Strategic Finance and Sustainability
The concept of strategic finance relates to making decisions that help the firm increase its cash flow in the long run. Strategic finance is about changing the focus from short-term profits to long-term value creation. On the other hand, sustainability is about including more stakeholders in the value creation process. For instance, in the past, companies only existed to serve the interests of the shareholders. Over time, the belief has changed, and companies now try to balance the interests of other stakeholders such as employees and suppliers as well.
Companies all over the world are changing the yardstick they use in order to measure their performance. Instead of simply relying on profits as the sole barometer of success, they now focus on the triple bottom line viz. profit, people, and the planet. The approaches of strategic finance and sustainability are similar to some extent. They are non-conventional in nature and broaden the horizons of people. In this article, we will have a closer look at how the concepts of strategic finance, as well as sustainability, are related.
Sustainability and Strategic Finance have the same Goals
The concept of sustainability, as well as that of strategic finance, are somewhat similar in nature. This is because they both lead the company in the same direction. Most of the Fortune 500 companies are already following sustainable finance practices. This is because, in the long run, practices related to sustainable finance are also practices that maximize the long-term value of any firm. In the modern world, companies cannot generate profit for too long if they end up hurting the environment or any specific groups in the process.
Sustainability Lowers the Cost of Capital
The cost of debt that a firm has to incur is directly related to the risks it undertakes. Firms which do not comply with sustainable finance practices are vulnerable to lawsuits and reputational risks. These risks ultimately lead to monetary loss. All this increases the probability of loss and hence reduces the expected value. The end result is that creditors start asking for more compensation in the form of higher interest payments.
For instance, companies such as Shell or British Petroleum have had to pay big sums of money because of the environmental damage caused by the oil spills and other practices which hurt the environment.
Similarly, companies like Nike have faced lawsuits for enabling child labor in third-world country sweatshops. On the other hand, if a company follows practices related to sustainability, its risks of lawsuits and related monetary losses are greatly reduced. Hence, the cost of debt is reduced by merely following the policies.
Similarly, companies that follow practices related to sustainability also have a lower cost of equity. This is because they voluntarily adopt fair practices when it comes to dealing with employees as well as vendors. Also, such companies tend to be excessively focused on product safety as well. These companies would rather recall faulty products and face immediate losses than face reputational risk.
Once again, this means that the company faces fewer labor strikes and the supply of raw materials is also steady in nature. This ends up creating value in the long run by lowering the cost of equity. Also, since vendors tend to receive payments on time, they do not build in interest costs in the prices of the goods and services that they offer.
Since both the cost of debt as well as the cost of equity are reduced because of sustainable finance, the overall cost of capital gets lowered. Lowering of the overall cost of capital leads to an increment in the long-term discounted cash flow value of the firm.
Sustainability Helps in Avoiding Volatility
The principles of sustainability dictate that the rate at which resources are used should be less than the rate at which these resources are naturally renewed.
For instance, the rate at which gold and silver are consumed in the modern world should be less than the rate at which it is mined. If this condition is met, then the chances of shortage or sudden spikes in supply are almost eliminated. Since the supply is more or less stable, the prices also tend to be stable. This helps companies reduce their cost of capital and enable the timely supply of their goods and services to the end consumer.
Sustainability Lowers Operating Costs
It is because of the efforts taken by pro-sustainability people that the dependence on fossil fuels has reduced over the ages. Pressures from environmental groups have forced companies to switch to environmentally friendly sources of power such as solar or wind energy. These sources of energy are not only renewable but also free! Hence, if the technology is developed which allows companies to harness this energy, their overall cost will be reduced.
It may seem like natural sources are expensive in the short run. However, this will only be temporary because of the fact that the technology is not developed well enough. The benefits will definitely be reaped in the long run.
The above points prove why the principles of strategic finance, as well as sustainability, are aligned in the long run. The principles of sustainable finance have already been adopted by the big companies of the world. It is high time that the smaller companies also start adopting the same.
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The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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- The Strategic Financial Planning Process
- Advantages of Strategic Financial Management
- Disadvantages of Strategic Financial Management
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- What is Strategic Budgeting?
- Strategic Finance and Capital Structure
- Strategic Finance and Competitive Advantage
- Strategic Finance and Sustainability
- Strategic Finance and Technology
- Strategic Finance and the Outsourcing Decision