Pathways Plus Strategic Management and Leadership

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1 Pathways Plus Strategic Management and Leadership Level 7 Unit 7007 Financial planning

2 Pathways Plus Unit 7007: Financial planning Copyright Chartered Management Institute, Management House, Cottingham Road, Corby, Northants NN17 1TT. First edition 2009 Authors: Consultant: Series consultant: Project manager: Editor: Page layout by: Jane Walker and Bill Snaith, Durham Business School Bob Croson Roger Merritt Associates Trevor Weston Suzanne Pattinson Decent Typesetting British Library Cataloguing-in-Publication Data. A CIP catalogue record for this publication is available from the British Library. ISBN All rights reserved, save as set out below. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the written permission of the copyright holder except in accordance with the provisions of the Copyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London, England WIT 4LP. Applications for the copyright holder s written permission to reproduce any part of this publication should be addressed to the publisher. Permissions may be sought directly from the Chartered Management Institute in Corby, UK. Phone Publications on (+44) (0) , or publications@managers.org.uk. This publication is sold subject to the condition that it shall not, by way of trade or otherwise, be lent, re-sold, hired out, or otherwise circulated without the publisher s prior consent in any form of binding or cover other than that in which it is published and without a similar condition being imposed on the subsequent purchaser. Approved centres may purchase a licence from the publisher, enabling PDF files of the publication to be printed or otherwise distributed solely within the centre for teacher and student use only according to the terms and conditions of the licence. Further information is available on the licence from the Chartered Management Institute. Phone (+44) (0) , or publications@managers.org.uk. Every effort has been made to trace holders of copyright material reproduced here. In cases where this has been unsuccessful or if any have inadvertently been overlooked, the publishers will be pleased to address this at the first opportunity. The publisher would like to thank the following for permission to reproduce copyright material: Bank of England for Figure 3.2a on p.128, Interest rate mechanism to control inflation ( Berr.gov.uk for Figure 3.1b on p.123, Monthly lending characteristics April 2006 March 2008 BMA Inc. for Figure 3.2c on p.48, Value stream costing The Centre for Management Buy-out Research/Barclays Private Equity for Figure 3.5a on p.94, Management Buy-outs and Buy-ins from Management Buy-Outs Past Achievements, Future Challenges. The publishers of the Harvard Business Review for Figure 2.3a on p.34, New product development risk from Day (1997); the table on p.36 from O Meara (1961); Figure 2.3c on p.36, Innovation and profitability from Moore (2004); Figure 1.3a on p.68, Annual budgeting and actual financial performance from Mankins & Steel (2005). The publishers of the Journal of Business Chemistry for Figure 2.2 on p.33, Two-by-two matrix from Feldmeier and Kienert (2008). This figure is based on a diagram from Kajüter (2002). 2

3 Pearson Education for Fig 2.1a, The product life cycle, on p. 26 and Fig 1.1b, Strategic and operational control, on p.62 (from Slack, Chambers and Johnston, Operations Management, Prentice Hall) and for Fig 2.4a, Cost allocation in activity-based costing on p40, Fig 3.2a, Total life cycle costing on p.45, Fig1.2a, Measuring cashflow, on p101 and Fig 1.3a, SVA and EVA approaches, on p103 (from Atrill, P. and McLaney, E., Management Accounting for Decision Makers, Prentice Hall, 2007). Cengage Learning for Fig 3.1a, Sources of government revenue, projections, on p.122 (from Society for Advancement of Management (SAM) Inc for Fig 3.3b, A supplier s view of ABC, on p.50 and Fig 3.3c, A customer s view of ABC, on p.51 from Evaluating Internal Operations and Supply Chain Performance Using EVA and ABC, by Terrance L, Pohlen and B. Jay Coleman, SAM Advanced Management Journal, p.49 and p.51, Vol 70, No. 2, Spring 2005 Tribune Media Services for Fig 2.3b, Familiarity Matrix on p.35 and Fig 3.1a Familiarity Matrix on p.86 from MIT Sloan Management Review, Entering New Businesses: Selecting Strategies for Success, Roberts E. B., and Berry C. A., 1985 by Massachusetts Institute of Technology. All rights reserved. Distributed by Tribune Media Services John Wiley & Sons Ltd for Fig 1.1c, Finance and the Strategic Process, on p.64 from JSC/Strategic Change, Grundy T., 13 (2004), Strategy and financial management in the football industry, pp reproduced with permission of John Wiley & Sons Ltd. 3

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5 Contents About Pathways Plus...7 Introduction Section 1 Strategic models and their financial impact Topic 1: Market-focused strategic models Market and product entry strategies Financial impact of strategic focus Customer profitability and the financial strategy Topic 2: Product or service-focused strategic models Financial implications of the product life cycle A balanced portfolio and its financial impact The financial impact on new product development Selecting profitable products Topic 3: Core competence-focused models Competences and capabilities Lean management and finance ABC and building the supply chain competence Make or buy decisions and the value chain Core competence and competitive power Section summary Section 2 Funding and investment Topic 1: Linking financial and strategic plans Strategic and operational plans and budgets The financial perspective for the overall strategy Where financial plans go wrong Topic 2: Funding the strategic plan Funding requirements Internal funding

6 2.3 External funding Gearing Topic 3: Investment opportunities Funding and the business life cycle Joint ventures Mergers and acquisitions Takeovers Management buy-outs and buy-ins Section summary...97 Section 3 Risk, economics and money markets Topic 1: Maximising shareholder wealth Residual income Shareholder value added Economic value added The profit impact of market strategy The marketable value of shares Topic 2: The impact of risk Types of risk Strategies to manage risk Managing the risk of global expansion Topic 3: The impact of the external environment Political interventions in funding and risk Economic implications in finance, funding and risk Section summary Further reading Before you move on Preparing for assessment The Management and Leadership Standards

7 About Pathways Plus Development guides There are 12 development guides in the Pathways Plus series to cover the 14 units of the qualifications at CMI Level 7: Strategic Management and Leadership Personal development as a strategic manager (ISBN: ) 7002 Strategic performance management (ISBN: ) 7003 Financial management (ISBN: ) 7004 Strategic information management (ISBN: ) 7005 Conducting a strategic management project (ISBN: X) 7006/ Organisational direction and strategic planning 7011 (ISBN: ) 7007 Financial planning (ISBN: ) 7008 Strategic marketing (ISBN: ) 7009 Strategic project management (ISBN: ) 7010 Organisational change (ISBN: ) 7012 Human resource planning (ISBN: ) 7013/ Being a strategic leader and strategic leadership practice 7014 (ISBN: ) For further details on the development guides: Phone: (+44) (0) Fax: (+44) (0) publications@managers.org.uk 7

8 Financial planning Qualification structure There are three qualifications available: CMI Level 7 Award in Strategic Management and Leadership Candidates need to complete any combination of units to a minimum of 6 credits to achieve the qualification. CMI Level 7 Certificate in Strategic Management and Leadership Candidates need to complete any combination of units to a minimum of 13 credits to achieve the qualification. CMI Level 7 Diploma in Strategic Management and Leadership Candidates need to complete all core units (Group A) and three optional units (Group B) to a total of at least 66 credits to achieve the qualification. Units Group A Unit 7001 Personal development as a strategic manager Credit Unit 7002 Strategic performance management 7 Unit 7003 Financial management 7 Unit 7004 Strategic information management 9 Unit 7005 Conducting a strategic management project 10 Unit 7006 Organisational direction 9 Group B Unit 7007 Financial planning 6 Unit 7008 Strategic marketing 6 Unit 7009 Strategic project management 6 Unit 7010 Organisational change 7 Unit 7011 Strategic planning 9 Unit 7012 Human resource planning 8 Unit 7013 Being a strategic leader 7 Unit 7014 Strategic leadership practice 7 6 8

9 About Pathways Plus SR How to use the development guides The development guides provide a critical commentary to the ideas of writers and thinkers in the management and leadership field. They offer opportunities for you to investigate and apply these ideas within your working environment and job role. Structure Each guide is divided into sections that together cover the knowledge and understanding required for the equivalent unit or units of the Chartered Management Institute Level 7 Strategic Management and Leadership qualifications. Each section starts with a clear set of objectives linked to the learning outcomes of the qualification. You don t have to complete the sections in the order they appear in the guide (the mind map at the beginning of each guide will help you decide which sections and topics are of particular need or interest) but you should try to cover all sections if you are aiming for a full diploma qualification. Activities Throughout the guides there are activities for you to complete. These activities are designed to help you reflect on your own situation and apply your research to your organisation. Space and tables are provided within the activities for you to enter your own thoughts or findings, but in some cases you may choose to copy out the table or make notes in a separate notebook. Timings Timings are suggested for each activity to give you a rough idea of how long you should devote to them. They re not hard and fast and you must decide whether you will benefit from spending longer on some activities than stated. Supporting resources The text of the guides is designed to provide you with an introduction to the subject and a commentary on some of the key issues, models and thinkers in the field. The activities are there to help provide a framework for your thinking. A key component of Pathways Plus (Pathways Plus because the development guides work together with the online supporting resources to provide an overall learning journey) is the list of references given throughout the text and at the end of each topic guiding you to the most appropriate supporting resources for you to explore yourself. These are marked with the symbol SR (as shown above). You have the opportunity to select those resources that are of most interest or relevance to you and to use them as a source of guided research on a particular topic. Many of the supporting resources are immediately available by logging into CMI s online 9

10 Financial planning P+ Student Resource Centre (SRC) or the CMI online management and leadership portal, ManagementDirect(MDir), whichever you have access to. These resources are marked in the reference list at the end of each topic with P+ standing for Pathways Plus. A button on the first page of the site (whether SRC or MDir) will take you straight to the list of supporting resources as listed in the Pathways Plus topics. When there, click on the title of your development guide, the section and the topic you re interested in and then click straight to the article, video, podcast, checklist, extract or report that you want to find. For those resources that are not available through the CMI site, you will be directed to other sources (some also online) to reach what you need. Preparing for assessment Further information on assessment is available in the Student Guide produced as part of the Pathways Plus series. If you have any further questions about assessment procedures, it s important that you resolve these with your tutor or centre coordinator as soon as possible. Further reading You will find suggestions for further reading at the end of this guide as well as in the Student Resource Centre section of the Institute website at Alternatively, mic.enquiries@managers.org.uk or telephone

11 Introduction Welcome to this development guide on financial management. We suggest that you approach this guide with the following thoughts: Financial planning is not a stand-alone process but part of the strategic and business planning processes. These processes are likely to be iterative as the organisation seeks to achieve its best commercial balance, of which finance is only one aspect. Short-term revenue-based planning is dealt with in Development Guide 7003 Financial management and this guide builds on that with a focus on longer-term planning. (It s assumed that you ve already studied Development Guide 7003 as you obviously have an interest in finance.) The guide is split into three sections. Section 1 looks at the link between financial planning and an organisation s strategic planning process. Section 2 is about planning, funding and investment issues and will help you develop a more detailed financial analysis of the chosen strategy. Section 3 is about risk and the impact of economics and money markets the uncontrollable elements that may impact on even the best analysed strategy. Development guide mind map Section 2: Funding and investment Section 1: Strategic models and their financial impact Assessment Financial planning Section 3: Risk, economics and money markets If you re studying for the Level 7 in Strategic Management and Leadership qualifications you will be assessed by your approved centre on your knowledge and understanding of the following learning outcomes: 11

12 Financial planning Unit 7007: 1 Understand how the financial plan supports strategic objectives 2 Understand the component parts of a financial plan 3 Understand how to promote the financial plan in support of strategic objectives 12

13 Section 1 Strategic models and their financial impact Introduction Strategy can t be separated from finance and finance can t be separated from strategy. Whatever an organisation plans to do in the longer term has to result in either more profit or a better use of financial resources. So in this section you ll be looking at: how the strategy of an organisation impacts on the financial plan how the financial plan impacts on and supports the strategy how these links can be incorporated in the financial plan the framework of strategic models and choices the organisation can make, and the varying impacts on financial plans. Using a systematic approach you ll look at different types of strategic models and set them within a financial framework. You ll also think about the financial systems and information that you may need to monitor performance against strategy. The financial framework requires you to consider the impact of your strategic analysis against the following nine figures that will later need to appear in the financial planning section of your strategic plan: income direct costs (Examining these two elements will help you consider the impact of your strategy on your gross profit.) indirect costs (including bank interest) (You will be able to consider the impact of your strategy on your net profit.) stock/inventory debtors/accounts receivable creditors/accounts payable (You will be able to consider the impact of your strategy on your working capital.) operating cashflow a balance between the additional profit from your strategy and the amount you ll need to invest in the working capital capital investment funding. (You ll now be able to look at the impact of your strategy on your capital structure.) 13

14 Financial planning 1.1 Market and product entry strategies 1.2 Financial impact of strategic focus 3.1 Competences and capabilities For a more detailed examination of each of these financial figures refer to Development Guide 7003 Financial management. Your financial team will translate these into the required financial statements, but as a strategic leader and manager you need to have an appreciation of financial impact and how these can be interrelated. Learning outcomes This section addresses the following learning outcomes: Understand how the financial plan supports strategic objectives Understand the component parts of a financial plan Understand how to promote the financial plan in support of strategic objectives Section mind map There are three topics in this section as shown below. Check the subjects within each one and then continue with the areas you need to explore. 1.3 Customer profitability and the financial strategy Section 1: Strategic models and their financial impact Topic 1: Marketfocused strategic models Topic 3: Core competencefocused models 2.1 Financial implications of the product life cycle Topic 2: Product or service-focused strategic models 2.2 A balanced portfolio and its financial impact 2.4 Selecting profitable products 2.3 The financial impact on new product development 3.2 Lean management and finance 3.3 ABC and building the supply chain competence 3.4 Make or buy decisions and the value chain 3.5 Core competence and competitive power 14

15 Section 1 TStrategic models and their financial impacttt Topic 1: Market-focused strategic models Introduction Most organisations use a number of strategic tools to arrive at their chosen strategy. In this topic you ll look at a number of core traditional strategies and analyse them from a financial standpoint. In any one plan you may not have used them all, but as a strategic manager you should have the ability to do so in the right circumstances. It s suggested that you use a financial framework to appreciate where the impact is going to be made financially. This will then input into the strategic choice process, and the chosen strategy will result from a more detailed financial analysis than one only using normal budgeting and business planning techniques. The Ansoff matrix financial framework is used as an example in this topic as well as in Topic Market and product entry strategies SR 16, 13, 1 Ansoff s matrix model illustrates four alternative strategies in relation to markets and products or services. Products Existing New Fig 1.1a: Ansoff s matrix Existing Market Share Product Development Markets New Market Development Diversification The diversification options are many and varied, ranging from a combination of market and product development to the acquisition of a new business in a different industry sector. The diversification option is therefore omitted from the following table. 15