Financial Policy and Corporate Strategy

Table of Content: 

1. ADVANCED ROLE OF CFO IN VARIOUS MATTERS INCLUDING VALUE CREATION - CA Final (AFM)
2. STRATEGIC FINANCIAL DECISION-MAKING FRAMEWORK
3. Functions of Strategic Financial Management 
4. STRATEGY AT DIFFERENT HIERARCHY LEVELS
5. Corporate Level Strategy
6. Business Unit Level Strategy
7. Functional Level Strategy
8. BALANCING FINANCIAL GOALS VIS-A-VIS SUSTAINABLE GROWTH

ADVANCED ROLE OF CFO IN VARIOUS MATTERS INCLUDING VALUE CREATION - CA Final (AFM)

Traditionally, the main role of CFO was concentrated to wealth maximisation for shareholders by taking care of financial health of an organization and overseeing and implementing adequate financial controls.

However, in recent time because of globalization, growth in information and communications, pandemic situation etc. their range of responsibilities has been drastically expanded, driven by complexity and changing expectations.

Now a days in addition to fulfilling traditional role relating to governance, compliances and controls, andbusiness ethics as a part of the leadership of role CFOs are also expected to contribute their support instrategic and operational decision making. 

In post-pandemic time their role has been advanced in the following areas in addition to traditional role: 
a. Risk Management: Now a days the CFOs are expected to look after the overall functioning of the framework of Risk Management system of an organisation.

b. Supply Chain: Post pandemic supply chain management system has been posing the challenge for the company to maintain the sustainable growth. Since CFOs are care takers of finance of the company, considering the financial viability of the Supply Chain Management their role has now become more critical.

c. Mergers, acquisitions, and Corporate Restructuring: Since in recent period to maintain the growth and capture the market share there has been a spate of Mergers and 
Acquisitions and hence the role of CFOs has become more crucial because these are strategic decision and any error in them can lead to collapse of the whole business.

d. Environmental, Social and Governance (ESG) Financing: With the evolving of the concept of ESG their role has been shifted from traditional financing to sustainability financing.

Thus, from above discussion it can be concluded that in today’s time CFOs are taking a leadership role in Value Creation for the organisation and that too on sustainable basis for a longer period. 

STRATEGIC FINANCIAL DECISION-MAKING FRAMEWORK

Capital investment is the springboard for wealth creation. In a world of economic uncertainty, the investors want to maximize their wealth by selecting optimum investment and financial opportunities that will give them maximum expected returns at minimum risk. Since management is ultimately responsible to the investors, the objective of corporate financial management should implement investment and financing decisions which should satisfy the shareholders by placing them all in an equal, optimum financial position. The satisfaction of the interests of the shareholders should be perceived as a means to an end, namely maximization of shareholders’ wealth. Since capital is the limiting factor, the problem that the management will face is the strategic allocation of limited funds between alternative uses in such a manner, that the companies have the ability to sustain or increase investor returns through a continual search for investment opportunities that generate funds for their business and are more favourable for the investors. Therefore, 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 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. In an idealized world, management is ultimately responsible to the investors. Investors maximize their wealth by selecting optimum investment and financing opportunities, using financial models that maximize expected returns in absolute terms at minimum risk. 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.

Functions of Strategic Financial Management 

Strategic Financial Management is the portfolio constituent of the corporate strategic plan that embraces the optimum investment and financing decisions required to attain the overall specified objectives. In this connection, it is necessary to distinguish between strategic, tactical and operational financial planning. While strategy is a long-term course of action, tactics are intermediate plan, while operations are short-term functions. Senior management decides strategy, middle level decides tactics and operational are looked after line management.

Irrespective of the time horizon, the investment and financial decisions involve the following functions1: 

• 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.

STRATEGY AT DIFFERENT HIERARCHY LEVELS

Strategies at different levels are the outcomes of different planning needs. There are three levels of Strategy – Corporate level; Business unit level; and Functional or departmental 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.

Business Unit Level Strategy

Strategic business unit (SBO) may be any profit centre that can be planned independently from the other business units of a corporation. 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

The functional level is the level of the operating divisions and departments. The strategic issues at this level are related to functional business processes and value chain. Functional level strategies in R&D, operations, manufacturing, marketing, finance, and human resources involve the development and coordination of resources through which business unit level strategies can be executed effectively and efficiently. Functional units of an organization are involved in higher level strategies by providing input to the business unit level and corporate level strategy, such as providing information on customer feedback or on resources and capabilities on which the higher level strategies can be based. Once the higher-level strategy is developed, the functional units translate them into discrete action plans that each department or division must accomplish for the strategy to succeed.

FINANCIAL PLANNING

Financial planning is the backbone of the business planning and corporate planning. It helps in defining the feasible area of operation for all types of activities and thereby defines the overall planning framework. 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) 

For an individual, financial planning is the process of meeting one’s life goals through proper management of the finances. These goals may include buying a house, saving for children's education or planning for retirement. It is a process that consists of specific steps that helps in taking a big-picture look at where you financially are. Using these steps, you can work out where you are now, what you may need in the future and what you must do to reach your goals. 

BALANCING FINANCIAL GOALS VIS-A-VIS SUSTAINABLE GROWTH

The concept of sustainable growth can be helpful for planning healthy corporate growth. This concept forces managers to consider the financial consequences of sales increases and to set sales growth goals that are consistent with the operating and financial policies of the firm. Often, a conflict can arise if growth objectives are not consistent with the value of the organization's sustainable growth. Question concerning right distribution of resources may take a difficult shape if we take into consideration the rightness not for the current stakeholders but for the future stakeholders also. To take an illustration, let us refer to fuel industry where resources are limited in quantity and a judicial use of resources is needed to cater to the need of the future customers along with the need of the present customers. One may have noticed the save fuel campaign, a demarketing campaign that deviates from the usual approach of sales growth strategy and preaches for conservation of fuel for their use across generation. This is an example of stable growth strategy adopted by the oil industry as a whole under resource constraints and the long run objective of survival over years. Incremental growth strategy, profit strategy and pause strategy are other variants of stable growth strategy.

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.

Sustainable Growth Rate

The sustainable growth rate (SGR), concept by Robert C. Higgins, of a firm is the maximum rate of growth in sales that can be achieved, given the firm's profitability, asset utilization, and desired dividend payout and debt (financial leverage) ratios. The sustainable growth rate is a measure of how much a firm can grow without borrowing more money. After the firm has passed this rate, it must borrow funds from another source to facilitate growth. Variables typically include the net profit margin on new and existing revenues; the asset turnover ratio, which is the ratio of sales revenues to total assets; the assets to equity ratio; and the retention rate, which is defined as the fraction of earnings retained in the business.

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. 

Since the asset to beginning of period equity ratio is constant and the firm's only source of new equity is retained earnings, sales and assets cannot grow any faster than the retained earnings plus the additional debt that the retained earnings can support. The sustainable growth rate is 
consistent with the observed evidence that most corporations are reluctant to issue new equity. If, however, the firm is willing to issue additional equity, there is in principle no financial constraint on its growth rate. Indeed, the sustainable growth rate formula is directly predicted on return on equity. 

The very weak idea of sustainability requires that the overall stock of capital assets should remain constant. The weak version of sustainability refers to preservation of critical resources to ensure support for all, over a long-time horizon. The strong concept of sustainability is concerned with the preservation of resources under the primacy of ecosystem functioning. These are in line with the definition provided by the economists in the context of sustainable development at macro level. 

The sustainable growth model is particularly helpful in situations in which a borrower requests additional financing. The need for additional loans creates a potentially risky situation of too much debt and too little equity. Either additional equity must be raised, or the borrower will have to reduce the rate of expansion to a level that can be sustained without an increase in financial leverage.