This lesson will initiate the theme of corporate finance and its effects on a business and its shareholders. It will argue about capital-funding sources and offer an example of a corporation needing to use capital funding for improvements.
DEFINITION OF CORPORATE FINANCE
Big business means big money. At any rate, that’s how they’ve always conceived of it. Of course, when you are an important part of the business’ administrative process relating to finances, there never seems to be sufficient money.
If you work for a small business, especially a start-up, it seems like no one is willing to give you money, and no one starting the business of finance either. Some days it feels like a no-win condition. We need money to grow and provide our product or service in order to earn revenue – we need money to make money.
Never fear. Business owners and corporate executives have dealt with this problem ever since humans first had pursued an idea to operate the business. One of the benefits of today’s modern business owner or corporate executive experiences is the number of sources. There are more sources from which, businesses can draw capital.
Those businesses work on more distinct and mature capital streams from which to seek financing.
Corporate finance is the area of finance that deals with providing money for businesses and the sources that provide them. These sources offer capital to corporations. Thus, the corporations are able to pay for structural improvements, growth, and other value-added projects and enterprises.
Capital is good that businesses can utilize now. For this lesson, it will principally turn to money. The reason for corporate finance is to make the most of shareholder value. There are many methods that a corporation can utilize to make the most of shareholder value.
One method is capital budgeting, which involves continuing planning for use of assets on corporate financial projects that influence the overall capital organization of the business. Managers and executives must pick criteria for the financial support of projects that will offer the best option of maximizing value for shareholders.
When executives settle on that there is no extra room for value growth, they are expected to pay out through dividend policies or reserve repurchase programs using the extra of capital. This adds perceived worth to the business because of its ability to pay out extra cash to investors.
A corporation has two main capital sources for investment purposes. These comprise:
1. Self-generation of assets (primarily through revenue streams)
2. External capital funding sources (primarily through debt and equity capital)
As managers and executives reflect on their options, they must settle on the most favorable mix of capital funding in order to make the most of value for the corporation. For example, self-generation of capital takes time and capital and the product (free cash on hand) can be nominal.
This would reduce shareholder worth over time. If they reflect on debt capital, the debt becomes a responsibility on the balance sheet and affects cash flow. Equity capital is less dicey than debt capital, but it weakens the value of share ownership.
EXAMPLE OF CORPORATE FINANCE
XYZ Inc. is a manufacturing company that manufactures telephone wire for telecommunication purposes. They function three plants in special locations. Each plant makes a diverse type of telephone wire.
Plant #1 makes an older type of wire called Cat 3 used primarily in developing countries and in low-end production.
Plant #2 makes a new type of wire called Cat 5, which is the primary type of telephone wire used worldwide.
Plant #3 makes special orders of various types of telephone wire, including sub-sea wire.
Each of the three plants is older and in need of capital improvements. Each plant needs all-embracing substantial remodeling to notify the facility, boost safety measures, and stick to modern building and fire codes. Additionally, each plant needs to modernize machinery to make the manufacturing process more capable and ultimately manufacture more products.
Corporation executives comply with each of the plant managers and commission a suggestion of needed improvements for each plant.
After receiving the suggestions from each of the three plants, executives work in coordination with the finance team to settle on projected costs of the improvements to each of the plants.
GOALS OF FINANCIAL MANAGEMENT
The main goals of the business always comply with the senior executive’s main target for fiscal organization. Although the business may have tangible goals that are part of a business strategy, there are also other goals, sometimes undeclared, that senior executive may crackdown on as they manage the company’s capital.
One of these undeclared goals is profit maximization.
Profit maximization is the well-known golden goose egg to shareholders and other investors. It means that the company is running operations and supervising capital to make sure that the company makes the maximum amount of profit.
Special studies in Finance emphasize corporate finance and its impact on shareholders. Senior executives feel strain to make sure that shareholder value is constantly maximized and the victim, in the end, is the customer. Companies shortchange customers as they cut corners concerning the worth of products or services. This might put aside the company money now but will rear its ugly head down the road.
Magalie D. is a Diploma holder in Public Administration & Management from McGill University of Canada. She shares management tips here in MGTBlog when she has nothing to do and gets some free time after working in a multinational company at Toronto.