1 / 17

Functional strategies - finance

Functional strategies - finance. Alan Eardley/Geoff Leese November 2006, revised July 2007, August 2008, August 2009. Introduction. Reminder of study of functional strategies Financial strategy issues Financial strategy objectives Capital structure (inc gearing) Capital types

mmasters
Download Presentation

Functional strategies - finance

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Functional strategies - finance Alan Eardley/Geoff Leese November 2006, revised July 2007, August 2008, August 2009

  2. Introduction • Reminder of study of functional strategies • Financial strategy issues • Financial strategy objectives • Capital structure (inc gearing) • Capital types • Sources of capital • International differences • Problems of “short-termism”

  3. Top level or SBU strategy Functional Strategies Corporate strategy Manufacturing Strategy (week6) Finance Strategy (week 7) Marketing Strategy (week 7) HRM Strategy (week 8) • Examples of functional strategies: • depends on level of SBU • depends on type of business • depends on organisation

  4. Finance strategy Issues covered by a typical financial strategy: • Raising capital and sources of funding • Long-term financial planning • Functional or departmental budgeting • Capital structuring ( and ‘gearing’) • Cash management • Reinvesting profits and cash surpluses • Capital investment appraisal All are more complicated for multinational corporations Manufacturing companies face particular problems

  5. Finance strategy A good finance strategy helps the company to: • Replace and renew capital assets • Pay interest, share dividends and loans • Make sure funds are available • At the right time • At the lowest cost • Build up and manage reserves • To enable capital renewals (e.g. plant, vehicles) • To cover unforeseen events (e.g. shortages) • Enable long term growth • ‘Fend off’ or enable take-overs

  6. Capital Structure How public limited companies obtain capital • Shares (flexibility vs loss of control) • Debentures (secured loans) • Can be repaid from profits or reserves • Loans and overdrafts (can be recalled) • Retained profits • No interest payments, recall or loss of control but • Can reduce share price – encourage take-over • Value of company exceed value of shares Capital structure needs to balance certain factors

  7. Capital Structure Factors determining the choice of capital structure: • The risks inherent in the company’s markets • Ability to generate new profit/earning opportunities • Estimates of future costs, profits and investments • Confidence and attitudes of major shareholders • Attitudes of the company’s management • Tax liabilities • Need for flexibility Note the classic example of the decline of GEC from 70s to the ‘Marconi era’ – from ‘cash mountain’ to over-investment and decline in valuation

  8. Gearing A very important factor in capital structuring • The ratio of borrowings* to total share capital • Affects the firm’s risk in various financial conditions High geared = risky for shareholders, but high return • More capital from borrowings • Less capital in shares Low geared = safe for shareholders, but lower return • More capital in shares • Less capital from borrowings * Borrowings includes debentures and loans, etc.

  9. Capital types Firms use two types of capital: • Fixed capital (spent on fixed assets) • Land and buildings, plant etc. • Working capital (spent on consumables) • Stock, wages, operating expenses etc. These two are inter-related: FC investment creates profits = allows investment in WC WC can be invested in fixed assets There is often a gap between investment and profit that the company has to cover: • Short and long term finance sources • Cash flow

  10. Capital types Short term finance • To cover ‘cash flow gap’ (trading cycle) • Overdraft, fixed-term loans, credit, debt factoring Long term finance • To finance long-lived assets • Term should equate to expected life of asset • Debentures and shares

  11. Share dilution One way to raise more capital is to issue more shares to finance expansion, take over or profit-making activities BUT… This can have negative consequences, such as: • Profits must be spread among more shareholders • Reduced % dividend payable on each share This is share dilution, and can result in: • A decline in the market price of the shares • Vulnerability to take over • Lack of confidence in the management • Lower credit rating (poorer borrowing prospects) This is over capitalisation - under capitalisation is the opposite

  12. Sources of capital 1 Shares (Ordinary and Preference) Public quotation on the UK Stock Exchange (SE) • Restrictions on ‘listing’ • Ready source of finance (when earnings high) • Improved public image (when successful) • Can make take over easier (and being taken over) • Shows worth of company ‘on the market’ • Reduces dependency on banks and lenders Alternative Investment Market (AIM) • Second-level securities market • Less restrictions than SE

  13. Sources of capital 2 Venture capital • Sharestaken by a finance company • Takes dividend profit for defined period • Usually sells shares back* at end of period Usually goes with rapid company expansion Drawbacks of venture capital include: • Relatively high cost of capital (may be > 30%) • Need to account to venture capitalist • Restrictions on further borrowing (‘gearing’) • Possibility of loss of control of targets not met * At a price agreed in the original agreement May be said to encourage ‘short termism’ in UK industry

  14. Sources of capital 3 Overseas – other EU stock markets (e.g. France) • Traditionally capital is in form of ‘borrowings’ • Some German firms have only 5% share capital • Banks and institutional investors are entrenched Therefore equity investment into UK is attractive • New affluence in ‘unified Europe’ • Lack of opportunities in local equity markets • EU banks have limited capacity for loans • Generally new EU investors are not ‘risk averse’ • Share investment is becoming fashionable • Development of EU stock markets (bourses)

  15. Problems with ‘short termism’ TheContinental system favours long term investment • Reinvest profits without worrying about share price • Less worries about hostile ‘take over’ activity The opposite (‘short termism’) has some problems: • Failure to develop new infrastructures • Failure to exploit new technologies • Continuation of outdated production methods Countermeasures may make things worse: • Cutting back on advertising and promotions • Running down R&D projects • Skimping on maintenance and training etc.

  16. Summary • Reminder of study of functional strategies • Financial strategy issues • Financial strategy objectives • Capital structure (inc gearing) • Capital types • Sources of capital • International differences • Problems of “short-termism”

  17. Further reading • Bennett chapter 10 • Finance - follow the link! • American, but some good articles here! • Advice for small businesses - follow the link! • Lots of useful stuff here. Follow the link to “Finance and Grants” this week.

More Related