Definition of Corporate Finance

Corporate finance is a branch of finance, alongside personal finance and public finance that deals with corporations. It is concerned with how companies raise and distribute funds towards projects to maximize profits while reducing costs. Corporate finance has been hailed as the backbone of any organization.

It deals with ensuring a company's resources are efficiently and effectively used. Therefore, the first role of a corporate finance expert is to know the assets a company owns and how best to allocate these resources. With this in mind, the company could now figure out ways to earn more with the slightest downturn.

Scope of Corporate Finance

Corporate finance is a broad subject, covering every aspect of a company's finance, such as:

• Whether the company should opt for equity or debt.
• Whether the company should invest now, and which options are best.
• Whether the company should give dividends to its shareholders, after what periods, and the actual amount.
• Whether the company should take a loan or sell its assets to clear a critical financial situation.
• Whether starting new branches is feasible financially, and what can be done to speed up profitability.

Generally, corporate finance deals with financial planning, acquiring and raising funds needed, monitoring finances, and investing.

Types and Sources of Corporate Financing

Generating funds may be a tough nut to crack for corporations. Financial experts have to weigh whether internal sources will bring more benefit than external sources or vice versa. While the decision boils down to facts, experience, and intuition, some corporations may be particular about what kind of financing they want for their projects.

Equity financing

This type of financing, also called owner's equity, deals with selling a company's shares (equity) to raise the needed capital. Equity financing is the best way for companies that do not want liability. Some examples of equity financing are crowdfunding, venture capitalists, angel investors, and Initial Public Offerings (IPOs).

Debt financing

On the other hand, debt financing draws its finances from bank loans, accounts payable, and any other form of liability. It usually requires collateral as a prerequisite. Also, it must be repaid in the future, although interest may be tax deductible.

Principles of Corporate Finance

Financing

While some corporations may choose one type of financing, others may choose to use a combination of both equity and debt financing. The corporate finance department assesses the best financing principle for a particular project at a certain period.

They should also consider current interest rates, short-term and long-term goals, and return on investment.

Capital Investment

Capital investment involves the finances required to acquire fixed assets, such as machinery, infrastructure, buildings, land, technology, and renovations. Also, capital investment refers to the finances invested into a company that is explicitly used to buy fixed assets and not in the business's daily operations.

Financial experts must accurately weigh investment options considering risk and return on investment. The general funds required to obtain capital should not outweigh the profits. Capital investments are one of the most fundamental principles of corporate finance and greatly rely on planning and budgeting.

Dividends

Dividends are retained earnings or profits, or both, paid out to shareholders by the company after specified periods, such as quarterly, annually, or biannually. Finance experts have the task of deciding whether to pay out all the dividends to shareholders, plow them back into the business, or invest them elsewhere.

When paid to shareholders, dividends may be either additional stock or cash. They paint a picture of the company's stock's worth, which may be a very salient feature for investors to consider.

Elements of Corporate Finance

Capital Budgeting

Most investments focus on return on investments, which is profits. However, capital budgeting concentrates primarily on cash flows and long-term investments. Here, decisions such as purchasing new computers or refurbishing existing ones are made. It is a very intensive decision-making process that may ultimately save the company funds wasted on uneconomic business decisions.

The following are a few of the decisions made at this level:

• Replacing or modernization
• Expanding or diversifying
• Research projects
• Contingency investments

Capital Structure

A corporation's capital structure is the composition of the capital sources and types available to the company. This may include both equity and debt financing. While equity consists of the shareholder's funds, preferred capital, and earnings that have been retained, debt comprises debentures, loans, and other borrowed funds.

To analyze the best capital structure for a company, it is essential to consider the need or urgency, importance, and existing theories, such as static trade-off or MM theory. In some instances, debt may be cheaper than equity. This level also requires serious decision-making.

Working Capital

This deals with the funds used for daily business operations, calculated as the difference between the current assets and current liabilities. The capital is used to pay vendors and service providers and handle everyday bills.

Working capital is very dynamic and can be affected by the slightest of reasons, such as shifts in purchasing power or choices, weather and seasons, or even changes in the supply and demand curves. Corporations need to create a flexible system. Future projections of the business may require additional working capital.

Example of a Corporate Finance Scenario

It isn't easy to compact a whole department's role into one example, but hopefully, this will suffice as one of the many tasks corporate finance handles.

Consider a company Y that deals with producing ice cream. Your best season is summer and the lowest is winter. However, this does not mean production halts during winter; it just simmers a bit. Your financial adviser comes up with a plan to expand just when winter is about to begin as a form of reverse psychology marketing strategy. You set the whole corporate finance department on task to come up with feasibility reports of all outcomes and advise you on the next action step.

With such a scenario in mind, it is clear to see how critical thinking is a vital tool in corporate finance. In the above example, some could claim that reverse psychology is too risky, while others could see it as a high return option since they could take advantage of buyers' curiosity.

Career options in Corporate Finance

Pursuing a career in finance, specifically corporate finance, is always marketable. Corporations will always need professionals to handle their finances effectively. The median annual salary for entry-level finance experts is $88,160, while for experts and executives, the amount goes up to $278,100.

Chief Financial Officer: A company's senior financial executive whose role encompasses all financial aspects of the corporation.

Corporate treasurer: Manage risk and money, and develop financial policies.

Financial controller: Prepares financial statements and ensures the corporation is tax compliant.

Other career options include chief compliance officer, hedge fund advisor, risk and compliance analyst, investment banker, and financial advisor.