Corporate finance is the area of finance dealing with the sources of funding and the capital structure of corporations, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to allocate financial resources. The primary goal of corporate finance is to maximize or increase shareholder value. Although it is in principle different from managerial finance which studies the financial management of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms.
The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the company’s financial needs and raise the appropriate type of capital that best fits those needs. Thus, the terms “corporate finance” and “corporate financier” may be associated with transactions in which capital is raised in order to create, develop, grow or acquire businesses. Recent legal and regulatory developments in the U.S. will likely alter the makeup of the group of arrangers and financiers willing to arrange and provide financing for certain highly leveraged transactions.
Among the financial activities with which a corporate finance department is involved are capital investment decisions. Should a proposed investment be made? How should the company pay for it with equity or with debt, or a combination of both? Should shareholders be offered dividends on their investments in the company? These are just some of the questions a corporate financial officer attempts to answer on a consistent basis. Short-term issues include the management of current assets and current liabilities, inventory control, investments and other short-term financial issues. Long-term issues include new capital purchases and investments.
One of the tasks in corporate finance is to make capital investments, and the corporate finance department is responsible for the deployment of a company’s long-term capital. The decision process of making capital investments is mainly concerned with capital budgeting, a key corporate finance procedure. Through capital budgeting, a company identifies capital expenditures, estimates future cash flows from proposed capital projects, compares planned investments with potential proceeds, and decides which projects to include in its capital budget.
This “capital budgeting” is the planning of value-adding, long-term corporate financial projects relating to investments funded through and affecting the firm’s capital structure. Management must allocate the firm’s limited resources between competing opportunities (projects).
Making capital investments is perhaps the most important corporate finance task and can have serious business implications. Poor capital budgeting that causes over-investing or under-investing could put a company in weaker financial condition, either because of increased financing costs or having an inadequate operating capacity.
In addition to handling the use of investment capital, corporate finance is also responsible for sourcing capital in the form of debt or equity. A company may borrow from commercial banks and other financial intermediaries, or may issue debt securities in the capital markets through investment banks. A company may also choose to sell stocks to equity investors, especially when raising long-term funds for business expansions. Capital financing is a balancing act in terms of deciding on the relative amounts or weights between debt and equity. Having too much debt may increase default risk, and relying heavily on equity can dilute earnings and value for early investors. In the end, capital financing must provide the capital needed to implement capital investments.
Capital budgeting is also concerned with the setting of criteria about which projects should receive investment funding to increase the value of the firm, and whether to finance that investment with equity or debt capital. Investments should be made on the basis of value-added to the future of the corporation. Projects that increase a firm’s value may include a wide variety of different types of investments, including but not limited to, expansion policies, or mergers and acquisitions. When no growth or expansion is possible by a corporation and excess cash surplus exists and is not needed, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company’s stock through a share buyback program.
Corporate finance is also tasked with short-term financial management, with a goal to ensure enough liquidity to carry out ongoing operations. Short-term financial management concerns exclusively current assets and current liabilities, or working capital and operating cash flows. A company must be able to meet all its current liability obligations when due. This involves having enough current assets that can be cash-ready, such as short-term investments, to avoid any liquidity or cash crunch from disrupting a company’s operations. Short-term financial management may also involve getting additional credit lines or issuing commercial papers as liquidity back-ups.
Achieving the goals of corporate finance requires that any corporate investment be financed appropriately. The sources of financing are, generically, capital self-generated by the firm and capital from external funders, obtained by issuing new debt and equity (and hybrid- or convertible securities). As above, since both hurdle rate and cash flows (and hence the riskiness of the firm) will be affected, the financing mix will impact the valuation of the firm.
Corporate Financing is a branch of specialization with long procedures, and compliances which is a hassle for the organization along with its day to day work.
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