The corporate finance are those who study the decisions to be taken within a company and how are you affect the financial situation of it. What corporate finance seeks is to increase the value and sustainability of the company, increasing its capital and growing with the decisions made.
This study focuses on finding financial solutions so that the company’s shareholders can obtain greater benefit from it, making it more sustainable within the current market, increasing its value, production and sales. It is merely responsible for the decision-making that concerns the finances and the economic situation of the company.
Corporate Finance concerns the financial decisions managers of enterprises have to make. It can be split in two basic questions:
- What real assets should the firm invest in? Capital budgeting (investment decisions) is a process a business undertakes to evaluate potential investment projects which require investment in real assets such as land, plant, machinery and new product development.
- How should the real assets be financed? The financing decisions (capital structure decisions) considers both, debt and equity (share capital) that are going to be used to finance the investments required in a project.
Objectives of Corporate Finance
The main objectives of corporate finance are:
- Capital structure of the company: with the analysis of the options and the studies of the decisions taken, it is sought to increase the capital of the company, so that it has a more sustainable economic situation.
- Investment management: they study the possible investments of the current capital, in order to obtain a greater economic benefit, making the company move forward with the ideal investments.
- Tax planning: this refers to the fiscal scope of the company, exactly the payment of taxes that must be made.
- Cash and cash control available: with this the area where all the movements that include cash is made is organized.
- Analysis of finances: A study of the situation, stability, and profitability of the company in terms of its finances. Study the possible business that the company may take in the future.
- Financing of future projects: talk about the savings fund that the company has to see if it is profitable to commit to other businesses, in addition to whether this would prove to be a good investment.
- Emerging markets: study the possible profitable markets, in addition to the investment in them.
Those responsible for this area will focus solely on those objectives, all of which are financial.
Corporate Finance Tools
The people in charge of finance use essential tools for good decision making.
This focuses on the investment made and the profitability of the new project in the current market. This studies the value thrown by a certain amount of total investment.
In a list of figures, where the total amount of investment is applied to obtain a percentage of the supposed profitability of the project. The result must be equal to or greater than the amount invested, logically, in order to make a profit. This study does not include time to obtain the profits, but the total amount.
Internal return rates
This studies the annual profitability of the project and the results in terms of the figures obtained. The initial investment value and the results of assets over time are referenced. An annual study is usually done to find out if it has been profitable.
Forms of Business Organizations
Most large businesses are organized in the form of limited liability companies or corporations. The form of organizing a business affects first of all, the source of the finances available and secondly, the conflicts of interests that might arise within an organization between the partners.
Proprietorship is the simplest form. It is owned and run by one single person which is called the proprietor. The limitations from the financial perspective is that the funding of the firm only can be provided by the sole proprietor. Also, the firm is legally not separated from the proprietor which means that the owner is unlimited liable with personal assets if the proprietorship firm is unable to pay. Therefore, the proprietorship firm is also not limited, and the liability of the firm is no restricted to the capital that has been invested. However, proprietorships are simple to start with, there is very limited regulations and the income is taxed together with that of the proprietor’s income.
Partnership firm can have several partners who contribute to the capital of the firm. This enables the firm to raise more capital than one single person in a proprietorship. As well as in the proprietorship, in a partnership firm the personal assets of the partners are unlimited liable to repay debts. However, there are venture capital funds where the general partners (venture capital manager) who actively manage have unlimited liability and the investors (limited partner) have limited liability.
To corporation is a legal entity separated from its owner which makes it possible to enter into contracts. The corporation is reliable for itself and cannot be transferred to the shareholders. Therefore, the owners or shareholders are limited liable and are taxed separately from the corporation. However, this might lead to a double taxation – the profit earned by the company will be taxed and the dividends paid to the shareholders too. Corporations make it possible that people can invest in the company even if they are not directly involved in managing the company. This enables the corporation to raise large numbers of money which then supports investments in the company’s expansion.
Decisions that encompass corporate finance
The decisions to seek the highest profitability of the company are classified in two:
- Short-term decisions: financial decisions revolve around the amount of existing liabilities and assets. The assets are based on movements such as staff salaries and liabilities on how to obtain greater sustainability. Analysts will seek to radically reduce the debts of the company, and study the actions.
- Long-term decisions : this focuses on possible investments with the company’s own capital. The managers will decide whether it is carried out based on cash, outstanding debts or with the percentage investment of each of the company’s investors.
These are the most specific decisions:
- Level of indebtedness and leverage: this based on the possibility of making a profit from the outstanding debts of the company, also the decision to settle outstanding commitments.
- Need for new investments: make the decision to invest in future projects that can enhance the sustainability of the company.
- Cash: makes decisions regarding the destination of the cash that is held as a fund. Usually this is to settle certain debts or for investment.
- Model to follow: they make the decisions of the path that the company will follow, as long as it is beneficial for everyone.
- Remuneration: the decision is made to pay back the money that all investors have invested.
Classification of corporate finance
The classification of corporate finance varies according to decision making:
- Management decisions : the tools and types of analysis used are those that classify this type of corporate finance. Here the number of personnel, the size of the company, the monthly salary and the process of growth of the company will depend.
- Investment decisions : this works through the general study of the company with reference to the investment of the funds you have. It acts when you have the final data of the study, because you already know what to invest in, whether it is an increase in personnel, new machinery for the production process, etc.
- Decisions of dividing : this type of finance seeks to find a balance between the shareholders of the company. Try to achieve economic stability and limit the company’s resources, in order to try to have a larger investment fund or capital.
- Financing decisions : this is about the analysis of obtaining funds to invest in a new project. Here a previous study of what the company has, its net capital, fixed assets and liabilities, must be carried out, in order to establish a real figure, which will be directed to the investment project. In the event that the company is going through a bad financial moment, it is with the financing study, it will look for alternatives to find the necessary funds for the project.
The corporate finance are widely used within companies, as these allow you to organize and explore possible investment plans, as well as markets of the future, which may cause actual business charge more stability, also used consciously money It is held as an investment fund or capital.
This area is of importance when the company is going through a bad economic moment and wants to make good use of its assets, helps in the growth and stability of both financial and workers.
Assets and sources of funds
The balance sheet provides information about the assets a firm owns on a specific date and how they have been funded. In order to finance the assets, the firm needs the same amount in total liabilities and equity -> Total assets = Equity + Total Liabilities
Equity and Liabilities
Shareholders funds include
- initial capital that shareholders have invested
- retained earnings (capital that has been reinvested)
Tangible and intangibles assets: Tangible (land, plant, machinery, warehouses, office buildings, transport equipment) and intangible (technical expertise, know-how, brands, patents). Particularly for technological enterprises ’intangible assets can provide a competitive advantage. Current assets are short term assets which exist one year or less. Examples would be receivable, cash and balance. The two major sources of funds in a firm are debt and equity. Debt is the money borrowed from investors and there have to be paid interest and principal. Debt can be borrowed in the form of a loan or bonds. The investors have priorities of being paid by the firm and if the company is not able to pay the investors can force it into bankruptcy. On the other hand, equity is provided by shareholders and there is no minimum re-payment required. Equity investors get a share of profits, can elect members of board directors, benefit from dividends if there are any, profit from share price increases, however bear the risk of losing their investment.
Separation of Ownership and Management
While being able to raise a significant amount of resources from large group of investors, it causes separation between the owners of the firm that is the shareholders and the management. This separation has advantages and disadvantages. A benefit is that the firm is being managed by professional managers who are selected for their ability. On the other hand, there is the principal-agent problem or also called agency-costs. That problem arises where an agent (manager) has to make decisions on behalf of the principal (shareholders) and the incentives of the agent and principal to do not align with each other. Also, the shareholders do not have the same information that mangers have resulting in information asymmetry between the principal and the agent. In such a situation, mangers may not work in the best interest of the shareholders. One of the challenges for large corporations is to align the interest of the mangers with that of the shareholders. There is actually a mechanism used by enterprises to help satisfying both interests. This is made by issuing stock options to managers. Estos stocks options provide the mangers the possibility to purchase share of the company at a pre-determined price. If stock prices then increase, the managers gain from it. This provides incentives for the mangers to put in more effort and manage the firm to create value which will result in an increase in the share price.
The corporation and the stock market
The first issue of share to the general public is called Initial Public Offering (IPO). On the stock market the investors can buy and sell shares and therefore supports companies to raise equity capital and provide liquidity to shares issued by the firm. Market capitalization of a firm is the market value of the equity share issued by the firm of a stock market is the sum of market capitalisations of all the companies listed on the exchange. Average daily turnover is the total turnover of share bought and sold on an exchange in a year divided by the number of days of trading in a year. The average daily turnover is a measure of the liquidity in an exchange because it measures the average value of shares transacted on a typical day on an exchange.
In my opinion corporate finance is one of the most important division of a business because matters such as financing, capital structuring and investment decisions are indispensable for a successful firm. As it focuses on maximizing shareholder value through long and short-term financial planning and the implementation of various strategies while balancing risk and profitability – it helps to stand out from the competition. Additionally, I believe all of the different business forms do have their advantages and disadvantages. It depends on the size of the business, number of partners, liability, taxation, fund raising abilities and organizational and management structure. Consider all of these points the decision has to be made. For example, the liability – how much risk am I willing to take? The liability includes different aspects such as the relationship between the partners, the riskiness of the market itself, the number of employees and the personal situation (house, family, children). It helps to make a decision by taking all of the mentioned points into account and weigh which form makes sense the most.