Finance for Strategic Management

By Professor: Raafat Shehata

Tel: 01227765708

[email protected]
 Fred David strategic plan
1-Vision, mission and core values.

2-External environmental scanning (EFAS).

3-Internal environmental scanning (IFAS) …… financial analysis.

4-Strategic objectives.

5-Strategy generation (matching phase) …… SPACE matrix.

6-Strategy selection.

7-Strategy implementation…Master Budget.

8-Strategy evaluation …… Balanced scorecards.

 Strategic Management Models

Strategic Steps Phase Strategic Model (s) Finance

Input EFAS - CPM - IFAS Financial analysis - IFAS
Strategy Formulation Matching BCG - IE Matrix - SAPCE - TOWS - Grand Strategy Matrix Financial Strength - SPACE Matrix
Decision QSPM Financial analysis - IFAS
Strategy Implementation Gantt Chart Financial Bugeting
Strategy Evaluation Balance Scorcards Financial KPIs
 Financial Statements
Old Name Balance Sheet Income Statement Cash Flows Statement

New Name Financial Position Statement Profit & Loss Statement Cash Flows Statement

Operating Cash Flows +

Equation Assets = Liabilities + Equity Revenues – Expenses = Net Profit Financing Cash Flows +
Investing Cash Flows
Reports what firm owns and Measures the firm’s operations Describe the activities
Usage
owes at certain point of time success at certain point of time that use and create cash
Compute the solvency ratios Evaluate the past performance Report of net cash flows
Assess the firm’s ability
Evaluate the capital structure Predicting future performance
Benefits to generate cash
Assess risk of achieving future Identify the cash needs
Assess the firm’s liquidity
cash flows and gaps in profits
 Balance Sheet
Assets Liabilities and Shareholders'Equity
Current Assets (CIA) Current Liabilities
Cash $100 Account Payable $30
Accounts Receivables $20 Notes Payable $10
Inventory $15 Salaries Payable $5
Prepaied Expenses $10 Unearned Revenue $2
Total current assets $145 Total current liabilities $47

Non-Current (Fixed) Assets (PPE) Non-Current Liabilities

Plant $180 Long-term debt $200
Property $45 Total Liabilities $247
Equipment $30
Others $71 Shareholders' Equity
Total non-current assets $326 Paid-in Capital $50
Common Stocks $80
Preferred Stocks $90
Retained Earnings $4
Total Equity $224
Total assets $471 Total liabilities and shareholders' equity $471
Note: Amouts in Millions of (USD)
 Income Statement
Net Sales Revenues 1,000
Cost of Goods Sold (COGS) -360
Gross profit 640

Operating Expenses (OPEX) -350

Operating profit (EBIT) 290

Interest expenses -100

Income before taxes 190
Taxes expenses -43
Net profit 147
Note: Amouts in Millions of (USD)
 Cash Flows Statement
Cash at Beginning of Year 15,700
Cash Flows from Operating Activities (CFO)
Cash received from customers 445,500

Cash paid for inventory purchases (264,000)

Cash paid for wages expenses (123,000)
Cash paid for account payables (32,800)
Net Cash Flow from Operations 25,700

Cash Flows from Investing Activities (CFI)

Cash received from sale of equipment 33,600

Cash paid for purchase of machines (75,000)

Net Cash Flow from Investing Activities (41,400)

Cash Flows from Financing Activities (CFF)

Cash receipts from issuing stocks 187,000

Cash paid for repayment of loans (34,000)

Cash Paid for dividends (53,000)
Net Cash Flow from Financing Activities 100,000

Net Increase in Cash 84300

Cash at End of Year 100,000
 Financial Statement Ratio Analysis

. Solvency . Efficiency
Liquidity
Profitability Ratios . Debt . Activity
Ratios
. Leverage Ratios . Turnover Ratios
1. Gross Profit Margin (GPM) 1. Current Ratio 1. Debt Ratio 1. Inventory Turnover Ratio
2. Operating Profit Margin (OPM) 2. Quick Ratio 2. Equity Ratio 2. Account Receivable Turnover Ratio
3. Debt to Equity Ratio 3. Account Payable Turnover Ratio
4. Assets to Debt Ratio 4. Long term Assets Turnover Ratio
3. Net Profit Margin (NPM) 3. Cash Ratio
5. Assets to Equity Ratio 5. Total Assets Turnover Ratio
(Financial Leverage) 6. Interest Coverage Ratio
 Interpretation of financial analysis ratios

Financial ratio analysis: compares relationships between financial

statement accounts to identify the strengths and weaknesses of
firm.

In order to interpret the different financial ratios, therefore the

analyst need to assess the calculated financial ratios using one or
more of the following techniques:-

1. Time series.
2. Cross sectional (if available).
3. Common size analysis (Vertical and Horizontal).
 Profitability Ratios
1
Net Sales Revenues 100
Cost of Goods Sold (COGS) -20
Gross profit 80

Operating Expenses (OPEX) -30 3

Operating profit (EBIT) 50
2
Interest expenses -10
Taxes expenses -5
Net profit 35
Note: Amouts in Millions of (USD)

𝑮𝒓𝒐𝒔𝒔 𝑷𝒓𝒐𝒇𝒊𝒕 𝟖𝟎
(1) Gross Profit Margin (GPM) = 𝑺𝒂𝒍𝒆𝒔 𝑹𝒆𝒗𝒆𝒏𝒖𝒆𝒔 GPM = = 𝟖𝟎%
𝟏𝟎𝟎

𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑷𝒓𝒐𝒇𝒊𝒕 𝟓𝟎
(2) Operating Profit Margin (OPM) = OPM = = 50%
𝑺𝒂𝒍𝒆𝒔 𝑹𝒆𝒗𝒆𝒏𝒖𝒆𝒔 𝟏𝟎𝟎

𝑵𝒆𝒕 𝑷𝒓𝒐𝒇𝒊𝒕 𝟑𝟓
(3) Net Profit Margin (NPM) = NPM = = 35%
𝑺𝒂𝒍𝒆𝒔 𝑹𝒆𝒗𝒆𝒏𝒖𝒆𝒔 𝟏𝟎𝟎
 Liquidity Ratios
Assets Liabilities and Shareholders'Equity
Current Assets (CIA) Current Liabilities
Cash $100 Account Payable $90
Accounts Receivables $20 Salaries Payable $10
Inventory $15 Taxes Payable $5
Prepaied Expenses $10 Unearned Revenue $2
Total current assets $145 Total current liabilities $107

𝑪𝒂𝒔𝒉+𝑨/𝑹+𝑰𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚+𝒐𝒕𝒉𝒆𝒓 𝟏𝟒𝟓
(1) Current Ratio = 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
= 𝟏𝟎𝟕 = 𝟏𝟑𝟓. 𝟓𝟏% = 𝟏. 𝟑

𝑪𝒂𝒔𝒉+𝑨/𝑹+𝒐𝒕𝒉𝒆𝒓 𝟏𝟎𝟎+𝟐𝟎+𝟏𝟎
(2) Quick Ratio = 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔 = 𝟏𝟎𝟕
= 121.49% = 1.2

𝑪𝒂𝒔𝒉 𝟏𝟎𝟎
(3) Cash Ratio = 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒕𝒊𝒕𝒆𝒔 = 𝟏𝟎𝟕 = 93.45% = 0.9
 Solvency (Debt) Leverage Ratios
3
Total Assets = Total Debts + Total Equity
100 = 30 + 70
1
2
𝑻𝒐𝒕𝒂𝒍 𝑫𝒆𝒃𝒕 𝟑𝟎
(1) Debt Ratio = 𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔
= 𝟏𝟎𝟎
= 𝟑𝟎%

𝑻𝒐𝒕𝒂𝒍 𝑬𝒒𝒖𝒊𝒕𝒚 𝟕𝟎
(2) Equity Ratio = 𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔
= 𝟏𝟎𝟎
= 70%

𝑻𝒐𝒕𝒂𝒍 𝑫𝒆𝒃𝒕 𝟑𝟎
3) Debt to Equity Ratio = 𝑻𝒐𝒕𝒂𝒍 𝑬𝒒𝒖𝒊𝒕𝒚
= 𝟕𝟎
= 42.85%
 Solvency (Debt) Leverage Ratios

4 5

Total Assets = Total Debts + Total Equity

100 = 30 + 70

𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔 𝟏𝟎𝟎

(4) Assets to Debt Ratio = 𝑻𝒐𝒕𝒂𝒍 𝑫𝒆𝒃𝒕
= 𝟑𝟎
= 𝟑𝟑𝟑. 𝟑𝟎%

𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔 𝟏𝟎𝟎

(5) Assets to Equity Ratio = 𝑻𝒐𝒕𝒂𝒍 𝑬𝒒𝒖𝒊𝒕𝒚
= 𝟕𝟎
= 142.85%

Note: Assets to Equity ratio is sometimes called Financial Leverage

from the firm’s perspective.
 Solvency (Debt) Leverage Ratios
Net Sales Revenues 100
Cost of Goods Sold (COGS) -20
Gross profit 80

Operating Expenses (OPEX) -30

Operating profit (EBIT) 50
6
Interest expenses -10
Taxes expenses -5
Net profit 35
Note: Amouts in Millions of (USD)

𝑬𝒂𝒓𝒏𝒊𝒏𝒈 𝑩𝒆𝒇𝒐𝒓𝒆 𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒂𝒏𝒅 𝑻𝒂𝒙 (𝑬𝑩𝑰𝑻) 𝟓𝟎

(6) Interest Coverage Ratio = = = 5 times.
𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔 𝟏𝟎

Note: Interest coverage ratio is sometimes called times interest earned.

 Activity (Efficiency) Turnover Ratios
Fiscal Year 2019 2020
Inventory 14 16
Account Receviables (A\R) 20 40
Account Payables (A\P) 25 35
Net Credit Sales 180 220
Net Credit Purchases 110 150
Cost of Goods Sold (COGS) 120 150
Fixed Assets 300 320
Total Assets 480 520
Amounts in Millions ($)

𝑪𝒐𝒔𝒕 𝑶𝒇 𝑮𝒐𝒐𝒅𝒔 𝑺𝒐𝒍𝒅 (𝑪𝑶𝑮𝑺) 𝟏𝟒𝟎

(1) Inventory Turnover Ratio = = = 14 times.
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑰𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚 (𝟏𝟒+𝟏𝟔)/𝟐

𝑵𝒆𝒕 𝑪𝒓𝒆𝒅𝒊𝒕 𝑺𝒂𝒍𝒆𝒔 𝟐𝟐𝟎

(2) Account Receivables Turnover Ratio = 𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑨𝒄𝒄𝒐𝒖𝒏𝒕 𝑹𝒆𝒄𝒊𝒗𝒂𝒃𝒍𝒆𝒔
= = 5.5 times.
(𝟐𝟎+𝟔𝟎)/𝟐

𝑵𝒆𝒕 𝑪𝒓𝒆𝒅𝒊𝒕 𝑷𝒖𝒓𝒄𝒉𝒂𝒔𝒆𝒔 𝟐𝟓𝟎

(3) Account Payables Turnover = = = 8.33 times.
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑨𝒄𝒄𝒐𝒖𝒏𝒕 𝑷𝒂𝒚𝒂𝒃𝒍𝒆 (𝟐𝟓+𝟑𝟓)/𝟐
 Activity (Efficiency) Turnover Ratios
Fiscal Year 2019 2020
Inventory 14 16
Account Receviables (A\R) 20 40
Account Payables (A\P) 25 35
Net Credit Sales 180 220
Net Credit Purchases 110 150
Cost of Goods Sold (COGS) 120 150
Fixed Assets 300 320
Total Assets 480 520
Amounts in Millions ($)

𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔 𝑹𝒆𝒗𝒆𝒏𝒖𝒆𝒔 𝟓𝟖𝟎

(4) Fixed Assets Turnover Ratio = 𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒇𝒊𝒙𝒆𝒅 𝑨𝒔𝒔𝒆𝒕𝒔
= = 1.87 times.
(𝟑𝟎𝟎+𝟑𝟐𝟎)/𝟐

𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔 𝑹𝒆𝒗𝒆𝒏𝒖𝒆𝒔 𝟓𝟖𝟎

(5) Total Assets Turnover Ratio = = = 1.16 times.
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔 (𝟒𝟖𝟎+𝟓𝟐𝟎)/𝟐

Note: calculated ratios for fiscal year 2020

 Operating Cycle

0 40 100
Inventory Period (DIO) Sales Period (DSO)
Payables Period (DPO)

Operating Cycle = DIO + DSO = 40 days + 60 days = 100 days

𝟑𝟔𝟓 𝟑𝟔𝟓
Days Inventory Outstanding (DIO) = 𝑰𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚 𝑻𝒖𝒓𝒏𝒐𝒗𝒆𝒓 = 𝟗.𝟏𝟐𝟓 = 40 days.

𝟑𝟔𝟓 𝟑𝟔𝟓
Days Sales Outstanding (DSO) = 𝑨𝒄𝒄𝒐𝒖𝒏𝒕 𝑹𝒆𝒄𝒊𝒗𝒂𝒃𝒍𝒆𝒔 𝑻𝒖𝒓𝒏𝒐𝒗𝒆𝒓
= 𝟔.𝟎𝟖 = 60 days.
 Cash Conversion Cycle (CCC)
0 30 40 100

Inventory Period (DIO) Sales Period (DSO)

Payables Period (DPO)

𝟑𝟔𝟓 𝟑𝟔𝟓
Days Payables Outstanding (DPO) = 𝑨𝒄𝒄𝒐𝒖𝒏𝒕 𝑷𝒂𝒚𝒂𝒃𝒍𝒆𝒔 𝑻𝒖𝒓𝒏𝒐𝒗𝒆𝒓 = = 30 days.
𝟏𝟐.𝟏𝟑

Cash Conversion Cycle = (DIO + DSO) – DPO = (50 + 60) – 30 = 70 days.

 Weighted Average Cost of Capital (WACC)
Weighted average cost of capital (WACC): represents firm’s average cost of capital from all
sources, including common stock, preferred stock, and forms of debt so WACC is the average
rate that firm is expected to pay to finance its business.

Capital = Total Debt + Total Equity

Capital = Loans + Common Stocks + Preferred Stocks + Retained Earnings
$100 = $10 + $20 + $30 + $40
Step 1 Weight 100% = 10% + 20% + 30% + 40%
Step 2 Cost N/A 5% 10% 12% 10%
Step 3 WACC = 10.10% = 0.005 + 0.02 + 0.036 + 0.04
Note: Amount in Billions of USD ($)

Note: calculating the Weighted Average Cost of Capital (WACC) of a firm is useful for firm’s
management, stock analysts, investors, creditors and many others.
 Required Rate of Return (RRR)
Required Rate of Return (RRR): is the minimum return used in corporate finance to analyze the
profitability of potential investment projects as compensation for a given level of risk associated with
certain investment.

Required Rate of Return (RRR) formula

RRR = Risk-free rate of return (RF) + β * (Market rate of return – Risk-free rate of return)

Where
β = Beta is the risk coefficient or the coefficient of correlation between investment and market

Item Rate
Risk free rate of return 2% RRR = 2% + 1.3 (11% - 2%) = 13.7%
Beta 1.3
Market rate of return 11%

Note: after calculate the Weighted Average Cost of Capital (WACC) it must be compared with the
rate of return.

Decision Criteria: in case of Rate of Return > WACC means high financial soundness.
or Rate of Return < WACC means poor financial soundness.
 Apache Corporation Case Study
• Apache Corporation reported the following financial statements ratio analysis in
addition to OC and CCC for fiscal year ended Dec. 31, 2022

SPACE Balanced Scorecard Quadrant

No. of Contribution
Item EFAS IFAS IE Matrix Products to Revenues
FS ES CA IS Financial Card
Star 23 47%
Score 3.6 3.5 Quadrant I 5.5 -0.09 -1 5 KPIs + Target Question Mark 4 10%
Cash Cow 18 30%
Dog 2 13%
OC CCC
27 Days 19 Days

Profitability Ratios Liquidity Ratios Solvency Ratios Activity Ratios

Gross Profit Margin 62% Current Ratio 149% Debt Ratio 22% Inventory Turnover Ratio 32 times
Operating Profit Margin 41% Quick Ratio 121% Equity Ratio 78% Account Receivable Turnover Ratio 74 times
Net Profit Margin 29% Cash Ratio 109% Debt to Equity Ratio 28.20% Account Payable Turnover Ratio 14 times
Assets to Debt Ratio 454.54% Fixed Assets Turnover Ratio 8.11 times
Assets to Equity Ratio 128.20% Total Assets Turnover Ratio 6.21 times

how to establish a relationship among the previous strategic models and financial
analysis?
 Apache Corporation Case Study
❑ Apache has high profit generation power i.e. NPM = 29%.
❑ Apache has sufficient liquidity to cover its short-term obligations.
❑ Apache has maintained excellent solvency ratio to cover its long-term obligations.
❑ Apache has reported good activity ratios in terms of low cash conversion cycle of 19 days.

Strategic and Financial analysis conclusion:-

❑ The above-mentioned points will be used as an input in IFAS in strength section (input stage).

❑ According to EFAS score 3.6 and IFAS score 3.5 Apache will be located in quadrant I (high and
high).

❑ According to SPACE matrix, Apache will score high in financial strength (5.5) in addition to the other
3 SPACE matrix dimensions so that after calculating both X axis and Y axis Apache will be placed on
the aggressive strategies quadrant (top right quadrant).

❑ Because Apache has strong financial position, it must prepare master cash budget for implementing
the selected strategy from QSPM model in the upcoming years to increase profitability.

❑ In order to evaluate the adopted strategy, Apache must develop balanced scorecards including
financial KPIs to be to monitor the outcome from the adopted strategy.
 CMX Cinemas Case Study
• CMX Cinemas reported the following financial statements ratio analysis in addition to
OC and CCC for fiscal year ended Dec. 31, 2019.
No. of Contribution
SPACE Balanced Scorecard Quadrant
Products to Revenues
Item EFAS IFAS IE Matrix
FS ES CA IS Financial Card Star 1 10%
Score 1.2 1.09 Quadrant IX 0.09 -5.8 -5.1 1.1 KPIs + Target Question Mark 2 20%
Cash Cow 1 40%
Dog 8 30%
OC CCC
313 Days 286 Days

Profitability Ratios Liquidity Ratios Solvency Ratios Activity Ratios

Gross Profit Margin 22% Current Ratio 19% Debt Ratio 81% Inventory Turnover Ratio 3 times
Operating Profit Margin 4% Quick Ratio 11% Equity Ratio 19% Account Receivable Turnover Ratio 2 times
Net Profit Margin -14% Cash Ratio 6% Debt to Equity Ratio 426.30% Account Payable Turnover Ratio 1 time
Assets to Debt Ratio 123.40% Fixed Assets Turnover Ratio 1.21 times
Assets to Equity Ratio 526.30% Total Assets Turnover Ratio 0.07 times

how to establish a relationship among the previous strategic models and financial
analysis?
 CMX Cinemas Case Study
❑ CMX has very bad profit generation power i.e. NPM = - 14%.
❑ CMX has insufficient liquidity to cover its short term obligations.
❑ CMX has incurred high debt ratios to cover its long term obligations.
❑ CMX has reported poor activity ratios in terms of high cash conversion cycle of 286 days.

Strategic and Financial analysis conclusion:-

❑ The above mentioned points will be used as an input in IFAS in weakness section (input stage).

❑ According to EFAS score 1.2 and IFAS score 1.9 CMX will be located in quadrant IX (low and
low).

❑ According to SPACE matrix, CMX will have very poor financial strength (0.9) in addition to the other
3 SPACE matrix dimensions so that after calculating both X axis and Y axis CMX will be placed on
the defensive strategies quadrant (down left quadrant).

❑ Because CMX has poor financial position, it must prepare cost reduction policy for implementing the
selected strategy from QSPM model in the upcoming years to minimize losses.

❑ In order to evaluate the adopted strategy, CMX must develop balanced scorecards including
financial KPIs to be to monitor the outcome from the adopted strategy.
 Transocean Offshore Case Study
• Transocean Offshore reported the following financial statements ratio analysis in
addition to OC and CCC for fiscal year ended Dec. 31, 2011.

SPACE Balanced Scorecard No. of Contribution

Quadrant
Item EFAS IFAS IE Matrix Products to Revenues
FS ES CA IS Financial Card Star 5 30%
Score 2.4 2.3 Quadrant V 2.8 -3.8 -1.5 2.1 KPIs + Target Question Mark 3 10%
Cash Cow 6 20%
Dog 4 40%
OC CCC
137 Days 119 Days

Profitability Ratios Liquidity Ratios Solvency Ratios Activity Ratios

Gross Profit Margin 37% Current Ratio 105% Debt Ratio 17% Inventory Turnover Ratio 10 times
Operating Profit Margin 14% Quick Ratio 97% Equity Ratio 83% Account Receivable Turnover Ratio 8 times
Net Profit Margin 4% Cash Ratio 86% Debt to Equity Ratio 20.48% Account Payable Turnover Ratio 7 times
Assets to Debt Ratio 588.20% Fixed Assets Turnover Ratio 3.7 times
Assets to Equity Ratio 120.40% Total Assets Turnover Ratio 1.09 times
how to establish a relationship among the previous strategic models and financial
analysis?
 Transocean Offshore Case Study
❑ Transocean has moderate profit generation power i.e. NPM = 4%.
❑ Transocean has moderate sufficient liquidity to cover its short term obligations.
❑ Transocean has incurred moderate debt ratios to cover its long term obligations.
❑ Transocean reported medium to low activity ratios in terms of cash conversion cycle of 119 days.

Strategic and Financial analysis conclusion:-

❑ The above mentioned points will be used as an input in IFAS in strength section (input stage).

❑ According to EFAS score 2.4 and IFAS score 2.3 Transocean will be located in quadrant V
(medium and medium).

❑ According to SPACE matrix, Transocean will score moderate in financial strength (2.8) in addition to
the other 3 SPACE matrix dimensions so that after calculating both X axis and Y axis Transocean will
be placed on the Conservative strategies quadrant (down right quadrant).

❑ Because Transocean has moderate financial position, it must prepare master cash budget for
implementing the selected strategy from QSPM model in the upcoming years to increase profitability.

❑ In order to evaluate the adopted strategy, Transocean must develop balanced scorecards including
financial KPIs to be to monitor the outcome from the adopted strategy.
ANY QUESTIONS ??
THANK YOU FOR
YOUR ATTENTION