Fundamentals Of Corporate Finance You Must Know
Big business equals big money. At least that’s how they’ve always said it. Of course, when you are an integral part of the business’ decision-making process concerning finances, there never seems to be enough money. If you work for a small business, especially a start-up, it seems like no one wants to give you money and no one starting the business has any either. Some days it feels like a no-win situation. We need money to grow and provide our product or service in order to earn revenue – we need money to make money. This necessitates following some fundamentals of corporate finance.
Never fear. This problem has been dealt with by business owners and corporate executives ever since humans first had the idea to go into business. One of the benefits of today’s modern business owner or corporate executive is that there are more sophisticated sources from which to draw capital and more defined and mature capital streams from which to seek financing.
Why is corporate finance so important?
The reasons why understanding the fundamentals of corporate finance is so important are:
- It helps in decision-making. Any decision taken needs to take into mind the availability of funds. So corporate finance aids the decision making of an organization -.
- The goals of an organization, be it short-term or long-term, need finance. Whether it is profitability, increasing customer base; finance is required to achieve goals
- It helps to minimize the cost of
- It helps to raise the capital needed to run the business.
- Financing is needed for organizations to carry out research and development.
- Finance is needed for the expansion of a business and for diversification.
Without finance, a business cannot run. Planning for finance, raising funds, deploying them, and managing them effectively are functions of corporate finance in businesses.
Planning for finance
Planning is a vital function of corporate finance. This tops the list of fundamentals of corporate finance. Key aspects include how much finance is required, how much money should be raised from external sources, which sources are available to raise funds, and how the money can be utilized in a profitable way. If the finances are well planned, then running the business would be easy.
Organizing finance
Once the amount of finance needed is decided, the next activity is to raise funds. The various sources of finance for a business include:
- Loans from financial institutions
- Funds from venture capitalists
- Bank overdrafts and loans from banks
- Accepting deposits from the public
- Issue of debentures and equity shares
- Trade credit from vendors
- Mortgages on property
- Leasing or hire purchase
- Grants from the government or other institutions
Investing funds
Once the funds are available, they need to be invested for the company’s usage. This is known as capital budgeting.
There are two elements here – fixed capital and working capital. Fixed capital refers to purchasing fixed assets like land, building, and machinery. Working capital refers to funds used for day-to-day operations and is used for the purchase of raw materials, payment of rent and salary, etc.
Managing the finances
Regular monitoring of the usage of finances is an essential part of managing finances in a corporate business. As we mentioned earlier, enhancing shareholder value is a key goal of corporate finance. Hence, ensuring optimum use of finances, preventing waste and misuse, and getting the maximum return on investments is something the corporate finance team would need to focus on. This also involves managing risks. There are various tools, including software that can be used to manage finances effectively.
Capital Sources
A corporation has two primary capital sources for investment purposes. These include:
- Self-generation of capital (primarily through revenue streams)
- External capital funding sources (primarily through debt and equity capital)
As managers and executives consider their options, they must determine the optimum mix of capital funding in order to maximize value for the corporation. For example, self-generation of capital takes time and resources and the end product (free cash on hand) can be minimal. This would decrease shareholder value over time. If they consider debt capital, the debt becomes a liability on the balance sheet and affects cash flow. Equity capital is less risky than debt capital, but it dilutes the value of share ownership.
Principles of corporate finance
Corporate finance can be broken down into three principles or areas of activity that together complete the full spectrum of corporate finance. These core principles of corporate finance are:
- Capital budgeting
- Capital financing
- Reinvestments and dividends
Capital budgeting
Capital budgeting is the planning process for company investment. To ensure the highest returns for a company’s long-term capital assets, the corporate finance activity of capital budgeting will need to be planned meticulously.
Investment decisions should always involve vigilant financial analysis, so businesses use a variety of advisory experts and accountancy tools to inform their decisions. They use the expertise of corporate finance specialists to help them recognize opportunities for capital expenditures and gauge the available cash generated by any potential financial projects.
Capital financing
The investment opportunities identified during the capital budgeting phase of corporate finance then undergo the capital financing activity – working out the best way to finance the investments.
The capital investments can be financed through debt or equity, and sometimes both. Other options include issuing debt securities through investment banks or selling stock to raise cash for investments. These latter options are especially useful for long-term capital expenditure or very large investments.
This activity can be problematic if an accurate journal of corporate finance is not kept to monitor both the debt and equity involved in the financing of investments. A corporate finance advisory specialist who knows all the fundamentals of corporate finance will always recommend ensuring debt is kept to a minimum to reduce the risk of default. The levels of equity involved will also need to be kept balanced, as using too much can have a detrimental effect on the company’s income and affect the value of the business for the original investors.
Reinvestments and dividends
The corporate finance specialists at a company will also decide what to do with the return of capital. The extra income from successful investments can fund the operations of the business itself or reinvest in new investment opportunities.
Another option is the distribution of the additional income to shareholders as dividends. This is not the only way shareholders benefit, as the extra income is kept within the business can help it grow, thus increasing the value of the original shares overall.
Conclusion
Corporate finance is an essential thing in today’s competitive world. It is thus very important to study and understand the fundamentals of corporate finance before you get into this sector. Hope this article was able to convey the fundamentals of corporate finance and everything one needs to know.
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