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» Introduction to Corporate Finance
Introduction to Corporate Finance
ntroduction to corporate finance is as follows:
Corporate finance has two basic functions :-
Acquisition of Resources
Acquisition of resource means fund generation at lowest possible cost. Resource generation can be done through :-
* Equity --- It includes proceeds obtained from stock selling, retained earnings, and investment returns.
* Liability --- It includes bank loans, warranties of products and payable account.
Allocation of Resources|
Investment of funds for profit maximization motive is known as allocation of resources. Investment can be categorized into two groups :-
* Fixed Asset --- Land, Machinery, buildings, etc.
* Current Asset --- Inventory, cash, receivable accounts, etc.
Corporate or business finance is all about raising and allocation of funds for increasing profit. Senior management chalks out long-term plan for fulfilling future objectives. Value of the company's stock is a very important issue for the management because it is directly related to the wealth of the share-holders of the company.
Functions of Corporate Finance are :-
- Raising of Capital or Financing
- Budgeting of Capital
- Corporate Governance
- Financial management
- Risk Management
All the above functions are interrelated and interdependent. For example, in order to materialize a project a company needs to raise capital. So, budgeting of capital and financing are interdependent.
Decision making of the corporate finance are basically of two types based on the time period for the same, namely, Long term and Short term.
i . Long term decisions :-
It is basically concerned with the capital investment decisions such as viability assessment of the project, financing it through equity or debt, pay dividend or reinvest out of the profit.
Long term Corporate finance which are generally related to fixed assets and capital structure are called Capital Investment Decisions. Senior managements always target to maximize the value of the firm by investing in positive NPV (Net Present Value) projects. If such opportunities don't arise then reinvestment of profits should be stalled and the excess cash should be returned to the shareholders in the form of dividends. Hence, Capital Investment Decisions constitute three decisions:-
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- Decision on Investment
- Decision on Financing
- Decision on Dividend
ii. Short term decisions :-
These are also known as working capital management which tries to strike a balance between current assets (cash, inventories, etc.) and current liabilities(a company's debts or obligations impending for less than one year).
Corporate finance is slightly different from the accounting one. This can be understood by the help of the following example :-
A Steel firm sells steel to a car manufacturer at $100 per ounce (suppose) but has not received the payment for the same. Let the Steel firm's cost of production be $90.
Now, according to the accounting rule the profit will be calculated as $(100-90) = $10 per ounce.
But according to Corporate Finance the calculation specifications will be :-
Inflow of Cash = 0
Outflow of Cash = -90
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