Finance Theory & Financial Strategy

Finance Theory & Financial Strategy

By Stewart C Myers

How do firms integrate strategic planning and financial analysis? It appears to be somewhat haphazard in many cases. Senior management sets a direction, vision and mission statement based upon who the firm is now and how it has evolved. Then sets the firm’s course based upon their ideas of who they are and who they may wish to become. The finance department that handles the financial planning and analysis may support the strategic initiative in some manner, but not in an integrated, holistic approach.

The firm may evaluate projects based upon the net present value (NPV) of expected cash flows for that project. In a strategic sense, the financial planning deals with the firm’s capital needs and decisions. One idea is to look at each project as its own mini-firm, an all equity project or company (Myers pg. 127). General Motors, for example, is based upon this strategic planning and financial planning. When a project is considered, looking at the NPV how it has been done. Will the project contribute to the bottom line or will it cost money. Larger companies may not be limited to the number and scope of projects as smaller companies are. On the other side, they may need larger projects to make a significant contribution to the firm.

One note by Myers, “is that the opportunity cost of capital depends on the use of funds, not on the source. You can make much more money through smart investment decisions than smart financing decisions.” The financing decision may boil down to saving 50 basis points, perhaps even 100 or 200 basis points depending upon the firm and capital accessed. Yet the project may have results that earn 15-16%, even 20%. This impact is dramatic and favorable as compared to the financing decision.

Myers believes that most strategic planners are not well schooled in the tools of modern finance (pg 12). The strategic planning may be more of an issue with marketing, how the customer sees and values the company. The marketing department should be able to determine the acceptance of the product, the pricing level, the market segmentation and niche, and desired attributes. Financial analysis can utilize that information to provide strategic planners into profit levels, NPV, cash flow, etc.

It was cited in the article that some strategic managers work to diversify the holding and product mix/industry of the company. Yet there is not any favorable market response to being diversified. It may actually have a relatively high cost for a firm to diversify into another industry either through acquisition or start-up. Yet the stock holder seems to have a lower cost to diversify: he/she can buy stock of several companies or into a mutual fund or several mutual funds, thus reducing risk to this particular industry. Myers noted “that if the market were willing to pay extra for diversification,