Principles of Strategic Financial Management
The field of strategy is not an exact science. This is because strategies are made based on the assumptions that an individual or a group of people have about the future. It is for this reason that if different people undertake the activity of strategic financial management, they are likely to come up with different results. As a result, the output from the strategic financial management process can be quite diverse.
Therefore, some guiding principles have been created to ensure that there is some form of standardization across various organizations. The basic principles which govern the implementation of strategic financial management have been listed in this article.
Principle #1: Matching Resources with Objectives
While implementing the principles of strategic financial management, an organization must be aware of the quantum of resources that it is likely to control in the long run. The company should also have a clear picture of the proportion in which these assets will be deployed across their portfolio.
The deployment of current resources has to be based on the final objective. Strategic investments are expensive to modify. For instance, it is difficult and expensive to shut down a factory after it has been set up. The financial experts help in understanding the level of projected economic activity in the future and how the resources can be best organized.
Principle #2: Maintaining Productive Capacity In Order To Meet Current Objectives
The field of strategic financial management is long-term in nature. However, the firm has to stay solvent in the short term for it to meet its long-term objectives. Hence, strategic financial management has to operate within the bounds of solvency.
A company should not continue making excessive investments, which would lead to cash burn in the short run, even if such research and development promise to make the company a market leader in the future.
If the cash burn continues unabated, the organization may find itself in a precarious position facing a hostile takeover. Hence current minimum objectives must be met. After meeting the basic objectives, the firm is free to deploy the excess cash flow with a longer time frame in mind.
Principle #3: Keeping an Eye on Financing
The investing decision may appear to be the key decision when it comes to strategic financial management. However, the financing decision is also equally important (if not more important).
Companies implementing strategic financial management should be aware that capital is a finite resource. They should be aware of the various sources of funding that they have at their disposal. They should also be aware of the cost of each of these sources of funding.
Companies generally have a target capital structure which they want to follow in the long run. The use of this target financial structure helps in tying up the short-term financing decisions with the long-term strategic decisions. It helps integrate the process of strategy and financial management.
Strategic financial management suggests that companies always maintain a debt ceiling beyond which borrowing should be strongly discouraged.
Principle #4: Evaluating Strategic Alternatives
Companies should continuously monitor their strategic alternatives. This includes using strategies such as partnerships and even outsourcing in order to meet their long-term objectives.
In some cases, outsourcing may even seem expensive in the short run. However, it gives the organization the opportunity to scale its operations up and down at will. This option is valuable to many firms as they would rather invest their capital in their core activities instead of spending it on building manufacturing hubs.
Similarly, many companies use franchising to grow in the long term. They are able to gain more market share even though it means a loss of control and division of profits in the short run.
The guiding principle here is that a company must try to maximize the upside in the long run while minimizing what the downside risks can be. Also, when companies view their relationships with other organizations as long-term partnerships, they are less likely to be transactional in nature.
The strategic financial management philosophy emphasizes the use of tools such as a balanced scorecard. These tools can be modified in order to inculcate the financial aspect into the stated objectives.
Principle #5: Integration of Financial Strategy with Other Strategies
The purpose of strategic financial management is to ensure that the financial objectives of the company are in line with its other strategies. In a traditional financial management context, financial decisions are made only by financial managers. However, strategic financial management emphasizes that the company must have deeper communication channels. It discourages working in silos.
According to this philosophy, there is nothing called a financial decision. The financial decision is just the spending of financial resources in the strategic interests of the firm. Since the strategic interests are shared across the firm, the decisions must also be shared.
These above-mentioned five principles serve as guiding pillars across organizations. This helps strategic financial management to follow the same path even though the implementation may vary across organizations.
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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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- Principles of Strategic Financial Management
- The Strategic Financial Planning Process
- Advantages of Strategic Financial Management
- Disadvantages of Strategic Financial Management
- Profit Maximization vs. Wealth Maximization
- Strategic Capital Budgeting
- 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