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Selecting Financial Strategies

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  1. Selecting Financial Strategies

  2. Some ways to raise finance Internal External

  3. Some ways to raise finance Internal External Retained profits Issue shares Working capital Bank loan / overdraft Asset disposals Debentures Sale & leaseback

  4. Retained profits The most important and significant source of finance for an established, profitable business

  5. Retained profits – main advantages • Cheap (though not free) • The “cost of capital” of retained profits is the opportunity cost for shareholders of leaving profits in the business • Very flexible • Management control how they are reinvested • Shareholders control the proportion retained • Does not dilute the ownership of the company

  6. Possible downsides of retained profits Danger of hoarding cash Shareholders may prefer dividends if the business is not earning a sufficient ROCE High profits and cash flows would suggest the business could afford debt (higher gearing)

  7. Working capital as a source of finance • Reducing working capital • A one-off benefit from lower working capital • The question – can it be sustained? • Finance often wasted in excess stocks and trade debtors • Look for very low stock turnover ratio or high debtor days

  8. Asset disposals Potentially another one-off boost to finance Good examples: spare land, surplus equipment Note – not all businesses have spare assets Often occurs after acquisitions

  9. Example of assets sale • Retailer JJB Sports has said it may be heading for a full-year loss of up to £10m after seeing sales fall in "extremely difficult" trading • JJB is looking to sell its Fitness Clubs business

  10. Sale and leaseback Specialist method of raising cash Involves selling fixed assets and then leasing them back from new owner Tends to involve business properties (e.g. hotels, supermarkets, offices – popular when property market was booming Note: can only be done once!

  11. Sorry – another football link! Leeds football club are trying to raise funds by selling off Elland Road football ground for £6m and then lease back. They are trying to sell to Leeds council. The negotiations are still underway. Example of sale & lease back

  12. Issuing shares 1 3 Company issues new shares Company has: More cash More shareholders 2 Shareholders buy the new shares

  13. Examples of issuing share rights • Working lunch great visual example of what share rights involve… • HSBC bank share rights issue

  14. Methods of issuing shares for a plc

  15. Share issues – benefits and drawbacks

  16. Raising Loan Capital Bank overdraft Bank loan Debentures Covered in BUSS2

  17. Debentures A debenture is a form of bond or long-term loan which is issued by the company, usually with a fixed rate of interest

  18. Debentures – key features Long-term: often 10-20 years Issued by the company (not a bank) Fixed rate of interest Usually secured against the assets of the company (provides some protection for debenture holders) Can be traded

  19. Cost Minimisation Strategies Cost minimisation aims to achieve the most cost-effective way of delivering goods and services to the require level of quality

  20. Cost minimisation • What strategies can a business take to minimise costs? (although this is a financial question the answer could come from any functional area or even a corporate solution) • Marketing • Low cost strategy • Operations Management • Relocation • Lean production • Human Resources • Changing organisational structure • Workforce plans • Corporate • Close unprofitable branches What financial strategies has Ryanair taken to achieve its objective of growth? What other factors have influenced these strategies ? Cost minimisation is a recurring theme in BUSS3

  21. Possible sources of cost reductions Eliminating waste & avoiding duplication (lean production) Simplifying processes and procedures Outsourcing non-core activities (e.g. transaction processing, payroll administration, call handling) Negotiating better pricing with suppliers Improving communication Pruning product ranges and customer accounts to eliminate unprofitable business Using the most effective methods of training and recruitment Introducing flexible working practices Aggressive control over non-essential overheads (e.g. banning first or business class travel unless essential)

  22. Potential problems with cost minimisation Business left with insufficient capacity to handle unexpected or short-term increases in demand Cost reductions by one department may surprise and/or annoy other functions if they are not properly communicated and coordinated

  23. Examples of profit centres Individual shops in a retail chain Local branches in a regional or nationwide distribution business A geographical region – e.g. a country (for multinationals) or county A team or individual (e.g. a sales team, a team of installers)

  24. Profit Centres A profit centre is a separately-identifiable part of a business for which it is possible to identify revenues and costs (i.e. calculate profit)

  25. Benefits and drawbacks of profit centres

  26. Plenary Q’s • Why might a car manufacturer need to raise large sums of money? • What options are available internally & externally to raise such sums to a car manufacturer in today’s economic climate? • What are the benefits of using retained profit for a major investment? What are the opportunity costs of using your retained profits too? (consider the ratios that will be effected)