In business, perpetuity is guaranteed when investment decisions are based on an in-depth analysis of the prevailing demands on the market. Decisions that are aimed at enacting investment proposals need to be well calculated in order to minimize the element of bad investment that usually leads to heavy losses or closure of the organization at hand (Agarwal, 2013). In the process of ensuring that an organization is financially healthy, there is the need to maintain a healthy balance of debt-to-equity ratio if it is to handle current and future expenditure on investments. Besides, it is also important to ensure that at any time a firm can meet its financial obligation. That is why due diligence needs to be applied before making any decision on investment operations irrespective of the fact whether it is capital intensive or not (Agarwal, 2013). In the process of applying due diligence before making investment decisions analysis should be applied in order to understand the prevailing circumstances (Wilbur et.al, 2000). This paper intends to evaluate how FRICTO analysis is utilized as a reference point in making investment financing decisions in organizations.
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FRICTO is an acronym for flexibility, risk, income, control, timing, and others. Flexibility (F) presents the company’s ability to meet its financial demands in the future with the help of alternative financing options. The higher company’s flexibility is more accessibility to the financial market the company has. As a result, it has the possibility to select a financial plan that is the most utility (Kester & Hoover, 2005). Risk (R) presents the effect of different financial decisions upheld regarding the risk that a company and its shareholders are exposed to in accordance with the rule more debts = more risk exposure. The other variable of this analysis is the income (I) which represents the benefits that an organization gets as a result of utilizing various financial options regarding its disposal. If the company’s EBIT (earnings before tax and interest) is higher than the financing indifference point (EBIT level at which the Earnings Per Share (EPS) is the same for two alternative financial plans), then the debt will increase the company’s EPS (Kester & Hoover, 2005).
Control (C) presents the impact of the alternative financial plans on the level of control that shareholders have in the company. The common phenomenon in the field of business is that the more the common shares are available, the less control individual shareholders have over the company at hand. Timing (T) is another element of the analysis that provides insights into market dynamics that influence the choice of the financial option taken by a company (Kester & Hoover, 2005). Different times present different shifts in the financial market in terms of interest rates, and this is a factor that affects companies’ debt-equity choice. The last element of the analysis is the other (O) factors that include the impact of the financial plan on other aspects of the business at hand.
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To get a more detailed perspective of FRICTO analysis, I undertook an interview session with Jack Henderson, who is an executive vice-president at Hunzicker Brothers Electrical Distributor in Oklahoma City, OK, USA. The goal of this interview was to understand how this tool is adopted by a company in the line of making diligent financing decisions while making investments.
Interview Questions and Jack Henderson’s Responses
What is your advice on how to manage finance in an organization?
Managing the finance according to Henderson should be centered on a well-detailed analysis platform, where all parameters of a company’s financial records are fully captured. It ensures that a company does not spend more money than it can afford. Moreover, Henderson pointed out that through well-captured financial records it becomes easier to identify ways of financing different projects. The records also help realize the ability of a company to ensure liability costs incurred as a result of financing projects via future benefits (loans).
What is the greatest challenge regarding project financing in any business?
Through Henderson’s response, it was evident that in most cases big companies only cater for a part of the project cost. The larger part is usually financed through an agreement with financial institution/s. According to Henderson, the greatest challenge of project financing is choosing the right plan. He pointed out that it is usually a process that is very durable since the management has to assess intensively the strong and weak points of a company in order to ensure that any project meets the potential ability of a company. He added that the financing plan must provide a situation where benefits should be higher than the liability cost expressed in terms of interest.
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Do you utilize the FRICTO analysis tool and if yes, how are the principles of FRICTO analysis implemented in your company?
Henderson indicated that Hunzicker Brothers utilizes the FRITCO analysis as a way of ensuring that any project, undertaken by the company, provides income to the company. According to Henderson, Hunzicker Brother’s financing plans, taken to fund various projects, are very flexible in the term of ensuring that the company remains able to spend more money that might be required with time to fulfill the plan or start another project. Moreover, he pointed out that a lot of researches are usually done in order to understand the risk that various financing plans pose both to the business and its interested parties. Usually, the aim is to minimize the risk by ensuring that various projects are financed through financial plans. He also explained that through the researches on risk factors, the company is able to finance its projects with minimal levels of risk exposure.
Moreover, Henderson informed me that in order to ensure the perpetuity of a company, one has to ensure that in any decision the interest of a company remains the priority. In this line of thought, he explained to me that the leadership in the Hunzicker Brothers analysis all available financing plans to identify the one that yields the highest income to the company. Here the aim is to identify the plan that has an accommodative repayment scheme regarding both the accumulative cost and repayment time frame. In terms of control, Henderson was keen enough to point out that the success story of the Hunzicker Brothers became possible because of the continued support of shareholders. According to his belief, it is a support base that cannot be put into jeopardy, and due diligence must be applied to maintain this status quo; it plays a huge role on the stage before the company commits itself to a financing plan. Besides, Henderson pointed out that while deciding on a financing plan, timing is crucial to the well-being of a company. He added that there are shifts that affect the cost of capital (R) and hence the need to look for financial help when the interest rates are low. I was informed that the Hunzicker Brothers undertakes a financial market shifts projection study, the aim of which is usually to identify the best economical time to look for financial aid in order to supply various projects. Lastly, in terms of others (O), Henderson informed me that business has many activities and hence the need to resort to any other components, relevant to the company’s ability to meet the added costs of a new financing plan. In Hunzicker Brothers, this entails performing that is called in-house reflection, where the aim is to perform a quick analysis of all ongoing capital intensive activities that affect the financial ability of the company. It has helped the company minimize the element of over-commitment concerning operational liabilities according to Henderson.
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The responses provided an explicit assertion that financial decisions involve a lot of reference to different variables that affect the affordability of the plan or welfare of the company at hand. Moreover, it was evident that researches are commonly undertaken, which helped decision-makers to chose what to do. Besides, it was also evident that the only way of safeguarding the interest of a company was to ensure that revenue exceeds expenditures thereby maintain a good mix of debt-equity. Over and above, through the interview, it became clearer that different financial plans have different impacts on the company at hand thus necessitating a keen analysis in order to ensure that the most utility plan is chosen.
The above information presents the financial decision-making process as a multi-stepped venture, where many variables are involved in the process of making the final decision. It is also clear that these decisions affect the perpetuity of the company at hand through the mere fact that they involve money in the money-out strategy. Moreover, it is evident that these decisions should be based on their utility capabilities if the perpetuity of the financial well-being is to be guaranteed. It is also clear that FRICTO analysis provides a tool that can be exploited by leadership if due diligent decisions on project financial plans are to be made.