What is the Link between Business Strategy & Finance
By understanding the Linkages between Strategy & Finance, you can
- Understand why Finance is an essential element for the success of a business
- Understand the link between Business Strategy & Finance
- Learn the important finance-related areas to be managed for the success of a business
It is said that
- A Business Strategy is totally conceptual until you start filling in the numbers.
- The sections about your marketing plan and strategy are interesting to read but don’t mean a thing if you can’t justify your business with good figures on the bottom line.
- The financial section of a business plan is one of the most essential components of a plan if you hope to win over investors or obtain a bank loan. Many businesses get into financial difficulties because they do not estimate and arrange the funding requirements.
- Even if you don’t need financing, you should deliver a healthy Financial Performance simply to succeed in your business.
One of the important elements in the success of Business is Finance. The relationship between Business Strategy and Finance can be established in the following six ways:
1) Managing Financial Performance
2) Managing Value Creation
3) Financial Planning
4) Fund Raise
5) Resource Allocation
6) Managing Stakeholder Expectations
Managing Financial Performance
- Financial performance is one of the key indicators of a firm’s success.
- Financial goals and metrics help businesses monitor & measure the success of the Business Strategy, take corrective actions, and ensure that the Strategy stays on track.
- Financial metrics help businesses implement and monitor their strategies with specific and measurable business and financial goals.
- The financial goal could grow @ 30% and achieve a turnover of Rs. 50 Cr in 22-23 and improve EBDITA margins from 8% to 10%.
Managing Value Creation
Value creation is the primary aim of any business entity.
From a financial perspective, value is said to be created when:
a) A Business earns Revenue that exceeds Expenses & reports a Profit.
For e.g., A Business having revenues of Rs. 50 Cr and expenses of Rs. 46 Cr is creating value
Note: A business can report losses in the short term as they invest in Marketing, Team, Product, Technology, etc. but will have to eventually report profits to create value.
b) A business earns a Return on Capital higher than the Cost of Capital.
For e.g. A business with a capital of Rs. 10 Cr with 50% Debt & 50% Equity has a Cost of Capital of 15% as illustrated below:
It should deliver a return of 15% or Profit Before Interest & Tax of Rs. 1.5 Cr (15% Return on Capital of Rs. 10 Cr) and above to create value
Execution of Business Strategy requires Financial Planning to forecast the sales, expenses, and the Investments for Capital Expenditure and Working Capital and accordingly estimate the Funding requirements.
Benefits of Financial Planning:
- Establishes clear financial goals and a roadmap to achieve the goals. The financial goals or targets could be for a month, quarter, a year, or long term for 3 to 5 years.
- Helps in Cashflow Management. Once a financial plan is ready, it will reveal the Cash flow requirements, which can be planned for
- Results in smart spends and decisions. The financial plan forces you to look at the spending based on the expected revenues and rationalize them.
- Helps in better Risk & Crisis management. Since you already have a financial plan, understanding the implications and making decisions becomes more manageable.
- Smoothens the Fund Raise process as the first thing an Investor or Banker will ask is a Business & Financial Plan.
Implementation of Business Strategy requires Financing or funds to be arranged for either funding Capital Expenditure, Working Capital, and Expenses.
Many businesses get into financial difficulties as they do not estimate, plan, and arrange for funding requirements.
In the current pandemic, the businesses that have survived are the ones that had funds to tide over the situation.
A business may have different ideas and plans that require funds. However, the availability of funds is limited. Finance helps in prioritizing resource allocations based on the objective of achieving strategic goals and maximizing returns.
Once the business goals are identified and finalized, fund allocation should be prioritized only for those activities that help the business achieve its goal.
Any diversion of funds into unrelated activities, businesses, or non-productive assets should be avoided.
Managing Stakeholder Expectations
All the stakeholders have financial expectations from a Business which must be managed and delivered to ensure that businesses continue to function without disruptions.
The stakeholders are Shareholders, Bankers, Suppliers, Employees, Customers, and Community.
- Shareholders expect a return on their invested capital in the form of Dividends and Capital appreciation.
- Bankers expect interest on loans and repayment of loans in time.
- Suppliers and employees expect timely payment from the businesses.
- Customers expect value for the price paid for the goods and services.
- The community expects benefits for themselves such as employment, business ethical conduct, and adherence to the laws and environment.
Any business that wants to successfully implement its Business Strategy must successfully manage the finance-related areas. A Business Strategy is successful if it is beneficial to the organization and financially viable. A business cannot implement a Business Strategy without using financial metrics or financial planning or without arranging for funds, thus making Strategy & Finance inseparable.