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)