Understanding The Corporate Finance

The term corporate finance is used to refer to the way companies acquire funding, how they manage and utilize their debt and equity, and how they control their investments. Corporate finance is the area of finance that deals with providing money for businesses (capital) to pay for structural improvements, expansion, and other value-added projects and enterprises, and the sources that provide them. Corporate finance also includes the tools and analysis used to prioritize and distribute financial resources. In addition, it deals with the day-to-day operations of a business’ cash flows, as well as with long-term financing goals.

Departments under corporate finance are charged with the responsibility of governing and overseeing their firms’ financial activities and capital investment decisions, which includes whether to pursue a proposed investment and whether to pay for the investment with equity, debt, or both. People who work in various corporate finance departments try to maximize the value of their business through three main activities:

• CapitalBudgeting
• Capitalfinancing
• Dividends and Return of Capital

Capital Budgeting does not only involve creating a long-term plan for the investment of the company’s assets, it also involves managing and researching short-term plans that can be made that offer favorable risk-adjusted returns. Capital budgeting can be easily carried out by using financial accounting tools that would help the company identify capital expenditures, estimate cash flows from proposed capital projects, compare planned investments with projected income, and decide the best project to include in the capital budget.

Balancing or having a mix of the two sources of funding (equity and debt) should be closely managed and monitored, because having too much debt may increase the risk of default in repayment, while depending too heavily on equity may reduce earnings and value for original investors. That is why corporate finance managers must be careful enough to determine which of the sources to rely on for financing. However, to create the most favorable capital financing, most corporate finance professionals will use a blend of equity and debt to avoid over-reliance on one source. In the end, capital financing must provide the capital needed to implement capital investments.

Dividends and Return of Capital: This aspect of corporate finance requires corporate managers to decide whether to hold on to a business’s excess earnings for future investments or to distribute these excess earnings to shareholders in the form of dividends. Whatever decision they make and whatever method and amount to return, is typically determined by corporate managers, who sometimes decide to keep the company’s earnings in order to invest back in the capital markets, or back into their own business.

Dividends are paid periodically, therefore for each period, the corporate management must decide what dividend to pay, since investors expect a certain dividend yield, and might be disappointed if it is lower.

However, retained earnings that are not distributed back to shareholders may be used to fund a business’ expansion and can be used as a source of funding for the company, especially if it does not incur additional debts nor dilute the value of equity.