What is Corporate Finance? [Concept and Definition]

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The world of corporate finance is not just the one we see in the movies: behind it, there are tips, techniques and methods that allow companies to manage their resources in a way that lets them reach their full potential. Corporate finance is the area that focuses on maximizing the value of a shareholder’s investment and analyzing the market in order to develop a short-term plan, creating strategies that will provide these shareholders with the greatest benefit.

In its definition, it is understood that corporate finance is the area of ​​finance that focuses on the study and management of sources of funding, the capital structure of corporations, and the actions that managers take to increase the value of the firm to the shareholders. The main goal of corporate finance is maximizing the shareholder value.

Types of corporate finance tasks

When talking about corporate finance, it is essential to take into account the different areas of which they are composed; for example, it is possible to speak of the area of ​​corporate finance focused on capital budgeting.

The main interest of this is to establish the criteria that will guide decision-making, that is, the handling of cash, inventories and loans or credits, to name a few. On the other hand, corporate finance is also related to investment banking; In this section, corporate finance is also associated with transactions in which capital is increased to create, develop, expand or acquire a business.

Capital investments

If we talk about corporate finance, it is necessary to talk about capital investments. This section includes capital investments and the use of a company’s long-term capital. The capital investment process is primarily related to capital budgeting; it is through this that a company identifies capital expenditures, the flow of capital to be derived from proposed projects, and compares the investments that have been planned to decide which of its projects will be included in the capital budget.

Equity investments are a key step within corporate finance, as it is well known that budget-related decision making can have positive or negative implications in both the short and long term. If a capital investment is made or a poor capital budget is proposed, the company in question could be affected in its operations.

Capital financing

On the other hand, corporate finance is also responsible for the source of capital, whether in the form of debt or shares. Thus, a company could request loans from financial institutions or intermediaries or carry out operations through investment banks. In addition, a company may choose to sell its shares to equity investors, specifically when large sums of money are required to ensure business expansion.

The financing Equity is a process that seeks a balance, since it is about deciding and analyzing the risks of choosing between debt and equity. If significant debt were to arise, potential risks would increase, so equity financing should provide the amount needed to make equity investments.

Dividends and return on capital

Return of capital is a key point for every company. One of the tasks of corporate finance is to efficiently manage resources and ensure that there is sufficient liquidity for the company in question to continue to operate and achieve the goals that it has set.

How important is the capital structure of a company in corporate finance?

The capital structure is a specific combination of debt and capital that a company uses to finance its operations and guarantee its growth and expansion plans. The own funds of a company are given through the shares that are assigned to each owner, which are guaranteed a certain flow of capital and profits. Debt takes the form of bonds or loans, while equity comes in the form of common stock, preferred equity, or retained earnings. Likewise, short-term debt is considered as part of the capital structure.

Without risks, there is no growth; However, in order to take the least amount of risks, companies take refuge in the capital structure, since it allows us to analyze a certain situation to maintain a balance within the company’s operation. When it comes to capital structure, the concept generally refers to the debt / equity formula, which allows a more in-depth look at the risks that result from a company’s financial practices.

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Valuation of investments and projects

But, how is it possible to objectively assess the investments and projects to be carried out in a company? Thanks to corporate finance, it is possible to determine risks and properly analyze any situation related to the financial well-being of a company.

Value flexibility

How can you make an accurate assessment of flexibility? The term known as financial flexibility is used to describe the ability of a company to deal with unforeseen expenses or investment opportunities. Financial flexibility can be determined by analyzing a company’s behavior with respect to the use of leverage or cash reserves.

Companies with more financial flexibility are not only better prepared to deal with economic crises, but also to take advantage of emerging investment opportunities. If a company did not have financial flexibility, it is very possible that its chances of survival in times of crisis would be reduced to minimum levels.

Quantifying the uncertainty

When talking about uncertainty, finance experts are referring to the lack of security surrounding a particular company-related event. In finance, uncertainty refers to the impossibility of preventing the consequences or results that a company faces due to the lack of sufficient information to establish a projection to face it.

However, this does not mean that it is impossible to quantify uncertainty, and it is that the term is essential for shareholders and business owners to understand what is in the game, especially in times of crisis. Today, there are well-founded processes to identify, record and disclose financial uncertainty.

To turn financial uncertainty to your advantage, it is recommended:

  1. Make a forecast: It is not enough to establish a financial plan annually: those involved must make corrections, projections and adaptations corresponding to changes in the world economic scene.
  2. Automation: The collection of data, figures and statistics shows a clear trend towards automated processes, leaving behind potential human errors.
  3. Efficient financial reporting: With automation, it is easier to obtain efficient reports that guarantee adequate results to those projected by the experts.
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FAQs

Corporate finance is an interesting and specialized world that opens the doors to new and better ways of operating a company; therefore, there are certain data that are essential to know in order to have a basic concept of this term.

What is the role of corporate finance?

Corporate finance is the area that is focused on maximizing the value of a shareholder and analyzing the market situation to develop a short-term plan, offering strategies so that these shareholders receive the greatest benefit.

In its definition, it is understood that corporate finance is known as the area of ​​finance that focuses on the study and management of financing sources, the capital structure of corporations, and the actions that can be taken to increase value. that the shareholders will receive.

What are the top 3 areas of corporate finance?

There are three main areas of corporate finance:

  1. Capital Raising: The most effective way to raise capital is through profits, and these can only be generated when the company invests in itself; To achieve this, an expert in corporate finance is required.
  2. Operating capital: This capital is what keeps a company’s operations afloat, from the purchase of goods to payroll payments, all these expenses must come from the sale of its goods or services.
  3. Budget capital: The budget capital is the area in which future situations that the company could go through are analyzed, thus, it will be possible to determine with greater precision what the plans to follow will be.

What is an example of corporate finance?

Here is a list of some activities related to corporate finance:

  1. The execution of an initial public offering (IPO). This is done when a company that operates with private funds makes the decision to join a stock exchange to have access to stock market funds.
  2. Carry out a bond issue: these are a long-term loan, and can be bought and sold on public markets; Any person who has a bond will be credited with the interest it generates.
  3. Securing a loan from a bank: the conditions under which these are made will vary depending on the credit history of the company.
  4. Redefine and renegotiate payment terms with suppliers and customers.
  5. The development and execution of dividend programs for shareholders.
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conclusion

Corporate finance is a fundamental factor in keeping a company afloat, even in times of economic crisis and uncertainty. It is through them that shareholders, investors and entrepreneurs can create a general and specific idea about market conditions and, based on them, develop action plans that favor the operations of the company in question.

The main interest of corporate finance is based on the establishment of criteria that must guide decision-making; These include cash management, inventories, and loans or credits, to name a few.

Likewise, corporate finance is also related to investment banking; In this section, corporate finance is also associated with transactions in which capital is increased to create, develop, expand or acquire a business.

 

Source: Investopedia.com / money-zine.com /

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