to the receipts.
In many corporate units, business companies, and government organizations, the usage of the word “urgency” is used as a criterion for the selection of investment projects. The following criteria are used to determine the urgency of a project:
- Offers adequate reason for conducting the project;
- It maximizes revenues;
- Contributes immediately to the achievement of the project’s objectives;
Despite the fact that urgency as a criterion lacks disadvantages of financial management due to the fact that it is not quantifiable, it does give an ordinal ranking scale for the selection of projects on a preferred per-exemption basis, which is extremely useful.
Return on Investment (ROI)
In addition to profit margins, scope of strategic financial management gives additional choice criterion based on accounting records or anticipated financial statements to assess profitability as a proportion of capital used on a yearly basis. The rate of return is calculated by comparing the outcomes of two alternative techniques of processing revenue in the study, each of which produces a different conclusion. Following subtraction of depreciation charges, the average income generated by the investment is calculated in the first scenario.
In the second scenario, the initial cost is used as the denominator, rather than the average investment, to calculate the return on investment. Using this formula, we can get the basic annual rate of return. This is in accordance with the “bigger and better” concept. If you choose to use this criteria, you may compare it to either the average investment in the year chosen for research or just to the original cost.
Benefit-to-Cost Ratio without Discount
It is defined as the relationship between the total benefits and the whole cost of the project. Benefits are accepted on their face worth. The ratio may be expressed as “gross” or “net.” When it is computed with benefits and without subtracting depreciation, it is referred to as “net.”
Unlike in the gross version, depreciation is subtracted from benefits before the final results are computed. Both ratios provide the same result: the same ranking. The net ratio is the same as the gross ratio minus one. Because of this relationship, it is straightforward to compute gross ratio and subsequently arrive at net ratio.
It is OK to use these criteria in conjunction with the “larger and better” concept. However, it does not adhere to the second concept of “bird in hand” because early revenues are given the same weight as later receipts throughout the project’s lifespan.
Benefit-to-Cost Ratio with Discount
Because it is based on the present value of future benefits and expenses, this ratio is more trustworthy than the previous one. It can also be expressed as gross or net, as in the previous example. It takes into consideration all revenues, regardless of when they are earned, and so complies with the “larger and better” concept to some extent. Because of the inclusion of the discount factor, early receipts are given a higher weight than late receipts in the accounting system.
This ratio meets the needs of both principles and serves as a useful criterion for decision-making in a variety of situations. Along with this scope of financial management will also give you good knowledge on the topic.
Present Value (PV)
The Present Value Method is a method of calculating the present value of a financial asset under scope of strategic financial management. Because it indicates that the value of money is continually dropping, this notion is valuable as a choice criteria because it reveals that a rupee obtained now is worth more than a rupee received at the end of a year. There are even limitations of financial statements analysis which you should be aware of it.
Apart from that, if the rupee is invested today, it will generate a return on investment and accumulate to Re. 1 (1+i) at the conclusion of the n-year term. As a result, a rupee received at the end of a period of ‘n’ is worth 1/(1+i)n at the present. A comparison of present value and cost of assets is required for investment decisions; if present value exceeds cost, the investment is considered to be appropriate.
Another offshoot of this criteria is the net present value approach, which is closely similar to the cost-benefit ratio in terms of calculation. It considers all sources of revenue as well as the timing of each source with appropriate weights. In this case, the difference between the present value of benefits and costs is taken into consideration rather than the ratio used in cost-benefit analysis.
This criterion is important for determining whether or not projects with a positive net present value at the company’s cost of capital rate should be accepted. In order to choose between two projects that are mutually exclusive, it is necessary to examine if incremental investment results in a positive net present value.
Internal Rate of Return (IRR)
It is a commonly utilized factor in the evaluation of investment opportunities. IRR is a measure of how profitable a business is. It takes into consideration the element of interest. It is referred to as marginal efficiency of capital or the rate of return above the cost of capital. In this section, it specifies the rate of discount that will be used to balance the present value of net benefits with the cost of the project.
This approach meets both of these requirements in equal measure. It is possible to explore in detail the factors that are employed in scope of strategic financial management, with specific reference to the capital structure of a business unit, in this section.
Capital structure of a corporate unit consists of two essential parameters: equity, which represents the ownership capital of the firm, and debt, which reflects the interest of debenture holders in the company’s assets. Tax savings, ease of sale, the advantage of leverage, lower cost of capital, no dilution of equity and probable loss of control, the inflationary trend of rising interest rates, lower cost of flotation and services, the logical consolidation and funding of short-term indebtedness through a bond issue, and the improvement in financial ratios are the factors that contribute to the inclusion of debt in a company’s capital structure.
When it comes to meeting a company’s funding requirements, there is no other option than equity financing. In order for a business to obtain debt, it must first have an appropriate equity basis, which acts as a buffer for debt financing. The investigation of the impact of leverage is the primary focus point for determining the optimal combination of debt and equity sources of funding. As a result, it is desirable to take this criterion into account when making financing decisions, particularly in regard to leverage and cost of capital.
As a result, from the standpoint of a corporate unit, scope of strategic financial management is not just concerned with ‘fund-raising,’ but also includes a broader perspective on efficiently managing the finances of the firm. Raising funds is not a problem in a developed capital market; the real challenge is putting capital resources to efficient use through effective financial organization, financial planning, and financial control. Scope of strategic financial management deals with tasks such as ensuring the availability of funds, allocating them for different uses, managing them, forecasting financial requirements, investing funds, performing profit planning,controlling costs, and estimating the rate of return on investment.