What is a corporate financial strategy?Posted on: July 19, 2022
Every business needs a financial strategy to help it grow and stay afloat, even large corporations for whom decisions are more about the transferring of resources or managing a portfolio of businesses.
The function of the finance department is increasingly seen as integral to informing corporate strategy, and the role of Chief Financial Officer (CFO) is as much a strategic partner in creating value across the business as a department head.
By combining data from the corporation’s financial management with its strategic planning, a roadmap can be created. Aligning mission and company goals with information on resources, risks, capital, and budget helps a business to navigate unpredictable economic conditions and minimise costs across the portfolio in the long run.
What are the three main areas of corporate finance?
The capital structure of a business is vital to maximising shareholder value and is at the crux of corporate finance strategy. Capital structure can be a combination of long-term and short-term debt along with common and preferred equity. The ratio between the business’ liability and its equity is considered to be an indicator of how well balanced or risky the company’s capital financing is.
These are the three main activities that contribute to capital structure:
Capital investments and budgeting
This involves planning where to place a company’s long-term capital assets to generate the highest risk-adjusted returns. Achieved through financial analysis, the primary decision-making is around which investment opportunities to pursue.
By using various accounting tools, the company can identify capital expenditures and approximate cash flows from proposed capital projects in order to compare potential investments against projected income. From there, the management team can then decide which projects to include in the capital budget.
Financial modelling helps to estimate the impact of an investment opportunity and compare alternative projects. The Internal Rate of Return (IRR) can be used in conjunction with Net Present Value (NPV) in comparing projects of interest.
Net present value:
- Measures the difference between the value of cash inflows and outflows over a period of time.
- Analyses a projected investment’s profitability.
Internal rate of return:
- Measures the annual rate of growth expected to be generated on an investment.
- Estimates the profitability of potential investment.
For investments with a non-monetary return on investment such as positive environmental or social impact, this would be classified as impact investing.
Capital financing encompasses decisions on how best to finance the capital investments that the management team lands upon. This can be through equity, debt, or a mixture of both. Debt is, of course, riskier, but it is this very risk that can lead to growth and success.
Equity is generally accepted to be a lot safer for an organisation but it’s more expensive, and if leant on heavily, can dilute earnings and value for original investors. To obtain long-term funding for major capital expenditures or investments, the company may consider selling company stocks or issuing debt securities in the market through investment banks.
The key formula for corporate finance professionals to understand here is Weighted Average Cost of Capital (WACC) and how to lower it as much as possible.
Dividends and return of capital
At the end of the company’s financial year, management and finance make strategic decisions on whether to reinvest profit into the company or to distribute it amongst shareholders in the form of dividends or share buybacks, and bonuses for stakeholders.
Retained earnings which aren’t distributed amongst shareholders can be used to fund the expansion of the business. This is considered a good allocation of funds, particularly as it doesn’t incur additional costs or dilute equity value through the issuance of more shares.
Capital investments should only be embarked upon if the figures indicate that the rate of return would be greater than the company’s cost of capital.
What are the components of corporate strategy?
There are four main components to corporate strategy which will inform the decision-making in corporate financial strategy:
Allocation of resources
This usually concerns two major resources: capital and people. Some of the factors that can affect these resources include:
- Identifying the key competencies vital to the business and ensuring that they’re evenly distributed throughout the company.
- Placing leaders in the locations where they are needed most and adding most value (which may change over time according to priorities)
- Maintaining a steady flow of talent throughout the business.
- Allocating capital across the business so that it continues to earn the highest risk-adjusted return.
- Keeping abreast of external opportunities such as mergers and acquisitions and distributing capital across both internal and external opportunities.
The design of any organisation refers to the necessary corporate structure and the systems in place that contribute to creating the maximum amount of value. Factors to consider include whether there is a head office or if the business takes a decentralised approach. This also has an impact on whether the teams operate in vertical hierarchies or flattened hierarchies, for example.
Key questions around organisational design include:
- How much autonomy is given to each business unit?
- Are decisions made top-down or bottom-up?
- How much influence do business units have on strategy?
- How will large initiatives be divided into smaller projects?
- How should business units and functions be integrated so that there are no redundancies?
- How should authority be delegated and what is the line of reporting?
Portfolio management takes into account the ways that the businesses within a portfolio complement and enhance one another. Corporate strategy and financial strategy intersect when:
- Deciding what nature of business would be considered or rejected as an area of expansion.
- Determining the extent of vertical integration the firm should have.
- Managing risk through diversifying and reducing potential correlation of results across businesses.
- Creating strategic options by seeding new opportunities that could go on to be heavily invested in if lucrative.
- Observing changes on the competitive landscape and ensuring the portfolio is balanced relative to arising trends in the market.
Balancing the trade-offs between risk and return is one of the most challenging aspects of corporate strategy. It’s crucial to maintain a holistic view of the business portfolio and ensure that the desired levels of risk management are being pursued while return generation is achieved.
In terms of managing risk, product differentiation is a very high-risk strategy which can however lead to high returns and owning the space. Many companies don’t take this risk but adopt a copycat strategy by modifying the designs of the market leaders. This can still potentially lead to bettering the leading designs incrementally. The other route to take is cost leadership.
Achieve an MBA Finance and become a strategic partner
Corporate financial strategy is somewhat different to business strategy because its focus is on managing resources, managing risk, and maximising returns rather than looking at gaining a competitive advantage. Business leaders responsible for decision making have to take into consideration many factors with the help of the CFO, including allocation of resources, organisational design, portfolio management, and strategic trade-offs.
Discover more about the symbiotic relationship of financial strategy and corporate strategy in the world of big business with an online MBA Finance from Keele University.