Selecting Financial Strategies

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Selecting Financial Strategies
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Some ways to raise finance
Internal
External
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Some ways to raise finance
Internal
External
Retained profits
Issue shares
Working capital
Bank loan / overdraft
Asset disposals
Debentures
Sale leaseback
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Retained profits
The most important and significant source of
finance for an established, profitable business
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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

Mrs Gordons additions
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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)

Mrs Gordons additions
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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

Mrs Gordons additions
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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

Mrs Gordons additions
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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

Mrs Gordons additions
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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!

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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.

Mrs Gordons additions
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Issuing shares
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3
Company issues new shares
Company has More cash More shareholders
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Shareholders buy the new shares
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Examples of issuing share rights

• Working lunch great visual example of what share
  rights involve
• HSBC bank share rights issue

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Methods of issuing shares for a plc
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Share issues benefits and drawbacks
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Raising Loan Capital
Bank overdraft
Bank loan
Debentures
Covered in BUSS2
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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
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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

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

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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

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Your go
Mrs Gordons additions
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Textbook p 55

• Sainsburys - mini activity
• VW - mini activity Q 12

Mrs Gordons additions
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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)
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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)

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Benefits and drawbacks of profit centres
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Plenary Qs

• 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 todays 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)

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Hwk

• Textbook read info on Profit centres p56 to
  58
• Make key revision notes
• What is a profit centre?
• Benefits limitations of profit centres.
• Implications of profit centres.