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Copyright Amity University


PAN African eNetwork Project

MASTER OF FINANCE & CONTROL

STRATEGIC FINANCIAL MANAGEMENT

Semester - III

By- Suraj Prakash


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Course Contents:

Module I: IntroductionRole of Finance and Strategy in Management Process, Strategic Droop,ManagementBehaviour and Convergence between Strategic and Financial AnalysisModule II: Financial Decision MakingValue Analysis A Strategic Perspective, Advances in Working CapitalManagement, Arriving at an Optimal Capital Structure, Impact of Inflation onFinancial Decisions, Dividends Decisions A Strategic PerspectiveModule III: Corporate ValuationRationale for Shareholders Wealth Maximization, New performance Metrics like

Economic Value Added (EVA) and Market value Added (MVA), VariousApproaches to Corporate Valuation, Alignment of Interest of VariousStakeholders of a Firm


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Module IV: Corporate RestructuringRestructuring and Merger & Acquisition, The Search Process, Valuation andDeal Structuring, Accounting and Tax Implications, Post Merger Integration andLearning, Restructuring through Privatization, Leveraged Buy-outs (LBOs)Restructuring of Sick Enterprises, Due Diligence and certification

Module V: Strategic Cost ManagementTransfer Pricing, Financial Aspects of Supply Chain Management, OperationsManagement Perspective on Costs, Strategic Cost Analysis (Using ActivityBased Costing, Target Costing and Life Cycle Costing) and Product Pricing atDifferent Stages of Products Life Cycle.


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Topic1. Role of Finance and Strategy in Management Process,

2. Strategic Droop,

3. Management Behaviour and Convergence between Strategic andFinancial Analysis

4. Value Analysis A Strategic Perspective,

5. Advances in Working Capital Management,

6. Arriving at an Optimal Capital Structure,

7. Impact of Inflation on Financial Decisions,

8. Dividends Decisions A Strategic Perspective


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StrategyA Vibrant Bank committed to excellence in performance

through customer satisfaction. Strategy is defined as where the organization wants to

go to fulfill its purpose and achieve its mission, it

provide the framework for guiding choices whichdetermine the organizations nature and direction andthese choices relate to organizations products andservice, markets and key capabilities, growth, return oncapital and allocation of resources.

OBJECTIVES of Strategic Planning Developing an integrated, coordinated and consistent

view of route the company wishes to follow, and Facilitating the adaptation of the organization to

environmental changes.


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Strategic PlanningThe aim of strategic planning is to create a viable link between

organizations objectives and resources and itsenvironmental opportunities. There are five competitiveforces forming central to formulating and implementation

business strategy. The threat of new entrants.

The threat of substitute products and services.

The rivalry amongst existing organizations within theindustry.

The bargaining power of suppliers.

The bargaining power of customer.


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Strategic Planning Process

DEFINE MISSION

SET OBJECTIVES

Analyze existingstrategies

Externalappraisal

(opportunitiesAnd threats)

MONITOR

Define strategic issues

Develop new or revisedstrategies

Determine critical

successfactors

Internalappraisal

(strength andWeaknesses)

Prepare plan

Implement plans



Strategic Financial Management

The strategic financial planning involves financialplanning, financial forecasting, provision of finance

and formulation of finance policies which shouldlead to firms survival and success.The responsibility of a finance manager and is

provide a basis and information of strategic

positioning of the firm and the industry. The firmsstrategic financial planning should able to meet thechallenges and competition and it would lead tofirms failure and success.


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The strategic financial planning should beenable the firm to judicious allocation of funds,capitalization of relative strengths, mitigationof weaknesses, early identification of shifts in

environment, counter possible action ofcompetitor, reduction of financing costs,effective use of funds deployed, timelyestimation funds requirement, identification of

business and financial risk etc.



Objective

Forecasting:-

Demand and sales volume/revenues.

Cash flows

Prices

Inflation rates

Labor union behavior

Technology changes

Inventory requirement

Organizing:-

Finance relation

Liaison with financial institutions and clients

Accounting system


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Planning:-

Investment planningMan power planningDevelopment processMarketing strategiesCo-ordination:-

Linking finance function with other areasLinking national budget and five years planLinking with labor union policiesLiaison with media

Control:-Financing chargesAchievement of desired objectivesOverall monitoring of the systemEquilibrium in the capital



Changing Scenario

The changing definition of competitiveadvantages, product profiles, product life cycles,productivity and employability, markets and market

variables have made the financial management oa business enterprise more complex.



The Three Major Ingredients forCorporate Success

Product

Profit(Bottom-line)

Capital Technology

People



Wealth Acceleration

profitability

InvestmentturnoverSick

Failure

Great enterprise

Very good health (BlueChip)

Good health

Return onInvestment

(ROI)

Sickness

+1+1-1 -1



Return On Investment (ROI)

Return OnInvestment = InvestmentTurnover X Profitability

Profit

Investment

=

Sales

Investment

X

profit

sales



Micro-level performance pyramid

PlantCapaci

ty

turnover

Profit for owners dividend = profitdeployment

Profit before tax tax = profit for owners

Together decide the ROI

Operating profit Interest = Profit beforetax

Premises

Capacity

turnover

Distribut--ion

Capaci

tyturnover

Inventory

sales

Recei--

vables

Turn--over

CashTurn--over

Sales

volume

Salesprice

Variable

costs

Fixedcosts

i.e..

Operatingprofit

investment

Investment turnover

profitability



The Strategies and the Strategist

The words strategy and strategic management becamepopular words after 1960. many theories weredeveloped on and around the concept of the strategy.Among the main question that arises around thestrategies are Is it a game plan, a policy, an actionplan or a tactic? Is it long-term or short-term? Is iqualitative or quantitative? Is it visible or invisible? Is ito be decided upon only by seniors? Is it a piece oadvice given by a staff executive or line executive?Ultimately, what is it?


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In my opinion, strategy is

A flexible approach for achieving thedesired results, with suitable success.



Styles and ways of strategies

strategies

A

B

C

Results,

CostsAnd

substances

MODERATE AND VISIBLE

AGGRESSIVE AND VERY VISIBLE

CONSERVATIVE AND LESS VISIBLE


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To make Notional Costing for true application of Profit

Centre Concept is a must. Combining Value Chain Analysis with Segmental ROI and

Enterprise Portfolio Mix theories.

Forming a U curve relationship with both vendors anddealers to create a strategic base for a long-term,profitable partnership.

Making Economic Value Added more meaningful byinternally developing a reliable benchmarks of achievablerates of return.

Achieving long term wealth maximization through financialengineering by attempting innovative net worth mix.

The Nine References for Strategic Financial



The Nine References for Strategic FinancialManagement

SoulSearching

ForContinued

Benchmarking

Sustainabili

ty

Sensitivity

(Time &

ability torespond

Systems

Selectivity

(Focuses)

Structural

Flexibility

succes

s

StrategicCost

Management

SuperiorityFirst, Fast,

Cheap andGood

Sanctity


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When the term profit mistaken to mean profiteering.

When rigidity in profit-pauses lack of pragmatism.

When the owners and their financial advisers, due to

their intellectual arrogance, cannot carry out lateralthinking for alternate solutions.

When executives responsible for taking decisions arevery often rewarded disproportionate, and more for theircompany loyalty than for their creativity and risk-bearing

capacity.


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Sub-optimal professional performance on six important fronts

creates a heavy loss of profit. These six areas of performancemay be summed up as-

ProductProduct PricePrice PlacePlace

PromotionPromotion PeoplePeople PoliticsPolitics

nPolitics refer to the ability of an enterprise to lobby with itsPolitics refer to the ability of an enterprise to lobby with its

policy maker. The term People includes all types ofpolicy maker. The term People includes all types ofstakeholders, both inside and outside the organization.stakeholders, both inside and outside the organization.nAlternate decision packagesAlternate decision packagesand and re-activere-activeand not and not pro-rata.pro-rata.

Scope of Discounting


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Scope of Discounting

ROI of 20%to be

achievedby middle-

levelexecutives

ROI of 20%to be

achievedby strategic

executive

ROI of 20%to be

achievedby owners

27%

25%

22

%

30%

20%

30%

32%

35%

25%

Strategic Addition

EntrepreneurialAddition


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Strategy droop

Strategy Droop---

The organization as a whole may have takentoo many projects simultaneously. Topmanagement knows that there is going to bestrategic slippage or strategic droop.

They start too many projects at a time, in the hopethat this will compensate for disappointingresults. This cultivates in harmfulinterpersonal rivalry, excess competition forrecourses, bad politics and sometimes the

resulted are inferior to what otherwise couldhave been achieved if lesser number of projectswere started.


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Value Analysis A StrategicPerspective


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Business ValuationBusinesses or fractional interests in businesses may be valued for variouspurposes such as mergers and acquisitions, sale of securities, and taxable

events.An accurate valuation of privately owned companies largely depends on thereliability of the firm's historic financial information.

Publiccompany financial statements are audited byCertified Public Accountants (US), Chartered Certified Accountants (ACCA) or

Chartered Accountants (UK and Canada) and overseen by a governmentregulator.

Alternatively, private firms do not have government oversightunless operatingin a regulated industryand are usually not required to have their financialstatements audited. Moreover, managers of private firms often prepare their

financial statements to minimize profits and, therefore, taxes. Alternatively,managers of public firms tend to want higher profits to increase their stockprice. Therefore, a firm's historic financial information may not be accurate andcan lead to over- and undervaluation. In an acquisition, a buyer often performsdue diligence to verify the seller's information.
http://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Public_companyhttp://en.wikipedia.org/wiki/Public_companyhttp://en.wikipedia.org/wiki/Certified_Public_Accountanthttp://en.wikipedia.org/wiki/Chartered_Certified_Accountanthttp://en.wikipedia.org/wiki/Association_of_Chartered_Certified_Accountantshttp://en.wikipedia.org/wiki/Chartered_Accountanthttp://en.wikipedia.org/wiki/Due_diligencehttp://en.wikipedia.org/wiki/Due_diligencehttp://en.wikipedia.org/wiki/Chartered_Accountanthttp://en.wikipedia.org/wiki/Association_of_Chartered_Certified_Accountantshttp://en.wikipedia.org/wiki/Chartered_Certified_Accountanthttp://en.wikipedia.org/wiki/Certified_Public_Accountanthttp://en.wikipedia.org/wiki/Public_companyhttp://en.wikipedia.org/wiki/Public_companyhttp://en.wikipedia.org/wiki/Business


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Advance Working CapitalManagement


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Meaning of Working Capital

The capital which is required for day to dayroutine activities like payment of wages,

purchase of raw material etc. is known asworking capital.


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Definition of Working Capital According to Genestenberg,

Circulation capital means current assets of acompany that are changed in the ordinarycourse of business from one form to another,

as for example, from cash to inventories ,inventories to receivables, receivables intocash.


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TWO IMPORTANT FACTORS1. CURRENT ASSETS :- Assets which can change into cash with in an yearstime .With out any decrease in the value & and disruption in the operation of the firm,

Say :-1.Cash in hand & Bank balance2. Bills receivable,3. Sundry debtors,4. Short terms loans & advances,5. Inventories of stocks- Raw material, Work in progress , stores & spares ,finished

goods ,6. prepaid expenses,7. accrued incomes.


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CURRENT LIABILITYObligation ,which have to pay in normal course of business with in an years

time. these are paid out of the current assets or earning of the firm.

Say :-1.Bills payable.

2.Sundry creditors,

3.Accrued outstanding expenses,

4.Short term loans , advances & deposit.

5.Dividend payable,

6.Bank Overdraft,

7.Provision for taxation.


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Concept of Working Capital

There are two concepts:

Gross working capital = Current Assets

Net working capital = Current assets Current

Liabilities

WEIGHTED OPERATING CYCLE (WOC)


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Copyright Amity UniversityCopyright Amity University

WEIGHTED OPERATING CYCLE (WOC)

WPC= Dr*Wr +Dw*Ww +Df*Wf +Dd*Wd -Dc*Wc

WhereDr= Duration of Raw Materials Stage Wr= Raw Material Stage

Dw= Duration of Work in Progress Stage Ww= Work in progress stage

Df= Duration of Finished Goods Stage Wf= Finished Goods Stage

Dd= Duration of Debtors Stage Wd= Debtors Stage

Dc= Duration of Creditors Stage Wc= Creditors Stage

Wr= Raw material Cost per Unit/Selling Price per Unit

Ww= Raw material Cost per Unit+(.5*Processing cost per unit)/selling price per unit

Wf= Cost of goods sold per Unit/selling Price per UnitWd= 1

Wc= Raw material Cost per Unit/Selling Price per Unit

Working Capital Requirement= (Amt. of Sales per Day*WOC)+

Required Cash Balance


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IMPORTANT CONCERN

1. Inventory Period =Average Inventory

Annual Cost of goods Sold

365

2. Account Receivable Period :-AVERAGE ACCOUNT RECEIVABLE

ANNUAL SALE

365

3. Account Payable Period :-AVERAGE ACCOUNT PAYALE

ANNUAL COST OF GOODS SOLD

365


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Kinds of working Capital

Kinds

ofWorking Capital

On the basis ofConcept

On the basis ofTime

GrossWorkingCapital

NetWorkingCapital

PermanentWorkingCapital

TemporaryWorkingCapital

RegularworkingCapital

Reserveworking

Capital

SeasonalWorkingCapital

SpecialWorking

Capital


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Graphic presentation ofWorking Capital

Time

Amou

ntof

wo

Amo

unto

fwo

Time

Permanent or Fixed

working capital

Temporary or Variable

Working Capital

Temporary or VariableWorking Capital

Permanent or Fixed

working capital


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Working Capital Cycle

Debtors

Cash

RawMaterial

Work in -

progress

FinishedGoods


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Factors affecting working capital

1.Nature of Business

2.Size of Business

3.Production Policy

4.Manufacturing process

5.Seasonal Variations

6.Credit policy

7.Rate of Growth of Business

8.Price level changes

9.Rate of stock turnover

10.Working capital cycle


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1.

2.Total cost incurred on material, wages, overheads.

3.

4.The length of time for which raw material are toremain in stores before they are issued to

production.5.

6.The length of production cycle.

7.

8.The average debt- collection period.


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5.

6.The amount of cash required to pay day to day

expenses.

7.

8.The average debt payment period.

9.

10.Time lag in the payment of wages and other expenses.

11.

12.The average amount of cash required to makeadvance payments.

D t i i th ki it l fi i


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Determining the working capital financingmix

Approaches toFinancing Mix

Hedging orMatchingApproach

ConservativeApproach

AggressiveApproach


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Sourcesof

Long- term/

Fixed/Permanent Working Capital


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1.Shares

2.3.Debentures

4.5.Public Deposits

6.

7.Retained Earnings8.

9.Long term Loans from Financial Institution


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Sources are:


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Sources are:

1.Indigenous Bankers

2.Trade Credit

3.Advances

4.Factoring5.Accrued Expenses

6.Deferred Incomes

7.Commercial Paper

8.Commercial Banks


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Question: From the following information you are

required to estimate the net workingcapital:

Cost per unit (Rs.)Raw Material 400Direct Labour 150

Overheads (excluding Depreciation) 300Total Cost 850


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Additional information Selling price Rs. 1000p.u.

Output 52000 units p.a

Raw Material in stock Average 4 weeks

Work- in process(Assume 50% completion stage with full material consumption)

Finished goods in stock average 2 weeks

Credit allowed by suppliers average 4 weeks

Credit allowed to Debtors average 4 weeks Cash at bank is expected to be Rs. 50000

Assume that the production is sustained at an even paceduring the 52 weeks of the year. All sales are in creditbasis.


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Copyright Amity UniversityCopyright Amity University

DIVIDEND DECESIONS

Ai


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Aim

The module aims to develop an understandingof Dividend related issues . It is also aimedto give insight about the relationship

between dividend and market price of ashare with a practical approach.


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Components of Dividend decision

oncept of dividend and dividendolicy

actors affecting dividend policy alter s Model ordon s Model M theory

DIVIDEND DECISION


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DIVIDEND DECISION

The dividend policy of a company determines

what proportion of earnings is distributed tothe shareholders by way of dividends, andwhat proportion is ploughed back for

reinvestment purposes. Since the mainobjective of financial management is tomaximize the market value of equity shares,one key area of study is the relationship

between the dividend policy and market priceof equity shares.


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Informational Content ofInformational Content of

DividendDividend

. In an uncertain world in which verbal statements. In an uncertain world in which verbal statementscan be ignored or misinterpreted, dividend actioncan be ignored or misinterpreted, dividend actiondoes provide a clear cut means of making adoes provide a clear cut means of making astatement that speaks louder than a thousandstatement that speaks louder than a thousandwords. words. SolomonSolomon


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DIVIDEND DECESIONSAn IntroductionMeaning of dividend- Dividend is a part of retained

earning which is distributed among the shareholders

on equity / Pref. shares ,they holdMeaning of dividend policy A question in front ofmanagement is either to retain the profit or todistribute it with an objective to maximize

shareholders wealth. A dividend policy is such whichexplains how much is to be paid and how much is tobe retained


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Objectives of dividend policy

1-Firms need for funds2- Shareholders need for income

3- firms investment opportunities andfinancial needs.4- Shareholders expectations

Constraints on paying


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Constraints on payingdividends

1.Legal restrictions

2.Liquidity

3.Financial conditions and borrowing capacity

4.Access to the capital market

5.Control

Stability of dividends


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Stability of dividends

It is considered a desirable policy . It meansregularity in paying some dividend annually.Three forms of stability may be distinguished

1.Constant dividend per share2.Constant Dividend payout ratio

3.Constant dividend per share plus extra dividend


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Constant dividend per share plus extradividend

This policy is desirable where earnings are fluctuating .

Merits of stability of dividends -

1.Resolution of investors uncertainty

2.Investors desire for current income3.Raising additional finance

Forms of dividends


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Forms of dividends

Cash dividends

Bonus Shares

Bonus Shares vs. Share split

Buy Back of Shares-

Dividend Theories


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Dividend Theories

On the relationship between dividend policy andvalue of firm, different theories have beenadvanced .these theories can be grouped into twocategories

1.Theories that consider dividend decisions to berelevant

2.Theories that consider dividend decisions to beirrelevant

Dividend Relevance


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Dividend RelevanceWalters Model

Prof. James. E. Walter argues that the choice ofdividend policy always affects the value of firm. It isbased on following assumptions-

1.Internal Financing

2.Constant return and cost of capital

3.100% payout or retention

4.Constant EPS and DIV

5.Infinite time


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Walters formula to determine the market price per share isas follows-

P=Market price per share DIV= Dividend per share EPS=Earning per share r = Firms rate of return k- Firms cost of capital or capitalization rate

( / )

(DIV/ ) (EPS DIV)

r k

P k k= +

Example


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p


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The impact of dividend payment on theshare price is studied by comparing the rate of

return with the cost of capital. When r > k, the price per share increases as the

payout ratio decreases (optimal payout ratio isnil)

When r = k, the price per share does not vary withthe changes in the payout ratio (optimal payoutratio does not exist)

When r < k, the price per share increases as the

payout ratio increases (optimal payout ratio is100%)


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Dividend policy : application of Walters'model

There are three type of firms as per this model- Growth firms-Internal rate more than opportunity cost of capital (r>k)

Normal Firms Internal rate equals opportunity Cost of capital (r=k)

Declining Firms- Internal rate less than opportunity cost of capital ( r


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Criticism of Walters' model No external Financing

Constant return ,r Constant opportunity cost of capital ,k


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Explanation of Walters' theories

Following is the data given for all three firms i.e.normal firms , growth firms , and declining firms .Prove how the value of firm is affected if DP ratio is--0%, 40%, 80% and 100%

Growth firm r=.15, k=.10,EPS=Rs.10

Normal firms-r=.10,k=.10,EPS=Rs.10

Declining firms -r=.08, k=.10,EPS=Rs.10


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Gordons Model

Myron Gordon develops one very popular model explicitly relating to themarket value of the firm to dividend policy. This model is based onfollowing assumptions-

1. All equity firm

2. No external financing

3. Constant return

4. Constant cost of capital

5. Perpetual earning

6. No taxes7. Constant Retention

8. Cost of capital greater than growth rate


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According to the Gordons model , the market value of a share is equal

to the present value of an infinite stream of dividend received by theshareholders . Thus the formula is -

Po= DIV1 /k-g

or

Po= EPS1(1-b)/ k-brEPS1= Earning per share

k =cost of capitalr= rate of returnb= retention ratiog=br= growth rate


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Dividend and Uncertainty

The Bird -In The-Hand Argument According to the Gordons model , dividend policy

is irrelevant where r=k, when all other

assumptions are held valid . As per this theorydividend policy does affect the value of shareeven when r=k.. This view is based on theassumption that under conditions of uncertainty ,investor tend to discount distant dividend( capital gains ) at a higher rate than theydiscount near dividends.


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Application of Gordons dividend Model

The implication of the dividend policy as per Gordon'smodel are as follows for normal ,growth and decliningfirms -

The market value of share ,Po increases with the retentionratio ,b, for the firms with growth opportunities i.e. r>k

The market value of the share , Po , increases with thepayout ratio, (1-b), for declining firms i.e. r< k

The market value of the share is not affected by dividendpolicy when r=k


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Explanation of Gordonstheories Following is the data given for all three firms i.e. normal

firms , growth firms , and declining firms . Prove how thevalue of firm is affected if Pay out ratio is --40%, 60% and90%

Growth firm r=.15, k=.10,EPS1=Rs.10

Normal firms-r=.10,k=.10,EPS1=Rs.10 Declining firms -r=.08, k=.10,EPS1=Rs.10


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Dividend Irrelevance MM Hypothesis

According to Modigliani and Miller , under a perfect market situation ,the dividend policy of the firm is irrelevant , as it doesnt affect thevalue of the firm .

Thus if the investment decisions are given , dividend decisions are of

no significance in determining the value of the firm .A firm may face the following 3 situations regarding the payment of

dividends-

The firm has the sufficient cash to pay dividends

The firm doesnt have sufficient cash to pay dividends , therefore itissues new shares to finance the payment s of dividend

The firm doesnt pay the dividend s, but a shareholder needs cash .


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Assumptions of this theory Perfect capital market

No taxes

Investment policies

No risk

Under the MM theory , rwill be equal to k, and identical for all the

shares . As a result , the prices of each share must adjust so thatthe rate of return and the capital gains will be equal to k on eachshare.


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Thus the minimum rate of return may becalculated as follows --

r = Dividends+ capital gains /Share priceOr

r= DIV+(P1-Po)/ Po


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Relevance of the dividend policy under

market imperfections-The MM theory on simplifying assumption. But these

assumption may not be found valid under in practiced . The

following are the situations where MM hypothesis may gowrong-

Uncertainty and shareholders preference

Transaction cost and case against the dividend payments

Tax differentials Informational content of dividends


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Q.4 Working capital cycle starts & ends from :-

1. Raw material to Finished good.2. Raw material to debtor collection .3. Creditor, raw material ,Finished goods to Debtors Collection.4. Raw material ,work-in-progress to Finished good.

Q.5 Higher amount of short term financial assets & very low amount of

permanent fixed assets. Is basic approaches for :-a) Aggressive approachesb) Moderate approaches.c) Conservative approaches.


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