STRATEGIC MANAGEMENT
6. Financial strategy
Financial situation of Hungarian firms
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Introduction
Many financial decisions are based on data and
documents of accounting (book-keeping).
Income statement summarises all the revenues,
then subtracts all the expenses realised over a
period of time. The bottom line is the profit or
loss realised (see the next slide).
Balance sheet is a cross-sectional picture of a
firm’s financial position at a given time. It shows
the value of their assets and liabilities (see the
slide).
Cash-flow report shows the flows of the money.
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The form of an income statement
Sales
Less: cost of goods sold
other expenses except interests
EBIT (earnings before interests and taxes)
Less: interests
Operating profit
Less: taxes
Net income
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The form of a balance sheet
Assets
Equity
Land, plant equipment Common stock
Other properties
Retained earnings
Current assets
Current liabilities
Cash
Long-term liabilities
Receivables
Inventory
Net income
Total of assets
Total of equity, liabilities
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Everyday mistake of an enterprise balance that it
does not register some intellectual properties
and the goodwill.
Goodwill is an intangible but saleable asset arising
from the reputation of a business and its relations
with its customers.
In the balance of a successful company the value
of goodwill can be greater than the value of all
other assets. So, selling a firm, it is extremely
important to count in its price the value of
goodwill. It was not the case in the
privatisation of some Hungarian firms.
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Financial strategies
After world war II. firms based their strategies first of all
on financial motives. Later the market-orientation
became most important.
But till today decisions
- on capital acquisition,
- on capital allocation (investments),
- on cash flow management and
- on creation and/or maintenance of the firm’s
profitability
remained important tasks of strategy makers.
The realisation methods of these tasks are as
follow:
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The first question of all rational decision is: what
are the main points of view (goals) in the given
topic? Classics said: it is the profit increase.
But A. Rappaport showed that more effective goal
is the increase of the value of the firm.
Accountants think that the firm’s value is equal
with the value of equity. According to
businessmen however, value of a firm is the
present value of its future incomes.
Present value (V0) of a value from a future year t (Vt)
can be calculate with the formula:
V0 = Vt / (1 + i)t , where i is the interest rate.
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There can be big differences between the results
of the profit based and business oriented
firm’s value evaluations. One of the main
cause of this, that
• the first calculations do not pay attention to
the value of the goodwill, but
• in many cases this could be the main factor,
because a goodwill loss could decrease
considerably the demand.
Parkinson remarked that in modern corporations the
great financial decisions are accepted by some
committees, where members are not rational.
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Capital acquisition
In a firm the possibilities of capital acquisition (and
types of financing) vary in accordance to the
stage in its life-cycle.
1. In general the foundation of a firm can only be
financed by „3F” (founders, family, friends).
2. Business angels (persons or institutions
respectively, which buy share from the
enterprise's equity capital) can help the capital
acquisition of a start-up company, and seed
capital can also help market entry. Because of
the great risks of a start-up, often the expected
return of this investments is very high (can be
20-30 %, even more per year).
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3. In the growth stage the firm’s investments
have to be financed partly by own funds
(equity), but in some cases by venture capital
(VC) as well. VC is a bank specialised to high
risks of the investments to new companies.
The minimal value of these investments is
high (e.g. 1000 thousand $), and the
expected return of its investments is very
high (e.g. 20 % pro year) as well.
When a business becomes successful, reaches
the maturity phase, the VC institution sells it
(e.g. in the stock exchange). But many of its
investments are failures.
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4. After a successful growth period enterprises can
get capital from the stock exchange (when they
sell their shares).
A big company can always demand credits from
the banks as well.
(Of course, if a manager can guarantee the
repayment /so, he is a rich man/ he always
receive bank credit.)
The volume of possible credit is equal from one
half to two third of the value of firm’s assets.
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Investments
The effectiveness of an investment can evaluate
with the help of the so called ROI (return on
investment) index, which is the present value
of the income resulted by this investment
divided by the value of the capital invested.
With the help of the risk discount we can add
the effects of the uncertainty of the future to
the results of the present value calculations.
The formula is the following: V0 = Vt / (1 + i +
+β)t , where β is the coefficient of uncertainty.
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Exercise. How many should we pay for a bill,
which will mature after a year and its value
will be 100 USD, further we expect that the
interest rate will be 5 % and we estimate that
the coefficient of uncertainty is 0,02?
V0 = 100 / ( 1 + 0,05 + 0,02 ) = 93,5 USD
• And how we can evaluate the „investment”
of buying this bill for 93,5 USD?
Of course, we will receive the interest and
the risk premium, but we will not realise
entrepreneurial profit.
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Cash flow management
The main goal of cash flow management is the creation
and maintenance of the firm’s liquidity. It creates rules
of scheduling revenues and expenses.
If in a period the expected revenues are higher, than the
expenses, it is possible to put the surplus in a bank for
some interest.
If the latter are higher than the previous, it is neither
possible nor desirable to make all possible investments
immediately, the capital allocation strategy sets
priorities (e.g. in base of ROI’s values) and timing for
them.
Other solution can be the recovering the lack through
credits. But good debt management is an important
task as well: if the debt ratio becomes high (e.g. more
than 0,3), the firm’s credibility goes bad.
Debt ratio: ratio of liabilities and total assets.
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Profitability control
Creation and maintenance of profitability is the
main task of managers. A manager has 3 types of
strategic tools for it:
- increase of prices,
(The price of a product is optimal, if its volume
of sales multiplied by its price is maximal.)
- increase of sales volumes (if the prices and the
production growth are harmonised by the
marketing strategy), finally
- reduction of costs by rationalisation.
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Data of basic financial documents can help the
mapping of the profitability problems. E.g. one
can calculate the following indexes:
1. Return on capital employed (ROE) is the ratio
of net income per equity and shows the
effectiveness of the firm.
2. Return on assets (ROA) is the ratio of net
income per total assets and shows the return of
the assets.
3. Multiplication of properties (MP) is the ratio of
total assets per equity.
ROE = ROA * MP
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Financial situation of Hungarian firms
The main features are as follows:
• There is a capital shortage at about one third
of firms (first of all at some new SMEs).
• Many firms fight against cash flow problems
(first of all because of frequent late payments
or non-payments).
• Plans always have to count with the high
Hungarian inflation (but it can be forecasted –
figure).
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Source: Own figure
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If Hungary will be member of European
Monetary Union, it will improve the financial
situation of the Hungarian firms.
The Maastricht criteria in Hungary:
• inflation is higher than 3% (today 5,4%),
• Interest rate is higher than 3%,
• in 2010 current account balance is acceptable
(active with 344 million euros),
• Dept is higher than the 60% of the GDP,
• exchange rate is highly fluctuating.
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Without financial knowledge it is impossible to
work out a good strategy.
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Thank you for your attention!
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