Corporate finance is concerned with the management of corporate funds. It has two major tasks viz. procurement of the funds and their effective utilization. Some other important decisions in this regard are with respect to financing, capital structure, investing, working capital, performance appraisal, and financial valuations.
Corporate finance management is practiced at the finance department of any business organization. It deals with all the matters related to finance and to be specific it deals with financing and investing decisions of the business. Financing decisions are concerned with selecting and acquiring right sources of finance in an appropriate mix for operating the business whereas investing decisions are the decisions about utilizing the acquired funds in the most efficient manner by analyzing the projects for their returns and their alignment with organizational goals.
Financing decisions involve analysis of different means of finance. Means of finance are globally classified into two – equity and debt. Equity is the owner’s funds which include preference capital and retained earnings apart from the equity capital. Debt, also known as the loan fund, includes debentures, term loans, and short-term borrowings. Financing decisions are taken based on the analysis of different means of funds in terms of their costs, dilution in control, risk, and restraint on managerial freedom. For determining the appropriate mix of these funds, capital structure techniques play an important role. Some of the major capital structure approaches are net income approach, net operating income approach, traditional position and Modigliani and Miller position.
On the other hand, investing decisions involve analysis of projects and capital expenditures using capital budgeting techniques. Net present value (NPV), benefit-cost ratio, internal rate of return (IRR), payback period etc are the renowned capital budgeting techniques. Investing decisions are taken based on the viability of the investment proposal in terms of its capital requirement, cash flows, profitability, etc. These parameters are best judged using the capital budgeting techniques.
The periodic aspect of corporate finance management explains long term and short term financial management separately. Long term, we discussed above whereas short-term financial management is the aspect where working capital management plays a big role. Working capital management deals with managing day to day finance requirements of a business. In business terms, we can say that it deals with current assets and current liabilities. Working capital management involves managing cash and liquidity, credit, inventory and the working capital itself. Different ratios and techniques are used to decide about the right cash and inventory levels.
Financial analysis and planning is another important facet of corporate finance. Financial statements are analyzed for appraising the financial performance of a business. Financial analysis is mainly done using the financial ratios which are classified into five types, such as profitability ratios, liquidity ratios, leverage ratios, turnover ratios and valuation ratios. Apart from ratios, another important tool is break-even analysis which explains the variation in profits due to output, costs and prices. More important than historical analysis is the planning about the future and here is where financial planning comes into play. Pro forma or projected financial statements are prepared by the finance manager to find out whether the business is directed towards the achievement of long terms goals of the business.
Nowadays, financial valuation is a key issue to address in corporate finance which was just of academic value previously. It involves the valuation of companies. It is a very complex issue to resolve. It has very significant value in big transactions such as mergers and acquisitions, disinvestment, spin off etc. Techniques such as book value, price to earnings ratio, discounting cash flows etc are used to assess the value of a company.
Discussed above are the most central issues in corporate finance. The main objectives are profit maximization and wealth maximization. Out of the two, maximization of wealth is considered superior to profit due to its longer term perspective. All the analysis and techniques are utilized to serve the common aim of wealth maximization.
Category: Corporate Finance
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