The evolution in the business world, whether it is business related to the manufacturing industry or service industry, has brought about the need to finance business establishment, growth, diverse functions, or long-term investments. The dire need for corporate finance has brought about the scope of its study and the need for professionals who serve as corporate financers or CFOs.
Many people who do not know about corporate finance think of it as simple loans that finance short-term business investments but in reality, corporate finance is a lot more complex than loans.
Per definition, corporate finance is the study of finance related to large business organizations called corporations, where there are many shareholders and every activity that the corporation performs must add to the value of the shareholder’s wealth. Corporate finance deals with the various sources through which funding are provided as well as capital structure of these corporations. Corporate finance is often considered as a branch of financial management and it differs from financial accounting greatly. The former explains capital allocation whereas the latter deals with the reporting of financial information.
There also exists a relation between corporate finance and investment banking. An investment banker analyses the feasibility of a project a corporation is pursuing and only finances the project if the ROI (Return on Investment) is positive. This performance measurement tool also helps compare different projects and their ROI, to make an informed decision.
Larger corporations employ well-experienced chief financial officers (CFO) in the corporate finance department that analyzes the financial activities within a firm. The goal of the CFO is to increase the price of a firm’s shares. Maximizing the value of a firm’s shares is an indication of the success it is enjoying in the market.
Corporate finance has two sub roles, which are:
- Capital Investment
It involves the formulation of a firm’s investment strategy and the various projects it plans to take up or invest in, that would promise them massive returns. The finance strategies must relate to the firm’s corporate strategy. This helps create harmony, a reason for the chief executives, strategic managers and project managers to sit together with the CFO and make decisions that increase the value of the business as well as the shareholder’s wealth. It is always beneficial to have larger internal rate of return than the market rate of return, which means the NPV (Net Present Value) of any investment should be greater than zero in order for the CFO to approve it for financing. Money comes either from the shareholder’s long-term investment, that comes from initial payments or from annual dividends that are re-invested.
The financing function deals with the raising of capital from financial markets. This function also encompasses the various concerns related to security with the amount of finance being raised. The investors (Investment Bank or Individuals) must be satisfied that their investment will prove to be worthy in relation to the project and will result in high returns. Debt financing is often referred to as leverage where companies prefer loans to finance their projects rather than diluting their equity or shares.
The factors that affect capital-structure assessments of a firm include:
- Business Risk
- Tax Exposure
- Financial Flexibility
- Growth Rate
- Market Conditions
Corporate finances have made it possible for businesses to expand into new horizons with effective corporate strategies that are built to last with an aim to enjoy higher returns on investment.