Building a financial strategy at multiple levels

The Palmer Company, founded by brothers Mark and Andrew Palmer, is a supplier of church candles. It enjoys the power to make candles modeled on more than 50 church mascots. They have partnerships with a number of Asian producers who make candles for them at very low prices and ship them to the United States. The company did $50,000 in sales in its first year.

Yet the Palmers didn't plan for the future in depth. They just want the company to go public, issue stock to the public, and finally get out and sit back. However, sooner or later they will have to deal with factors such as financing (the company's survival will likely depend on its ability to raise enough money to support organizational growth or strategic acquisitions) and environmental factors (the brothers must realize that they may be large companies with broad distribution capabilities) and many other issues.

A sound financial strategy can help business owners like the Palmer Brothers handle these issues effectively.

Financial strategies vary by business size

There is more than one way to develop a financial strategy, they change as a business grows, and more complex for large, medium, small or newly established businesses, the strategy There is also a difference, and this difference depends on the democratic degree of management and the maturity level of the enterprise.

For small businesses and start-ups, the owner has multiple roles, managing operations, finance and sales as well as people and marketing. With few employees, owners tend to rely on intuition to make decisions. Because sound decision-making requires multi-dimensional consideration, a lack of financial expertise can put a business at risk.

Mid-sized companies are relatively stable than the above-mentioned companies, but because financial personnel are specialized in financial work, they are only good at statistical historical data in the financial field but are not sensitive to forward-looking.

For large corporations, such organizations have abundant resources dedicated to the financial arena. Under the leadership of experienced senior managers, organizations have the manpower and experience to deal with key issues. At the same time, special funds are set up to formulate financial policies and develop financial strategies to promote the prosperity of the company and ultimately enhance shareholder value.

The finance function therefore needs to evolve with the organization. Businesses are dynamic and the finance function must be flexible to respond quickly and accurately to environmental factors. Continuously updating, reviewing and evaluating the financial strategy is an effective way to control this innovation.

A Five-Level Approach to Building Financial Strategy

Regardless of size, companies must take a multi-level, multi-perspective approach to carefully crafting their financial strategy. This method is easy to understand in a pyramid-shaped diagram. The bottom layer is the basic matters related to the company structure and enterprise plan, and the more you go to the top, the more flexible the innovation. This multi-layered model serves two purposes: as a blueprint for the finance function and as a reference for developing and maintaining the company's overall strategy.

This model has five layers, each with different considerations: the first layer is about the life cycle; the second layer is about the financial data users; the third layer is the infrastructure; the fourth layer is the balance sheet; The fifth level is the income statement.

The first layer: to cooperate with the enterprise development cycle. In the first layer, in order to understand the life cycle more intuitively, no matter how far it is from the future, we can first imagine the exit of the company and all the factors that lead to this result (eg: equity investment, business resale, terminal liquidation Wait). An exit strategy is the end of the business life cycle. A good financial strategy links current operations, future exits, and turning points in between.

Business leaders must also periodically review the lifecycle by answering the following questions: Is a continuity plan in place? Is the expansion planned? Is it through internal growth or through external M&A? How much financial support is needed? Which financing channel is better? How big is the debt load? Do companies need to reposition themselves in other products and markets? and many more. The fundamental purpose of this is to establish a strict chronology of these significant events described above.

Tier 2: Timely delivery of financial information. Business leaders must make it clear that financial results are communicated to data users, and the data user base will expand as the company grows or receives third-party investment. The ability to provide the data that users need in a timely manner determines the success or failure of an enterprise. The financial function must recognize this and strike a balance to deliver accurate and timely information to meet user needs.

Tier 3: Define the financial infrastructure. Financial infrastructure must support decision making (for internal data users) and financial data investigation (for external data users). The financial infrastructure also evolves with the business.

Business leaders must therefore focus on three important areas: financial organization, information systems, and data flow processes. Financial organization refers to employees and their instruments of practice. This structure will evolve with the company. Ensuring that this development is controlled and thoughtful is a challenge for any business leader. If the financial organization is not needed until the time of crisis, management will miss the opportunity to develop. To minimize disruption during the collection and processing stages, and thus maximize analytics, businesses need to obtain data and classify records quickly and accurately. Doing these jobs will be more difficult as the business matures. After all, the optimal system and personnel mix must be established within reasonable budgetary control. Decisions about capital expenditures or staffing investments can also be made only after users' needs to use the data are understood.

Tier 4: Optimize the balance sheet. At the beginning of the life cycle, the owner of a small or newly established business is focused on survival and rapid growth. Therefore, optimizing the balance sheet is a must. After development, it needs to deal with capital management strategy (including assets and liabilities) and some other items that can show profitability. Business owners must become accustomed to balance sheet manipulation to ensure that the company is up to the challenge of future life-cycle milestones.

It is critical to manage three specific areas of the balance sheet: Accounts Receivable, Inventory and Accounts Payable.

Accounts Receivable: Will Customers Pay? If so, how long will it take? Enterprises need to know how long the enterprise can run smoothly if there is no payment from customers?

Inventory: Supply chain exports, purchase prices, production variables, etc. all affect inventory movements. What are the delivery conditions for the customer, are they flexible? Is their delivery time reasonable? Sound guidelines for designing inventory management and accounting operations can help control inventory and its impact on cash balances.

Accounts Payable: How quickly can the company pay? While in theory the faster the payment the better, in practice the company needs to hold on to the funds for as long as possible.

Tier 5: Profit and loss policies to stabilize operations. The business environment requires a financial strategy that both covers financial statements and facilitates stable operations. Stable operations depend on the fifth level of financial strategy: profit and loss policy. For example: if the small or newly established business is a capital raising type, then maximizing shareholder wealth (which can be achieved by keeping the stock price high) has a major priority. However, there is often a conflict between pleasing shareholders and solid foundations and steady development.

Understanding the income and expense items on the income statement and how they are organized in the course of business operations can lay a solid foundation for business analysis and decision-making, providing a first-mover advantage.

A benefit item is divided into two parts: a record item and an action item. The record item is the strict confirmation and recording of income, which is especially sensitive for listed companies or financiers. Action items are the practical part of a revenue policy.

Since reserve capital is especially important in the early days of a business, it is also important to be clear about expenses and their purpose. What are the types of expenses? Is it a capital expenditure for furniture or computer equipment? Or wages or regular fees for utilities? Unlike earnings, spending factors and strategies often stem from expense matters. A sound spending strategy takes into account cash flow, working capital, and revenue and expenditure and expectations.

Just as no two eggs are alike, every business is unique. Today's fast-paced business environment makes developing strategy at any level a challenge. A multi-level model enables the development of financial strategies to be sequenced and well-structured. The overall goal of this model is to create a flexible decision-making mechanism to anticipate and influence changes when and where necessary. Mastering this model will spawn a strategic culture in the organization.

Originally reprinted with permission from Growth and Profitability: Optimizing the Finance Function for Small and Emerging Businesses by Michael C. Donegan, published by John Wiley and Sons, Inc., 2002 copyright. Translated by Wang Qiwen.