Financial Policy and Corporate Strategy – CA Final SFM Study Material is designed strictly as per the latest syllabus and exam pattern.
Financial Policy and Corporate Strategy – CA Final SFM Study Material
Question 1.
Write a short note on: “Interface of Financial Policy and strategic management”. [Nov. 2012] [May 2016] [4 Marks]
Answer:
Interface of financial policy and strategic management:
Strategic management deals with formulating various functional plans for the organization as a whole but all plans move around one common thread and that is finance. Finance serves as the back bone of any organization.
The first main function of finance is to source it and formulate a policy regarding capital structure. It will be a very important dimension of any strategic plan. Whether the funds required for expansion activity should arise out of ownership capital and/or borrowed funds is an important finance decision which will directly impact the strategy, as cost of capital will vary as per the two approaches. The companies may even raise funds through Public Deposits.
There are some norms for debt equity ratio which need to be followed for minimizing the risk of excessive loans. Public sector organizations follow a norm of 1:1 and for private sector firms, the norm is 2:1. However, it varies from industry to industry. For capital intensive industries, the proportion of debt to equity is much higher.
Once the funds are mobilized, another important dimension of strategic man-agement and financial policy interface is the investment and fund allocation decisions. A planner has to frame policies for regulating investment in fixed assets and in current assets. Investments proposal may be divided into three groups. One type of proposal will be for addition of a new product, another type of proposal will be to increase the level of operation of an existing product. The third will be efficient utilization of resources and cost reduction. The planner’s job will be to make the best possible allocation under resource constraints.
The next interface between strategic management and the financial policy decision is dividend decisions. It deals with the extent of earnings that is to be distributed amongst the shareholders. Stable dividend policy has positive im-pact on share prices. Some companies pay a constant percentage of earnings as dividends while others may follow a stable fixed dividend and additional dividends, if earnings are high. Alternatives like stock dividend can also be resorted to as a strategic planning as it entails no cash outflow.
Thus we can see that financial policies are very important for overall organi-zational performance and directions of growth. In this interface, sometimes, financial policy is the cause and corporate strategy is the effect and sometimes corporate strategy is the cause and financial policy is the effect.
Question 2.
Write short note on: “Balancing Financial Goals vis-a-vis Sustainable Growth”. [May 2014] [4 Marks]
Answer:
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. It measures the limit of how much a firm can grow without borrowing more funds.
SGR = ROE × (1- Dividend payout ratio)
This model assumes that the business wants to :
- Maintain a target capital structure without issuing new equity.
- Maintain a target dividend payout ratio.
- 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 of the 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.
Economists and business researchers contend that achieving sustainable growth is not possible without paying heed to growth strategy and growth capability. One is not possible without the other. The very weak idea of sustainability requires that the overall stock of capital assets should remain constant. It refers to the preservation of capital 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.
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 to match the raised loans or reduce the expansion to a level that can be sustained without an increase in financial leverage.
Therefore, balancing financial goals vis-a-vis sustainable growth means to set sales growth goals that are consistent with the operating and financial policies of the firm. Decisions should be taken considering not just the current stakeholders but also the future stakeholders.
Sustainable growth is important to enterprise long-term development. Too fast or too slow growth will go against enterprise growth and development, so finance 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.
Question 3.
What makes an organization sustainable? State the specific steps. [May 2019] [Nov. 2016] [4 Marks]
Answer:
- If an organization desires to be sustainable then it must:
- Have a clear strategic direction.
- Be able to scan its environment or context to identify opportunities for its work.
- Be able to attract, manage and retain competent staff.
- Have adequate administrative and financial infrastructure.
- Be able to demonstrate its effectiveness and impact in order to leverage further resources and
- Get community support for and involvement in its work.
The organization must take the following steps in ensuring its stability:
Step 1: Define objectives. The organization must be aware about its priorities and objectives and try to achieve these objectives and ensure stability there-after. These objectives can be related to target payout ratio, optimal capital structure without raising funds through issue of new equity shares or market share and level of sales.
Step 2: Identify the variables and the variants. These variables generally are, net profit margin, asset turnover ratio, financial leverage ratio, dividend payout and retention ratio, asset to beginning of period equity ratio. Incremental growth strategy, profit strategy and pause strategy are variants that need to be defined.
Step 3: Analyze any change in variables and its impact on sustainability of the organization and take appropriate action wherever required. If a firm is mature then it has actual growth rate that is less than SGR model. The management’s principal objective is finding productive uses for the cash flows that exist in excess of their needs.
Comment: Since the asset to equity ratio in the beginning 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.
Question 4.
What makes an organization financially sustainable? [May 2017] [4 Marks]
Answer:
If an organization desires to be financially sustainable then it must:
- Have more than one source of income;
- Have more than one way of generating income;
- Do strategic, action and financial planning regularly;
- Have adequate financial systems;
- Have good public image;
- Be clear about its value;
- Have financial autonomy.
Question 5.
Write short note on various processes of strategic-decision making. [Nov. 2017] [4 Marks]
Answer:
The various processes of strategic decision making are as follows:
The Classic Decision Making process: The “classic” decision making process is traceable to John Dewey’s formulation of the problem solving process. With minor variation it can be found in many places. It is the archetype of the rational-analytic approach to problem solving and decision making. The process can be divided into following steps:
- Access the situation.
- Gather facts and assess unknowns.
- Identify Alternatives.
- Establish Decision Criteria.
- Weigh Alternatives.
- Select Best Alternative.
- Review Decision.
This process is simple, easily understood, appeals to the belief in rationality, widely known and the managers are comfortable with it but it does not reflect the reality of strategic decision-making situations; it assumes that casual linkages are knowable and known and does not reflect the political aspects of strategic decision making; it ignores intuition.
The military model: The military model is a variation of the classic model. The model that appears to be right is from the U.S Army war college.
It involves the following steps:
- Set organizational Goals and Objectives.
- Develop Alternatives.
- Compare/Evaluate Alternatives.
- Choose amongst alternatives and if there is any need, develop new alternatives.
- Implement Decision
- Command, Lead and Manage. Corrective action may be taken if there is any requirement for the same.
It hints at the iterative nature of decision-making by reviews and corrective action and feedback loops, but suffers from the same shortcomings as the Classic model.
III. Mintzberg’s General Model : The most frequently cited model of the decision making process identifies three main phases with subroutines or sub-phases within each. These phases are:
1. The Identification phase: It involves the “Decision recognition rou-tine” where opportunities, problems and crisis are recognized and decisional activity is evoked and the “Diagnosis Routine” where op-portunities, problems and crisis is collected and problems are clearly identified.
2. The Development phase: It involves the “Search routine” and the “Design Routine”. Organizational decision makers go through a number of activities to generate alternative solution to problems in the search routine and readymade solutions which have been identi-fied are modified to fit the particular problem or new solutions are designed.
3. The selection Phase: This phase includes the “Screen routine” which is activated when the search routine identifies more alternatives than can be intensively evaluated. A quick scan is done in this phase and infeasible alternatives are eliminated.
The main problem with this process is that it looks complicated and therefore, it is not easily grasped.
Question 6.
Explain briefly, how financial policy is linked to strategic management.
Answer:
The success of any business is measured in financial terms. Maximizing value to the shareholders is the ultimate objective for financial policy. For this to happen, at every stage of its operations, including policy-making, the firm should be taking strategic steps with value maximization objective. This is the basis of financial policy being linked to strategic management.
The link can be clearly seen in respect of many business decisions. The following examples clearly establish the linkage:
- Manner of raising capital as source of finances and capital structure are the most important dimensions of strategic plan.
- Cut-off rate for acceptance of investment decisions.
- Investment and fund allocation is another important dimension of interface of strategic management and financial policy.
- Foreign exchange exposure and risk management,
- Liquidity management.
- A dividend policy decision deals with the extent of earnings to be distributed and a close interface is needed to frame the policy so that the policy should be beneficial for all.
- Issue of bonus shares.
Thus, financial policies cannot work in isolation to other strategic management decisions.
Question 7.
Enumerate ‘Strategy’ at different levels of hierarchy. [Nov. 2018 Old Syllabus] [4 Marks]
Answer:
‘Strategy’ at different levels of hierarchy:
Every successful organisation has to strategize and these strategies are formu-lated at various levels of the organisation.
The planning needs of these levels are different and therefore strategies are also formulated at different levels of hierarchy.
(1) Corporate strategy: At the corporate level planners decide about the objective or objectives of the firm along with their priorities. A corporate strategy provides with a framework for attaining the corporate objectives under values and resource constraints, and internal and external realities.
(2) Business Strategy: It is the managerial plan for achieving the goal of the business unit. However, it should be consistent with the corporate strategy of the firm and should be drawn within the framework provided by the corporate planners.
(3) Functional Strategy: It is the lowest level plan to carry out principal activities of a business. Functional strategy must be consistent with the business strategy, which in turn must be consistent with the corporate strategy.
Question 8.
Discuss briefly the key decisions which fall within the scope of financial strategy. [Nov. 2019] [4 Marks]
Answer:
The Financial strategies are related to various areas of financial management. Financial management involves acquiring capital, finding the sources of finance and making right use of funds.
The major decisions which fall under financial strategy arc as follows:
- To raise capital with short-term dcht, long-term debt, preferred stock or common stock.
- To lease or buy fixed assets.
- To determine an appropriate dividend payout ratio.
- To extend the time of accounts receivable.
- To establish a certain percentage discount on accounts within a specified / period of time.
- To determine the amount of cash that should be kept in hand.