- AuthorMarshall Hargrave
Marshall Hargrave is a former Securities & Exchange Commission (SEC)-registered investment advisor with over 10 years of experience writing about corporate governance, personal finance, and investing. Marshall graduated from Appalachian State University with a Bachelor’s degree in Finance. He holds a Series 65 license and is a Chartered Financial Analyst (CFA) level 2 candidate.
View bio - InstructorTammy Galloway
Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.
View bio
Understand financial strategy for business. Learn about financial investments and strategic financial planning. Analyze a variety of financial strategy examples.Updated: 11/21/2023
Table of Contents
- What Is Financial Strategy?
- Financial Strategies for Business: Debt
- Financial Strategies for Business: Equity
- Financial Strategies for Business: Investment
- Lesson Summary
Frequently Asked Questions
Why is investment superior to holding cash?
Investing is better than simply holding cash because investments, such as stocks or bonds, offer higher rates of returns than checking or savings accounts. Inflation can also negatively affect cash savings.
What are the two ways to finance an organization's assets?
There are two key ways that businesses finance their assets: debt and equity. Debt can include loans or bonds, while equity is raised by offering shares.
What is meant by financial strategy?
Financial strategy is how a company will meet its short- and long-term goals to stay financially viable. Financial strategies include financial planning, budgeting and assessing costs and resources.
Table of Contents
- What Is Financial Strategy?
- Financial Strategies for Business: Debt
- Financial Strategies for Business: Equity
- Financial Strategies for Business: Investment
- Lesson Summary
Financial strategy is how a company plans to reach its short- and long-term goals. A company's financial strategy contains three major components: financing, investing, and dividends.
There are two key types of financial instruments used for financing: debt and equity. These are used to finance such things as a company's assets and operations. Another key part of a company's financial strategy is its investments. The company will actively invest accumulated cash as part of a sound financial strategy. Investing is a strategy a company uses to make money, such as collecting stock dividends or bond interest payments as profits.
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A company may use debt as a strategy for reaching its financial goals. There are two key forms of debt that a company can use: loans and bonds.
Loans
Loans are taken from banks or financial institutions and must be repaid in monthly payments over several years. However, the ability to get a loan is predicated on a few things, including a company's financial health and credit rating. There are key advantages and disadvantages to loans.
Advantages of Loans:
The advantages of loans may include the ability to boost a company's credit rating. Taking out loans also means a company can keep its cash to be used for investments.
- Can increase credit rating with on-time payments
- Do not have to use cash or investments
Disadvantages of Loans:
Loans do come with disadvantages, however. Loans, as contractual arrangements and agreements, must be repaid. If the company refuses to repay the loan, the creditor, or creditors, can enforce repayment.
- They are contractual arrangements
- Creditors have a legal stance in enforcing repayment
Bonds
Bonds are comparable to loans in that they are debt and must be repaid. A company will sell bonds and receive money from investors. The bonds will be paid in full at a time in the future. In the meantime, the company will make periodic interest payments to investors.
Advantages of Bonds:
Bonds come with advantages, including the ability to delay large repayments. Loans often require repayment to start almost immediately. Bonds delay repayments for years, even though interest payments are due monthly or semi-annually.
- Repayments are delayed because they have longer terms than loans
- Lower interest than debt
Disadvantages of Bonds:
On the downside, bonds are contractual obligations and require repayment at some point. If unpaid, creditors can enforce repayments. Bonds can also require a higher interest rate compared to debt.
- Like loans, these are contractual obligations
- Higher interest rates compared to debt
Example of Using Bonds as a Financial Strategy
Companies will still issue bonds despite the disadvantages. Bonds are more versatile than loans for businesses that seek greater flexibility.
When a business seeks financing for the purchase of a new location, for example, a bank might make them an offer for a loan with a five-year term and an interest rate of 6%. The company will then work with financial advisors to put together a bond offering.
The bond offering has an interest rate of 8%, but maturity is not until 10 years. In the meantime, the company only has to make semi-annual interest payments. The requirements are less stringent than the debt offering. The company ultimately decides on bond financing because it can get a longer-term repayment and more flexibility compared to a loan.
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Issuing equity is another key way for a company to finance its strategies. Equity is the issuance of stock. Investors will buy the company's stock, and the company will receive cash to finance assets or operations.
Advantages of Using Stocks in a Financial Strategy
Stocks can pay dividends. From a company perspective, dividends are not required or guaranteed. Dividends are the investor's profit from a stock and are a percentage of earnings paid to investors. However, a company has no obligation to pay or continue paying dividends.
Equity allows a company to raise money without having to repay it. There are no contractual obligations and no required payments.
Disadvantages of Using Stocks in a Financial Strategy
Issuing stock comes with disadvantages as well. This includes the pressure to pay dividends. Dividends, again, are not required to be paid, but if a company pays a dividend, investors expect those dividends to continue. They may also come to expect that past increases in dividend payments will continue.
Another disadvantage to the company could be the lack of demand to purchase the stock. By using equity, a company has to give up some of its ownership.
Examples of Issuing Stock as Part of a Financial Strategy
The company issues stocks instead of bonds to preserve and boost its cash flow. Issuing equity does not require repayment; thus, the company can take the proceeds from the equity issuance and invest without worrying about loan payments.
Alternatively, a company might choose to issue a mixture of debt and equity. Finding the optimal capital structure can allow the company to get the best of both worlds and reduce its cost of capital.
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The third financial strategy for businesses involves investments. This is how the company invests its money. Holding cash is a poor investment strategy for a company. This is because a company can invest in stocks and bonds and get a higher rate of return than cash held in a checking account.
Just as individuals invest in companies by purchasing stocks, companies also invest in other companies. A business may invest in other companies for the benefit of dividend payments and a rising stock price on their investments. Companies can also invest in bonds, such as an insurance company that collects cash premiums and invests them profitably. The insurer can invest in the stocks and bonds of other companies, since the money collected from policyholders is not paid out in claims immediately.
Companies, like individual investors, seek a profit through dividends, stock price increases, and bond interest when they invest in other companies.
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Financial strategy is how a company will meet its short- and long-term goals for financial viability. A company can finance its assets with debt, equity, or a combination of both. Dividends, which are a percentage of a company's earnings paid to stock investors, are an investor's profit from a stock. Dividends are neither guaranteed nor required. The belief that "cash is a poor investment" involves the notion that investment vehicles, such as stocks and bonds, always pay more interest than cash in checking accounts.
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Financial Strategy in Accounting
Molly, a certified public accountant with a Chartered Global Management Accountant (CGMA) certification, is facilitating a class for students wishing to follow her success. She starts by telling them that the CGMA certification has over 37 topics, but they will focus on financial strategy today. Financial strategy outlines an organization's financial short and long-term goals.
For the rest of this lesson, we will follow along as Molly explores the three components of financial strategy: financing, investment and dividends.
Financing
Molly asks the students to identify two ways an organization finances assets. One student mentions 'debt' while another states 'equity.' Molly affirms and explains that debt falls into two categories: obtaining a loan or selling bonds. Organizations can seek a loan from financial institutions, which is dependent on their credit rating and the health of their financial statements. The benefits of financing assets with a loan include increased credit rating if payments are paid on time and retaining cash. Drawbacks include the loan's interest payments and having a contractual arrangement, which means creditors have legal stance to enforce the contract.
Bonds are similar to a loan, whereby an organization receives money from investors with a promise to repay sometime in the future. The organization pays interest to the investor and the partnership represents a contractual arrangement, which are disadvantages to the organization. A benefit of selling bonds is the delay in repayment, which can have a longer term than a loan, sometimes extending 20 to 30 years.
Next Molly explains that financing with equity includes selling stock. When investors purchase stock, the organization receives cash to finance their assets. She groups students and asks them to identify the advantages and disadvantages of selling stock. One group states that there is no guarantee of dividends (a percentage of the company's earnings) or increase in the stock price. However, a disadvantage includes a lack of demand to purchase the stock.
One student raises her hand and wonders if organizations can use both debt and equity to finance assets. Molly says, 'absolutely, but they must find the most optimal mixture.'
Now let's explore investments.
Investments
Just as individuals invest in organizations, organizations invest in each other, buying stocks and bonds. Molly posts the following statement on the board: 'Cash is a bad investment!' She asks students to explain. One student states that cash in a bank account receives little interest, while stocks, bonds and other investment vehicles provide higher interest rates. Molly agrees and provides an example of an insurance company who invests cash premiums, since the monies are not paid out in claims immediately. Just like individuals investing in stock, investors expect monies in the form of dividends and/or an increase in stock price. Additionally, they require interest payments for their investment in bonds.
Next, let's look at dividends.
Dividends
Finally, Molly tells her students that when investors purchase stocks they expect two things: an increase in the stock price and dividends. Dividends are monies from an organization's earnings paid to investors in return for their investment in stock. As mentioned earlier, dividends are not guaranteed; however, they are expected. Dividends are usually paid quarterly and can be automatically reinvested based on the investor's preference.
Molly asks the class if they have any questions, then thanks them for participating.
Lesson Summary
Financial strategy outlines an organization's financial short and long-term goals. There are three main components of a organization's financial strategy: financing, investment and dividends. Financing involves determining if using debt, equity or a mixture of both is advantageous for purchasing assets. Investment focuses on making a profit, where stock dividends or bond interest represents the investor's profit.
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