What is Corporate Finance?
Corporate finance is a subdivision of finance that deals with financing, capital structuring, and investment decisions to maximize shareholder wealth: the short and long value of shares.
Ultimately, corporate finance tries to acquire economic resources for the organization and allocate them in the best possible way. The purpose is to reduce the implicit risk of certain decisions and achieve optimal company development, acquiring more and more value.
The corporate finance department’s functions are planning, defining the capital structure, determining the economic viability of a project, raising sufficient funds, designing investment policies, directing financial negotiations, or planning the payment of dividends.
Corporate Finance Activities
Corporate finance acts as a link between the company and the capital markets. On the one hand, they must ensure that the organization uses the appropriate sources of financing at a minimum cost. On the other hand, they try to ensure that the company uses the funds raised correctly and generates the maximum return for its owners.
Thus, we can classify different activities within corporate finance as investment decisions, financing decisions, dividends, and management decisions. The latter concern operational decisions and those relating to day-to-day finances. Let’s look at the first three in-depth.
Investment Decisions or Capital Budgeting
The investment principle specifies that companies invest only in projects or actions (purchase of machinery, acquisition of equipment, expansion of staff) that produce a return that exceeds the rate of return. Where to place long-term capital assets to generate the highest returns by adjusting for risk is part of the capital investment decision, also known as capital budgeting.
To do this, the organization must know its cost of capital to put its funds to work so that the returns on investment are more significant than the cost of money that the company must pay.
In the development of this activity, a series of financial accounting tools charity through which capital expenditures and cash flows calculate, investments are compared. And, finally, the entity decides which projects are financially viable. And which ones will provide the best long-term financial performance and profitability.
Undoubtedly, capital investment decisions are crucial for corporate financing. Allowing the company to identify where it can make money and spend it.
Equity Financing Decisions
The financing principle suggests that the appropriate financing mix for a company maximizes the value of the investments made. Thus, financing decisions within corporate finance are concerned with deciding how to finance the firm’s capital investment objectives.
It can be by investing the capital of the company, through social capital (money that companies obtain by selling shares to investors). Debt (borrowed financing, either as credit or debt capital by issuing debt securities through investment banks ), or a hybrid. The company can also opt for bank loans, corporate loans, and other fundraising possibilities.
The key is to achieve a sustainable balance between debt, equity. And other financial instruments to not depend on a single source or model of capital. Excessive debt can increase the risk of default. By contrast, relying too heavily on stocks will help dissolve earnings and investor value.
Dividend and Return on Capital Decisions
The dividend principle requires that cash generated more than the needs of a good project remain returned to the owners. This activity inherent in corporate finance decides whether to retain excess profits from a company or distribute them.
In the former scenario, the corporate finance department may choose to preserve earnings. For future investments, acquisitions, or expansions after calculating a higher return rate on the investment than the cost of capital.
In the opposite case, if that rate is not guaranteed, it could remain decided that it is time to distribute profits among shareholders. Either in the form of dividends or by repurchasing shares from their investors.
Every decision affects the stability of the company. Therefore, proper management of corporate finances is key to providing the most significant added value and ensuring its development.