Borrowings - Strategic Management

One of the major issues to consider is the burden of interest which heavy borrowing will incur. In theory no money will be borrowed unless it earns more for the company than it costs. There are some problems here. First, the calculations must be made on expectations – which may be wrong, either through error or a change in the basic circumstances. Companies do not always make the profits they forecast. This is really a question of acceptable risks, which must be taken into account when the plan is prepared.

Second, to maintain a positive cash flow, the retained profits on the projects for which finance is required must be greater than the interest. Third, a project may be a good investment, but may not break even for several years. During this early period the interest burden – along with other unrecovered costs – must be paid from elsewhere. This is another indication of the need to have an overall financial plan since the total picture may alter conclusions which would be drawn from a study of individual projects. Cost is as important in considering borrowed finance as it is with equity. With borrowed funds there may be the added complication of having to choose between fixed and fluctuating rates, which requires an assessment of future interest levels before any sensible decision can be made.

Probably the most widely used source of short-term finance is the bank overdraft, which can often be the simplest and cheapest method of obtaining working capital. In times of credit squeeze this source may not be so readily available, and levels of overdraft previously negotiated may be reduced. One of the advantages of overdrafts is that levels can usually be negotiated in advance, but only taken up as required. Additional sources of finance are factoring debtors and discounting bills of exchange. The former may be an expensive and unpalatable solution. The latter is nowadays more likely to arise in companies with export business.

It is possible to obtain long-term loans from banks and finance houses of various types. In some countries there are government-backed development corporations designed to provide this type of credit. The stock market may be tapped through the issue of debentures, although success is likely to be dependent on both the standing of the company and the state of the money market. It must be remembered that debentures carry a fixed interest rate, which may present the company with a long-term disadvantage if an issue is floated at a time when interest is abnormally high. (This, of course, is a comment which applies to all fixed-interest loans.)Long-term finance needs may also be obtained from mortgaging existing property or taking out a mortgage to buy a new property.

In these cases the funds are likely to come from houses which specialise in this type of operation. A variation of using property to raise finance is sale and leaseback. This is venture capital and not a loan. Although it brings in an immediate capital sum it may be expensive (although not necessarily when looked at over the long term if in a situation of rising rents) and suffers from the further disadvantage that it reduces flexibility. Once sold in this fashion, the property is no longer available as specific or general security for other loans – and in a normal situation of rising property prices may remove from the company an asset which increases steadily in value. Medium-term credit can be obtained from most of the sources mentioned and in addition from leasing and hire purchase. Taxation implications must be considered in making the decision, since the effect of tax may change the real cost to the company.

The final financial strategy selected should be fully integrated and include provision for contingencies .A good financial plan is more than projection of the application and sources of funds statement. In addition, there are few companies whose strategic decisions in the area of finance are as simple as the factors so far discussed might suggest.One overriding strategic consideration is that the company should try to select its sources in a way that leaves it the utmost flexibility. This means, all other things being equal, that unsecured loans are preferable to secured loans, or that equity might be better than a loan which puts a charge over all the company’s assets.

This flexibility question also has implications in the next point. It pays to be right in the assessment of funds needed. Often it is simpler to raise one large sum than two smaller ones, and the costs of so doing are likely to be less. If the loan requires the mortgaging of property, it may be less easy to raise a second mortgage than to obtain the whole sum on a first mortgage – a smaller loan can take away as much flexibility as a large one. On the other hand, the raising of too much finance, of either equity or loan is expensive and strategically dangerous.

Financial strategy in multinational operations has added complications quite apart from the legal ones. Some international companies try to arrange finance so that subsidiaries remit as much money back to the centre as is possible, and the subsidiaries themselves operate on the largest local loans they can raise. This is not solely financial in its implications, and may impinge on operations: for instance, the ‘loading’ of raw material prices to get money back to the centre may make the subsidiary avoid certain operations which appear to be unprofitable in its own eyes, while the burden of interest payments may further decrease the company’s apparent earnings.

Certainly any multinational strategy must give consideration to national and international sources of funds, and one element which should be defined in the plan is the constraints which should be observed by subsidiary companies. The backing of the parent is often sufficient to enable the local subsidiary to obtain larger loans more easily than it would if it relied solely on its own assets. Equity stays with the company. Loans have to be paid back (although in practice certain types of loan finance may continue almost indefinitely). Provision must be made in the plan for any refunding operations which might be necessary over the period of the plan. In some cases the intention may be to pay back the loan: in others it may be to renegotiate for a further period.

A further aspect of the plan should cover financial public relations, which may be a helpful tool in giving the company credibility, and ensuring that it is known to the financial world and the investing public. Credibility will often hold up share prices when there is an off-trend drop in profits because the explanation given is accepted. It may help the company in driving off an attack from a would be acquirer or getting the terms of its own acquisition bids accepted.

No one should believe that financial public relations will have more than passing value unless the company is basically sound. A massive edifice cannot be erected in safety on crumbling foundations, and although a PR ‘front’ may prop things up for a short while, it will not last for long unless backed by facts and results. Although financial public relations may be a specialist area it cannot be separated from the general public relations activities of the company. It is not possible to present two different pictures of the company without both losing credibility.Financial plans may have to deal with surplus liquid funds as well as shortages.

Strategic changes and implications of too much cash have already been discussed. If surpluses do exist, it is up to financial management to make the best use of them, and this is a requirement whether the funds available are moderate or excessive. A well-prepared plan will aid this task in two ways. The projections of capital needs will reveal the changing amount of excess funds available and, therefore, the length of time for which financial management can afford to offer when investing, and sensitivity analysis will help the assessment of the risks in tying up cash in this way. Environmental assessments will enable investments to be made against the background of an appreciation of the money market, changing interest rates, and general economic conditions.


All rights reserved © 2018 Wisdom IT Services India Pvt. Ltd DMCA.com Protection Status

Strategic Management Topics