What is a Financial strategy?
A financial strategy refers to a business or individual’s approach to managing and using financial resources to achieve goals. It is an important part of the overall business strategy. It involves planning and decision-making related to investment, budgeting, fundraising, cost management, forecasting future financial scenarios, and managing financial risks.
The main objectives of a financial strategy are typically to increase shareholder value, secure the Company’s financial stability, and ensure the availability of funds for future growth or to deal with unpredicted situations.
Key components of a financial strategy might include:
- Investment strategy: Deciding what to invest in (equipment, personnel, research, development, etc.), when, and how much to invest. It can also refer to investment in financial assets, like stocks or bonds. Investment Strategy: Explained with Types and Examples
- Financing strategy: Determining how to raise the capital needed for investment, whether through equity (like selling company shares), debt (like loans or bonds), or internally generated cash flow. How to make a Financing strategy: Explained with a case study
- Risk management strategy: Identifying financial risks that the Company faces (like exchange rate risk, interest rate risk, or credit risk) and deciding how to mitigate them, typically through financial instruments like derivatives or operational changes. Risk Management Strategy in Finance: Explained with an Example
- Cash flow management strategy: Managing the Company’s cash flow to ensure there is always enough cash available to meet its immediate needs, like payroll or debt payments. Cash flow management Strategy: Full Explanation
- Capital structure strategy: Deciding what mix of equity and debt the company should have. This affects the risk and return of the Company and its valuation. Business Capital Structure
- Dividend policy: Determining how much of the Company’s earnings should be paid out to shareholders as dividends and how much should be retained for reinvestment in the Company. Dividend Policy: Meaning | Types | Factor Affecting | Examples
Remember, a well-designed financial strategy should align with the Company’s broader business goals and strategies, considering internal factors (like financial health, risk tolerance, and operational needs) and external factors (like market conditions, industry trends, and regulatory environment).
How to make a financial strategy?
Creating a financial strategy is a multi-step process involving a deep understanding of the Company’s financial situation and business goals. Here are the steps to creating a financial strategy:
- Set clear goals: This is the first and perhaps the most crucial step. It involves identifying what the organization or individual wants to achieve financially. This could range from expanding the business, launching a new product, or improving financial stability. These goals should align with the broader business strategy.
- Understand your current financial situation: Analyze your current financial statements, including income statements, balance sheets, and cash flow statements. Assess your assets, liabilities, revenues, expenses, and cash flows to understand your financial standing.
- Forecast future scenarios: Based on historical data and expected market trends, project your future income, expenses, and cash flows. This can help you anticipate future financial needs and challenges.
- Identify investment needs and sources of capital: Based on your goals and forecasts, determine how much capital you will need and where you will invest it. Then, decide where this capital will come from, whether internal cash flows, debt, equity, or a combination.
- Manage financial risks: Identify the key financial risks you face, such as exchange rate risk, interest rate risk, or credit risk. Determine how you will mitigate these risks through financial instruments or operational changes.
- Create a budget: Based on the above steps, create a detailed budget that outlines your expected income and expenses. This will serve as a guide for your financial decision-making.
- Monitor and revise your strategy: Implement your strategy and monitor your financial performance regularly to ensure that you are on track to meet your goals. Adjust your strategy if your actual performance deviates from your plan or your business environment changes.
Creating a financial strategy is not a one-time task but an ongoing planning, implementation, and review process. It requires financial knowledge, strategic thinking, and careful management. It’s often beneficial to involve financial professionals in this process, either from within your organization or as external consultants.
Examples of financial strategy
A financial strategy can take various forms depending on a business’s goals, needs, and circumstances. Here are some hypothetical examples:
- Tech Start-up’s Financial Strategy: A tech start-up might set a goal to develop and launch a new product within two years. To do so, it decides to invest heavily in research and development. Given the high upfront costs and uncertain short-term revenue, the Company might choose to fund these investments through venture capital. It plans to prioritize growth over profitability in the short term, expecting that this strategy will maximize its value in the long term. Financial Strategy of a Technology Startup
- Manufacturing Company’s Financial Strategy: A manufacturing company might set a goal to expand its operations by opening a new factory. It decides to fund this expansion partly through internal cash flows and partly through a bank loan. The Company plans to manage the risk of this new debt by maintaining a conservative cash flow management strategy, ensuring it always has enough cash to make its debt payments.
- Retail Business’s Financial Strategy: A retail business might aim to improve its financial stability by reducing its debt. It chooses to do this by cutting costs, increasing prices, and using excess cash flows to repay its loans early. It might also decide to hedge its interest rate risk by switching from variable-rate to fixed-rate debt.
- Individual’s Financial Strategy: A personal financial strategy might involve an individual setting a goal to retire comfortably at age 60. To achieve this, they might invest a portion of their income in a diversified portfolio of stocks and bonds. They also might decide to purchase life and health insurance to manage the risk of unexpected costs. As they get closer to retirement, they gradually plan to shift their investments from riskier stocks to safer bonds.
These strategies are tailored to the entity’s specific goals, resources, and risk tolerance. The specific tactics used in each strategy (like raising venture capital, taking on debt, hedging risks, or investing in stocks and bonds) can be used in different ways to support different strategies. It’s the combination of these tactics with clear goals that form a coherent financial strategy.
Case study on a financial strategy
Let’s consider a case study of Apple Inc.’s financial strategy:
Apple Inc. is well known for its strong financial strategy. A key aspect of Apple’s financial strategy has been its effective use of capital to generate shareholder value.
Capital Allocation: Apple’s cash flow from operating activities for the twelve months ending Sep ’22 was $24.977 bn. This reserve provides Apple with financial flexibility and security, allowing it to invest in research and development, acquisitions, and other strategic opportunities as they arise.
Shareholder Returns: Apple has consistently returned a significant portion of its profits to shareholders. Since initiating its capital return program in 2012, Apple has returned over $573 billion to shareholders through dividends and share repurchases. Share repurchases, in particular, have been a key part of Apple’s strategy. By repurchasing its own shares, Apple reduces the number of shares outstanding, which increases earnings per share and can lead to a higher stock price.
Investments and Acquisitions: While Apple is known for its conservative approach to acquisitions, the Company has used its strong balance sheet to make strategic purchases that support its product and service portfolio. This includes the acquisition of companies like LuxVue (for display technologies), Turi (for machine learning), and Anobit (for flash storage), among others.
Debt Financing: Apple has also strategically used debt despite its large cash reserves. The Company started issuing bonds in 2013 to help fund its capital return program, taking advantage of low-interest rates to borrow at a lower cost than repatriating overseas earnings would have incurred (prior to U.S. tax law changes in 2017). As of September 24, 2022, the Company had outstanding fixed-rate notes with varying maturities for an aggregate principal amount of $111.8 billion (collectively the “Notes”), with $11.1 billion payable within 12 months.
Risk Management: Apple manages financial risk through various methods, including using derivatives to hedge against foreign exchange risk and commodity price risk.
This case study illustrates how Apple’s financial strategy supports its business goals and creates shareholder value. The Company’s strategic use of capital — through a combination of capital returns, strategic investments, debt financing, and risk management — has played a key role in its financial success.
