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Why Corporate Finance is called “lifeblood of the business”?

By January 11, 2022July 23rd, 2024Blog8 min read
Corporate Finance

We need capital to run a business as without money, operating a business becomes a difficult task. Corporate finance is knowing when, where and how can we get capital for our business. It most importantly also includes how to allocate capital and make use of the same.

In other words, the tools and actions that are utilised in distributing the financial resources of the organisation and the strategies taken to achieve the ultimate financial goal.

Objective: The main objective of corporate finance is making financial decisions by maximising corporate value with managing the financial risks of the company.

5 Functions of Corporate Finance:

    1. Capital Budgeting

In the capital budgeting function, owners have to choose the right project for investing in land and resources. The Corporate financier selects a projecting considering the ROI and the risk associated with it. There are two major roles of a financer – evaluate every large investment in the capital budgeting process and secondly, delivering new products, services and processes for customers. Some companies regularly make huge capital outlays like Intel, Shell and Samsung.

3 Steps of capital budgeting process:

    1. Discovering potential investments.
    2. Evaluating from the investment opportunities available and identifying those that generate appropriate shareholder value.
    3. Implementing and observing the investments

    1. External Financing

External financing function deals with raising capital to support operations and investment programs of the company. Initially, corporations may raise capital privately (either from family, friends or professional investors). The professional investors like venture capitalists specialise in high-risk or high-return investments in developing entrepreneurial business. And, once this small company reaches a certain level, they may decide to conduct an IPO (Initial Public Offering), selling shares to outside vendors. Additionally, listing shares for stock exchange trading. Later on, companies have the alternative of raising cash reserve by selling additional cash.

    1. Corporate Governance

Corporate governance structure and company-wide ownership forces managers to behave ethically and make decisions that benefit shareholders. Hence, an established corporate governance system is essential. Governance systems determine who benefits most from company activities; then, they develop procedures to maximise firm value and to ensure that employees act ethically and responsibly. Good management develops from a corporate governance system that recruits and promotes qualified employees to achieve company goals by salary and other financial or non-financial incentives.

    1. Risk Management

The risk-management function identifies, measures, and manages many more types of risk exposures, including predictable business risks. These risk exposures include losses that could result from commodity price changes, adverse interest rate movements and currency value fluctuations. The strategies for managing these risks are among the most sophisticated of all corporate finance practices. The risk-management task attempts to quantify the sources and magnitudes of firms’ risk exposure and to decide whether to accept these risks simply or to manage them.

    1. Financial Management

This function is about managing companies internal cash flow, working capital, debt and equity financing and to ensure that companies can pay off their liabilities whenever required. The more debt a firm uses in its capital structure, the less likely the firm will be able to meet its debt service obligations, and the more likely default will occur. It is this default likelihood that introduces bankruptcy costs into capital structure.

Types of Corporate Finance

Corporate Finance is broadly classified as short- and long-term finance.
  1. Short-term corporate finance: They are short term loans for a tenure up to one year. Interest payable with principal advance and repayment tenures are of as short-term duration as compared to other types of corporate finance.
    • Bank Overdrafts: A bank overdraft is said when cash is withdrawn from a bank account, and the balance becomes below zero, which is a negative balance.
    • Trade credit: A trade credit is an agreement wherein one can purchase goods without making any payment at that time and can pay the supplier at a later date, decided between both the parties.
    • Financial lease: A financial lease is a type of finance wherein a financial company is legally the owner of the asset for a fixed duration of the lease. The lessee has the operating control over the asset and has a substantial share associated with economic risks from a change in the valuation of your underlying assets.
    • Accrual accounts: Accrual accounts are recording expenses and income in cash and credit.
    • Operating lease: Operating lease is an agreement wherein lessee can use valuable assets, although cannot take ownership of assets legally.
    • Hire Purchase: It is always a good idea to rent assets according to the requirement wherein one gets a cash flow over the lease cycle.
  1. Long-term corporate finance: They are long term loans for a tenure of more than one year. The advantage for such loans is the low-interest rate a s well as a minimum monthly payment.
    • Bank Loan: Bank loan sets a fixed time for repayment (3, 5, 10 or 20 years) along with interest and principal amount.
    • Debentures: It is a medium- to long-term debt instrument used to borrow money with a fixed interest rate.
    • Merchant loan: Financial institutions provide funds to businesses as shared ownership rather than loans.
    • Flotation: It is the process of transforming a private company into public by issuing shares. It basically allows companies to obtain funds externally.
    • Equity Issuance: An equity issuance term is used for a sale stock or new equity by a company to investors.
    • Stock Dilution: Stock dilution means that it decreases in current shareholder’s ownership of a company as a consequence of the company issuing new equity

Importance of Corporate Finance

  • Research and Development:

    A company needs to invest in research and development to survive in the market and develop new products to satisfy the consumers. Companies can employ staff to prepare questionnaires, do market analysis, toll survey with the help of financial support.

  • Achieving long term and short-term goals:

    Every organisation has short- and long-term goals and to fulfill those goals corporate finance is required. Short term goals are managing short term assets, salaries to employees, bank draft, trade credit, etc. And long-term goals are acquiring long term loans, increasing customer base, etc.

  • Company Promotions:

    Finance is needed for preparing project reports, Articles of Association, Memorandum of Association, etc. Also, for purchasing fixed assets like land and building, raw materials.

  • Uncertainties:

    A company has to be financially prepared for uncertainties if they arise like loss due to natural calamity, strike, court cases, etc.

  • Diversion and expansion:

    Diversion is to produce and sell new products, and expansion is increasing the size of the company. Corporate finance plays a role here for purchasing modern machines and technology.

  • Government agencies:

    Funds are required to pay duties and taxes to government agencies like income tax, sales tax, excise duties, etc.

Other than the above pointers, corporate finance is also vital in raising capital, paying loans or debts, depreciation of assets, and adequate funds for the smooth functioning of the organisation.

Wrapping Up!

Every big or small business needs corporate finance to operate and get profitable value with the investment. You need a specific individual or a department (according to the size and nature of your business) to take care of the financial activities of the firm and ensure that the business isn’t lacking due to its financial handling.

Corporate finance primarily focuses on maximising shareholder value through short- or long-term financial activities. The idea is to plan and implement strategies that focus on value creation which should be appropriate. Thus, capital investment and investment banking are part of corporate finance essentials.

Rakesh Narula & Co. (RNC) is a well known and reputed name providing techno-commercial services as IRDA Licensed Category ‘A’ insurance surveyor & loss assessor and consultancy services in valuation of assets, investment banking, corporate finance, etc. Consult Rakesh Narula & Co. to know more about our services!