Corporate finance is the area of finance that deals with the financial decisions of corporations. The main goal of corporate finance is to maximize shareholder value. Corporate finance deals with the sources of funding for a corporation and the corporation’s capital structure. It also includes managing the short-term and long-term financial goals of the corporation.
What is Corporate Finance?
Corporate finance is planning, developing, and controlling a business’s capital structure. It aims to enhance organizational value and profit through optimum decisions on investment, finance, and dividend. Corporate finance focuses on capital investment to meet a business’s financial needs to obtain a favourable capital structure.
Types Of Corporate Finance
There are two common types of corporate finance Equity finance and debt finance.
Equity finance allows businesses to obtain funds from retained earnings or by issuing shares of stock. Another type is debt finance, which involves borrowing money through loans, usually from financial organizations, issuing bonds, etc.
Some other types of corporate finance are not so common, but businesses can do them as per their requirements. These are-
- Short-Term Corporate Finance
- Long-Term Corporate Finance
Short-Term Corporate Finance
Corporate finance loans given to a company for a short period of a few months (or a maximum of one year) are short-term finance. Short-term corporate finance loans include the following –
- Financial Lease: In this type of corporate finance, the financial entity owns the asset until the lease is paid off. In some cases, companies also retain operational control over assets until full payments are made on time.
- Trade Credit: Generally, trade credit is a part of the B2B structure. It is an agreement where the customer can subsequently purchase any offered goods by paying the supplier.
- Accrual Accounts: In this type of corporate finance, the accrual method of accounting is followed. It enters the sale when creating the invoice instead of receiving the cash.
Long-Term Corporate Finance
Corporate financial loans or assistance extending for one year or more are long-term corporate finance. Long-term corporate finance loans include –
- Debentures: A type of bond, a debt instrument used by large corporations and governments that agree to finance borrowings with a fixed interest rate. Due to the lack of collateral backing, the reputation of the entity issuing the bond is the only aspect to rely on to receive the principal amount and interest.
- Bank loan: The most common financing option that almost every other company relies on to structure its expansion. They can choose medium to long-term financing options or types of loans for businesses depending on their needs.
- Flotation: Refers to converting a private entity into a public one by issuing shares to the general public. This type of corporate financing ensures the corporation receives funding from outside means rather than relying on earnings and new projects to maximize profits.
Scope Of Corporate Finance
Various objectives and responsibilities within the corporate finance sector are referred to as the “scope of corporate finance.” The objectives mainly focus on the sustainable expansion of the company and maximizing wealth creation, as summarized below:
- Businesses should conduct thorough market research before raising funds from the capital market. Market analysis to keep up with rapidly changing trends by accumulating similar practices.
- Play an advisory role in the case of mergers, acquisitions, and takeovers.
- Taking decisions to diversify and expand as per the growth of the company.
- Controlling expenditures through capital budgeting and allocating only the most profitable projects.
- Utilizing the fundamentals of corporate finance to analyze various investment options and determine the optimal mix of financing instruments.
Importance Of Corporate Finance
Corporate finance is the finance branch that deals with businesses’ financial decisions. It covers a wide range of topics, such as the valuation of firms, the issuing of new equity, the management of risk, and the optimal allocation of resources. The Importance of corporate finance can be seen in the following ways.
Corporate finance is important for the:
- Efficient allocation of resources
- Short-term and long-term goals achievement
- Raising capital
- Decision-making power
- Management of risk
- Research and development
- Marketing a company/product
- Growth and diversification
- Issuing of new equity
- Minimizing manufacturing cost
- Valuation of firms
- Effective functioning
Principles Of Corporate Finance
There are three main principles of corporate finance to promote company value:
Investment Principle
This principle guarantees using scarce financial resources to make the most efficient decisions. A company should properly allocate finance, keeping in view the potential opportunities. The company should invest in securing a steady flow of economic opportunities while keeping the money under control for future use.
Financial Principle
Organizing a business structure requires a mix of capital, debt, and equity. This theory is concerned with reaching the optimal mix of multiple financial instruments keeping future implications in mind.
Dividend Principle
Due to continued participation in investment opportunities, companies, where the cash flow generated, exceeds the current investment, and the hurdle rate tries to find fair ways to reward investors and repay loans. Companies can use the extra cash to make payments or expand their business.
