The business world involves multiple disciplines, but one of the most important points for a company to stay afloat is the constant search to increase its value; however, it is often difficult to identify the best way to achieve this goal. At this point, corporate finance enters the scene. In order to know the importance of corporate finance when making business decisions, we must first know what they refer to and distinguish their objectives.
What is corporate finance?
We can define corporate finance as those finances that are related to obtaining and applying the resources of a company since they are closely related to the generation of business value and obtaining the maximum benefits for the company.
Corporate finance is in charge of analyzing and studying business variables with the objective of making decisions in search of the creation of more capital.
Being a professional in corporate finance implies taking a very important role within the company. To be successful in this area, you must work with established goals and always keep in mind the objectives that must be met as a finance professional.
What are the objectives of corporate finance?
It is important to know that the main objective of corporate finance is to maximize economic benefits within a company and at the same time develop investment projects. Each company will give greater shape and meaning to these objectives, however, we can synthesize them as follows:
Maximize the economic value of the entity.
Control and manage financial risk.
Define the investment in the assets of an entity.
Define financing through liabilities or stockholders' equity.
Control the levels of profitability, productivity, leverage, and liquidity of the business.
Corporate finance in business decision making
Now that we know what corporate finance is and its main objectives, it is time to find out what role it plays in business decision-making. Its main importance lies in the fact that this area of business management must always be taken into account for any corporate decision, since in this way the search for efficient and sustainable use of the company's financial resources will be maintained, ensuring its well-being.
Corporate finances are used to carry out good decision-making about the company in the following points.
The remuneration to the shareholders.
The sources of financing for the company and its projects.
The level of indebtedness.
Cash flow optimization.
The viability of an investment project.
The financial model.
They come to influence the areas of corporate social responsibility and employee incentive policies.
It is important to identify that many decisions are made based on corporate finance and that is why they are classified as follows:
This type of decision studies the different sources to fund the investments that are to be made. With this decision, it is determined if it is convenient to use resources from the same company or if it is a better strategy to request credits.
They start with a detailed study of the current needs of the company, in this way the real assets in which it must be invested are determined in order to achieve the increase in profits that are set as a goal. This investment can be made in different areas of the company, such as machinery, equipment, etc.
Decisions on dividends
In corporate finance, one of the important points is to decide how the retribution will be made to the shareholders that are part of the company, seeking their benefits; but at the same time prioritizing the financial balance of the company.
In this type of a decision, the financial state of the company is important to make strategic and operational decisions, such as:
Opening of new production lines.
Acquisition of new production equipment.
Activities in corporate finance
Investments and capital budget
Capital investing and budgeting is one of the activities in corporate finance concerned with planning where to place the firm's long-term capital assets to generate the highest risk-oriented returns.
This consists, above all, in deciding whether to pursue an investment opportunity through extensive financial analysis.
Capital investment and budgeting use accounting tools to identify capital expenditures, estimate project cash flows, compare planned investments with projected revenues, and decide which projects to budget for.
Financial modeling, linked to the activity in question, is used to estimate the economic impact of an investment opportunity and compare alternative projects.
Analysts often use the Internal Rate of Return (IRR) along with the Net Present Value (NPV) to compare projects and choose the optimal one.
This is one of the core activities in corporate finance and encompasses decisions about how best to finance capital investments through company equity, debt, or a combination of both.
Long-term financing for capital expenditures or relevant investments can be obtained by selling shares or issuing debt securities in the market through investment banks.
The two sources, equity, and debt, must be carefully balanced, as having too much debt can increase the risk of default while being overly reliant on equity can dilute earnings and value for original investors.
In summary, it allows optimizing the company's capital structure by reducing its Weighted Average Cost of Capital (WACC) to the minimum possible.
Dividends and return of capital
Dividends and return on capital require corporate finance professionals within the company to decide whether to retain excess earnings for future investment and operating requirements or distribute them to shareholders in the form of dividends or share buybacks.
Retained earnings that are not distributed to shareholders can be used to finance business expansion. This is often the best source of funds in that it does not add debt or dilute equity value by issuing more shares.
In case it is believed possible to obtain a rate of return with a capital investment greater than the cost of capital of the company, it should be attempted; otherwise, it is preferable to return that capital to shareholders with dividends or share buybacks.
Given the fundamental role of corporate finance in the sum of company decisions, it is an unavoidable task to study the subject in depth or to have experts in the area so that any organization can take advantage of them in each of its long-range financial decisions.