The Financial Ingredient: Financial Management in the Corporate Strategy Equation
It seems like a principal that is easy to understand; to make corporate decisions you must understand the financial ramifications of the actions that are being taken. How else can you make strategic business decisions; right? You have to consider how the strategic position being taken will affect the company’s financial infrastructure.
While this ideology may be simple to understand it is often ignored (or at the very least undervalued) when company’s are developing their operating strategies. This is not to say that decision-makers don’t consider the financial costs of such decisions, because they might; this is to say that many times they don’t fully under- stand how their financial infrastructure will be affected in the long and short-term as it relates to other factors beyond costs.
When operating strategies are being created, it is incumbent on management to understand how their decisions will affect the manner by which the company can do business, especially from a financial perspective. Some of the areas where these decisions can have the greatest affect include the following:
Capitalization – Capitalization should always be a major consideration when corporate strategy is being developed, as it is deeply tied into every facet of operations. Financial assets are the lifeblood of all organizations, and in many cases they are grossly under-analyzed when corporate strategies are being developed. Most organizations carefully review how decisions will affect profits and they also analyze the costs associated with the decisions. However, there is a general lack of focus on other capitalization issues such as the affects of the decision (be it an acquisition, a marketing plan, etc.) on other areas of the business. For instance, if the company is deciding to implement a costly marketing plan for one product, how will that affect the marketing of other products, will it have an affect on research and development, will it infringe on the company’s ability to implement other growth strategies (be it new product development, expansion, etc.). From a capitalization standpoint management must perform the proper due diligence to understand the affects of decisions on capitalization for the purpose of risk. As we have seen in the past three years, it is extremely risky for an organization to not properly analyze their capital situations and make decisions accordingly. These failures have led to companies making huge bets on a particular decision only to lose; and when they lose the ramifications are far reaching and can (in some cases) completely destroy a company.
Liquidity – For most organizations the ability to maintain high levels of liquidity represent the organization’s ability to maintain the type of operational flexibility that allows companies to not only operate in the short and long term but also provides them the ability to make investments; to take advantage of opportunity, and to stave off disaster when problematic issues arise. It seems over the past decade that many key decision makers forgot why liquidity is important, and through their actions businesses failed, jobs were lost, and entire economies were damaged. Earlier in the decade when debt capital was free owing, private equity and venture capital finance was plentiful, and consumers were in a consistent spending pattern, liquidity was not as important because capital could always be acquired through other means. However, those managers that decided that abandoning long- held liquidity practices was a prudent strategy because there were growth opportunities available or there were opportunities to increase profits through investments in unsustainable sectors soon found out that abandoning those practices was extremely irresponsible and ultimately caused the destruction of tens of thousands of businesses throughout the world. When decisions are made (no matter their level of importance) it is vital that management always adhere to the liquidity strategies that have guided the company in the past. The fact is that if things go bad, liquidity is likely to be one of the major determinants of a business’s ability to continually operate and succeed in the long-term. As stated, now that lenders have substantially curtailed the availability of debt capital and because many private equity firms and venture capital firms have drastically decreased their investing activities; companies are forced to be dependent on those liquid assets that they have been able to maintain throughout the crisis; and for those that don’t have positive liquidity ratios, they are experiencing extremely trying times as they try and locate the capital they need to operate.
Debt Situation – Debt isn’t bad, in fact it’s been a major driver in innovation, growth, and the overall development of companies throughout the world for centuries. However, just like citizens, companies have to be responsible for how they acquire and how they use debt to build and sustain their businesses. The fact that debt was so easily obtainable during the last decade was a major contributor to the global recession that we are all still dealing with. Just like individuals with credit cards, companies used this debt to over extend themselves and take risks that they probably shouldn’t have taken. The biggest problem is that in many cases these weren’t rogue actions but strategic actions that were approved by those tasked with leading these companies. This simply isn’t good business, as debt should be used as a tool to better implement strategy or take calculated risks, but debt should never be the entire strategy. Companies simply took risks without considering the ramifications that would commence if their strategies failed, and when they did fail many of these companies had no realistic way of settling their debt which placed undue strain on the entire global financial system. From a strategic position companies must have plausible ways to control debt (regardless of whether times are good or bad). If the strategy being implemented fails, will you have a realistic way of settling the debt that has been acquired to implement the strategy? If not, then management must rethink whether or not that strategy is a responsible one to implement. From a strategic standpoint it is ok to use debt as a tool, but if contingency strategies aren’t developed to responsibly dispose off the debt then management should re-analyze whether that is the strategy that needs to be implemented.
As with many of the problems that have been uncovered at the corporate level over the past three years, the problems with strategy (specifically from a financial perspective) is that key corporate leaders are extremely myopic in their views of not only strategy but also risk. If the overall intent is to create sustainable businesses that can function in a variety of economic and social climates, then management must get back to a fundamental understanding of how strategies should be developed, implemented, and evaluated. If the strategy is based on irresponsible risks that could leave the company crippled or destroyed then that strategy isn’t right for the company. Even if the opportunity is potentially lucrative, leaders must understand that their job is to first protect the company, and then to make the company more prosperous. If that is the case then protecting the lifeblood of the company (the finances) is the easiest way to ensure the longevity of the company, so it is incumbent upon management to always ask; “HOW DOES THIS STRATEGIC DECISION AFFECT THE FINANCIAL INFRASTRUCTURE OF OUR COMPANY TODAY AND TOMORROW”.
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