Corporate finance consists of the financial activities related to running a corporation, usually with a division or department set up to oversee the financial activities. Corporate finance is primarily concerned with maximizing shareholder value through long-term and short-term financial planning and the implementation of various strategies. Everything from capital investment decisions to investment banking falls under the domain of corporate finance.
Among the financial activities with which a corporate finance department is involved are capital investment decisions. Should a proposed investment be made? How should the company pay for it with equity or with debt, or a combination of both? Should shareholders be offered dividends on their investments in the company? These are just some of the questions a corporate financial officer attempts to answer on a consistent basis. Short-term issues include the management of current assets and current liabilities, inventory control, investments and other short-term financial issues. Long-term issues include new capital purchases and investments.
One of the tasks in corporate finance is to make capital investments, and the corporate finance department is responsible for the deployment of a company’s long-term capital. The decision process of making capital investments is mainly concerned with capital budgeting, a key corporate finance procedure. Through capital budgeting, a company identifies capital expenditures, estimates future cash flows from proposed capital projects, compares planned investments with potential proceeds, and decides which projects to include in its capital budget.
Making capital investments is perhaps the most important corporate finance task and can have serious business implications. Poor capital budgeting that causes over-investing or under-investing could put a company in weaker financial condition, either because of increased financing costs or having an inadequate operating capacity.
In addition to handling the use of investment capital, corporate finance is also responsible for sourcing capital in the form of debt or equity. A company may borrow from commercial banks and other financial intermediaries, or may issue debt securities in the capital markets through investment banks. A company may also choose to sell stocks to equity investors, especially when raising long-term funds for business expansions. Capital financing is a balancing act in terms of deciding on the relative amounts or weights between debt and equity. Having too much debt may increase default risk, and relying heavily on equity can dilute earnings and value for early investors. In the end, capital financing must provide the capital needed to implement capital investments.
Corporate finance is also tasked with short-term financial management, with a goal to ensure enough liquidity to carry out ongoing operations. Short-term financial management concerns exclusively current assets and current liabilities, or working capital and operating cash flows. A company must be able to meet all its current liability obligations when due. This involves having enough current assets that can be cash-ready, such as short-term investments, to avoid any liquidity or cash crunch from disrupting a company’s operations. Short-term financial management may also involve getting additional credit lines or issuing commercial papers as liquidity back-ups.
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