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Financial Strategy Week 2
Corporate Financial Strategy Chapter 4- Linking Corporate and Financial Strategies
Business risk: inherent risk associated with both the underlying nature of the particular business
and the specific company strategy which is being implemented
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Business risk relates to all of the risk a company faces, other than those relating directly to
financing decisions
o Deals with volatility of operating cash flows
Financing risk is about debt/equity mix
Debt and equity have different risk profiles for investor and company, and their use has to
be balanced to meet the company’s particular circumstances
o Company with high business risk should not adopt high financial risk
Once a business risk is analysed, the company’s financial strategy should be designed to
complement it to enhance SH value
Company-specific risks are irrelevant in a diversified investment portfolio- all that matters is
correlation with markets
Where sales-costs=profits, identifying what affects each element helps examine operating
results e
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what effects sales (selling price etc)

Strategic Analysis
Porter’s 5 Forces
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5 forces which drive industrial competition
o Relative bargaining power of buyers, that of suppliers, threat of new entrants, threat
of substitute products, degree of rivalry among existing firms in the industry
Strengths of these forces indicate attractiveness of an industry to a particular player and
suggest where they may wish to compete

Pestle Analysis
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Attempting to understand how changes will affect company’s competitive position
Considers PESTLE factors and how they will affect the company’s industry
Suggested to draw up five forces analysis and see how PESTLE factors will impact analysis

Resource-Based Theory
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Suggests competitive advantage lies in company’s set of unique assets e
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what it is good at
Any assets which an organisation has which contributes to competitive advantage must have
VRIN characteristics
o Valuable, Rare, Inimitable and Non-substitutable
An assessment of business risk should consider these assets and identify what needs to be
done to preserve & enhance them

 A business strategy is derived from analysis of external forces (Porter model/ PESTLE) and of
the company’s internal resources and capabilities (VRIN)
 Should also link to drive value in the business using the 7 drivers of value (see CH1)
 Value created is also a function of management ability- implementation is key
 SH value is dependent on market itself- price rarely reflects fundamental value
Business risk represents the risks to the company’s operating results
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A company will use its asset base to generate profits- which will be paid to SH’s and retained
for future growth
Level of profits depends on operating efficiency
o Ultimate profit available to SH’s depends on interest burden company carries
Directors have 3 decisions for their financial strategy:
o How large do we need asset base to be?
o How much of the company’s finance should be as debt?
o How much of the profit should be paid out as dividends?
Can issue new equity to reach target debt-equity ratio (so it can take on more debt)

Features for user (company)

Features for provider (investor)

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Debt
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Interest must be paid
Repayments must be
paid
 Lender may have the
right to repossess
assets
HIGH RISK
 Interest is contractual
 Repayment is
contractual
 Lender may obtain
security against assets
LOW RISK

Equity
 Can choose whether to
pay dividends
 No repayment
obligation
LOW RISK
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Dividends are at
discretion of company
 No requirement to
repay the capital
HIGH RISK

Very high business risk enterprises should be funded with equity- which investors know is
potentially at risk
o Therefore high business risk should be paired with low financial risk
Funding only regarded as ‘true’ debt if there is an alternative way out e
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guarantor
In general, business risk tends to reduce as companies mature and become well-established
o Cash flow becomes heavily positive, unlike at launch and growth stage
Low business risk combined with low financial risk can lead to unsatisfied SH’s and be
attractive for a hostile takeover bid as it leads to company being undervalued by capital
markets

Product life cycle (S Curve)
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Biggest problem is that it is easier to use this technique to explain why sales moved as they
did (ex-post analysis) than it is to predict
Focuses on level of sales over the life cycle, also plotting profits and cash flows against it
Launch stage- profit and cash flows negative
Growth stage- big increase in sales, profits positive and cash flows almost positive
Maturity stage- supply and demand more in balance- stable profits, CF and sales
Decline stage- demand for product reduces so sales, CF and profits decline
Product life cycle highlights changes in market share for competitors in any industry
Can apply Boston matrix (BCG)

High
Low

Market Growth

Boston Matrix
STAR
Cash inflow: sales- high
Cash outflow: marketing, fixed assets,
working capital- high
Net cash flow: ? (starts negative,
becoming neutral or positive)
Business risk high, financial risk lowequity (growth investors)
Nominal dividend payout ratio
High P/E
SP growing & volatile
CASH COW
Cash inflow: sales- high
Cash outflow: ongoing cost base- low
Net cash flow: positive
Business risk medium, financial risk
medium- debt and equity (retained
earnings)
High dividend payout ratio
Medium/low P/E
SP stable & limited volatility

QUESTION MARK
Cash inflows: sales- low
Cash outflows: R&D, launch
marketing, fixed assets- high
Net cash flow: negative
Business risk very high, financial risk
very low- equity (venture capital)
Nil dividend payout ratio
Very high P/E
SP growing & highly volatile
DOG
Cash inflow: sales- low
Cash outflow: maintenance- low
Net cash flow: neutral (starts positive,
becoming neutral)
Business risk low, financial risk highdebt
Total dividend payout ratio
Low P/E
SP declining & volatile

Market Share
High
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Low

Cash cows fund new projects (question marks) as they generate more cash
Can be linked to product life cycle- Question mark=launch, Star= growth, Cash cow=
maturity, Dog= decline

Debt profile
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How much should be ST and how much LT?
o Depends on business, assets & structure of operations
o Should match LT assets with LT finance & vice versa
o Additional inventories funded ST e
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overdraft
o If company has permanent WC this is LT needs

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Advantage of LT over ST debt is that once loan is agreed, company can be confident it will
not be taken away
ST debt needs to be refinanced at regular intervals
Through diversification, investors can avoid risk and create their own risk portfolio
Many companies regard diversification as a risk reduction exercise
Volatility is a good indicator of risk in assessing any financial investment, as a ‘guaranteed’
level of return represents a low risk to the investor
o If a company diversifies into launch and growth products, the associated risk will
increase from the perception of the investor- increased return demanded



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