Corporate finance deals with how corporations address funding sources, capital structuring, accounting, and investment decisions.
Corporate finance is also often concerned with maximizing shareholder value through long- and short-term financial planning and implementing various strategies. Corporate finance activities range from capital investment to tax considerations.
Corporate finance has three main areas: capital budgeting, capital financing, and working capital management. Capital budgeting is the process of prioritizing funds toward the most profitable projects. Capital financing is determining how a company\’s investments and endeavour will be financed. Working Finance management is concerned with cash flow for day-to-day operations and maintaining liquidity.
Corporate Finance Activities
- Investments and capital budgeting
Investing and capital budgeting includes planning where to place the company’s long-term capital assets in order to generate the highest risk-adjusted returns. This mainly consists of deciding whether or not to pursue an investment opportunity, and is accomplished through extensive financial analysis.
- Capital financing
This core activity includes decisions on how to optimally finance the capital investments (discussed above) through the business’ equity, debt, or a mix of both. Long-term funding for major capital expenditures or investments may be obtained from selling company stocks or issuing debt securities in the market through investment banks.
- Dividends and return of capital
This activity requires corporate managers to decide whether to retain a business’s excess earnings for future investments and operational requirements or to distribute the earnings to shareholders in the form of dividends or share buybacks.
Why is Corporate Finance Important?
- Growth and Expansion: Effective corporate finance strategies allow companies to grow. By making smart investment decisions, businesses can increase their market share and profitability.
- Risk Management: Understanding finance helps companies identify and mitigate risks. This can include market fluctuations, economic downturns, or changes in consumer behavior.
- Financial Health: Regular analysis of financial statements and cash flow helps companies maintain good health. This is crucial for attracting investors and ensuring long-term stability.
How Companies Raise Funds
- Equity Financing: This involves selling shares of the company to investors. In exchange, these investors get ownership stakes and a say in company decisions. It’s a way to raise money without incurring debt.
- Debt Financing: Companies can also borrow money through loans or by issuing bonds. While this gives them immediate cash, it requires regular repayments and interest, which can be a burden.
- Retained Earnings: Companies can reinvest their profits back into the business instead of paying them out as dividends. This is often a cost-effective way to fund growth.