Corporate Financial Strategy

This article focuses on corporate financial strategy. It provides an overview of the history, strengths, and weaknesses of the corporate financial strategy field. The main components of corporate financial strategy, including value-based management, strategic planning, mergers and acquisitions, cost analysis, and capital budgets, are addressed. The relationship between corporate financial strategy and investor relations are described.

Keywords Business Strategy; Business Units; Capital Budgeting; Capital Budgets; Corporate Development; Corporation; Cost Analysis; Cost Benefit Analysis; Cost-Effectiveness; Financial Strategy; Growth; Growth Companies; Investor Relations; Operating Business Plan; Performance; Strategic Planning; Value-Based Management; Vertical Merger

Finance > Corporate Financial Strategy

Overview

Corporate financial strategy is a business approach in which financial tools and instruments are used to assess and evaluate the likely success and outcomes of proposed business strategies and projects. In the twenty-first century, corporate leaders and decision makers use corporate financial strategy to:

• Actively enhance shareholder value
• Fundraise
• Attain venture capital
• Promote corporate growth.

Corporations promote growth through organic or inorganic business activities. Corporate growth refers to economic expansion as measured by any of a number of indicators such as: Increased revenue, staffing, and market share. Issues that effect corporate value and growth include human capital, intellectual property, change management, and investment funding. Growth corporations tend to have an operating business plan that guides the company toward growth choices and activities. An operating business plan refers to a dynamic document that highlights the strengths and weakness of the company and guides the company toward learning and increased efficiency. A corporation's operating business plan is informed and driven by its corporate financial strategy.

The Combination of Finance & Strategy

The field of corporate financial strategy brings together the forces of corporate finance and corporate strategy to compliment and balance one another. In successful corporate finance strategy, corporate finance and strategy functions work together to create shareholder value. Corporate financial strategy is a multi-faceted and multi-field approach to business operations and management. The history of finance and strategy in corporate settings has been one of divisiveness and territoriality. Finance and strategy, and financial and strategic decision making in general, have long been considered separate intellectual and decision-making forces. Chief financial officers have been known to favor either finance or strategy as their main decision making influence. For example, chief financial officers and managers that favor economic or finance-based decision-making may rely on managerial economics or applied economics to make business decisions. Ultimately, there is no substantial conflict between corporate finance and corporate strategy tools and instruments. Finance and strategy, which have a history of being separate endeavors in the corporate sector, are complimentary functions that have the potential to reinforce and balance one another. Corporations that integrate finance and strategy functions have the greatest opportunities for growth and value added endeavors (Thackray, 1995).

Corporations, in the twenty-first century, share many of the same characteristics. For example, the modern corporation is usually organized into business units. Each business unit within the modern corporation is accountable for its' own profits or losses. Business planning is generally decentralized. Business unit product line managers focus on profits for single products over the shorter term. Rapid development and innovation in information technology continues to change production functions and the nature of the products and services sold and delivered to customers (Egan, 1995). Despite the similarities that characterize modern corporations, corporations do differ in their ability to combine finance and strategy factors. In the increasingly competitive global market, successful integration between finance and strategy dimensions may mean the difference between corporate success and corporate failure. Chief financial officers, managers, and planning teams that use financial strategy as their decision-making compass may create more wealth and growth for their companies and shareholders than those corporations that base their business decisions on either finance or strategy.

Steps for Developing Successful Corporate Financial Strategy

Corporate financial strategy is most successful when the strategy is maintained internally and aligned with the operations of the corporation. Fully integrated corporate financial strategies can be developed using the following steps (Mallette, 2005):

• Build a sufficient capital structure: Capital structure refers to the means through which a company finances itself. Financing may come from long term-debt, common stock, and retained earnings. Corporations can determine the best capital structure for its purposes through the use of three forms of analyses: Downside cash flow scenario modeling, peer group analysis, and bond rating analysis. Downside cash flow scenario modeling is a process in which a capital structure is taken from a set of downside cash flow scenarios. Peer group analysis is a process in which common capital structures and fads of peer businesses, are evaluated for insight into operating features. Bond rating analysis is a process in a review of the debt capacity within certain debt ratings.
• Determine the correct market valuation: Correct market valuation evaluates whether the corporation is undervalued or overvalued in the marketplace. Market valuation refers to a measure of how much the business is worth in the marketplace. Review financial measures such as investor expectations for growth, margins, and investments. Compare investors' expectations and managements' expectations to check for disparity.
• Establish the optimum corporate financial strategy: Develop an optimum strategy for value creation that provides sufficient funding, financial balance, and a growing cash reserve.

Ultimately, corporate financial strategy is a firm-specific enterprise. Corporations design their individual corporate financial strategies based on their available tools, resources, insights, goals, and objectives. Common components of corporate financial strategies include: Value-based management, strategic planning, mergers and acquisitions, cost analysis, and capital budgets. The following section describes and analyzes the main components of corporate financial strategies used today in the private sector. This section serves as the foundation for later discussion of the relationship between corporate financial strategy and investor relations.

Applications

Chief financial officers, managers, and planning teams develop their corporate financial strategies to maximize and optimize growth and shareholder value. Corporate financial strategies are characterized as return driven strategies. A return driven corporate strategy refers to a set of corporation specific guidelines for creating, maintaining, and analyzing corporate strategy focused on utmost, long-range wealth development. In the twenty-first century, managers have an increased responsibility to create shareholder value, watch the performance of a business, and safeguard long-term business success. Return driven corporate financial strategy prioritizes value added outcomes and directs the business with a critical eye toward return, value, and growth (Frigo, 2003). The following components of corporate financial strategies, including value-based management, strategic planning, mergers and acquisitions, cost analysis, and capital budgets, are used by chief financial officers, managers, and planning teams to create shareholder value.

Value-Based Management

Chief financial officers, managers, and planning teams may choose to base their corporate financial strategy on the principles of value-based management. Value-based management refers to a management approach focused on maximizing shareholder value. Value-based management includes strategies for creating, measuring, and managing value. Value-based management is an integrated and holistic approach to business that encompasses and informs the corporate culture, corporate communications, corporate mission, corporate strategy, corporate organization, corporate decision making, and corporate awards and compensation packages. The economic value added (EVA) strategy is one of the most common tools used in value-based management. Economic value added refers to the net operating profit minus a charge for the opportunity cost of all the capital invested in the project. Economic value added analysis is considered a beneficial lens for looking at varying company unit performances on a cost-of-capital basis where risks are adjusted. Value added managers may receive compensation based on the outcome of economic value added analysis. Ultimately, the economic value added approach is a measure of economic performance and a strategy for creating shareholder wealth (Bhalla, 2004). Critics of economic value added approaches have two main complaints. First, critics argue that economic value added approaches are too costly to apply. Second, critics argue that economic value added approaches are too intellectually rigorous and demanding for many managers to use successfully and effectively (Thackray, 1995).

Strategic Planning

Chief financial officers, managers, and planning teams may choose to base their corporate financial strategy on strategic planning. Growth companies tend to engage in active organizational and strategic planning. The leaders and managers of growth companies tend to excel at understanding, assessing, and forecasting potential problems. This long-range vision allows managers to address problems and plan solutions before situations become destructive to the organization and inhibit growth. Strategic planning refers to the process of establishing a business’s long-term corporate goals and deciding on the most effective way to achieving those aims. There are five key elements vital to strategic planning (Bhalla, 2004):

• Identification of the problems and opportunities that exist
• Formation of goals and objectives
• Procedures for providing solutions or paths that the firm can follow
• Choosing the best solution based on possible solutions and firm objectives
• Instituting a review procedure to evaluate how the best solution has performed.

Corporations' strategic plans and corporate financial strategies are usually integrated intro a general business strategy. The corporate business strategy refers to the context for specific business decisions and operating strategies. Examples include a strategy for growth, business focus, product cannibalization, partnerships, and global focus. All successful corporations engage in corporate development and strategic planning.

Mergers & Acquisitions

Chief financial officers, managers, and planning teams may choose to base their corporate financial strategy on corporate mergers and acquisitions as the vehicle for creating growth and shareholder value. The convergence of the financial industry that began in the 1970s started a process of ongoing and frequent mergers and acquisitions. Corporations that choose merger and acquisition as their path or engine for increased value and growth must make decisions regarding what mode of merger or acquisition to choose based on their resources, industry, and goals. There are three main types of mergers and acquisitions: Horizontal merger, vertical merger, and conglomerate merger.

• Horizontal merger refers to the business act in which one company obtains the rights to another company that whose products are similar and whose consumers are in the same area. Thus, competition is greatly reduced and, in many cases, eliminated.
• Vertical merger refers to the business act in which one company acquires customers or suppliers, thereby lowering the cost of production and distribution.
• Conglomerate mergers refer to all non-vertical and non-horizontal mergers and acquisitions. Examples of common conglomerate mergers and acquisitions include pure conglomerate transactions, geographic extension mergers, and product-extension mergers.

Determining Merger Type

Corporations decide what type of merger or acquisition to pursue based on their overall financial strategies, objectives, and resources. Corporations with significant capital resources may choose to pursue the purchase of assets. In the purchase of assets scenario, the buyer purchases another company's assets and, in some instances, its debts. Corporations may choose to pursue the purchase of stock. In the purchase of stock scenario, the buyer purchases some of the seller's stockholdings and inherits the seller's obligations and rights, including debt, in proportion to the purchased share. Corporations may choose to pursue a statutory merger. In the statutory merger scenario, the merger allows the merging companies to continue existing as a single legal entity. Ultimately, there are numerous different types of mergers and acquisitions that correspond to varying business needs and business models (Lu, 2006). Common management problems and issues experienced during and after mergers and acquisitions include strategic, moral, organizational, legal, financial issues, and human resource issues.

Merger & Acquisition Management

Mergers and acquisitions, throughout their lifecycle from first proposing the idea to post-merger, require careful oversight and management. Corporations are increasingly implementing ongoing merger and acquisition management policies to guide merger and acquisition activities. Corporate merger and acquisition management policy ranges from very simple to very complex. Simple corporate merger and acquisition policy generally includes the mandate that any merger and acquisition transaction over a certain dollar amount must go to the board of directors for approval. Complex merger and acquisition management policy may include, for example, rules and strategies for strategic plan approval, sale of company assets, reporting of inquiries, and formulating a takeover defense. Corporate development officers are generally in charge of developing merger and acquisition management policy as well as overseeing all merger and acquisition proposals (Liebs, 1999).

Cost Analysis

Chief financial officers, managers, and planning teams may choose to base their corporate financial strategy on the data gathered from ongoing cost analysis. Cost analysis refers to the microeconomic techniques used to assess the effectiveness of production, the best factor allocation, the economies of scale, and cost function. Cost analysis incorporates the expenses associated with raw materials, components, subassemblies, communications, transportation, and customer support services (Egan, 1995). Corporations use multiple cost analysis tools to aid financial and strategic decision-making. There are four main kinds of cost analysis: Cost-benefit, cost-effectiveness, cost-minimization, and cost-utility. Each of the four types is used by corporations for decision-making share the same the same framework or guiding principles. For example, the type of cost analysis:

• Specifies the analytic perspective that provided the framework for determining who pays the costs for and who benefits from a particular service or intervention.
• Defines and specifies the anticipated benefits and outcomes of a service or intervention.
• Identifies all of the actual and potential costs using the specified analytic perspective to determine the costs.
• Accounts for how time may affect projected costs.
• Evaluates the results and considers alternative explanations for the conclusions.
• Calculates a cost-benefit or cost-effectiveness ratio as a summary measure (Beyea, 1999).

While there are four related types of cost analysis, cost benefit analysis is the most popular and widely used analytical tool for economic decision-making in the private sector. Cost benefit analysis (CBA), a type of investment appraisal also referred to as benefit-cost analysis, is one of the most prominent and widely used analytical and quantitative tools for decision making in the corporations. Cost benefit analysis produces data about the cost and benefit of a product, service, production method, or investment. This data can be presented in three main ways to aid the evaluation stage of analysis:

• First, data can be presented in a cost-benefit ratio.
• Second, data can be presented through a calculation of the present total project value.
• Third, data can be presented by evaluating the internal rate of return of the investment. The third method, the internal rate of return, or rate-of-return analysis, is the most common cost benefit analysis tool used to evaluate investments and make decisions (Hough, 1994).

Capital Budgets

Chief financial officers, managers, and planning teams may choose to base their corporate financial strategy on their capital budgets. Capital budgets, determined in the capital budgeting process, refer to a financial plan to finance long-term capital expenses such as fixed assets, facilities, and equipment. Capital budgeting is the analytical process of determining the optimal investment of scarce capital so as to realize the greatest profit from that investment. Capital budgeting ranks proposed investments in order of their potential profitability. There are two main criteria for selecting potential business investments:

• First, business managers, engaged in capital budgeting, generally have a minimum desired rate of return specified as the cut-off point to determine whether or not a project should be accepted of rejected.
• Second, business managers, engaged in capital budgeting, generally experience constraint from top management regarding the total amount of potential investment.

Corporate managers, engaged in capital budgeting, take hold of stockholders' funds and work to maximize their earning potential through four main strategies: The postponability method, the payback method, financial statement method, and discounted cash flow technique. Corporate managers engaged in capital budgeting also develop an economic forecast for each proposed project. The corporate manager generally chooses the project that has the highest future earnings and the lowest associated costs. This approach is complicated by the different risks associated with each potential project. Thus, competing investment projects have different levels of associated risk (Parkinson, 1971).

Ultimately, the components of corporate financial strategies, including value-based management, strategic planning, mergers and acquisitions, cost analysis, and capital budgets, can lead organic and inorganic corporate growth efforts. Investors and economists debate the relative strengths and weaknesses of organic and inorganic business growth. Inorganic and organic business growth each move in and out of favor depending on the strength of the economy, political environment, and government regulations. Organic growth is created by expanding existing business resources rather than through mergers and acquisitions. Inorganic growth is created by corporate development practices. Corporate development refers to the activities that companies undertake to grow through inorganic means such as mergers and acquisitions, strategic alliances, and joint ventures.

Issues

Investor Relations as Corporate Financial Strategy

Corporate financial strategy is a holistic endeavor that involves every level and aspect of corporate life. Corporate financial strategy, which endeavors to create shareholder value, is dependent on successful and harmonious investor relations. Investor relations refer to the communication of company information to the financial community, analysts, investors and potential investors. An investor relation is a strategic tool in a corporation's overall financial strategy. Corporations rely on investors to provide capital. Corporations turn to investors for fundraising and raising capital. To facilitate this relationship and promote trust, corporations engage in investor relations. Investor relations offer present and future investors with the precise portrayal of a corporation’s accomplishments and potential and influences the corporation’s overall image and financial reputation. Financial reputation refers to the general assessment of a business’s economic prospects made by the financial rating industry.

Investor relations, also referred to as customer relationship management (CRM) or investor communication, is overseen by corporate communication executives; financial directors; company secretaries; or external consultants. “Investor relations involves continuous, planned, deliberate, sustained marketing activities that identify, establish, maintain and enhance both long and short term relationships between a company and not only its prospective and present investors, but also other financial analysts and stakeholders. Corporate communication strategy attempts to win the approval of financial stakeholders” (Dolphin, 2004, p. 25). Investor relations help corporations gain support of important financial opinion formers. Ultimately, strategic corporate marketing combines the disciplines of finance and communication for the purpose of creating shareholder trust and value (Dolphin, 2004).

Conclusion

In the final analysis, corporate leaders and managers, including the chief executive officers of large firms and the business managers of small family businesses, need to have an understanding of how market forces affect business practices in order to be competitive in their industry. Corporate decision makers use and rely on the tools, methods, and approaches of corporate financial strategy to make informed business decisions that maximize profit and secure market share.

Terms & Concepts

Business Strategy: The context for specific business decisions and operating strategies.

Business Units: Self sufficient groups within a form that create and distribute pre- and post-order supporting services for different products to consumers worldwide.

Capital Budgeting: The analytical process of determining the optimal investment of scarce capital so as to realize the greatest profit from that investment.

Corporate Development: The activities that companies undertake to grow through inorganic means such as mergers and acquisitions, strategic alliances and joint ventures.

Corporation: A firm that is owned by stockholders and managed by professional administrators.

Cost Analysis: The microeconomic strategies that evaluate and assess the effectiveness of production, the best factor allocation, and the economies of scale and cost function.

Cost Benefit Analysis: A systematic and formalized set of procedures for assessing whether to fund and implement a service, product, or program.

Cost-Effectiveness: An orderly and measurable method for examining the costs of various ways of gaining the same stream of benefits or a specific goal.

Growth: Economic expansion as measured by any of a number of indicators such as increased revenue, staffing, and market share.

Growth Companies: Companies whose rate of growth considerably surpasses that of the typical in its category or the inclusive rate of financial gain.

Operating Business Plan: Dynamic document that highlights the strengths and weakness of the company and guides the company toward learning and increased efficiency.

Performance: The overall results of general activities of an organization or investment over a certain period of time.

Strategic Planning: A company’s strategy of detailing its strategy, or initiative, and deciding on how to allocate its financial resources to most efficiently achieve the goals.

Vertical Merger: The business act in which one firm acquires either a customer or a supplier.

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Suggested Reading

Breen, W., & Lerner, E. (1973). Corporate financial strategies and market measures of risk and return. Journal of Finance, 28, 339. Retrieved September 9, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=4656712&site=ehost-live

Hamilton, C. (1978). Corporate financial strategies under uncertainty: Valuation and policies in dynamic disequilibrium. Journal of Financial & Quantitative Analysis, 13. Retrieved September 9, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=4760177&site=ehost-live

Shilling, A. (1998). The cleanup crew has arrived. Forbes, 162, 287-287. Retrieved September 9, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=1333652&site=ehost-live