What is Corporate Finance?
Corporate finance is one of the types of finance associated with capital expenditures, investments, and all spending by a corporation. Not only does it keep a record of them, but also assists the management to take appropriate actions for discovering ways to increase the value of their products and services. It revolves around the results of using appropriate tools and analyses that focus on the allocation and distribution of financial resources.
The principal objective of corporate finance is the planning and execution of various strategies to optimize the value of a company. It adds more value to the business through the implementation of resources and timely decision making, along with risk management. The corporation uses all of its resources to increase shareholder value, and it is the end goal.
Corporate finance is also related to investment banking, where the corporation is responsible to evaluate their financial needs and takes measures to generate capital accordingly. In other words, corporate finance is linked to all types of transactions that raise capital for future purposes.
The task of the corporate finance professional is to assist the company in arranging funds for the project, the growth of the organization, efficient cash management, and the preparation of a future financial plan for the company.
Important Activities of Corporate Finance
Corporate finance revolves around three important activities without which no corporation can meet its financial requirements.
Capital Budgeting and Investment:
The process starts with planning about where the long-term assets will go and how the corporation will utilize them. It helps the corporations to figure out whether this investment opportunity is worth it or not. Here, accounting tools and financial analysis emerge as important elements because they identify capital expenditures, decide about the suitability of the projects, estimate cash flows, and compare investments with detailed financial analysis. Here, financial modeling is needed to evaluate the economic impact of these opportunities that are, later on, compared with alternative projects to know their effectiveness.
In this activity, the corporation decides on how to finance the capital through equities, debt, or both. Long-term funding, generated from shares or debt securities, will be utilized to handle major capital investments or expenditures. Here, the corporation will have to make efforts to maintain a balance between the two funding sources because it will minimize the risk of re-payment to the creditors.
Return on Capital and Dividends:
This is where corporate managers have to decide whether they are going to use excess earnings for future investments or distribute among shareholders as dividends or share buybacks. There would be some retained earnings, which the corporation will use to find the expansion of their premises to avoid diluting the value of money or additional debts on them.
Importance of Capital Structure in Corporate Finance
There is no doubt in saying that capital structure is responsible to maximize the worth of the business, as it is the combination of short-term and long-term debt along with preferred and common equities. Also, the equity to liabilities ratio describes the management of capital financing. Though, if a company has a high ratio of debt as compared to equity, then it would be a huge risk or shareholders that eventually lead to affecting the company’s success and growth.
Corporate Finance Resources
The next most important factor to understand corporate finance is to know its resources. They are crucial for any corporation to grow over time as they give a direction on how and from where they can expect to be funded. Common forms of corporate finance resources are:
- Investment banking
- Financial modeling
- Acquisitions and mergers
- Valuation methods
Fundamental Propositions of Corporate Finance
Corporate finance is one of those areas that bring in new things every time a person tries to unfold something he/she has been studying for a long time. It has some fundamental propositions that everybody should understand in order to make appropriate decisions in the future.
- Internal consistency is the only objective that targets business operations and depends upon some bedrock principles, including the importance of accounting income over cash flows, risk rewarding, the efficiency of markets to control scams, and the impact of decisions on a firm’s value.
- Corporate finance is referred to as an integrated whole. It is not a collection of business decisions; rather, it explains the effects of investment decisions over financing decisions or vice versa. While there are some situations where these decisions do not affect each other, there are some conditions where firms have to go through a hard time to resolve their problems. For instance, when a firm received investment from unreliable resources, they have to deal with dividend problems (due to insufficient funds to reward their shareholder).
- Corporate finance works equally for everyone. All businesses have to make decisions in light of corporate financial matters so that they do not have to face issues in the future. Corporate strategists, IT managers, marketing managers, HR managers, and other concerned professionals gather information and base their corporate finance decisions on them.
- It is a creative and fun field that enables people to play with numbers and create accounting statements. Here, the worth mentioning fact is that it is not just a quantitative study, rather; it involves creative thinking and qualitative analysis.
- By applying corporate finance theories and models in the real-world, it will be quite easy for corporate professionals to get the desired results.
The concept and purpose of corporate finance should have been clear by now. Corporate finance is the acquisition and allocation of corporate funds or resources, with the aim of maximizing shareholder wealth. It Is a combination of investment, financing, and dividend principles responsible to meet corporation’s requirements to accomplish their targets and reward their shareholders.