A business that maximizes its owners’ wealth allocates its resources

A business that maximizes its owners’ wealth allocates its resources

efficiently, resulting in an efficient allocation of resources for society as a whole. Owners, employees, customers, and anyone else who has a stake in the business enterprise are all better off when its managers make decisions that maximize the value of the firm.

Just as there may be alternative routes to a destination, there may be alternative ways to maximize owners’ wealth. A strategy is a sense of how to reach an objective such as maximizing wealth. And just as some routes may get you where you are going faster, some strategies may be better than others.

Suppose a firm has decided it has an advantage over its competitors in marketing and distributing its products in the global market. The firm’s strategy may be to expand into European market, followed by an expansion into the Asian market. Once the firm has its strategy, it needs

a plan, in particular the strategic plan, which is the set of actions the firm intends to use to follow its strategy. The investment opportunities that enable the firm to follow its strat- egy comprise the firm’s investment strategy. The firm may pursue its strategy of expanding into European and Asian markets by either estab- lishing itself or acquiring businesses already in these markets. This is where capital budgeting analysis comes in: We evaluate the possible investment opportunities to see which ones, if any, provide a return greater than necessary for the investment’s risk. And let’s not forget the investment in working capital, the resources the firm needs to support its day-to-day operations.

Suppose as a result of evaluating whether to establish or acquire businesses, our firm decides it is better—in terms of maximizing the value of the firm—to acquire selected European businesses. The next

SELECTED TOPICS IN FINANCIAL MANAGEMENT

step is to figure out how it is going to pay for these acquisitions. The financial managers must make sure that the firm has sufficient funds to meet its operating needs, as well as its investment needs. This is where the firm’s financing strategy enters the picture. Where should the funds needed come from? What is the precise timing of the needs for funds? To answer these questions, working capital management (in particular, short-term financing) and the capital structure decision (the mix of long- term sources of financing) enters the picture.

When managers look at the firm’s investment decisions and consider how to finance them, they are budgeting. Budgeting is mapping out the sources and uses of funds for future periods. Budgeting requires both economic analysis (including forecasting) and accounting. Economic analysis includes both marketing and production analysis to develop forecasts of future sales and costs. Accounting techniques are used as a measurement device: but instead of using accounting to summarize what has happened (its common use), in budgeting firms use accounting to represent what we expect to happen in the future. The process is sum- marized in Exhibit 29.1

EXHIBIT 29.1 The Firm’s Planning Process

Define the objective:

Maximize owner wealth

Develop a strategy and a strategic plan:

Define comparative and competitive advantages

Develop the investment

Develop the financing strategy:

Develop budgets:

Coordinate the

strategy:

Identify the needs for evaluate investment

Identify and

investment plan needs

financing and the opportunities

with the financing plan

means of financing

Evaluate performance:

Post-auditing, compare results with plans

Strategy and Financial Planning

Once these plans are put into effect, they must compare what hap- pens with what was planned. This is referred to as post-auditing, which firms use to:

■ evaluate the performance of management, ■ analyze any deviations of actual results from planned results, and ■ evaluate the planning process to determine just how good it is.