Financial Planning and Policy for Large Corporations

Financial planning and policy is essential for large corporations to manage financial decisions and to report accurate results internally and externally. Financial planning and policy is conducted by a firm's financial leaders often led by the CFO (chief financial officer). The financial arm of a corporation understands reporting requirements and establishes plans and policies to guide financial decisions regarding dividends, financing, investment and capital management.

Keywords Budgeting and Control; Capital Investment; Corporate Finance; Corporate Financial Management; Corporate Financial Planning; Financial Planning; Financial Policy; Fiscal Policy; Return on Capital; Working Capital Management

Finance > Financial Planning & Policy for Large Corporations

Overview

Large corporations have a need to establish guidelines for financial planning and policy. The guidelines are needed because corporations are typically managing large amounts of money and have obligations to employees and stockholders to carefully manage the money that is generated within the company. These obligations require corporations to employ internal and external financial experts to develop and implement financial decisions such as financing, investment, dividends and maximizing the use of funds created. Experts have postulated a relationship between financial policy and the ability to create wealth for stockholders (Bah & Dumontier, 2001). There is a verified relationship between certain types of financial decisions such as research and development, debt financing, investment and dividends.

Proper Financial Planning for the Corporation

Financial managers are central to corporate governance, and in addition to expertise in financial areas, these individuals must also possess a high-level sense of ethics to ensure that the decisions they make will be honest and straightforward. Financial planning is necessary because without it companies may lose money and jeopardize the survival of the organization. Poor financial planning can cause companies to lose value, which has ramifications for stockholders, potential investors, customers and creditors.

Financial Analysis, Planning & Reporting (2002, p. 6 — 7) listed ten financial planning mistakes corporations should seek to avoid. These included:

• Having a vague business plan.
• Ambiguous financial reports.
• Unmanaged earnings expectations.
• Bad mergers and acquisitions.
• Overvalued stock repurchases.
• Misaligned executive pay levels.
• Faulty measurement systems.
• Too much detail.
• Playing it too close to the vest.
• Lack of automation.

Business Plans

Business plans are important to detail how a business is run and how it plans to make and use its finances. Financial Analysis, Planning & Reporting (2002) reminded investors that Enron was a company where investors did not understand how Enron was making its money and advised investors to be wary of things they don't understand in business plans. If the plan is too complex, lacks detail or seems impossible it may not be a good plan.

A comprehensive formal business plan should contain the following elements: cover page, table of contents and table of appendices, executive summary, body of the business plan (Niemand, 2013). The business plan in itself does not, and cannot, guarantee success, but "coupled with a rather large dose of discipline" can be valuable in enhancing the chances of success, Niemand writes.

Reports

Reports, like business plans, should be clear and easy to understand. Anything that is not standard should be called out in the financial reporting notes and explained. Many corporations may be anxious to report good news to prevent fluctuations in stock price. However, once it is discovered that reports are inflated, stock prices may still react. Similarly, corporations should be straightforward in earnings projections as well. However, many companies often underestimate earnings so that a number is reported that is known to be achievable. Investors will need to monitor these actions to determine if a company is a good investment or simply good at managing the reporting of its earnings achievements.

Mergers & Acquisitions

Mergers and acquisitions are dangerous for corporations because they usually involve the merging of different cultures and management/reporting practices. A merger or acquisition may be seen as a positive for a company and a way to make money and improve earnings. However, many mergers and acquisitions cost money in terms of figuring out how to merge cultures, staffing, equipment and real estate. As a result, the path to greater earnings and benefits may be longer than anticipated by management and stockholders. This area is another one requiring companies to manage and set expectations appropriately internally and externally. Corporations may often engage in stock buy-back programs but investors must be clear on the true value of a company's stock to avoid loss of value. Most corporate financials managers hold a belief that their corporation is worth more than stock price and analyst projections suggest.

Rehm, Uhlaner, and West looked at what kind of merger strategy is most apt to generate excess returns for shareholders (2012). The authors looked at more than 15,000 non-bank mergers that occurred over a 10-year period. Companies that made frequent acquisitions of smaller firms recorded higher returns than did those who focused on making "the occasional large deal." Among those pursuing the latter strategy, companies in "slow-growing, mature industries" were more likely to be successful than those in fast-growing segments such as high technology (Rehm, Uhlaner & West 2012).

Stock Options

Stock options are usually a way to provide incentives in the compensation of corporate executives. However, when stock prices fall, so does the value of the executive compensation package. In some cases, companies will make adjustments to alleviate the pain felt by executives. These adjustments may make the executives feel better but doesn't hold them to endure the same risk and reward structure as stockholders. It also seems unfair to allow top CEOs and other executives to prosper while stockholders feel pain.

Measurement Systems

Corporations must engage in strategic performance measurement to keep track of how the company is performing against its internal targets and against the industry. Corporations must ensure that they are measuring the right things, measuring these things accurately, and have in place accountabilities and early warning systems to indicate when the company is off-course.

Detail

If corporations reduce the amount of detail in planning processes they will be able to concentrate on the things that are most important, measure accurate performance and take steps to improve performance. Too much detail is confusing internally and externally and creates a planning infrastructure that is difficult to manage and that does not suit the purposes of the company.

Accountability

When Financial Analysis, Planning & Reporting (2002, p. 7) discussed companies "playing it too close to the vest" in financial planning, it meant that involvement by all facets of the business is necessary to ensure that accurate, relevant information is used in the planning process.

Following the financial scandals of Worldcom, Tyco, and Enron in the very early 2000s, popular opinion pointed to a failure of corporate accountability. Karim and Taqi (2013) wrote that research does suggest that "a number of interdependent variables defining overall corporate performance are positively influenced by accountability effects, including performance, satisfaction, conformity, and goals and attentiveness." When planning is done by a few and others are not consulted, only a few are accountable and much of the needed information is not available. Greater involvement by various business units can also improve the performance of those units as they have greater understanding, involvement and accountability for company performance. Financial Analysis, Planning & Reporting (2002) also recommends the use of electronic software for financial planning. Software can reduce the amount of time spent collecting financial information and can improve the accuracy of reporting. Some systems also have the capability to allow financial managers to do high level analysis and modeling of complex 'what-if' scenarios.

Implications of Financial Policy

Corporate financial policy can have a variety of implications for firms, industries, investors and the economy in general. In the retail industry, companies have to be concerned about the fact that consumers don't have as much money available to spend on typical retail items. This shortage is due to consumers being saddled with heavy debt and small pay increases being given to workers. Retailers are also looking at the fact that the global consumer is becoming wealthier and has more disposable income to spend. So, companies may be looking more closely at global markets to increase opportunities. Technology has also allowed retailers to reach out to customers across the globe.

Wal-Mart

Home Textiles Today (2007) reported on Wal-Mart's explanation of its financial policy that encompasses a very long range view of 10 — 15 years in the future. This policy includes:

• Stock buybacks.
• Increasing dividends.
• Reducing domestic capital expenditures.
• International expansion.

Some of Wal-Mart's international expansion includes investment in a joint venture with a Japanese company. Wal-Mart may be easily able to increase the dividends it offers because of a high cash flow. Home Textiles Today (2007) reported that Wal-Mart paid $2.8 billion in dividends and $1.4 billion in repurchasing shares of stock. In fiscal year 2008, Wal-Mart is planning to offer $3.6 billion in dividends and has already made $5 billion in share buybacks. Wal-Mart has a vested interest in remaining atop the retail industry and financial policy must reflect knowledge of consumer behavior while predicting where that behavior is headed. Additionally, Wal-Mart plans to reduce capital expenditures and expects its return on investment to remain constant. Industry analysts and ratings agencies may have some concerns about the risk of Wal-Mart's international investments. Wal-Mart must be able to show clear financial policy that mitigates that risk. Such evidence might include the identification of criteria that prove the decisions are in line with sound financial policy. Home Textiles Today (2007) noted Wal-Mart's successful international expansion in Canada and Mexico that was criticized by industry analysts and less successful expansions in Germany and South Korea that fuel criticism of Wal-Mart's plans.

Cable & Telecommunications

Siderman (2007) discussed the cable and telecommunications industry by describing the competitive landscape. For example, phone companies find themselves losing land line customers due to the proliferation of cellular phones and competitors with lower packaged rates. However, these same companies have seen increases in the demand for digital subscriber lines (DSL). Cable and phone companies are competing for video customers and telecommunications company mergers have resulted in companies attempting to mitigate the risk by acquiring a growing market.

Companies in the telecommunications industry may continue to be a part of a growing market but only if they determine how to best position themselves in a time when there are no dividing lines between what a company is, does and what it can offer. Siderman (2007) predicts that cable companies will be the winners by peeling off phone customers interested in voice over IP (VoIP). Cable companies may also be able to benefit from dissatisfied phone company customers.

Siderman (2007, para. 6) noted that "financial policy must reflect maturing markets" when referring to traditional land line phone companies. In addition to offering a wide variety of products, Siderman (2007) recommended that land line phone companies adjust their financial policies in order to allow their credit ratings to remain high. Some companies have experienced difficulties in credit ratings because they are in the middle of negotiating mergers and acquisitions or buyout agreements. Company financial policy may indicate how a company will use the available cash in the business. Mature industry companies may choose to use that cash to invest in new technology or to buy other companies in growing telecommunications sectors. These companies are essentially betting their business and creating policy based on what they believe will happen in their mature sector while investing in what may happen in a newer or growing sector.

Another example of the implications of financial policy according to Siderman (2007) are the decisions that cable companies, which are performing well now, will need to make as the industry matures. Cable companies are flush with cash and will have to make decisions such as how to use the cash available. Should they invest in newer technology? Will they have to make significant capital outlays to improve or upgrade existing equipment? Could they possibly improve the technology used by technicians? Companies like this will also have to consider what should be done to face off competition and solidify industry position.

Cable companies, though reaching saturation of the video product market, are choosing to offer other kinds of services such as digital video recording and high speed Internet. Cable companies must consider how to manage competition from satellite and DirecTV. Product differentiation may be needed along with company differentiation. Siderman (2007) noted that companies are also rated on their liquidity which continues to be a challenge for companies as they acquire other businesses. Even companies with high credit ratings have to consider the cost of credit acquisition and how to avoid becoming overly laden with debt.

Boyer (2007) reported on the airline industry accepting more credit and debit purchases from passengers. This has resulted in an increase in purchases on board. Credit and debit cards are used to pay for food, beverages, phone calls and entertainment on board airplanes. Airline financial policies that support bringing this technology to passengers on all planes require capital investments in infrastructure for processing payments. An airline's financial decisions also depend on the available cash and debt load of the company.

The Role of Financial Policy

Federal monetary financial policy and the corporate financial policy of various growing industries are viewed as influencers of the broader economy. The Economist (2007) pointed to successful financial policy as responsible for the benefits to the economy in the last twenty years. Some of these benefits include low inflation, few fluctuations in unemployment figures and expanding economies for rich nations. However, the 2007 subprime mortgage crisis is seen by some as the result of progress in policy now taking a turn for the worse. Industries that are improving, growing and experiencing good results can mean that there is a willingness to take on more debt and risk. As inflation increases, companies are forced to raise their prices and the workers will want to share in the company's profits. Federal and corporate financial policies are tied together. The Economist (2007) indicated that as companies take on more risk and debt they will seek lower interest rates to manage the cost of debt.

Riccio (2007) reported that U.S. companies are at the lowest point in history in terms of the credit profile of these firms. Weakening of corporate credit ratings could indicate a trend toward increasing defaults among companies. Riccio (2007, para. 2) identified two possible causes of lowering of credit ratings as "investors accepting higher risk" and "more aggressive corporate financial policies aimed at appeasing shareholders." Industrial firms that are in the Standard and Poor's 'B' rating category make up about half of the corporate credit ratings today and were only 7% of corporate ratings in 1980. Middle market companies have become involved in bond and loan markets and the number of leveraged buyouts has increased. Riccio also observed drops in A-rated companies and investment grade (BBB-rated) companies. The financial risk taking by industrial companies can't always be mitigated by federal intervention but there is federal responsibility to monitor and adjust interest rates to influence the economy and avoid problems.

Viewpoint

Financial Planning & Policy Decisions

Leary & Roberts (2005, p. 2575) described a traditional corporate finance viewpoint which states that corporations will gravitate to an "optimal capital structure that balances the costs and benefits associated with varying degrees of financial leverage." These benefits can include tax benefits, profitability, the ability to obtain cash and the favorability of interest rates.

Financial policy decisions have to evolve with the changing economic times and what is best for a company based on its size, financial position, industry and growth opportunities. Although corporate budgets help companies grow by placing an emphasis on improving company profitability, the traditional focus on earnings is not suitable for changing corporate needs. Companies must incorporate performance measurements in budgeting, control and other financial planning and policy decisions. Many companies use benchmarking, the practice of matching their financial practices against best practices in an industry, for example. Other companies are using activity based costing making it easy to allocate costs to the cost center responsible for the cost. Corporate financial planning and policy are increasingly tied more closely to company strategic plans and benchmarks are set to achieve specific financial goals.

Financial pressures can cause some companies to resort to changing balance sheets based on company financial policies (Benito & Young, 2007). The decisions made by financial managers are tied to the corporate budget, the availability of funds and how those funds may be used. Balance sheet changes can help a company exhibit a higher level of profit than may actually be present. Companies may also take on greater debt to avoid becoming insolvent (Benito & Young, 2007).

Corporations can make financial policy decisions such as how to allocate cash between corporate accounts and pension accounts (Kim, 2004). The decisions related to pension management are found to be important financial policy decisions that affect the benefits to stockholders. Pension fund financial policy was also directly related to company value prior to the enactment of ERISA (Employee Retirement Income Security Act). Kim (2004) noted that a company's financial policy can affect consumers through stock value, dividends and labor cost.

Corporate taxation affects corporate financial policy because taxes impact profit (Contos, 2005). Gordon and Lee (2007) noted the relationship between taxes and the corresponding effect on corporate decisions regarding the use of debt financing or equity financing. Companies may have tax based incentives to use debt depending on the short versus long term cost of debt tied to overall interest rates. The effect of reducing the corporate tax rate is to reduce the amount of debt financed capital (Gordon & Lee, 2007). Contos (2005) also found that corporations have incentives to borrow because interest paid on financing is tax deductible. The dividends that are paid to stockholders are not tax deductible thus influencing financial decisions related to dividends and borrowing. These findings were confirmed regardless of the size of company, although large companies feel the impact of taxes greatest on their decision to use debt.

Three Categories of Corporate Financial Policy

There are three categories of theories on corporate financial policy. These include taxes, contracting costs and information costs (Barclay & Smith, 2005).

• The taxes category notes that companies can deduct interest rates but not dividends so companies can add debt to improve tax liability and improve cash flow after taxes. The disadvantage of this approach is that it only takes into account the affect of taxes.
• Contracting costs begin to include other financial considerations of higher debt and not just looking at the tax advantages. If a company ends up bankrupt there are financial costs associated with what Barclay and Smith (2005) call financial distress costs. If there is too much debt, a corporation may miss out on investments and without enough debt, a corporation can over-invest.
• Information costs are based on the fact that financial managers within a firm know more about the firm's finances and decisions than investors (Barclay & Smith, 2005). Barclay and Smith (2005) noted three important theories of financing decisions related to information costs, including market timing, signaling, and the pecking order.

Market timing describes an asset allocation where investment increases if the investor believes that the equity market will outperform T-bills and decreases if the equity market doesn't outperform treasury bills (Morgenson & Harvey, 2002). Leary and Roberts (2005) explain market timing as a corporation's timing its decisions about issuing securities and participating in the equity market. It also becomes important for corporations to consider the cost of adjusting to these decisions. Acquiring debt or taking on equity financing does not occur without cost (Leary & Roberts, 2005).

Signaling is when corporate managers want to communicate confidence to investors. Debt may indicate that a company is confident because it knows it must make debt payments. Pecking order indicates that there are varying costs associated with external financing so companies have a pecking order or preference in the sources considered for financing (Morgenson & Harvey, 2002).

The investor must believe the financial information received from corporate financial managers. But, the information is likely to be biased because internal managers may be more optimistic than reality reflects and may naturally feel that the valuation of their company is lower than reality. Unfortunately, the cost of bad financial planning and policy may not be easily or readily seen and the ramifications of these decisions may only be felt later at the expense of stockholders.

Terms & Concepts

Budgeting and Control: A budget is a detailed report of financial activity. Budgetary control is oversight and monitoring of a budget to make sure it remains in line with corporate objectives and standards.

Capital Investment: Money a corporation uses to invest in a capital asset such as equipment or other long term asset such as land or buildings.

Corporate Finance: An area of finance that deals with operating a corporation, making financing decisions and making investment decisions for the corporation.

Corporate Financial Management: Applying financial principles for corporate financial and resource management decisions to create, maintain and increase the value of the corporation.

Corporate Financial Planning: Long and short term financial planning for corporations.

Financial Policy: Description of the choices and criteria a corporation develops for the amount of debt the corporation can tolerate, how it will finance projects, how it will mitigate risk and maximize value of the company while yielding a return to stockholders.

Fiscal Policy: The federal government's budgetary decisions.

Return on Capital: The return on investment a company receives for selling an asset.

Working Capital Management: Working capital is current assets minus current liabilities without including short term debt. Working capital management is a plan that determines how a corporation is going to manage the working capital that is available. It may also include strategies for increasing and maximizing working capital.

Bibliography

10 corporate financial planning mistakes to avoid in 2003. (2002). Financial Analysis, Planning & Reporting, 2, 6. Retrieved November 17, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=6760098&site=ehost-live

Bah, R. & Dumontier, P. (2001). R&D intensity and corporate financial policy: Some international evidence. Journal of Business Finance & Accounting, 28(5/6). Retrieved October 1, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=4889788&site=ehost-live

Barclay, M. & Smith, C. (2005). The capital structure puzzle: The evidence revisited. Journal of Applied Corporate Finance, 17, 8-17. Retrieved October 1, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=16672067&site=ehost-live

Benito, A. & Young, G. (2007). Financial pressure and balance sheet adjustment by firms. Oxford Bulletin of Economics & Statistics, 69, 581-602. Retrieved November 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26771862&site=ehost-live

Boyer, M. (2007). Airlines moving toward cashless in-flight buying. American Banker, 172, 10. Retrieved November 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26161164&site=ehost-live

Contos, G. (2005). An essay on the effects of taxation on the corporate financial policy. Proceedings of the Annual Conference on Taxation, 415-423. Retrieved October 1, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=23548667&site=ehost-live

Gordon, R. & Lee, Y. (2007). Interest rates, taxes and corporate financial policies. National Tax Journal, 60, 65-84. Retrieved October 1, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=24699957&site=ehost-live

Karim, N., & Taqi, S. (2013). The importance of corporate management accountability. Journal of Managerial Sciences, 7, 59-73. Retrieved November 19, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=87064137&site=ehost-live

Kim,C. (2004). Corporate financial policy with pension accounts: An extension of the Modigliani — Miller Theorem. International Economic Journal, 18, 215-236. Retrieved October 1, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=14333847&site=ehost-live

Leary, M. & Roberts, M.R. (2005). Do firms rebalance their capital structures? Journal of Finance, 60, 2575-2619. Retrieved October 1, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=18795361&site=ehost-live

Morgenson, G. & Harvey, C. R. (2002). The New York Times Dictionary of Money Investing. New York, NY: Times Books.

Niemand, T. (2013). Do all business plans provide a recipe for success? Finweek, 50-52. Retrieved November 19, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=91608861&site=ehost-live

R. K. (2007). Landry's up on legal remedy, AMO down on more debt. Bank Loan Report, 22, 6. Retrieved November 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26543871&site=ehost-live

Rehm, W., Uhlaner, R., & West, A. (2012). A clearer-eyed view of M&A. McKinsey Quarterly, , 10-12. Retrieved November 19, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=74755472&site=ehost-live

Riccio, N. (2007, September 27). Corporate credit ratings hit a low point. Business Week Online, 19. Retrieved November 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26844385&site=ehost-live

Siderman, R. (2007, October 11). Cable vs. Telco: The battle heats up. Business Week Online, 9. Retrieved November 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=27032322&site=ehost-live

The turning point. (2007). Economist, 384(8547), 35-37. Retrieved November 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26710269&site=ehost-live

Suggested Reading

Baker, M. & Wurgler, J. (2002). Market timing and capital structure. Journal of Finance, 57, 1. Retrieved October 1, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=5889290&site=ehost-live

Bris, A., Koskinen, Y. & Pons, V. (2004). Corporate financial policies and performance around currency crises. Journal of Business, 77, 749-795. Retrieved October 1, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=15648481&site=ehost-live

Brummer, A. (2007). No one can yet say how bad it is. New Statesman, 137(4868), 21. Retrieved November 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=27397303&site=ehost-live

Faulkender, M. & Wang, R. (2006). Corporate financial policy and the value of cash. Journal of Finance, 61, 1957-1990. Retrieved October 1, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=21796398&site=ehost-live

Finance: Think long, think global. (2007). Home Textiles Today, 28(27), 8. Retrieved November 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=27325827&site=ehost-live

Food and Agriculture Organization of the United Nations. (2007). Financial and budgetary control. FAO Corporate Document Repository. Retrieved November 17, 2007, from http://www.thetimes100.co.uk/theory/theory — financial-budgetary-control — 120.php

Potter, A. (2007). So we fool God with financial loopholes. What of it? Maclean's, 120, 16. Retrieved November 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=27074964&site=ehost-live

Rossett, J. (2003). Labour leverage, equity risk and corporate policy choice. European Accounting Review, 12, 699-732. Retrieved October 1, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=11762979&site=ehost-live