In a fast changing world, brimming with social and economic uncertainty, financial information plays a vital role in the life of an organization and does so with two sets of eyes. One set looks back to see what has happened. This is the accounting function, which is simply about the recording of events and the production of the financial reports that satisfy the stewardship responsibility of management. The other set looks forward to determine the most appropriate strategic direction for an organization, guiding managerial actions, motivating behaviors, and creating and supporting the cultural values necessary to achieve an organizations strategic objectives. This book is all about the second set of eyes, which are the lenses of STRATEGIC FINANCIAL MANAGEMENT, that help organizations plot their way through an environment filled with opportunities and dangers. For students, aspiring managers as well as those who already have management responsibilities this book provides an insight, through the eyes of the characters of a start-up company, of some of the ideas and models that help to identify the possible strategies capable of maximizing an organization's value, which is the same as making the owners as wealthy as possible, to determine how to finance the organization in the most proper way, to allocate the collected capital in the most effective way, to monitor the implementation of the chosen strategy to see whether it is meeting the planned objectives, and to reasonably decide on the reinvestment and distribution of profits.
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Our friend Pearl wants to start a trading house. For better or worse, the world is quite a bit different now than it was in the early days of the great Japanese trading houses, the sogo shosha
literally meaning all round trading companyâwhich Iâm sure she understands only too well. Perhaps the most significant change to impact her idea is that technology now makes it much easier for buyers to deal directly with suppliers. Is there really a place for a trading house anymore?
Well as the French like to say, plus ça change plus câest la mĂȘme chose. For suppliers, the cost of dealing with a large number of customers, some of whom only buy in irritatingly small quantities and some of whom can be quite demanding, is something they would like to avoid if they can. Sure, with a good understanding of their cost structures they can charge these smaller customers a higher price for their product or service, but somehow that really never quite matches the additional burden on their business associated with these customers. Having fewer, larger customers is much more manageable and often more profitable in spite of predictably lower selling prices. So yes, perhaps there is a niche for a trading house. Those technological changes that made Pearl question the prospect of her idea may yet prove to be the foundation of her success.
Think!
Having doubts? Then think of what Amazon.com has done for book publishers.
With a little more confidence that success is probable, Pearl starts to plan the journey for her business venture. She is thinking of many things that need to be considered, some of which are obvious and others not quite so. Where to start?
Think!
What would you be thinking about? Make a list and compare it with the one that follows.
Letâs make a list, not in any particular order, for the moment:
What do I want to sell?
Who can I get it from?
Who could I sell it to?
Whatâs the best way to structure the organization?
Who will help me?
What resources will I need?
How much money will I need?
Where will I get the money I need?
Thatâs not a complete list, of course, but it will get her started. The more she thinks about it, the more she realizes that she will not be able to get this venture underway all by herself. Some things Pearl can do. Indeed, the first three items on the list are best handled by her. She needs to decide who of her friends around the world will best be able to help her, whom she feels more comfortable dealing with, and what she can buy from them. Then she needs some market research to help decide on the best products to include in her range. Although not really a financial management issue right now, at some point, and not too far away, there will be a need for some input from a financial management specialist.
The immediate need is for some input from that specialist to decide on a legal form and structure for the organization, and for the last three items on that list. No one in her family has that background, so Pearl needs to move quickly to get access to someone with this expertise as it will be vital to the financial health and overall profitability of her organization. The person she chooses should not be a bean counter, the person who balances the books each month and writes paychecks, but rather a financial planner, who has a good appreciation of the business, continually monitors performance, reports results, and is constantly alert to financial warning signals so that corrective action can be taken in time. Itâs important not to have the wrong person in this role, and itâs equally important to give that person the opportunity and encouragement to perform this important task.
Pearl has someone in mind, a trusted confidant of her late husband, who she believes will do a superb job. It is time for some fast, sweet-talking so she can get on with realizing her dream.
Chapter 1
In the Beginning
Introduction
Shakespeare once wrote, âWe are such stuff as dreams are made on,â1 and so it is with our business organizations. They exist simply as a result of putting dreams into action. Dreamers, by themselves, rarely have all the necessary skills to put their dreams into effect. The doers rarely achieve very much unless their energy is properly focused toward a clearly defined goal. Together they can achieve a great deal.
Translating this to the commercial world, no one part of an organization can deliver everything that is needed. Put it this way: Marketing by itself can do nothing unless it has a product or service to sell, which will be delivered by operational departments. Similarly, the accounting department has nothing to account for unless the business is making, marketing, and selling its products or services. It is this interdependence that pervades this book.
How do you picture interdependence? Well think of a wheel like the organizational one that is shown in Figure 1.1. When a wheel is properly constructed, it will turn smoothly and enable the user to get where they want to go more quickly and easily, and so it is with any organizationâs wheel. Strategy can be likened to the hub of the wheel, the focus of the forces that will make the wheel turn. Radiating out from the hub are all the spokes that represent each of the different functions within an organization. The rim that helps to keep all of these spokes in place and maintains the integrity of the wheel is the financial management function. If any one element is missing, the wheel will quickly become distorted giving a very bumpy ride indeed before collapsing in a tangled mess!
Figure 1.1. An organizational wheel.
Think!
Picture the wheel of your organization. Is it strong, or is the hub, rim, or one of the spokes weak and creating a problem?
Itâs easy to see how important it is not only to recognize that there are many different strands to an organization that need to work together but also to understand how they work together to create value.
Deciding the Objectives
In our bicycle wheel, the hub represents an organizationâs strategy, which is the focal point of everything that it does. Because it draws on, and then contributes to, each of the business disciplines, it is not considered a discipline in its own right. Whatâs more, it probably isnât really a function but more of an agenda: a series of fundamental questions and problems that concern organizations and their successful development. In other words, itâs about the future accomplishments of the organization, and so the imperative is to address these questions and problems by whatever means we have at our disposal.
The strategy agenda is concerned with three levels, which are inextricably linked in much the same way as the personal telescope shown in Figure 1.2. We must not only consider the success of the organization when deciding the objectives but also think about the environment in which we operate and the individuals whose actions help shape the organizationâs accomplishments.
Where does financial management fit in all of this? Well think back to the wheel, and youâll see that the rim represents financial management. As we contemplate and decide on the objectives for each of the business functions, the spokes, we need to understand the financial implications of each objective to ensure that we are eventually going to meet the needs of the owners.
The Organization
As I have already suggested, all of the functions of an organization must operate in concert with each other. We, as owners, must understand the needs of its organizational form; the laws governing its operation; and all of the standards, responsibilities, and obligations involved. This means we need to develop sound practices of communication, as well as monitoring and controlling all activities.
Whether an organization is starting from scratch, like the case study in this book, or is an ongoing business, the needs are the same. The organization must have a basic formâa sole proprietorship, a partnership, a company, or a trust.2 Which to choose? Each has its own advantages and disadvantages in four key areas of considerationâcontinuity, liability, administrative burden, and contribution to society. The first two organizational forms do not legally separate the organization from its owners, creating problems with continuity and liability. The third and fourth organizational forms overcome those problems but enforce an increased administrative burden. The contribution to society, in the form of taxes, may be different for each of the organizational forms depending on regulations in force at any given time and in any given place but will ultimately depend on the extent of business activity and the level of profit achieved by the organization.
Figure 1.2. The strategy telescope.
The choice, which may always be changed at a later date, will reflect our personal view as owners. Nevertheless, each form of operation has statutory and practical requirements, some of which are different and some of which are the same. Whichever form is chosen, we need to create a management structure to fulfill these requirements. Generally, our external financial advisor will jog our memory about these needs, but the responsibility to satisfy them lies with us, as does sound management of the organization.
Importantly, in terms of financial management, every business structure considers the same things, which are those that impact the monetary situation. In essence, any business exists to prosper and make money for the owners. This requires a sound business plan, a good understanding of the financial activities that underpin our organization, and effective accounting for the organizationâs activities. Understanding why each of these things is important will become clearer as you progress through this book.
For those of you who are going solo, questions about how you can implement all of the suggestions contained in this book will arise. Letâs be honest. Itâs just not possible to do everything yourself. What I hope you will do is look at your organization and the way you operate it and compare what you see with the ideas put forward in this book. Then isolate the activities you consider essential. Can you cope with those on your own? If you decide that you canât, then as our friend Pearl is about to do, go and ask a specialist for help. In many cases, the benefits that you get from a specialistâs advice will far outweigh the costs.
Money to Start With
All organizations need capital to survive. If you are just starting out, then a good rule is to have between 1 and 2 years of both business and personal expenses covered before embarking on a business venture. All well and good, but how much is it and where does it come from?
Think!
If you recently started out in business, or are thinking about it, then where did, or will, your initial investment come from?
In better economic times it might have been possible to negotiate a loan from a bank for some start-up capital, but there would be no way that the bank would have lent us all we need. Itâs our venture, not theirs, and so they would have expected us to put in the majority of the initial investment required to get the business up and running. Following the global financial crisis, it is almost certain that we shall have to provide all of the initial investment ourselves. We might still be able to get a loan if we are able to offer some security. More importantly, for business loans, lenders now want to see a positive operating and financial track record with all loan applications, and since we are just starting out we donât have that.
So letâs break open the piggy bank and put as much as we personally can into the initial investment. If thatâs not enough, then letâs talk to grandparents, parents, siblings, and friends to see if any of them are prepared to help get the venture underway.
