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What is a Strategic Financial Planning?
Strategic planning is borne out of the fact that all markets - capital, labor, and product are imperfect and hence they need effective measures to gain profitability. That is why strategies are made to manage business organizations in imperfect and changing markets. It is also believed that imperfections and changes in the markets provide opportunities that can be exploited by business firms financially.
In general strategic financial planning, managers are expected to perform the following two tasks −
Allocation of funds, and
Generation of funds
Allocation of funds is an investment decision, whereas generation of funds is a financial decision.
Financial theories make two assumptions in order to serve these tasks by financial managers.
The first assumption makes it clear that the aim of a firm is to maximize the wealth of its owners or shareholders. The assumption is based on the fact that shareholders provide the wealth for running the businesses. The managers only act on shareholders’ behalf. It is, therefore, implied that their decisions will increase the value of the shareholders’ wealth.
The second assumption is that the share markets are efficient. In an efficient share market, the information about shares is known to all. Moreover, there is no transaction cost for buying and selling the shares. In an efficient market, no shareholder can influence the market too.
Efficient share markets enable lending and borrowing effortless. This ultimately leads to investment and consumption.
Lending pushes the consumption to a later date, whereas borrowing brings it forward. The separation between investment and consumption is known as Fisher Separation Theorem. The theorem implies that financial decision-making can be delegated on behalf of shareholders by finance managers.
Therefore, from the corporate finance theory, we can make the following assumptions −
To increase the owner’s wealth
Owners have the primary interest in the organization and the most important aim of the managers of a company should be to increase the owner’s wealth.
Shareholders’ wealth equals to current value
Shareholders’ wealth is designated by the current value of the share.
Net present value increases the current value
Investments that offer positive net present value (NOV) should only be accepted by the managers. Positive net present value increases the current value of a company’s share.
NPVs of additional projects do not add value
Net present values of additional projects do not add value to shareholders’ wealth point of view. Therefore, they should not be intended.
In fact, additional projects should be avoided when the net present value is positive for a company.
Imperfections in Strategy
Dividend decisions and the capital structure of a company are important because of imperfections in the strategy.
Economics already postulates that labor markets and product markets are not perfect. Empirical studies have also shown that capital markets are not perfect in general. The finance professionals do not approve of the market imperfections, such as information gaps, transaction costs, agency costs, signaling effects, taxes, etc. However, all of the imperfections are discussed within a theoretical system that considers the hypothetical market theory to be true.
It is an important duty of financial experts to look at the business environments in which the companies operate to build a strategic plan to profit from the conditions. The experts need to forecast the future conditions and plan the allocation and generation of funds. Business organizations, therefore, take the help of strategic planning to sail through competitive business conditions and exploitative business environments with the help of strategic planning.
It is well-known to economists that a perfect market does not exist and all markets have some sort of imperfections that offer opportunities to business companies to derive profits from them. Business managers need to effectively plan their strategies to exploit the environments positively. It is equally important to keep an eye on the future of the markets in order to apply strategic planning in a systematic and exclusive manner.
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