Corporate finance deals with a corporation’s capital structure, including its funding and the actions that are been taken by management to increase the value of the company.
Corporate finance is the subfield of finance that deals with how corporations address funding sources, it also looks into the capital structuring of the corporation, corporate accounting, and investment decisions.
Corporate finance is often concerned with how shareholders’ value can be maximized through long- and short-term financial planning and the implementation of various strategies.
Corporate finance activities range from capital investment to tax considerations.
Corporate finance also includes the tools and analysis which is utilized to prioritize and also distribute financial resources.
The main purpose of corporate finance is to maximize the value of a business through planning and implementation of financial resources while balancing risk and also ensuring profitability.
Types of corporate finance activity
- Mergers and acquisitions (M&A), and demergers which also involve private companies.
- Mergers, demergers and takeovers of public companies, which also include public-to-private deals.
- Management buy-outs, buy-ins or similar of companies, divisions or subsidiaries – usually backed by private equity.
- Issuing of equity by companies, including the listing of companies on a recognised stock exchange by way of an initial public offering (IPO) and the use of online investment and share-trading platforms; the purpose of this may be to raise capital to restructure ownership.
- Financing and structuring joint ventures or how to finance a project.
- Raising infrastructure finance and advising on partnerships and privatizations of public-private companies.
- Raising capital via the issuance of other forms of equity, debt, hybrids of the two, and any related securities for the restructuring and refinancing of businesses.
- Raising capital for seed, start-up, development or expansion.
- Raising capital for specialist corporate investment funds, such as private equity, debt, real estate, venture capital and infrastructure funds.
- Issuing secondary equity, whether by means of private placing or further issues on a stock market, especially where linked to one of the transactions listed above.
- Restructuring and raising private corporate debt funds or debt.
The Three Important Activities that Govern Corporate Finance
1. Investments & Capital Budgeting
Investing and capital budgeting includes proper planning of where to put the company’s long-term capital assets to generate the highest risk-adjusted returns possible.
This consists of deciding whether to pursue an investment opportunity or not and is achieved through extensive financial analysis.
Corporate finance tasks also include making capital investments and deploying a company’s long-term capital.
The primary process of capital investment decisions is concerned with capital budgeting.
Through capital budgeting, a company can identify capital expenditures, estimates future cash flows from proposed capital projects,
Capital budgeting also enables the company to compare planned investments with potential proceeds and decide which projects to include in its capital budget.
Making capital investments is one of the most important corporate finance tasks that can have serious implications on a business.
Poor capital budgeting (e.g., excessive investing or not well-funded investments) can compromise a company’s financial position, either because of increased financing costs or inadequate operating capacity.
By using financial accounting tools, a business identifies its capital expenditures, estimates cash flows from proposed capital projects, compares planned investments with projected income, and comes out with the decision of which projects to include in the capital budget.
Financial modeling is used to estimate the economic impact of an investment opportunity on a business and also compare alternative projects.
An analyst will often use the Internal Rate of Return (IRR) in conjunction with Net Present Value (NPV) to compare projects and pick the one that is optimal for the business.
2. Capital Financing
This core activity entails decisions on how to optimally finance the capital investments through the business’ equity, debt, or with the mix of both.
Long-term funding for major capital expenditures or investments may be obtained from selling stock of the company or issuing debt securities in the market through investment banks.
Corporate finance is also in charge of sourcing capital in the form of debt or equity.
A company issue may debt securities in the capital markets through investment banks or may borrow from commercial banks and other financial intermediaries.
A company may also decide to sell stocks to equity investors, especially when it needs large amounts of capital to expand a business.
Capital financing is a balancing act especially when it comes to deciding on the relative amounts or weights between debt and equity.
Balancing the two sources of funding (equity and debt) should be properly managed because having too much debt may increase the risk of the company defaulting in repayment, while depending so much on equity may also dilute earnings and value for original investors.
In the end, capital financing must provide the capital required to implement capital investments.
3. Dividends and Return of Capital
This activity requires corporate managers to decide whether to keep a business’s excess earnings for future investments and operational requirements or to distribute the excess earnings to shareholders in the form of dividends or share buybacks.
Retained earnings that are not distributed back to the shareholders may also be used to fund a business expansion.
This can often be the best source of funds because it does not incur additional debts nor diminish the value of equity by issuing more shares.
At the end of the day, if corporate managers assume they can earn a rate of return on a capital investment that’s much greater than the company’s cost of capital, they should pursue it.
Or else, they should return excess capital to shareholders via dividends or share buybacks.
How Important is a Company’s Capital Structure in Corporate Finance?
A company’s capital structure is crucial to maximizing the potential value of the business.
Its structure could be a combination of long-term retained earnings and short-term debt and/or common and preferred equity.
The ratio between a firm’s liability and its equity is often the basis for knowing how well balanced or risky the company’s capital financing might be.
A company that is deeply funded by debt is considered to have a more aggressive capital structure and, therefore, potentially holds greater risk for stakeholders.
Meanwhile, taking this risk is often the primary reason for a company’s growth and success.