Fundamentals of Business

Corporate finance

Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to enhance corporate value while reducing the firm's financial risks. Equivalently, the goal is to maximize the corporations return to capital.

Although it is in principle different from managerial finance which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms.

The discipline can be divided into long term and short term decisions and techniques. Capital investment (capital expenditure) decisions are long term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, the short term decisions can be grouped under the heading

Working capital management (revenue expenditure)

This subject deals with the short term balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short term borrowing and lending (such as the terms on credit extended to customers).

The financing decisions
the sources of financing will, generically, comprise some combination of debt and equity. Financing a project through debt results in a liability that must be serviced-and hence there are cash flow implications regardless of the project's success. Equity financing is less risky in the sense of cash flow commitments, but results in a dilution of ownership and earnings. The cost of equity is also typically higher than the cost of debt and so equity financing may result in an increased hurdle rate (break even) which may offset any reduction in cash flow risk.

Difference between Funding and financing an enterprise
Funding is when an enterprise's need for funds is met using its own reserves and Financing is when an enterprise need for for funds is met externally through shares or borrowing.

What is the money for?
There are only two things to decide, that is: short term (revenue expenditure) and long term (capital expenditure) needs.

Capital investment (capital expenditure) decisions

Capital investment decisions thus comprise an investment decision, a financing decision, and a dividend decision.

The investment decision

Management must allocate limited resources between competing opportunities ("projects") in a process known as capital budgeting. Making this capital allocation decision requires estimating the value of each opportunity or project: a function of the size, timing and predictability of future cash flows.

Project valuation

In general, each project's value will be estimated using a discounted cash flow (DCF) valuation, and the opportunity with the highest value, as measured by the resultant net present value (NPV) will be selected This requires estimating the size and timing of all of the incremental cash flows resulting from the project. These future cash flows are then discounted to determine their present value these present values are then summed, and this sum net of the initial investment outlay is the NPV. In conjunction with NPV, there are several other measures used as (secondary) selection criteria in corporate finance. These are visible from the DCF and include payback, IRR (Internal Rate of Return), Modified IRR, equivalent annuity, capital efficiency, and ROI.