If you assume that corporate finance is a function unconnected to the real operations of a company, you’d better think twice.
Every single decision made in a business has financial implications, and any decision that involves the use of money is a corporate financial decision. Corporate finance is how to best raise money and use it. Corporate finance involves managing the required finances and its sources.
It is the discipline of finance that deals with financing, capital structuring, and investment decisions. It is primarily concerned with maximising shareholder value through long and short-term financial planning and the implementation of various strategies. The activities in corporate finance range from capital investment decisions to investment banking.
In short, corporate finance focuses on how to maximise the value of the company through its financing and investment decisions, i.e. how to best raise money and use it.
Corporate finance departments are charged with governing and overseeing their firms’ financial activities and capital investment decisions. Such decisions include whether to pursue a proposed investment and whether to pay four the investment with equity, debt, or both; it also includes whether shareholders should receive dividends. Additionally, the finance department manages current assets, current liabilities, and inventory control.
What is the importance of corporate finance?
Large companies need data insights that can support them to make decisions like
- Shareholder’s dividends issue
- Proposals of investment options
- Managing of liabilities, assets and capital investments
These areas, not exclusively though, highlight the importance of corporate functions.
A company’s capital structure is crucial to maximising the value of the business. Its structure can be a combination of long-term and short-term debt or common and preferred equity. The ratio between a firm’s liability and its equity is often the basis four determining how well balanced or risky capital financing is.
A company that is heavily funded by debts has a more aggressive capital structure and therefore, potentially holds more risk four stakeholders; however, this risk is often the primary reason four a company’s growth and success.
The importance of corporate finance is equally divided between the following phases:
Here is where the comprehensions are made use of to determine the finances of the company effectively. Decisions need to be taken on how much finance is needed, how it will be sourced, where it will be invested, would the investment bring in profits, how much is anticipated profits and such to decide on a firm plan-of-action.
This is a vital stage highlighting the importance of corporate finance and decisions taken here will involve assessment of company assets four sources to fund investments. To raise enough capital a company may decide to sell shares, issue debentures and shares, take bank loans, ask creditors to invest etc. Thus, it has serious financial implications on profit and liquidity being related to the short-term funding and managing plans of the company to finance long-term investments.
Investments can be either on working capital or fixed assets. Fixed capital is utilised four financing the purchase of machinery, infrastructure, buildings, technological upgrades and property. However, working capital is required four day to day activities like raw-material purchases, running expenses of the company, salaries and overheads and bills. There is a lot of data analytics and foresight required before making such investments and companies will raise funds only when they have a well-justified investment plan with good ROI before raising and providing capital four such investments. It is an important stage in the process and relates to excellent planning and managing of assets which directly impact the company’s health and performance.
Risk management and financial monitoring
Persistently keep an eye on the investments is required. Risk-management aims to reduce and mitigate the undertaken risks of investments and forms a part of the on-going monitoring process. A lot of technology is involved with complex tools suites and technologies being deployed to provide minute-by-minute assessments of prices and its fluctuation, risk assessment, market trends, and monitoring of the debtor and creditor positions. The goal is to ensure higher-returns four the investors.
Further to the phases listed above, the following points summarise the important of corporate finance:
- Corporate finance sets objectives that improve company’s valuation and make investors happy.
- The function makes strategic growth or restructuring decisions that impact in the mix of geographies, business units, products/services of the company in order to improve the valuation.
- It raises capital four expansion or restructuring projects and deal with investors.
- Corporate finance function takes decisions on merging with or acquiring other businesses, or the negotiating the best price and terms four the company during an M&A activity.
- It avoids or manages risks four the company.
Activities in corporate finance
Investments & Capital Budgeting
Investing and capital budgeting is one the activities in corporate finance that 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 to pursue an investment opportunity through extensive financial analysis.
Investing and capital budgeting as one the activities in corporate finance uses financial accounting tools to identify capital expenditures, estimate cash flows from the proposed capital projects, compare planned investments with projected income, and decide which projects to include in the capital budget.
Financial modelling, also falling under Investing and capital budgeting as one the activities in corporate finance, is used to estimate the economic impact of an investment opportunity and compare alternative projects. An analyst with often use Internal Rate of Return (IRR) in conjunction with Net Present Value (NPV) to compare projects and pick the optimal one.
This is one of the core activities in corporate finance and includes decisions on how to optimally finance the capital investments through the business’ equity, debt, or a mix of both. Long-term funding four major capital expenditures or investments may be obtained from selling company stocks or issuing debt securities in the market through investment banks.
Balancing the two sources – equity and debt, should be closely managed as one of the activities in corporate finance because having too much debt may increase the risk of default in repayment, while depending too heavily on equity may dilute earnings and value four original investors.
In short, it is one of the activities in corporate finance to optimise the company’s capital structure by lowering its Weighted Average Cost of Capital (WACC) to be as low as possible.
Dividends & Return of Capital
Dividends & Return of Capital requires the corporate finance professionals within the company to decide whether to retain a business’s excess earnings four future investments and operational requirements or to distribute the earnings to shareholders in the form of dividends or share buybacks.
Retained earnings that are not distributed back to shareholders may be used to fund a business’s expansion. This can often be the best source of funds, without incurring additional debts or diluting the value of equity by issuing more shares.
If the corporate finance professionals with the company believe they can earn a rate of return on a capital investment that’s greater than the company’s cost of capital, they should pursue it, otherwise, they should return that capital to shareholders via dividends or share buybacks.