Responsibilities of Pension Fund Regulators
In the previous article, we have already determined why it is important to closely monitor the workings of pension funds and also to regulate them. However, regulation is a broad concept. It encompasses a wide variety of actions that need to be undertaken. In this article, we will have a closer look at various activities […]
Cash Burn Rate: The Basics
The startup and entrepreneurship game has undergone a lot of changes in the recent past. Earlier, having a free cash flow was the hallmark of a successful business. All businesses including startup businesses were valued on the basis of the profitability or the free cash flow which they generate. To date, most startup valuation models […]
Calculating Free Cash Flow to the Firm: Method #2: Cash Flow From Operations
Now, it’s time to move on to the second metric which can be used to derive the free cash flow to the firm (FCFF). This metric is the cash flow from operations. These types of questions involve a complete cash flow statement being provided as the question and expect the student to derive free cash […]
The Importance of Personal Finance
There is no shortage of education in the field of finance. There are various academicians who work tirelessly in the field of finance. Many theories have been developed, and many conjectures have been disproved. Every year thousands of people graduate with finance as their major. However, most of these people are trained in the field […]
Mental Accounting
Traditional economic theory assumes that all money is fungible. The meaning of the word fungible is “interchangeable.” Hence, according to economic theory, if we have $100, the value of that should be the same for us regardless of how that was obtained. However, behavioral finance theory argues that this is not the case. According to […]
The study of financial management is imperative for anyone trying to make a career in the industry. However, traditional financial management helps to make short-term decisions.
For example, the main purpose of financial management is to guide corporations about making three decisions viz. the investment decision, the financing decision as well as the dividend decision. However, these decisions are taken with a short to medium-term perspective in mind.
Over time, research has shown that companies that tend to become most successful financially tend to have a long-term horizon while making decisions. This is the reason why strategic financial management has become an important subject.
In this article, we will have a closer look at what strategic financial management is and how it differs from traditional financial management.
The term strategic financial management is a combination of two terms viz. strategy and finance. Strategy, by definition, implies a long-term perspective. Hence, as explained above strategic financial management is about the management of the finances of any company in such a manner that it enables the meeting of the long-term goals. The assumption here is that the company has a clear idea of what its long-term financial goals are. This is because, in the absence of such knowledge, it is impossible to make any long-term decisions.
Traditional financial management emphasizes that any project which provides a positive net present value must be accepted. However, strategic financial management has a different opinion in this case.
Strategic financial management realizes that many projects can have a positive net present value. However, the company may not have the capital to go through with all the projects. Hence, some projects may need to be prioritized over others. In such cases, simply prioritizing the projects with the maximum net present value may not be feasible. This is where strategic financial management comes into play. It helps companies select the most optimal projects, which will give them the maximum probability of meeting their long-term objective.
The bottom line is that strategic financial management helps companies identify projects which may appear to be sub-optimal in the short run but may actually be the most optimal in the long run. It changes the lens through which the company views its operations as well as its finances.
Strategic financial management encompasses the entire spectrum of financial activities performed by any organization. Some of the key decisions which are enabled by strategic financial management have been mentioned below.
For instance, Uber, Airbnb, Facebook are all leaders in their own industries. However, they own very few assets. Companies that use strategic financial management to make decisions about their long-term assets would have noticed this trend earlier than other companies. Hence, they would have invested in making long-term commitments towards illiquid assets which may end up providing a sub-optimal return in the long run.
It is strategic financial management that sensitizes the organization about the effectiveness of its decision when a broader time frame is considered. It is no coincidence that companies which place a higher emphasis on strategic financial management have invested heavily in the digitization of their business even though it might be eating into their profits in the short run.
For example, many American companies have been located in China in the past. However, if the decision were to be made now, fewer companies would choose to locate in China. This is because of the continuous tensions and trade wars between the two countries.
This is what makes long-term location in China a riskier proposition than locating in another country that may be slightly more expensive in the short run but less prone to trade wars in the future.
If the company can absorb the costs of acquiring another company and add value in the long run, such an acquisition would be justified. However, strategic financial management ensures that companies keep their long-term goals in mind before taking a decision regarding an acquisition.
The bottom line is that strategic financial management is not a new technique of modeling financial data for making business decisions. In most cases, the tools and models used are the same. The change lies in the manner in which these results are interpreted. The long-term point of view changes how appealing each option looks and may influence the one which gets selected.
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