Corporate Finance

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Contributed by: Hira Aziz

 

Summary
World of corporate finance

What is Corporate Finance? Meaning.

Corporate finance (CF) is an umbrella term indicating the area of finance dealing with the acquisition, structuring and allocatation of the necessary capital of companies and corporations.


Defined somewhat more extensively, CF deals with managing the sources of long term funding (equity) and short term funding (debt capital), managing the capital structure (leverage), and making decisions about investment inititatives (projects) to increase the overall value generation by the firm. The term also includes the many instruments (methods, ratios), practices and analysis performed.


Goal of Corporate Finance

The primary goal of CF depends on the corporate purpose, but is typically to maximize or increase (long term) shareholder value.


Sub-Disciplines of Corporate Finance. Areas

The main sub-areas of corporate finance are funding capital, maintaining a leveraged capital structure, making decisions about the investment of capital in profitable projects, maintaining liquidity for day to day business operations and the dividend policy. The principal task of corporate finance is to enlarge the value of the company. In order to attain that goal corporate finance expands its work into five areas:

  1. Capital Acquisition (Funding): This involves the financing of capital and is typically done by issuing shares or debentures in the capital market, taking loans from financial institutions (banks), or by reinvesting prior earnings.
  2. Capital Structuring (Leverage, Gearing): A core function of corporate finance is to maintain the balance between equity and debt in the capital structure while lowering the overall cost of capital.
  3. Capital Budgeting (Investing): A well-researched and planned capital investment will regenerate considerable returns (money) and increases the value of the company. Poorly invested capital will degrade the financial position of the company. For investing long-term capital, corporate finance departments use capital budgeting in order to identify capital expenditures and discounted future cash-flows of the proposed project. To choose the best possible investment project, the returns should also be risk-adjusted. See also: WACC.
  4. Working Capital Management: This involves the management of short-term liquidity that is needed for carrying the day to day business operations that includes providing finance for current assets, current liabilities, and working capital needed for inventories and short-term borrowing and lending (such as the terms on credit extended to customers).
  5. Dividend Policy: This is concerned with the financial policies regarding paying cash dividends to the shareholders in the present or reinvesting them in the business (and paying an increased dividend at a later stage). Whether to issue a dividend, and how much, is determined mainly on the basis of the company's unallocated profit (excess cash) and the company's future, long-term earning power. As said, payment of surplus earnings can happen in the form of cash dividends, but also by repurchasing the company's stock (share buyback). See also: Total Shareholder Return.

Corporate Finance in Investment Banking

The terms "corporate finance" is also used by investment bankers to indicate the role of investment banks in assisting in the evaluation of a company's financial needs and in raising the appropriate type of capital that best fits those needs.


Sources:
Pascal Quiry, Yann Le Fur, Pierre Vernimmen, Antonio Salvi and Maurizio Dallocchio (2011), "Corporate Finance: Theory and Practice"
Stefan Deutscher (2003), "Corporate Finance and the Theory of the Firm".


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Compare with: Mergers and Acquisitions  |  Corporate Governance  |  Corporate Performance Management

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