What is Corporate Finance? How Does it Work?

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Corporate Finance

Any small business owner will know that funding a business is not an easy task. It requires a constant flow of cash in order to minimise cost overhead and maximise profits. Even a small disruption in the cash flow can lead to severe consequences. However, sometimes having sufficient financial resources almost seem like an impossible thing. That’s when corporate finance comes in. In this post, we will take a closer look at what exactly corporate finance is and how it can help you grow your business.

What is Corporate Finance?

Corporate finance plays a crucial role in every business. It refers to the capital model of a corporation, including its funding and any actions that are taken by the management to increase the value of the organisation. If the return generated exceeds the total cost of capital, then the value of the corporation is said to be increased.

Regardless of the type and size of the business, every business seeks to streamline their finances for optimum return. Corporate finance focuses on the process of how businesses deal with their funding requirements, capital projects and capital structuring. This also influences their investment decisions, which can make them invest with debt or equity, or a mix of both.

How Does Corporate Finance Works?

Corporate finance emphasises on improving the financial health of a company by planning, managing and controlling its financial activities. This includes taking crucial decisions about investments, budgeting and capital allocation. Corporate finance works on 4 primary elements: capital budgeting and investments, capital financing, return of capital and dividend distribution, and short-term liquidity.

#1 Capital Budgeting and Investments

Capital budgeting involves planning where to invest the company’s capital assets that generate maximum, risk-adjusted returns. This majorly consists of ascertaining funding requirements of the business and deciding whether to pursue an investment project.

As a part of capital budgeting, a financial expert will go through various investment products and use financial accounting tools to identify estimated capital expenditure, cash flows in the proposed project, comparing planned investments with projected return and deciding which project to include in the capital fund.

Capital budgeting is perhaps the most crucial corporate finance task that can bring serious implications on business. Poor capital budgeting can compromise your organisation’s financial position, either by increasing costs or disrupting operational efficiency.

#2 Capital Financing

This part of corporate financing includes how to raise funds for capital investments. Usually, capital investments can be achieved through equity financing, debt or a mix of both. The company may choose to borrow from commercial banks or London bridging finance. Or, the company can sell stocks to equity investors in order to raise a large sum of money.

However, too much debt or equity may not seem appealing to corporations. Too much debt increases the risk of default in repayment, while investing heavily in equity may reduce the value and earnings for the original investors. Instead, they look for a well-balanced combination of equity and debt.

The ultimate goal is to optimise the organisation’s capital structure by lowering its cost of capital across all sources, such as preferred shares, common shares and debt. This can lead to higher earnings and better day to day operations.

#3 Short-term Liquidity

Short-term liquidity refers to the capital amount required to carry out day to day operations. Efficient financial management is also about maintaining sufficient cash flow in line with business terms. As a result, maintaining liquidity can save the corporation from going bankrupt.

In order to maintain adequate liquidity, the company must evaluate its current assets and current liabilities, or capital sources and necessary cash flow. They need to calculate their monthly revenue, and how much it costs to carry out continuing operations.

A company should always be in the position to meet current cash obligations when they are due. That means they need to have enough liquid assets to avoid disruptions in carrying out daily operations. In case there is a disruption, they may consider using bridging loans to bridge the short-term funding gap.

#4 Return of Capital and Distributing Dividends

Public companies hold accountability to their shareholders. Hence, they often wonder about how much profit is considered excess and what they should do with it. This part of corporate finance refers to making decision about whether to retain a company’s excess income or distribute the cash amongst shareholders.

If the company wishes to retain the earnings, it can be utilised for future investments, business expansion or in an event of emergency. If they decide to distribute amongst shareholders, it can be done by paying them through dividends.

Retaining earnings is often the best way to save funds for the growth of the business as it doesn’t incur any debt. If the finance managers believe that they can gain a better return by investing excessive earnings, they should pursue it. Otherwise, they can pass on the earnings to shareholders.

Let us understand the working of corporate finance through an example

In a real estate company, the department computes capital budgeting requirements to acquire the asset or property. They will seek efficient resources of funding, which will determine their capital structure, which will be equity, debt or a combination of both.

Another important element of corporate finance is working capital management. This includes computing total capital, returns acquired against the capital and managing capital requirements for day to day operations. Decisions concerning how much profit to retain and how much to distribute amongst the shareholders will also be considered. All these critical decisions directly impact the value of your profit.

Why is Corporate Finance Important?

The capital structure of a business plays a vital role in increasing the value of a business. With corporate finance, businesses can acquire finances through the reliable sources to manage their long-term as well as short term sources of finance business activities. It demonstrates how a company utilises and manages finances to stay at the forefront of the market. Proper planning for capital budgeting and capital structure is vital to mitigate risk and increase profitability. Corporate finance also helps a business maintain liquidity, allowing them to pay for expenses and bills when they are due.

The Bottom Line

Corporate finance is a subset of its main field of Leeds bridging finance. It relates to budgeting and capital requirements of a company to meet their end goals. Availing corporate finance in the UK is more accessible than before. There are companies that offer a range of specialised finances for corporations to help address their need for capital. These finances are available at favourable terms, allowing businesses to tailor their repayment according to their cash flow.