01. Aims of Financial Strategy:
Financial strategy aims to maximize the financial value of a firm. Financial strategy can provide competitive advantage through low costs funds. In any financial strategy, achieving the desirable debt equity ratio by borrowing for long term financial needs and generating cash flow internally is a crucial issue. Studies point out that high debt levels lead to improved productivity and improved cash flows. Studies also point out that diversification strategy mainly influences the financial strategy. Equity financing is much preferred for related diversification whereas debt financing is preferred for unrelated diversification.
02. Broad Areas of Financial Strategy
1. Evaluating Financial Performance:
The financial position of a company at a given time can be evaluated by such typical financial statements as income statements, balance sheets and cash flow statements. These statements can be analyzed by using some quantitative measures such as financial ratios. These ratios may be based on sales, or profits or return-on-investment (ROI) and so on.
2. Financial Forecasting:
Financial forecasting is used to estimate a firm’s future financial needs. Based on these forecasts, various budgets can be prepared. Based on these budgets, proper allocation of funds to various activities can be made. Such budgets and expenses are a function of future sales and revenues. Accurate forecasts made on the scientific techniques can provide a basis for strategic decisions.
3. Capital Structure Planning:
Capital structure decisions require a reasonable mix of debt and equity capital. This is measured by the debt equity ratio. This can create an optimum mix of debt and equity capital in order to minimize the various risks involved in excessive borrowing. Good capital structure produces financial stability. It relates to sound strategic decisions.
03. Dividend Decisions
The dividend decision of the firm is of crucial importance for the finance manager. It determines the amount of profit to be distributed among shareholders and the amount of profit to be retained in the business for financing its long-term growth. The objective of the dividend policy is to maximize the value of the firm to its shareholders.
It is important to decide —’how much of profits is to be paid out as dividends and how much is to be retained for growth?’ A firm has to strike a good balance between paying reasonable amount of dividend to shareholders and the growth requirements of the firm. The company has also to resolve another issue – how much is to be paid as cash dividend and how much as stock dividend (bonus shares). All these issues need to be addressed in the financial strategy.