A group of specialists believes that strategic financial management is just concerned with money. Every commercial transaction involves the exchange of money, either directly or indirectly. This makes it reasonable to believe that the scope of strategic financial management covers everything that happens in a business. However, this definition is overly broad.
There are many organizations, such as schools, associations, and government agencies, where funds are procured and used. According to a widely accepted perspective, strategic financial management involves the procurement of funds and their effective use in a business.
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
Make Restitution
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.
The payback choice criterion differs from the concepts mentioned above. It does not follow the “larger and better” or “bird in hand” principles. The payback criterion ignores the first principle because it does not consider the cash flows generated after the investment is recovered. It also partially disregards the second principle. Once the investment is recovered, it assigns zero value to any future receipts.
Urgency
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)
Strategic financial management impacts profit margins. It provides additional criteria for choosing based on accounting records or expected financial statements. These criteria help assess profitability as a proportion of capital used annually. The rate of return is calculated by comparing the results of two alternative revenue processing techniques. Each technique 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.
A corporate unit’s capital structure consists of two key components: equity and debt. Equity represents the firm’s ownership capital. Debt reflects the interest of debenture holders in the company’s assets.
Several factors contribute to the inclusion of debt in a company’s capital structure. These factors include tax savings, ease of sale, and the advantage of leverage. Debt also leads to a lower cost of capital and avoids the dilution of equity. However, it may result in a probable loss of control. The inflationary trend of rising interest rates, lower flotation costs, and services also play a role. Debt financing allows for the consolidation and funding of short-term debt through bond issues. It can improve financial ratios.
Equity financing is essential for meeting a company’s funding requirements. A business must first establish an appropriate equity base before obtaining debt. This equity acts as a buffer for debt financing. The impact of leverage is crucial when determining the optimal mix of debt and equity. Therefore, it is vital to consider this when making financing decisions, particularly regarding leverage and the cost of capital.
Conclusion
From a corporate perspective, strategic financial management is not only about raising funds. It also involves efficiently managing the firm’s finances. In developed capital markets, raising funds is not the issue. The real challenge lies in using capital resources effectively. This requires financial organization, planning, and control.
Strategic financial management includes tasks such as ensuring the availability of funds. It also involves allocating funds for various uses, managing them, and forecasting financial needs. The process also covers investing funds, planning profits, controlling costs, and estimating the rate of return on investment.