Corporate finance is a branch of finance that deals with the foresight of managing company resources as well as the capital structure to increase the value of the company. It also includes the analysis and tools that are used by the management to make vital decisions such as dividend and investment decisions which help to distribute the company’s financial resources.
The ultimate significance of corporate finance is to maximize the value of the shareholders through a well-thought long and short-term planning of finances and implementations of viable strategies. Hence the activities in corporate finance will range from investment banking to capital investment decisions.
Corporate finance is essential in overseeing and governing a firm’s capital investment decisions and financial activities. Some of the capital investment decisions include whether to proceed with the proposed investment project, whether the investment will be financed by debt, equity, or even both, whether the shareholder should receive dividends or not. This subset of finance is also important in the management of inventory control, current liabilities and current assets.
For easy decision making, corporate finance is governed by three major activities namely
Capital and investment budgeting gives an overview to finance management on which investment to invest the company financial resources and whether the investment has high returns with minimum risks.
This is done through extensive financial analysis using financial tools such as cash flows, capital expenditures, estimates, comparisons of project income and investment returns to determine whether the project is viable or not.
Financial modeling can also be used to estimate the impact of economics on the investment opportunity. A SWOT analysis can also be used to understand the strengths, weakness, opportunities, and the threat of the project. To easily and positively pick an optimal investment, investment analysts use the Net Present Value (NPV) and Internal rate of return (IRR) to compare the projects at hand.
Here, the core activity is whether the company should finance the investment by the use of equity or debt or a mix of both. If the decision is on long term financing, selling stocks or issuing of debt securities is the best option unlike short term funding which may include borrowing money from a bank or family members.
By and large, by lowering the weighted average cost of Capital (WACC), the managers understand that the company’s capital structure can be optimized.
This activity gives the corporate managers a chance to either retain the company’s return of capital for future investments or to pay off the shareholders in the form of share buybacks or dividends. For the retained earnings, they are used to expand the business hence they cannot be distributed back to shareholders.
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