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Priorities of financial strategy at the different stages of the life cycle of the enterprise

Ivan Franko National University of Lviv Iryna Pasinovych

Ivan Franko National University of Lviv DOI: 10.23734/23.18.017

Priorities of financial strategy at the different

The purpose of the article is to determine the impact of the life cycle stages of an enterprise on the financial aspects of its activities and to substantiate the feedback

‒ taking into account the stages of the life cycle in the formation of its financial strategy.

In this research the authors proceed from the fact that the life cycle and its stages are an objective factor in the functioning of the business entity, but subjective management decisions, in particular in the financial plane, the enterprise can influence the trajectory of the life cycle curve, continuing or shortening the duration of a certain stage.

The essence and the importance of formation of the financial strategy of the enterprise

With the transition to a post-industrial economy, the strategic approach in man- agement becomes a guarantee of the normal functioning and development of business entities, and the presence of strategic thinking in the management of companies transform into the factor of their competitiveness in the long run. The complexity and instability of external conditions actualize the flexibility of enterprise strategy, its multi variateness, require highly qualified developers, the availability of a systematic approach to solving problems.

The growing importance of financial relations in conjunction with the concept of strategic management requires special attention to the development and implementa- tion of the financial strategy of the enterprise. It is the financial strategy in the context of diversifying financial relations, the emergence of new hybrid forms of financing, strengthening the financial dominance in economic processes becomes the main func- tional strategy.

The existence of a long-term development strategy, specified in the financial pa- rameters, is a prerequisite for attracting investment, especially on a large scale. After all, with the development of market relations, orientation towards goods, technology has changed the interest in the finance of the enterprise and its management. This means that not only the possibility of increasing production volumes, but the improvement of finan- cial indicators is a key factor in making investment decisions. For potential investors, the existence of an understandable financial strategy of the enterprise is not only a risk factor, but also a tool for evaluating its financial potential. Thus, it can be argued that a financial strategy is a financial policy aimed at achieving a certain increase in the market value of a business with an adequate level of riskiness and liquidity. Although the financial strategy is subordinate to the corporate strategy of the enterprise, its role is decisive.

The value of a financial strategy for an enterprise is that it makes possible:

to maintain a strategic vector of development according to changing environmental fac- tors; to concentrate efforts and resources on the most promising and most advantageous directions for the enterprise; to track, analyze and forecast actual and objective external trends; to specify possible ways to minimize risks; to eliminate the disadvantages of gen- eral corporate management, to form an adequate organizational structure of management;

to balance the financial, industrial and social interests of economic agents.

However, the main value of the financial strategy of the enterprise, in our opinion, is that it is a factor of subjectivity, a tool for securing interests of stakeholders.

The multidimensional nature of the financial function and the multitude of tasks associated with it, the content of the financial strategy require an integrated approach.

The current strategy, according to Blank I (2008)1, should contain the following compo- nents (dominant fields):

1. Strategy for the formation of financial resources (financing strategy).

2. Investment strategy of the enterprise.

3. Strategy of providing financial security of the enterprise.

4. The strategy of improving the quality of financial management of the enterprise.

The first two directions are crucial for increasing the value of the enterprise. It is the maximization of value, and not the maximization of profit; it is the strategic goal of fi- nancial management. A well-grounded financing strategy leads to a reduction in the value of capital by choosing the most effective sources of funding, and rational investment contributes to the growth of business profitability in the future.

The financial strategy integrates a list of the main characteristics, the specific manifestation of which varies in individual enterprises in a rather large range, depending on the scale and characteristics of the activity, the internal financial structure, and the volume of financial potential, external environment, and others.

The scope of the economy in which the enterprise operates determines the amount of capital required for operating activities, the nature of resources, the duration of the financial cycle, and thus outlines the direction of its financial strategy. The financial strategy is developed by enterprises of the real sector as well as for financial enterprises.

It is relevant for large enterprises, including TNCs, and for small enterprises. For each individual enterprise, the financial strategy is a unique model of its financial behavior, reflects the priorities of managers in the field of sources and forms of financing, invest- ment, management of financial risks.

In Ukraine we can notice the growth of attention to the development of financial strategy in the banking and insurance business. The contemporary paradigm of bank

1 I. Blank, Financial Management, Elga, Kyiv 2008.

management involves the need to reorient the activities of banks from short-term results (in terms of profit, profitability of sales, market share served) to achieve long-term goals (the growth of capitalization and increase market value by providing customers with greater value in the forming of new banking products and services).

The financial strategy of an insurance enterprise is conditionally divided into three main components: strategy of management of insurance reserves, strategy of management of own capital, strategy of risk management. Financial strategies of leading insurance groups cover a wide range of activities (insurance, asset management, banking) and are aimed primarily at capturing profitable strategic financial positions. In strategic financial management, leading insurance companies take into account fluctuations in exchange rates, use offshore companies, and introduce information openness.

Also, the scale of business affects the content and detail of strategic financial de- cisions. It is a mistake to think that a strategy is needed only for large companies with significant capital, while small business plans for the short term, is too sensitive and vulnerable to environmental changes in order to shape long-term strategies. However, the analysis of special literature and business practices suggests that small businesses that seek to secure their long-term competitiveness and development must have a finan- cial strategy.

Important is the fact that in the process of implementing a strategy, the enterprise focuses not on one-time benefits, but on long-term goals. In essence, the goals are the benchmarks for enterprise development, and the strategy is a plan for their achievement.

If in a particular period, before the leaders of the enterprise there is a dilemma, for ex- ample, about the directions of investment of funds, allocation of resources, expediency of realization of a certain project or conclusion of an agreement (especially if it requires additional attraction of debt capital), it is the availability of a strategic approach able to send on the right path. The decision should be implemented if it contributes (does not hurt) to achieve strategic goals. Thus, the strategy involves clear compromises and a con- scious refusal to produce certain products or conclude agreements, focusing primarily on corporate interests, and not on the priority of the interests of structural or functional units.

To formulate a financial strategy, it is necessary to take into account a wide range of external factors, among them:

• general economic objective trends (they determine the prospects or hopelessness of a certain type of activity, investments and promote understanding of trends in the country or industry);

• legislative regulation of entrepreneurial activity and theirs predicted changes;

• economic and political situation in the country (contributes to the assessment of possible changes in the exchange rate, inflation, predicts the likelihood of a fi- nancial crisis, the independence of the judiciary, and the scale of the shadow economy);

• financial position and competitive advantages of existing and potential compe- titors, reliability of suppliers and solvency of buyers;

• the state of commodity and financial markets and theirs changes.

Influence of the life cycle of the enterprise on choice of financial strategy

Formation of financial strategy as a component of the overall strategy of the busi- ness entity, filling it with specific content, time frame, mechanisms of implementation depends on many factors, in particular on the stages of the life cycle of the enterprise.

Each enterprise develops cyclically and with corresponding changes. Development can be interpreted as „irreversible process aimed at changing the material and spiritual objects in order to improve them”. The life cycle of the enterprise is a set of specific goals and objectives of the enterprise, defined organizational and managerial decisions, the implementation and of which ensures its growth.

After analyzing the works of economists, two main theories of the enterprise’s life cycle, which are widely covered in the scientific literature, can be distinguished. For example, Larry Grainer2 in 1972 has developed an evolutionary concept of enterprise development. He sad, that overcoming the crisis, specific for this stage, carries out tran- sition from one phase to another. The model of organizational development by L. Grein- er shows that the need for changes in enterprises sooner or later arises irrespective of the ideology of development they follow, and management paradigm, which dominate in their functioning. However, how these changes in the enterprise will be carried out depends not only on the duration but also on the effectiveness of it’s functioning.

The second most widespread concept of the enterprise’s lifecycle belongs to I. Adiz- es (1998)3. The basis of separation of the phases of the cycle is the correlation of two parameters: flexibility (the ability of the enterprise to adapt quickly to internal and ex- ternal changes) and controllability (the degree of regulation of the enterprise and its members, as well as the rigidity of coordination and control mechanisms). According

2 L. Greener, Evolution and Revolution as Organizations Grow, „Harvard Business Review” 1972, Issue 4, p. 37-46.

3 I. Adizes, Corporate Lifecycles: how and why corporation grow and die and what to do about it, Prentice Hall, Englewood Cliffs 1998.

to the enterprise’s life cycle model proposed by Adizes, companies are „experiencing”

their childhood, adolescence, rapid growth, the period of stabilization and old age. Adiz- es argues that at the beginning, they mostly do not think about strategic guidelines, op- erate according to a spontaneous strategy, there is no planning system; owners try to focus on efficiency. And if an enterprise starts to be interested in strategy, it means that it has passed its childhood stage.

Each of the stages of the life cycle is characterized by its inherent problems and priorities that impose an imprint on financial activity. We interpret the financial activity as:

• activities aimed at capital formation of the enterprise;

• activity on management of financial resources of business entities;

• activities to create the necessary conditions for business development;

• the system of using various forms and methods of financial support for the functioning of enterprises.

When comparing an enterprise with a living organism, we can say that finance is a blood system of an enterprise and provides the formation and „transportation” of as- sets to the relevant systems of vital activity of the enterprise. In general, agreeing with the crisis theory of enterprise development, as a living organism or system, we consider it appropriate to highlight the specifics of financial decisions that are made at each stage of the enterprise’s life cycle, namely the stages of birth, stability and decline.

At the stage of birth an investment decision is made ‒ one of the most important business initiatives of owners and managers, since investments determine the allocation of financial resources for a relatively long period. At this stage, the enterprise is determined by the strategy of financing fixed capital ‒ from the conservative (when fixed capital is fi- nanced by its own funds and long-term loans) to aggressive (when short-term loans are involved in financing fixed capital). The latter is rare, that is, the main sources of financing are private sources ‒ the owners’ funds. At the birth stage, incomes of the enterprise are small, profits are minimal, or absent altogether. Often, the main management tool at this stage is the financial plan, which takes a special place in the business plan.

Growth is characterized by a stable positive dynamics of income indicators, how- ever, and the cost of the enterprise is significant, especially on marketing promotion of sales. At this stage, the search for additional resources is necessary to increase pro- duction volumes. However, attraction of borrowed funds should not cause excessive in- crease in financial risk, which will make the enterprise sensitive to the impact of negative internal and external factors.

At the stage of birth and growth, the enterprise strives to achieve and exceed the profitability threshold, recover initial costs and move to the profitability zone.

Stability is characterized by the relative stability of sales over a long period, which provides the enterprise with stable profits. At this stage, the priorities should be to opti- mize their own and borrowed sources to maintain financial sustainability, develop a ra- tional dividend policy that would, on the one hand, satisfy the owners, and, on the other hand, facilitated the accumulation of funds for modernization, technological upgrading, diversification of activities. Since stable financial results have a positive effect on the creditworthiness and investment attractiveness of an enterprise, this stage is most favor- able for attraction of borrowed capital, realization of investment and innovative activity.

At the stage of stability, it is important to ensure a stable high return on investment, the level of which cannot be lower than medium-sized, otherwise the process of outflow of investors will begin, which will signal the beginning of the last stage ‒ a decline.

The decline is primarily driven by a declining sales and profits dynamics, and problems with financing current activity. There are various scenarios for the development of events, depending on the strategic goals of the enterprise ‒ from transformation, adoption of non-standard managerial decisions to rehabilitation, reorganization or liqui- dation. Ultimately, the downturn may end either by the collapse of the business or its rebirth. In any case, the development of events will require well-balanced and sound fi- nancial decisions. Table 1 summarizes important aspects of the enterprise at different stages of the life cycle.

Table 1. Characteristics of the enterprise’s life cycle stages Features of the

Stage of Life Cycle

Stage of Life Cycle

Birth Growth Stability Decline

Goal and the main priorities

Search for its own market niche and the formation of competitive product advantages

Increase market share and maxi- mum satisfaction of the needs of the target group of con- sumers

Growth of the market value of the enterprise

Solving current problems

Sale volumes Small Gradually and con- tinuously increas- ing sales volumes

Relative sales volatility

Reduced sales due to falling demand and increased com- petition

Methods and tools of man-

agement Single management Delegation of au-thority Project manage-

ment Bureaucracy

Features of the Stage of Life


Stage of Life Cycle

Birth Growth Stability Decline

Priorities of financial activity

Optimization of investment decisions; analysis and evaluation of financial fea- sibility of project realization, search of a stable source of financing

Financing of mar- keting activities;

search for addi- tional resources needed to increase production vol- umes; efficiency of distribution and use of financial resources

Optimization of the ratio of own and borrowed resourc- es, use and accu- mulation of profit

Achievement of a satisfactory financial condi- tion, or carrying out an assessment of the value of the property complex for resale

Investment activity

Determination of optimal sources, methods and con- ditions for capital formation

Investing in the development of the material and technical base and capacity building

Capacity analysis of the implemen- tation of new in- vestment projects, diversification of activities

Collapse of its own investment pro- grams, assessment of the market value of the enterprise

Innovative activity

Generation of a promising business idea that will be the basis of entrepreneurial activity

Innovative activity aimed at product improvement

Innovation activity orientation towards new business projects

Reduction of at- tention to inno- vation (in terms of business clutter) or the search and implementation of innovations that will help to revive business

The main sources of fi- nancing

Internal - owners’

funds Internal - profit External - loans Mixed - balancing external and inter- nal sources Priority direc-

tions of the use of financial resources

Formation of technical and technological basis of enterprise

Financing mar- keting activities aimed at increasing demand

Capital investments aimed at new markets or new business

Current financing needs of the enter- prise

Dynamics of financial results

Income is small, profits are minimal,

or absent Profit growth Stability of profits Slow profit dy- namics Type of finan-

cial strategy

Selection of financ- ing strategy

Strategy of finan- cial support of ac- celerated growth

Strategy of finan- cial support of sus- tainable growth

Anticrisis financial strategy

Source: developed by authors

It should be noted that these aspects are largely interconnected and interdependent.

Thus, the results of innovation determine the directions of investment of funds, the volume and dynamics of financial results will affect the decision on the appropriateness

of attracting borrowed funds, etc. The table was built on the basis of statistical observations of the activities of Ukrainian enterprises4 and interviews with entrepreneurs5.

An important characteristic of the life cycle stages is investment activity, its fi- nancing and efficiency. The starting point for justifying investment decisions should be innovation, the implementation of which can provide the enterprise with a new quality and impetus for development. Innovation should be perceived by the enterprise as the basis of its survival in a competitive environment. The effectiveness of innovation activ- ity is one of the factors that determine the trajectory of the life cycle curve. Thus, insuf- ficient attention or ignoring of innovation activity reduces the duration of the stage of maturity and accelerates the stage of decline. It should be noted that innovations include not only technical and technological developments, the development of new products and services, but also the search and use of new forms of business, new methods of market activity, and new financial instruments. At the same time, systematic innovative activity requires significant funds ‒ investments, and there is a high level of risk, as the positive result of innovation activity is difficult to predict. Thus, the efficiency of spending finan- cial resources on the implementation of innovation and investment activities is determined primarily by the professionalism of managers, their ability to analytical and predictive assessments.

It should be noted that most of the components of the table coincided with the characteristics of the enterprises at different stages of the life cycle, inherent in econom- ically developed countries. However, significant differences were found in the diversity of funding sources in Ukraine and other countries. Thus, a large-scale survey of enter- prises in the OECD countries has revealed specific sources of funding, which vary in each of the stages of the life cycle6. At the stage of Birth, it is the means of entrepreneurs, subsidies (irreversible financial assistance), the funds of relatives, friends, business angels and support from incubators. Then strategic investors can join them. At the Growth stage loans, equity, venture capital and mezzanine financing are used.

At Stage Stability, it is proposed to co-operate with the investment banks or raise equity capital. At the stage of the Decline instruments of venture and mezzanine finance, possible mergers and acquisitions, as well as return from public to private property be- come again relevant (see Fig. 1).

4 O. Sych, I. Pasinovych, Consolidation of financial resources for postindustrial cities revitalization /

„Economic Annals” 2015, vol. ХХІ, № 9-10, p. 87-90.

5Doing business - Measuring Business Regulations, http://www.doingbusiness.org/data/exploreecon- omies/ukraine [access 29.06.2018].

6 K. Wilson, F. Silva, Policies for Seed and Early Stage Finance: Findings from the 2012 OECD Fi- nancing Questionnaire, „OECD Science, Technology and Industry Policy Papers” 2013, No. 9, OECD Publishing, http://www.ac.dk/media/423711/policies-for-seed-and-early-finance.pdf [access: 29.06.2018].