Most businesses requires substantial amounts of capital to both develop and operate. Therefore, cost and availability of capital have an enormous impact on the business. When demand is high, large amounts of cash are generated. Likewise, when demand drops, cash gets used up very quickly. Businesses respond to and operate under a variety of financial strategy options.
For example, airlines often use leasing as a financial option to expand whereas lodging and restaurant companies may use franchising to do the same. Strategy selection also varies by type of business. Strategy selection is influenced by your overall goals, objectives and mission statement. In your business it may be viewed with multiple perspectives.
For example, strategy selection may be influenced by the organization’s need for cash or by its desire to achieve its return on invested capital (ROIC) objectives. Publicly traded companies may be focused on earnings before interest, taxes and depreciation and amortization whereas a private company may have a focus on the acquisition of assets or ownership.
Depending on your mission and goals, financial strategies will vary. Most businesses have ROIC financial goals and needs for cash generation. Financial strategy selection is about selecting the best ways to achieve these goals, meet ROI objectives and satisfy investors. Let’s now look at some of these financial strategy options.
Return on Investment Capital
If a business objective is to receive a high ROIC, selecting an ownership strategy that entails new construction for all its operations would likely be disastrous. Very large amounts of capital would be needed, thus a very large investment and the return would take years to materialize for most businesses. On the other hand, if the same business selected a management contract (manage others assets for a fee), or sold an asset (rollover) its investment is minimal and its return is very quick, thus resulting in a high ROIC on a percentage or dollar basis, in relationship to the minimal investment. Here are 10 financial strategy options — not all will relate to every industry sector — ranked from high to low ROI:
- Management contracts
- Rollover asset
- Additional capacity
- Franchises
- Management contract with limited equity investment
- Buy out of negative leases
- Acquisitions
- Joint venture
- Management contract with major equity investment
- Ownership (new construction)
These financial strategy options are based on the premise of quicker returns. There are various ways in which to mix these strategies to accelerate growth, minimize investment and improve returns and the timeliness of those returns.
The basic formula for calculating ROIC is to divide your profit by your current investment. Average ROIC is a function of your average profit per year divided by the average remaining mortgage balances per year, over the life of the investment.
The fastest way to improve ROIC is to rollover an asset, or sell something. Assuming you receive more for that asset than you owe or assuming you receive much more due to appreciation, your ROIC will improve dramatically. You are increasing your return and decreasing your invested capital at the same time. Here are five of the faster financial strategies and methods by which to improve ROIC.
- Rollover of assets (sale)
- Management contracts
- Additional capacity (assumes demand high)
- Buy-out of negative leases
- Buy-in to joint ventures with a management contract
To the contrary, any financial strategy that requires large amounts of capital and takes a longer period of time to generate earnings is going to be slower method of achieving returns. The three slowest financial strategies or methods to improve return on invested capital are: new construction or ownership, new construction or joint venture and acquisitions.
Cash Generation
Understanding how to generate cash in relationship to your business’ time horizon is essential to survival. The fastest way to generate each is to rollover an existing asset, or sell it. The least amount of cash and the longest time to generate cash will come from developing a concept — opening an operating business model that is successful and worthy of franchise investment — and then providing for the marketing of the franchise.
Compared to owning a cash-generating business or acquiring one, development is always the longest road to cash generation. Here are ways to generate cash, from fastest to slowest.
- Rollover of an asset
- Ownership
- Acquisition
- Management contract
- Franchise
Selecting the right financial strategy should be premised upon your objectives and needs for ROIC, time constraints and your expectations and needs for cash generation.
Ronald A. Nykiel is the dean of the College of Business at Husson University. He has written numerous books and articles on customer services and marketing. He has served as the chief marketing officer for major multinational and service-sector corporations.