One of the key tasks for any business is to manage its finances. Whether it is small-scale or large-scale businesses, all of them frequently face issues related to how they should use their funds, whether they should borrow more capital, what projects are worth investing in, and where to cut down expenditure. Such issues related to a firm’s capital come under the ambit of corporate finance. As tricky as it may sound – thanks to the use of technical corporate jargon – corporate finance is no rocket science.
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What is Corporate Finance?
In simple terms, corporate finance refers to the financial decisions or strategies undertaken by firms or companies or corporations to expand their business. It studies how businesses take their financial decisions, what factors they consider, what strategies they adopt, and other related principles.
In many countries, the definition of corporate finance is more or less restricted to capital transactions of a firm where it focuses on optimum utilization of the existing capital and raising new capital. However, in the US, the definition of corporate finance is understood in broader terms. Along with the financial transactions of a business, it also includes various strategies and techniques incorporated by firms for capital allocation, cash flow management, investment of assets of the firm. Thus, corporate finance studies:
- Finance planning and management
- Administering of funds
- Raising and allocation of funds
One of the most critical concepts in corporate finance is understanding the value of assets. It is critical for businesses to correctly assess the value of a particular object. Only then it is possible to make wise decisions for companies. Understanding the value of objects is extremely important because no business should invest in something more than it’s worth. For example, you would not want to invest your capital in a business activity or product that does not have the potential to generate enough returns. Assessing the value of objects in corporate finance is termed asset valuation.
Scope of Corporate Finance
The most crucial role of corporate finance is to cater to the financial needs of businesses and resolve financial issues. Here is why sound knowledge of corporate finance is of utmost importance for every business:
Understanding the financial requirements of your business:-
One of the most relevant scopes of corporate finance is studying the financial needs of a business. It is crucial for companies to know about their financial position and how they can raise capital. Corporate finance helps the firms decide whether they should raise funds in the form of debt or equity. It includes a lot of comparative market research and in-depth analysis that assists in creating capital raising strategies.
Knowledge of corporate finance is also necessary to plan business investment strategies. A firm needs to assess its prior investment patterns and the returns generated over time. It helps them predict where the firm should invest the larger portion of its capital to keep the risk low. You must know how to select the suitable classes of assets, feasible revenue model, estimate the profits of an asset, find out its intrinsic value, and consider several other factors.
Optimum utilisation of resources:-
Both over and underutilisation of sources of a company’s resources can cause damage. Corporate finance helps firms decide how much money they should invest in various resources. For instance, how much should a company pay its employees, how much to spend on raw material, etc.
Aids in decision making:-
Majority of the crucial decisions taken in a business-like starting a new project or a vertical, are driven by the firm’s financial situation. Corporate finance aids the decision-making process by figuring out the amount of capital needed in a new venture. Corporate finance also helps firms decide whether they should expand or diversify their business. It is only feasible if the firm is financially sound.
Managing contingent situations:-
If there is one thing that we have realised in the past two years is, life is unpredictable. Contingencies in the market can arise at any time. One of the significant examples of contingencies that disrupted the corporate sector is the pandemic where firms had to face losses and cut down their employees’ salaries. Therefore, an important aspect of corporate finance involves managing your finances for unforeseen situations and risks in the business sector.
Beneficial for stakeholders:-
One of the most vital objectives of corporate finance is to protect the stakeholders’ interests. The shareholders invest in shares to earn dividends and increase their returns. Corporate finance facilitates wise financial decisions by the company management, leading to high profits for the shareholders. This, in return, makes the corporate entity trustworthy, thereby encouraging more people to start investing in the company.
Types of Corporate Finance
Corporate financing is majorly done in two ways – either the firm partners/owners/promoters invest their own money, or they borrow money from outsiders.
Let us see the different types of equity and debt corporate financing.
It is also called ownership finance, where investors invest their money and get a certain percentage of ownership in the company. The following are the different methods of equity financing. The company does not have to repay the money to its investors in equity financing.
Angel investors are usually high net worth individuals who invest individually or as a group in startups. They typically offer early age funding to firms and get royalties or equity of the company in return. Angel investors are also called seed investors. They are not concerned with the management of the company’s daily affairs.
Initial Public Offering (IPO) is the process in which a listed company offers its shares to the public for the first time. The companies usually fix the price of their shares through the book-building process. They raise money from the public and allot equity or preference shares.
VCs or Venture Capitalists is generally a fund managed by a professional investment team experienced in managing a portfolio of different asset classes. This type of financing is similar to angel investing. Once the angel investment has happened in the seed stage and the company is attracting further funding rounds, this is where venture capitalists come in since this is the likely route for startups to extend funding rounds and get a share of the profit in the subsequent rounds.
This method of equity financing involves raising capital from various high net worth investors or investment platforms. The investors get percentage ownership in the company based on their investment.
When a firm borrows money from external sources, it is called debt financing. The company has to return the funds raised from various institutions with interest in debt financing. The following are the most popular types of debt financing:
Companies borrow money from banks, usually for long periods like 5-10 years. Bank overdraft is another popular mode of debt financing.
When a company borrows money from the public, it issues debentures bonds.
Apart from banks, firms also take commercial loans from non-banking financial institutions.
How Can You Learn Corporate Finance?
Learning the fundamentals of corporate finance will be beneficial if you start your venture or plan a career in the corporate sector. To understand the principles of corporate finance in-depth, you can pursue MBA (Global) from Deakin Business School offered by upGrad. This program includes relevant subjects like leadership, strategic thinking and planning, business strategy formulation, and design thinking. You will also learn the fundamentals of accounting, how to perform project evaluation, and much more. In addition, you will also research different Harvard case studies and industry-relevant projects.
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As finance is an integral part of any business, corporations must consider many factors while making financial decisions. This is crucial for the growth of firms. Therefore, if you are a finance enthusiast who wants to climb the corporate ladder, you must possess extensive theoretical and practical knowledge of corporate finance. The MBA (Global) program from Deakin Business School offered by upGrad will help you learn corporate finance in detail.
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What are the objectives of corporate finance?
Corporate finance is crucial for every business as it helps understand the financial requirements of the business and the correct mode to raise funds. Corporate finance also eases the decision-making process and facilitates the smooth functioning of a company during contingencies.
What are the major types of corporate finance?
The two main financing methods for corporate entities are equity financing and debt financing. Equity financing methods include angel investing, venture capital, crowdfunding, and more. Debt financing modes include borrowing loans from banks and non-banking financial institutions.