What Is Corporate Finance?
Corporate finance is the division of finance that deals with how corporations deal with funding sources, capital structuring, and investment decisions. Corporate finance is primarily concerned with maximizing shareholder value through long and short-term financial planning and the implementation of various strategies. Corporate finance activities range from capital investment decisions to investment banking.
Understanding
Corporate Finance
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 for the investment with equity,
debt, or both.
KEY TAKEAWAYS
- Corporate finance is often
associated with a firm's decision to undertake capital investments and
other investment-related decisions.
- Corporate finance manages short-term
financial decisions that affect operations.
- In addition
to capital investments, corporate finance deals with sourcing capital.
It also includes whether
shareholders should receive dividends. Additionally, the finance
department manages current assets, current liabilities, and inventory control.
Types of Corporate Finance
Tasks
1. Capital Investments
Corporate finance tasks
include making capital investments and deploying a company's long-term capital.
The capital investment decision process is primarily concerned
with capital budgeting. 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.
Making capital investments
is perhaps the most important corporate finance task that can have serious
business implications. Poor capital budgeting (e.g., excessive investing or
under-funded investments) can compromise a company's financial position, either
because of increased financing costs or inadequate operating capacity.
2. 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.
Balancing
the two sources of funding (equity and debt) should be closely managed because
having too much debt may increase the risk of default in repayment, while
depending too heavily on equity may dilute earnings and value for original
investors.
Ultimately,
it’s the job of corporate finance professionals to optimize the company’s
capital structure by lowering its Weighted Average Cost of Capital (WACC) as
much as possible.
3. 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.
Retained
earnings that are not distributed back to shareholders may be used to fund
a business’ expansion. This can often be the best source of funds, as it does
not incur additional debts nor dilute the value of equity by issuing more
shares.
At
the end of the day, if corporate managers 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 excess capital to
shareholders via dividends or share buybacks.
How Important is a Company’s Capital Structure in Corporate
Finance?
A company’s capital structure is crucial to maximizing the value
of the business. Its structure can be a combination of long-term and short-term
debt and/or common and preferred equity. The ratio between a firm’s liability
and its equity is often the basis for determining how well balanced or risky
the company’s capital financing is.
A company that is heavily funded by debt is considered to have a
more aggressive capital structure and, therefore, potentially holds more risk
for stakeholders. However, taking this risk is often the primary reason for a
company’s growth and success.
Additional Corporate Finance Resources
Thank you for reading finance with brain guide and overview of
the corporate finance industry. To keep learning and advancing your
career these additional finance with brain resources will help you along your
path:
- What is Investment Banking?
- Mergers & Acquisitions
- Financial Modeling Guide
- Valuation Methods
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