Selecting Financial
Strategies
Selecting Financial
Strategies
Some ways to raise finance
InternalInternal ExternalExternal
Some ways to raise finance
InternalInternal ExternalExternalRetained profitsRetained profits
Working capitalWorking capital
Asset disposalsAsset disposals
Sale & leasebackSale & leaseback
Issue sharesIssue shares
Bank loan / overdraftBank loan / overdraft
DebenturesDebentures
Retained profits
The most important and significant source of
finance for an established, profitable
business
The most important and significant source of
finance for an established, profitable
business
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
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)
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
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
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
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!
Example of sale & lease back 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.
Issuing shares
Company issues new shares
Company issues new shares
11
Shareholders buy the new shares
Shareholders buy the new shares
22
Company has:More cash
More shareholders
Company has:More cash
More shareholders
33
Examples of issuing share rights Working lunch great visual example of
what share rights involve…
HSBC bank share rights issue
Methods of issuing shares for a plc
Flotation Share issued on Stock Exchange for the first time
Opportunity for existing shareholders to realise profits on their investment
Costly + time-consuming process
Aims to raise at least £25-50million + of new capital
Rights issue Fresh issue of new shares to existing shareholders
Shareholders have the “right” to subscribe for the new shares, usually at a significant discount to the existing share price
Share issues – benefits and drawbacks
Benefits Drawbacks
Able to raise substantial funds if the business has good prospects
Can be costly and time-consuming (particularly flotations)
Broader base of shareholders Existing shareholders’ holdings may be diluted
Equity rather than debt = lower risk finance structure
Equity has a cost of capital that is higher than debt
Raising Loan Capital
Bank overdraftBank overdraft
Bank loanBank loan
DebenturesDebenturesCovered in BUSS2
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
A debenture is a form of bond or long-term loan which is issued by the
company, usually with a fixed rate of interest
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
Cost Minimisation Strategies
Cost minimisation aims to achieve the most cost-effective
way of delivering goods and services to the require level of
quality
Cost minimisation aims to achieve the most cost-effective
way of delivering goods and services to the require level of
quality
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
Cost minimisation is a recurring theme
in BUSS3
What financial strategies has Ryanair taken to achieve its
objective of growth?What other factors have
influenced these strategies ?
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)
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
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)
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)
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)
Benefits and drawbacks of profit centres
Advantages Disadvantages
Useful insights into where profit is earned within a complex business
Can be time-consuming to both set-up and monitor
Supports budgetary control at a detailed level, including setting profit objectives
Difficulties in allocating costs (particularly) and revenues (occasionally)
Can improve motivation of those responsible for the profit centre
May lead to conflict and competition rather than cooperation within the business
Comparisons can be made between similar profit centres (e.g. shops in a chain)
Potentially de-motivating if profit centre targets are too tough, or if unfair cost allocations are made
Improves decision-making at a local level (likely to be closer to customer needs)
Profit centres may pursue their own objectives rather than those of the broader business
Finance can be allocated more efficiently – where it makes the best return
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)