Corporate finance deals with the capital structure of a corporation, including its funding and the actions that management takes to increase the value of the company. Corporate finance also includes the tools and analysis utilized to prioritize and distribute financial resources.

The ultimate purpose of corporate finance is to maximize the value of a business through planning and implementation of resources, while balancing risk and profitability.

The Three Important Activities that Govern Corporate Finance

1. Investments & Capital Budgeting

Investing and capital budgeting includes planning where to place the company’s long-term capital assets in order to generate the highest risk-adjusted returns. This mainly consists of deciding whether or not to pursue an investment opportunity, and is accomplished through extensive financial analysis.

By using financial accounting tools, a company identifies capital expenditures, estimates cash flows from proposed capital projects, compares planned investments with projected income, and decides which projects to include in the capital budget.

Financial modeling is used to estimate the economic impact of an investment opportunity and 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 optimal one.

2. Capital Financing

This core activity includes decisions on how to optimally finance the capital investments (discussed above) through the business’ equity, debt, or a mix of both. Long-term funding for major capital expenditures or investments may be obtained from selling company stocks or issuing debt securities in the market through investment banks.

Balancing the two sources of funding (equity and debt) should be closely managed because having too much debt may increase the risk of default in repayment, while depending too heavily on equity may dilute earnings and value for original investors.

Ultimately, it’s the job of corporate finance professionals to optimize the company’s capital structure by lowering its Weighted Average Cost of Capital (WACC) as much as possible.

3. Dividends and Return of Capital

This activity requires corporate managers to decide whether to retain a business’s excess earnings for future investments and operational requirements or to distribute the earnings to shareholders in the form of dividends or share buybacks.

Retained earnings that are not distributed back to shareholders may be used to fund a business’ expansion. This can often be the best source of funds, as it does not incur additional debts nor dilute the value of equity by issuing more shares.

At the end of the day, if corporate managers believe they can earn a rate of return on a capital investment that’s greater than the company’s cost of capital, they should pursue it. Otherwise, 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 value of the business. Its structure can be a combination of long-term 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 determining how well balanced or risky the company’s capital financing is.

A company that is heavily funded by debt is considered to have a more aggressive capital structure and, therefore, potentially holds more risk for stakeholders. However, taking this risk is often the primary reason for a company’s growth and success.

Types of Corporate Finance

The two chief types include –

1. Equity Financing – Companies can raise finance through equity issuance or obtain from retained earnings. Equity comes in the form of common stock, preference stock etc. A company can sell its shares by getting itself listed on a stock exchange or through over the counter (OTC) exchanges. Too much equity dilutes shareholders’ voting rights and reduces dividend share.
2. Debt Financing – Debt financing refers to obtaining the finance required through loans, usually from financial institutions, or through bond issuance, etc. Debt financing attracts the cost of regular interest payments and repayment of the principle at the end of the loan tenure. Too much of debt induces the risk of defaultor going bankrupt in case of non-repayment of the debt.

Examples of Corporate Finance Activities

Corporate finance jobs entail managing the interaction between corporations, assets, markets, investors, government, financial institutions and intermediaries. Following are some examples of such activities –

1. Financial modeling: Financial modeling helps to analyze the value and risk associated with investment options.
2. Bank loan: Taking a loan from a bank to meet business needs and associated due diligence to analyze the cost of loan and repayment capacity.
3. IPO: Initial public offering(IPO) generally helps to raise capital through equity financing.
4. Refinancing and renegotiating all debts and payments: As the market changes, corporations may strategically negotiate to update the terms of loans or other payment agreements.
5. Dividend distribution: Dividend distribution depends on the policy set by the management. It can be regular or irregular.

Why is it Important?

Corporate finance aims to obtain finances through the right sources to manage day-to-day and long-term financial activities. It strategizes how a company uses and manages capital to maximize value. Planning appropriate capital budgeting and structures is vital for balancing risk and profitability.

A company’s management evaluates future cash flows from investment

through capital budgeting tools. They find the least expensive fund sources or the right mix of debt and equity in the capital structure. For short-term needs, working capital requirements are paid attention to.

Hence, we can say that these strategies ensure the going concern concept of the organization. Moreover, it improves the statistics on financial statements. Consequently, it will maximise value, or more specifically, the maximization of stock price.