The Fundamentals of Corporate Finance

Corporate finance involves the planning and financing of investments made by a company. It also involves the distribution or reinvestment of the income generated by such investments.

One of the main purposes of corporate finance is to maximise shareholder value through various financial strategies that include both short-term and long-term investments.

Principles of corporate finance

Corporate finance can be broken down into three principles or areas of activity that together complete the full spectrum of corporate finance. These core principles of corporate finance are:

• Capital budgeting

• Capital financing

• Reinvestments and dividends 

Capital budgeting

Capital budgeting is the planning process for company investment. To ensure the highest returns for a company’s long-term capital assets, the corporate finance activity of capital budgeting will need to be planned meticulously. 

Investment decisions should always involve vigilant financial analysis, so businesses use a variety of advisory experts and accountancy tools to inform their decisions. They use the expertise of corporate finance specialists to help them recognise opportunities for capital expenditures and gauge the available cash generated by any potential financial projects. 

This form of financial modelling plans out the intended expenditure for a particular investment and projects the estimated income, thus informing the decision on whether to invest or not. The capital budgeting phase of corporate finance usually compares the projections of multiple similar opportunities to identify the most suitable for investment.

Capital financing

The investment opportunities identified during the capital budgeting phase of corporate finance then undergoes the capital financing activity – working out the best way to finance the investments.

The capital investments can be financed through debt or equity, and sometimes both. Other options include issuing debt securities through investment banks, or selling stock to raise cash for investments. These latter options are especially useful for long-term capital expenditure or very large investments. 

This activity can be problematic if an accurate journal of corporate finance is not kept to monitor both the debt and equity involved in the financing of investments. A corporate finance advisory specialist will always recommend ensuring debt is kept to a minimum to reduce the risk of defaulting. The levels of equity involved will also need to be kept balanced, as using too much can have a detrimental effect on the company’s income and affect the value of the business for the original investors.

Reinvestments and dividends

The corporate finance specialists at a company will also decide what to do with the return of capital. The extra income from successful investments can fund the operations of the business itself or reinvested in new investment opportunities. 

Another option is the distribution of the additional income to shareholders as dividends. This is not the only way shareholders benefit, as the extra income being kept within the business can help it grow, thus increasing the value of the original shares overall.

Usually the decision as to whether to use the money to grow the business, reinvest it in new opportunities or give back to the shareholders via dividends will be decided based on the most economically viable option. If retaining the money can earn a rate of return on an investment bigger than the cost of capital, then this will be the most beneficial decision for all.

Corporate finance specialists

The complicated processes involved in corporate finance have given rise to a wealth of specialist professionals. Corporate brokers, for example, are experts on capital markets transactions. They will advise companies on how best to generate new finance for the likes of acquisitions, IPOs or secondary equity issuance.

While most of the senior corporate finance positions will be some sort of advisory role, other specialists are integral to the activities. These include the transaction services specialists who can be hired to perform specific tasks such as due diligence on a potential investment. 

We can help

If you’re interested in finding out more about the fundamentals of corporate finance, or any other aspect of your business and its finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.