EDUCBA

EDUCBA

MENUMENU
  • Free Tutorials
  • Free Courses
  • Certification Courses
  • 250+ Courses All in One Bundle
  • Login

Corporate Finance

By Jesal ShethnaJesal Shethna

Home » Finance » Blog » Corporate Finance Basics » Corporate Finance

cf

Definition of Corporate Finance

You will have heard much about the term “Corporate Finance” if you belong to the finance domain. Corporate Finance forms the most basic component of how a business is run.

Business involves decisions that have financial consequences, and any decision that involves the use of money is said to be a corporate finance decision. Corporate finance is one of the most important parts of the finance domain as whether the organization is big or small, they raise and deploy capital in order to survive and grow. There are various roles that corporate finance plays, which are very interesting and challenging, one of the main roles is that of being a financial adviser. Corporate finance in investment banks is different from departments like sales or trading, as they are not trading or making markets but rather they help companies with certain financial situations. In simple words, they act as a broker or consultant when companies need to raise capital, are considering merging or buying another company or want to issue debt – all of which may enhance the value of their company. This can include helping manage investments or suggesting a mergers and acquisitions (M&A) strategy. Along with this, the corporate finance people at the investment bank will help the M&A deals go through as well.

Start Your Free Investment Banking Course

Download Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

In short as a corporate financier you would be working for a company to aid them find sources through which funds could be raised, expand the business, plan the future course of actions, manage money and ensure sound profitability and economic viability.

The objective of maximizing the value of the corporation while minimizing the risk is the soul of corporate financial theory.

Principles of Corporate Finance

Let’s understand the three most fundamental principles in corporate finance which are- the investment, financing, and dividend principles.

1. Investment Principle/h4>
This principle revolves around the simple concept that businesses have resources which need to be allocated in the most efficient way. The first and important decision that needs to be made in corporate finance is to do this wisely, i.e. decisions that not only provide revenue opportunities but also saves money for the future. This also encompasses the working capital decisions such as the credit days to be allotted to the customers etc. Corporate finance also measures the return on a planned investment decisions by comparing it to the minimum tolerable hurdle rate and deciding if the project/investment is feasible to be undertaken.

2. Financing Principle

Most often businesses are funded with either debt or equity or both. In the investment decision that we earlier discussed once we have finalized the mix of equity and debt and its effects for the minimum acceptable hurdle rate, the next step would be to determine if the mix is the right one in the financing principle section.

The job here for the corporate-financier is to make sure that the business has right amount of capital and the right mix of debt, equity and other financial instruments.

In order to determine the optimal mix, we need to study conditions where the optimal financing mix minimizes the acceptable hurdle rate. We also need to analyze the effects on firm value due to the change in capital structure. After we have defined the optimal financing mix, next we need to consider would be whether it would be a long term or a short term financing. We then include other considerations such as taxes and land up with strong decisions on the structure of financing.

“The risk return tradeoff” – Riskier assets yield higher expected returns.

3. Dividend Principle

Businesses reach a stage in their life cycle where they grow and mature and the cash flow they generate exceeds the expected hurdle rate. At this stage, the company needs to determine the ways of rewarding the owners with it. So the basic discussion here is that if the excess cash should be left in the business or given away to the investors/owners. A company that is publicly held has the option of either pay off dividends or buy back stocks.

Popular Course in this category
Sale
All in One Financial Analyst Bundle- 250+ Courses, 40+ Projects250+ Online Courses | 1000+ Hours | Verifiable Certificates | Lifetime Access
4.9 (3,296 ratings)
Course Price

View Course

Related Courses
Business Valuation Training (16 Courses)Equity Research Training (17 Courses)Project Finance Training (8 Courses with Case Studies)

Understanding the Concept

cncepts

Corporate finance is a very vast area of finance. There are so many fundamentals and concepts that need you should have a knack of. Let’s understand a few of them;

1. Capital Budgeting

Capital budgeting is the process of planning expenditures on assets (fixed assets) whose cash flows are expected to extend beyond one year. Managers study projects and decide which ones to include in the capital budget.

  • The “capital” refers to long-term assets.
  • The “budget” is a plan which details projected cash inflows and outflows during future period.

The most common approaches that are used in project selection are discussed below:

Net Present Value (NPV):

This method discounts all cash flows (including both inflows and outflows) at the project’s cost of capital and then sums those cash flows. The project is accepted if the NPV stands positive.

NPV = Σ [CFt/ (1 + k) t]

Where CFt is the expected cash flow at period t, k is the projects where CFT is the expected cash flow at period t, k is the project’s cost of capital and n is its life.

Internal Rate of Return (IRR):

It is the discount rate that forces a project’s NPV to equal to zero.

NPV = Σ[CFt/(1 + IRR)t]

Note this formula is simply the NPV formula solved for the particular discount rate that forces the NPV to equal zero. The IRR is the expected rate of return on a project. The NPV and IRR approaches will usually lead to the same accept or reject decisions.

Payback period:

It is the expected number of years required to recover the original investment. Payback happens when the cumulative net cash flow equals 0. The shorter the payback period, the better it is. A firm should establish a benchmark payback period and reject the proposal if payback is greater than benchmark.

2. Time Value of Money

“A dollar today is worth more than a dollar tomorrow”

If you have a dollar today, you can earn interest on it and have more than a dollar next year. For example, $100 of today’s money invested for one year and earning 8% interest will be worth $108 after one year.

Annuity

An Annuity is a bunch of structured payments or equal payments made regularly, like every month or every year

Perpetuity

A perpetuity is a special kind of annuity – it has an infinite number of cash flows, all of the same dollar amount. Thus, it is an annuity that never ends!

3. Cost of Capital

Capital is an essential factor of production and has a cost. The suppliers of capital require a return on their money. A firm must evidently ensure that stockholders or those that have lent the firm money, such as banks, receive the return that they seek. The cost of capital is significant for a firm to calculate, as this is the rate of return that must be used when evaluating capital projects. The return from the project must be superior than the cost of the project in order for it to be acceptable.

One of the methods to calculate the cost of capital is Weighted Average Cost of Capital (WACC). The weighted average cost of capital (WACC) is defined as the weighted average cost of the component costs of debt, preferred stock, and common stock or equity. It is also referred to as the marginal cost of capital (MCC) which is the cost of obtaining another dollar of new capital.

4. Working Capital Management

Working capital management involves the relationship between a firm’s short-term assets and its short-term liabilities. The goal of working capital management is to ensure that a firm is able to continue its operations and that it has adequate ability to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital encompasses managing inventories, accounts receivable and payable, and cash.

5. Measures of Leverage

Leverage, in the sense we use it here, refers to the amount of fixed costs a firm has. These fixed costs might be fixed operating expenses, such as building or equipment leases, or fixed financing costs, such as interest payments on debt. Greater leverage leads to greater variability of the firm’s after-tax operating earnings and net income.

With this we have touched upon the important concepts of corporate finance. There is a lot more to learn in this vast area.

Overview of Corporate Finance Career

career

As we all know that business makes money which has to be managed well, which is when corporate finance team comes into the picture. Corporate finance professionals are accountable to manage the money of the organization i.e. to know from where to source it, deciding how to spend it to get the maximum returns at the lowest possible risk. They seek to find ways to ensure the flow of capital, increasing profitability and decreasing the expenses. They have to monitor the other departments on their expenditure and if the company is in a position to take the risk of additional expenditure. They explore the best ways to help the company expand whether it is through acquisition or investing internally.

Well, there is a different career profile of corporate finance in Investment Banks, here the corporate financiers must not only be aware of the finance world but also have clear viewpoints on investing, stocks and how to value companies. They can use their creativity here by listening to what the client wants to achieve and then suggesting interesting and potentially revolutionary ways they can go about making their thoughts a reality. Yes, the corporate finance team does get a lot of the glory and while salaries can go sky-high, you’ll have to work hard for it.

Are you thinking to pursue a career in corporate finance and interested to know more about this? Read this article on “Corporate Finance Jobs”.

A career in Corporate Finance is quite challenging, and the demand for this field is accelerating with time. It has great career prospects if you feel you would enjoy doing all that we have discussed above.  Hope this would have helped you in understanding all you wanted to know about Corporate Finance. All the Best!!! 🙂

Corporate Finance Infographics:

Learn the juice of this article in just a single minute, All you wanted to know about Corporate Finance Infographics.

Recommended Articles

Here are some articles that will help you to get more detail about Corporate Finance so just go through the link.

  1. Best Way To Get Corporate Finance Theory & Practices
  2. Best Guide On Discounted Cash Flow
  3. Effective Management of PR and Corporate Communication
  4. 10 Definitive Rules for Successful Corporate Management
  5. Best Guide on Corporate Finance Theory & Practices
  6. Finance vs Economics: Functions
  7. Mortgage Banker vs Broker | Top Differences
  8. Examples of Discount Rate Formula

All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)

250+ Online Courses

1000+ Hours

Verifiable Certificates

Lifetime Access

Learn More

10 Shares
Share
Tweet
Share
Primary Sidebar
Finance Blog
  • Corporate Finance Basics
    • BPO vs KPO
    • C Corporation
    • Brick and Mortar
    • Business Entity Concept
    • Bounced Check
    • Capital Maintenance
    • Bridge Financing
    • Business Exit Strategy
    • Callable Bonds
    • Affiliated Companies
    • Certified Check
    • Chattel Mortgage
    • Contingent Beneficiary
    • Debt Collector
    • Closed Corporation
    • Cumulative Voting
    • Consumer Loan
    • Commercial Loans
    • Collateralization
    • Commercial Credit
    • Collection Agency
    • Classification of Financial Markets
    • Class Action Lawsuits
    • Prudence Concept in Accounting
    • Calmar Ratio
    • Asset Classes
    • Audit Evidence
    • Contingent Liability
    • Employee Stock
    • Financial Liabilities
    • Incurred Cost
    • Partial Income Statement
    • Deferred Tax Asset
    • Tax Fraud
    • Non-Operating Income
    • Variable Costing
    • Mixed Cost
    • Prime Cost
    • Regressive Tax Examples
    • Unqualified Opinion of Auditor
    • Bonds Payable
    • Class A Shares
    • Contingent Liability Example
    • Contingent Shares
    • Contributed Capital
    • Brownfield Investment
    • Internal Audit
    • Indirect Taxes
    • Fund Management
    • Fixed Cost
    • Debt Equity Swap
    • Cash Flow Hedge
    • Risk Shifting
    • High Yield Investments
    • General Obligation Bond
    • Forward Market
    • Box Spread
    • Fixed Income Trader
    • Trade Discount
    • Quick Assets
    • Notes Payable
    • Revenue Bonds
    • Euribor
    • Settlement Date
    • Short Covering
    • Short Selling
    • Dividend Examples
    • Time to Market
    • Junior Accountant
    • Commodity Derivatives
    • Flash Report
    • Idle Time
    • Leasehold Improvement
    • Product Portfolio
    • Risk Parity
    • Branch Accounting
    • Credit Enhancement
    • Basis Trading
    • At the Money
    • Accounts Receivable
    • Long Term Investments
    • Negative Goodwill
    • Recourse Factoring
    • Residual Value
    • Short Term Loan
    • Tax Exempt
    • Audit Report Format
    • Cash Investment
    • 457 Plan
    • Audit Procedure
    • Audit Materiality
    • Audit Committee
    • Asset Allocation
    • Non-Cash Expenses
    • Dividend Policy Types
    • Credit Terms
    • Dividend Payable
    • Profit Center
    • Absorption Costing
    • Final Dividend
    • Hybrid Securities
    • Other Current Assets
    • Simple Random Sample
    • Dependency Ratio
    • Effective Duration
    • Loan to Value Ratio
    • Inventory Turnover Ratio
    • Advantages of Ratio Analysis
    • Loss Ratio
    • Delaware Corporation
    • Articles of Incorporation
    • Negative Covenants
    • Statutory Liquidity Ratio
    • Leverage Ratio for Banks
    • Accrued Liabilities
    • Activity Ratio
    • Debt Service Coverage Ratio
    • Return on Investment Ratio
    • Turnover Ratios
    • Cash Conversion Cycle
    • Lumion vs V-Ray
    • Capital Intensive
    • Voided Check
    • Negotiable Instruments
    • Portfolio Optimization
    • 401k Plan
    • Non-Marketable Securities
    • Stock Certificate
    • Treasury Stock
    • Appropriate Retained Earnings
    • Stockholder
    • Share Vesting
    • Shares Issued
    • Preferred Shares
    • Share Buyback
    • Shareholder Types
    • Tax Loss Harvesting
    • Statutory Audit
    • Audit Risk
    • Fund of Funds
    • Accredited Investor
    • Cost Centre
    • Lessee
    • Golden Handcuffs
    • Ordinary Shares
    • Restricted Stock Units
    • Goodwill Valuation
    • Share Classes
    • Lessor
    • Preferred Dividends
    • LIFO Liquidation
    • Dilutive Securities
    • Restructuring Cost
    • Non-Cumulative Preference Shares
    • Pass Through Entity
    • Management Discussion and Analysis
    • Premium on Stock
    • Leveraged Loans
    • Dividend
    • Dividend Policy
    • Financial Reporting Objectives
    • Financial Reporting
    • Internal Controls
    • Capital Investment
    • Debt to Equity Ratio
    • Dividend Growth Rate
    • Market Capitalization
    • Deal Origination
    • Importance of Working Capital
    • SWOT Analysis
    • White Knight
    • Root Cause Analysis
    • Realized Gain
    • Return on Operating Assets
    • Offshore Investments
    • Transfer Price
    • Times Interest Earned Ratio
    • Debt Coverage Ratio
    • Dividend Discount Model
    • Combined Ratio
    • Merger Arbitrage
    • Gordon Growth Model
    • Advantages of Joint Venture
    • Interest Coverage Ratio
    • Reserve Requirements
    • Asset Turnover Ratio
    • Price to Rent Ratio
    • Ratio Analysis Types
    • Debt Ratio
    • Business Risk
    • Financial Leverage
    • Dividend Payout Ratio
    • Mistakes in DCF
    • Risk/Reward Ratio
    • Full Form of FIPB
    • Financial Risk
    • CAPE Ratio
    • Overcapitalization
    • Systematic Risk
    • Hedge Ratio
    • Full Form of NHB
    • Sensitivity Analysis
    • Current Ratio
    • Corporation Examples
    • Asset to Sales Ratio
    • Balance Sheet Ratios
    • List of Financial Ratios
    • Coverage Ratio
    • Forward PE Ratio
    • Interpretation of Debt to Equity Ratio
    • Capitalization Ratio
    • Importance of Ratio Analysis
    • Quick Ratio Interpretation
    • Corporate Finance Basics
    • PEG Ratio
    • Corporate Finance Interview Questions
    • Price to Earnings Ratio
    • Structured Note
    • Limitations of Ratio Analysis
    • NPV vs IRR
    • IRR vs ROI
    • Imputed Interest
    • Full Form of HR
    • Shareholders Agreement
    • Earnings Per Share
    • Corporate Finance Jobs
    • About Corporate Finance
    • Corporate Finance Theory & Practices
    • Career in Corporate Finance
    • Simple Interest Rate vs Compound Interest Rate
    • Stocks vs Shares
    • Bonds vs Debenture
    • Bull Market vs Bear Market
    • Mortgagee vs Mortgagor
    • Horizontal Integration vs Vertical Integration
    • Money Market vs Capital Market
    • Leveraged vs Unleveraged
    • Dividends vs Capital Gains
    • Present Value vs Net Present Value
    • Qualified vs Ordinary Dividends
    • ROE vs ROA
    • Bond vs Loan
    • Stock Dividend vs Stock Split
    • Audit vs Assurance
    • Coupon Rate vs Interest Rate
    • Growth Stock vs Value Stock
  • Accounting fundamentals (658+)
  • Asset Management Tutorial (198+)
  • Banking (44+)
  • Credit Research Fundamentals (6+)
  • Economics (44+)
  • Finance Formula (382+)
  • Financial Modeling in Excel (13+)
  • Investment Banking Basics (120+)
  • Investment Banking Careers (26+)
  • Trading for dummies (67+)
  • valuation basics (27+)
Finance Blog Courses
  • Online Business Valuation Training
  • Equity Research Certification
  • Project Finance Course
Footer
About Us
  • Blog
  • Who is EDUCBA?
  • Sign Up
  • Live Classes
  • Corporate Training
  • Certificate from Top Institutions
  • Contact Us
  • Verifiable Certificate
  • Reviews
  • Terms and Conditions
  • Privacy Policy
  •  
Apps
  • iPhone & iPad
  • Android
Resources
  • Free Courses
  • Investment Banking Jobs Offer
  • Finance Formula
  • All Tutorials
Certification Courses
  • All Courses
  • Financial Analyst All in One Bundle
  • Investment Banking Training
  • Financial Modeling Course
  • Equity Research Course
  • Private Equity Training Course
  • Business Valuation Course
  • Mergers and Acquisitions Course

© 2022 - EDUCBA. ALL RIGHTS RESERVED. THE CERTIFICATION NAMES ARE THE TRADEMARKS OF THEIR RESPECTIVE OWNERS.

EDUCBA
Free Investment Banking Course

Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA
Free Investment Banking Course

Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA Login

Forgot Password?

By signing up, you agree to our Terms of Use and Privacy Policy.

Let’s Get Started

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Loading . . .
Quiz
Question:

Answer:

Quiz Result
Total QuestionsCorrect AnswersWrong AnswersPercentage

Explore 1000+ varieties of Mock tests View more

Independence Day Offer - All in One Financial Analyst Bundle (250+ Courses, 40+ Projects) Learn More