Financial Strategy involves decision making in three areas:
- Dividend policy
Most theory assumes all companies have a single goal of maximising shareholder value. However many businesses have rather more complex objectives including objectives around economic development and the creation of long term sustainable businesses to create higher value jobs.
The starting point for any strategy is the definition of stakeholders, objectives and values. Ideally these will be communicated through the organisation so that all decisions are informed against them. The Balanced Scorecard (Developed by Professor Robert Kaplan of Harvard Business School) is a widely used tool to keep managers considering strategy and objectives in their day-to-day decisions.
Investment Decisions include decisions about:
- Plant and equipment
- Working capital
- Product and market development
There are a range of investment appraisal techniques, but cash flow based models are by far the best. These models sometimes give the impression that investment decisions are made in a state of certainty – they are not. An essential component to always include in every investment decision in sensitivity analysis or “what if analysis” – detailing what might happen under different scenarios with probability assigned to each different outcome.
These techniques are so fundamental that all managers should be trained to understand them and how their decisions and actions can make an investment succeed or fail.
The most fundamental understanding all managers must acquire is an understanding of the difference between profit and cash and the ability to look at decisions and assess them in terms of both the impacts on profitability and cash flow.
They should also understand the concepts of Return on Investment (ROI) and Return On Capital Employed (ROCE). These both give a mean of the return a company or project delivers for every dollar invested in it.
Most Managers do not need such a comprehensive understanding of the two other areas of financial strategy – financing or dividend decisions – however they do need to understand the Cost of Capital and the returns that project needs to deliver.
All accountants and managers seeking senior positions in large companies should understand more about all three aspects of Financial Strategy including financing options and the required returns and dividends for shareholders.
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