What Is Corporate Finance (Explained: All You Need To Know)

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What Is Corporate Finance

Corporate finance is a general term that refers to the manner corporations address their financial needs through different types of funding sources and strategies.

In other words, when we talk about corporate finance, we are talking about the manner the company will fund its operations in the short term and going forward.

For businesses to survive, they must be profitable.

To generate revenues and profits, companies will need to ensure that they have the right funding strategies allowing them to achieve their objectives over time.

Corporate finance can consider many aspects of a business, such as accounting, capital investments, capital structures, cash flows, and taxation.

When companies make the right funding decisions to manage their current operations and plan for their growth, the company’s chances of succeeding and being profitable are much better.

Conversely, if a company does not make proper corporate finance decisions, it may end up having liquidity and cash flow issues even though the business is fundamentally profitable.

Keep reading as I will further break down the meaning of corporate finance and tell you how it works.

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Why Is Corporate Finance Important

Corporate finance is a very important corporate function as it allows company leaders to make the most optimal financial decisions for the company.

Companies may have many competing investment options and they must assess their different investment options and select the ones that have the best return while balancing risk.

Should the company invest in capital assets?

Perhaps, the company should invest in the acquisition of another firm?

Should the company invest in R&D so it can launch a new product?

In addition, the company will need to have a way to decide how to fund its investment decisions.

Should the company raise capital through equity?

Will it be better to borrow the needed capital at the current rate of interest?

Corporate finance decisions also include all the decisions related to how profits should be shared with shareholders and investors.

Should the company pay dividends or keep the funds as retained earnings?

Is it better to buy back some of its outstanding shares or pay down debt?

In the end, corporate finance decisions are crucial to a company’s overall profitability and long-term viability.

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Corporate Finance Activities

There are three main corporate finance activities that companies are concerned about, namely, capital investments, capital financing, and return on capital to investors.

Capital investments refer to a company’s strategy in purchasing capital assets allowing it to generate revenues and remain profitable in the long run.

Generally, companies will evaluate different investment options, perform capital budgeting, create financial models, and ultimately decide on the capital investment that has the potential of generating the most return while managing risk.

Companies will look at the return on investment, internal rate of return, net present value, and other financial metrics to make their decision.

The next category is capital financing primarily concerned with the optimization of the manner the company funds its operations.

A company can fund its operations using equity, debt, or a combination of debt and equity.

Having the right balance of debt and equity can help the company manage risk and optimize its cost of capital.

The third category has to do with the manner a company will pay dividends to its shareholders and distribute profits to investors.

In this context, a company will need to decide if it will pay dividends to shareholders, if it’s going to keep the funds as retained earnings, if it’s going to buy back shares, or find other ways to provide a return to investors.

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Corporate Finance And Working Capital

Corporate finance is also concerned with a company’s short-term liquidity and working capital.

In other words, the company will need to decide how it will fund its current business operations and ensure that it has enough liquidity to run its business.

In this context, corporate finance allows companies to make decisions on how to manage their current assets, current liabilities, and cash flow.

A company must have enough liquidity to pay for its operating costs, assume its financial obligations toward creditors, and plan for its short-term capital requirements.

For a company to handle its working capital needs, it must typically look at its cash management, inventory management, debt management, and short-term financing needs.

Cash management is to plan for the liquidity needed to fund its day-to-day operations.

Inventory management is to ensure that the company is able to produce in an uninterrupted fashion.

Debt management is to determine if the company should extend credit to customers or not, discounting policies, using lines of credit, managing credit scores, and assessing default risk.

Short-term financing is the process of determining if the company generates enough cash flows to fund its operations or consider alternative funding options such as factoring, bank overdraft, bank loan, and so on.

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Corporate Finance FAQ

What are the main corporate finance principles?

The main corporate finance principles are investment principles, financing principles, and dividend principles.

Investment principles refer to the evaluation of different investment options, risk assessment, and profitability.

Financing principles refer to the manner the company will finance its investment decisions to maximize value.

Dividend principles have to do with how the company will use its surpluses to fund its growth or pay dividends to its shareholders.

What are the different types of corporate finance?

Companies essentially have three ways of funding their options, using the cash flow they generate, equity financing, and debt financing.

A company can use the profits it generates from its operations to continue expanding or fund its operations.

Alternatively, a company can raise capital by selling equity securities such as common shares or preferred shares.

Finally, another type of corporate financing option is debt financing which includes bank loans, credit lines, bond and debenture issuance, and so on.

What are some examples of corporate finance activities?

Although there are many corporate finance activities, here are some examples:

• Preparing financial models to assess different investment options
• Securing an additional line of credit from the bank
• Assessing the possibility of raising capital through an initial public offering
• Paying off debt to reduce default risk
• Saving cash to prepare for an acquisition
• Paying out dividends to shareholders 
• Ensuring that production remains uninterrupted 
• Managing supply chain costs 

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Takeaways 

So there you have it folks!

What does corporate finance mean?

In a nutshell, corporate finance refers to how a company manages its capital structure along with its funding strategies in such a way that it can create more value for its shareholders.

Fundamentally, the main objective of corporate finance is to make financial decisions that have the potential of creating the most value for its shareholders while balancing risk.

When companies make sound corporate finance decisions, they are able to increase the value of the organization, generate profits, and be in a position to pay dividends to their shareholders.

You can say that corporate finance deals with investment decisions, financing decisions, and offering a return on investors.

The main tasks in corporate finance are capital budgeting decisions, capital structure decisions, working capital requirements, and dividend distribution decisions.

Now that you know what corporate finance means and how it works, good luck with your research!

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