7. Analysing the Strategic Position of a Business

Influences on the Mission of a Business

• An effective mission statement:

  • Differentiates the business from its competitors

  • Defines the markets or business in which the business wants to operate

  • Is relevant to all major stakeholders- not just shareholders and managers

  • Excites, inspires, motivates and guides- particularly important for employees

• Mission statements are often criticised because they are:

  • Not always supported by actions of the business

  • Often too vague and general or merely statements of the obvious

  • Viewed as a public relations exercise

  • Sometimes regarded cynically by employees

  • Not supported wholeheartedly by senior management

• Mission and vision statements:

  • They communicate the purpose and values of an organisation to the stakeholders. Employees and other stakeholders need to understand the purpose and implementation.

  • They inform the strategy adopted by an organisation

  • They enable measurable goals and objectives to be identified which allows an organisation to gauge the success of its strategy

• Factors influencing the mission:

  • Size of the business

  • Range of activities undertaken

  • Who are the owners and major stakeholders?

  • Changes over time in market conditions and customer needs

  • Actual performance of the organisation

• External factors outside the control of the business:

  • Economic conditions

  • Government regulation

  • A business’s own strengths and opportunities

  • Level of concern for environmental and social responsibilities

Internal and External Influences on Corporate Objectives

• What are Business Objectives?

  • Specific intended outcomes of business strategy and activity

  • Targets which a business sets to help it achieve its aims

• Typical Corporate Objectives:

  • Sales Revenue

  • Profit

  • Return on investment

  • Growth

  • Market share

  • Cash flow

  • Value of the business

  • Corporate image and reputation

• Internal Influences:

  • Business Ownership: Who are the business owners and what do they want to achieve?

  • Attitude to Profit: Is the business run to earn profits or is it not-for-profit?

  • Organisational Culture: How is the business structured? How are objectives set and decision-making?

  • Leadership: How strong is the influence of leadership in the business in terms of objectives and how decisions are made?

  • Strategic position and resources: What options and choices does the business realistically have based on existing market position and resources?

• External Influences:

  • Short-termism: External investor pressure to focus on and achieve short-term objectives at the expense of long-term strategy.

  • Economic environment: Perspective on key economic growth, consumer spending and interest rates?

  • Political/legal environment: What is the impact of uncertainty about changes in the political and legal environment?

  • Competitors: Do competitor actions and strategies shape what a business thinks it can achieve?

  • Social and Technological change: How rapid is the pace of social and technological change in business’ markets? Does this make objective-setting and decision-making easier or harder?

• Corporate Objectives:

  • Coordinate business activity across different functions

  • Provide an overall sense of direction

  • Act as a focus for decision-making

  • Ensure that success or failure can be measured: SMART objectives

  • Encourage a sense of purpose among employees

  • Guide the setting of functional objectives

• Examples of corporate objectives:

  • Maximising shareholder value and wealth

  • Maximising sales revenue and profit

  • Focusing on core capabilities and adding value

  • Diversifying the business into new sectors or markets

  • Addressing environmental and social responsibilities

Strategy and Tactics

• What is a strategy?

  • Long-term plan, based on the business vision

  • Designed to achieve corporate objectives

  • Commit most of the business’ resources

• What are tactics?

  • Tend to be short-term, responding to opportunities and threats

  • Often influenced by functional objectives

  • Commit less resources

Strategic vs Tactical - Business Theory

• Strategic Business Theory:

  • Mission statement

  • Vision and values

  • Organisational culture

  • Business plan

  • Growth strategy

  • Segmentation, targeting and positioning

• Tactical Business Theory:

  • Marketing mix

  • Financial and non-financial rewards

  • Inventory management

  • Location decisions

  • Day-to-day customer service decisions

SWOT Analysis

• What is SWOT Analysis?

  • SWOT Analysis helps a business assess its competitive strength and the nature of its external environment

• SWOT Analysis Overview:

  • Strengths and Weaknesses are Internal to the Business

  • Opportunities and Threats are External to the Business

• What factors are used to assess Strengths and Weaknesses?

  • Competitive Advantages

  • Role for Benchmarking

  • Key Performance Indicators

• Likely Evidence of Strengths and Weaknesses:

  • Market share (%)

  • Profitability (operating profit %)

  • Efficiency (unit costs)

  • Brand recognition and loyalty

  • Market capitalism (value and growth)

  • Reputation for quality

• Evaluating Strengths and Weaknesses:

  • It is important to focus only the most important

  • Is the judgement made reliable (independent)?

  • How sustainable are the strengths?

  • Can weaknesses be overcome? How?

• What should be used to analyse Opportunities and Threats?

  • Political

  • Economic

  • Social

  • Technical

  • Legal

  • Environment

• What factors are used to assess Opportunities and Threats?

  • How to take advantage of opportunities

  • How to protect against threats

  • Role of risk management and contingency planning

• How useful is SWOT Analysis?

  • Positive:

    • Logical Structure

    • Focuses on strategic issues

    • Encourages analysis of the external environment

  • Negative:

    • Too often lacks focus

    • Independent?

    • It can quickly become out-of-date

Financial Ratios

• Return on Capital Employed (ROCE):

  • What does ROCE stand for?

    • Return on Capital Employed

  • ROCE is a useful ratio to:

    • Evaluate the overall performance of the business

    • Provide a target return for individual projects

    • Benchmark performance with competitors

  • How to calculate ROCE:

    • ROCE (%) = \frac{Operating Profit (NET Profit)}{Total Equity + Non-Current Liabilities} \times 100

  • Evaluating ROCE:

    • ROCE is a widely used measure of return on investment by businesses

    • Key points to remember:

      • ROCE will vary between industries

      • It is based on a snapshot of a business's balance sheet

      • Comparisons over time and with key competitors are most useful

• Current Ratio:

  • Liquidity Ratios:

    • Assess whether a business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due

  • Examples of financial statements: Incomes Statement:

    • Measures business performance over a given period of time, usually one year. It compares the income of the business against the cost of goods or services and expenses incurred in earning that revenue

  • Statement of Financial Position (Balance Sheet):

    • A snapshot of the business’ assets (what it owns or is owed) and its liabilities (what it owes) on a particular day

  • Cash Flow Statement:

    • This shows how the business has generated and disposed of cash and liquid funds during the period under review

  • Liquidity is determined by the relationship between Current Assets and Current Liabilities:

    • \frac{Current Assets}{Current Liabilities}

  • Evaluating the Current Ratio:

    • A ratio of 1.5-2.5 would suggest acceptable liquidity and efficient management of working capital

    • A low ratio (e.g. well below 1) indicates possible liquidity problems

    • High ratio: too much working capital tied up in inventories or debtors?

  • Top Grade Evaluation of Current Ratio:

    • The industry or market matters

      • Firms have different requirements for holding inventories or approaches to trade competitors.

      • How does the current ratio compare with competitors?

    • The trend is more important

      • A sudden deterioration in the current ratio is a good indicator of liquidity problems

Assets and Liabilities

• Current Asset Examples:

  1. Cash

  2. Stock Inventory

  3. Accounts Receivables (Invoices)

  • Max: Twice the assets than liabilities

  • Minimum: 1 asset to .5 liabilities

• Payables Days: Trade Payables (Creditors):

  • Amounts owed by a business to suppliers and others

  • What does it show:

    • The average length of time taken by a business to pay amounts it owes

  • Payables (Creditors) Days:

    • (Trade payables/Cost of sales) \times 365

  • Evaluation of payable days:

    • Interpreting the results:

      • In general, a higher figure is better for cash flow

      • Ideally, payable days are higher than receivable days

      • Be careful: a high figure may suggest liquidity problems (stretching supplier goodwill)

    • Look out for:

      • Evidence from the current ratio or acid test ratio that business has problems paying creditors

      • Window-dressing: This is the easiest figure to manipulate

• Receivables Days: Trade Receivables (Debtors):

  • Amounts owed to a business by customers

  • What are Receivables Days?

    • The average length of time taken by customers to pay amounts owed

  • Receivables (Debtor) Days:

    • {Trade receivables/Revenue (sales)} \times 365

  • Evaluating Receivable Days:

    • Interpreting the results:

      • Shows the average time customers take to pay

      • Each industry will have a ‘norm’

      • Look out for significant changes

    • Look out for:

      • Comparisons (good or bad) v competitors

      • Balance sheet window-dressing

• Inventory Turnover:

  • What is inventory:

    • Inventories are the raw materials, work-in-progress and finished goods held by a business to enable production and meet customer demand

  • Examples of Inventory:

    • Raw Materials and Components

    • Work in Progress

    • Finished Goods

  • What is Inventory Turnover:

    • How many times does a business replace its inventory each year (by turning it into sales)

  • Inventory Turnover:

    • \frac{Cost of Goods Sold (£)}{Average Inventories Held (£)}

Inventory and Gearing

• Interpreting the Inventory Turnover Figure:

  • Look for changes from one year to another (and compare with other similar businesses)

  • A fall in inventory turnover might suggest a buildup of slow-moving or obsolete inventory

• Gearing:

  • What is Gearing?

    • ‘Gearing’ measures the proportion of a business's capital (finance) provided by debt

  • Two Ways of Measuring Gearing:

    • Debt/ Equity Ratio

    • Gearing Ratio

  • What is the Capital Structure of a Business?

    • The capital of a business represents the finance provided to it to enable it to operate over the long-term. There are two part to the capital structure

    • Equity:

      • Amounts invested by the owners of the business:

        • Share Capital

        • Retained Profits

    • Debt:

      • Finance provided to the business by external parties:

        • Bank Loans

        • Other Long-Term Debt

  • Capital Structure Objectives:

    • Reasons for higher equity in the capital structure

      • Where there is greater business risk (e.g. a startup)

      • Where more flexibility is required (e.g. don’t have to pay dividends)

    • Reasons why high levels of debt can be an objective

      • Where interest rates are very low debt is cheap to finance

      • Where profits and cash flows are strong; so debt can be repaid easily

Gearing Ratio and Its Benefits

• The Gearing Ratio (%):

  • Gearing \% = \frac{non-current liabilities}{total equity + non-current liabilities}

• Evaluating the Gearing %:

  • Gearing ratio of 50% + normally said to be high

  • Gearing of less than 20% normally said to be low

  • But levels of acceptable gearing depends on business and industry

• Benefits of High Gearing:

  • Less capital required to be invested by shareholders

  • Debt can be a relatively cheap source of finance compared with dividends

  • Easy to pay interest if profits and cash flows are strong

• Benefits of Low Gearing:

  • Less risk of defaulting on debts

  • Shareholders rather than debt providers ‘call the shots’

  • Business has the capacity to add debt if required

• Value of Financial Ratios in Assessing Performance:

  • What is the value of Financial Ratios in Assessing Performance?

    • Teams of investment analysts pour over the historical and forecast financial information of quoted companies using ratio analysis as part of their toolkit of methods for assessing financial performance. Venture capitalists and bankers regularly use ratios to support their analysis when they consider investing in, or loaning to businesses.

  • Ways to assess performance:

    • Comparing performance over time:

      • A danger of examining just one year's results is that the numbers can hide a longer-term issue in the business.

      • It is possible to see whether a trend is emerging by looking at data over several years. Public companies in the UK are required to publish a five-year summary of the income statement to help shareholders assess trends.

    • Comparing performance against competitors or the industry as a whole:

      • Assuming that the detailed information is available, a comparison against competitors is useful for management and shareholders to assess relative performance.

      • Has the business' revenues grown as fast as close competitors? How has the business performed compared with the market as a whole?

    • Benching against best-in-class businesses:

      • Comparisons with other businesses that are not direct competitors can also be useful, particularly if they help set the standard that the business aims to achieve. Care has to be taken with this, though. The benchmark business might operate in a very different industry, with significantly different profit margins and balance sheet norms.

• The main strength of ratio analysis is that it encourages a systematic approach to analysing performance:

  • However, it is also important to remember some of the drawbacks of ratio analysis

    • Ratios deal mainly in numbers – they don't address issues like product quality, customer service, employee morale and so on (though those factors play an important role in financial performance)

    • Ratios largely look at the past, not the future. However, investment analysts will make assumptions about future performance using ratios

    • Ratios are most useful when they are used to compare performance over a long period of time or against comparable businesses and industries – this information is not always available

    • Financial information can be