Corporate Finance
Corporate finance encompasses the strategies, tools, and structures that enable corporations to grow from startups to large and powerful enterprises. Browse Investopedia’s expert written library to learn more.
Understanding Corporate Finance
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What is corporate finance?
Corporate finance focuses on how corporations can use long- and short-term financial planning and other strategies to source funding, structure capital, make investments and employ accounting techniques to maximize shareholder value. It focuses both on day-to-day cash flow and on long-term planning.
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How do corporations finance themselves?
Corporations have a wide range of ways to raise capital for growth. These include retained earnings (better known as profits), taking on debt, and selling off ownership (equity funding). Success lies in finding the correct mix of these methods—and companies can be valued by how they balance their funding sources.
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How does capital budgeting work in a corporation?
Capital budgeting uses three methods to determine whether a possible capital investment makes sense. The payback period calculates how long it would take for the project to earn enough to recover its cost. The internal rate of return is how much the project should earn—and whether that’s higher than the borrowing cost. The net present value method lets you compare the proposed project to other options to see which project would make more.
Learn More: An Introduction to Capital Budgeting -
How do you read a corporate cash flow statement?
A cash flow statement is a sort of corporate checkbook that reconciles a company’s balance sheet and income statement. It records the inflow and outflow of cash and lets investors know whether the revenues that a company has booked on its income statement have actually been received. Note that while a positive cash flow is good, the statement doesn’t account for liabilities and assets; it’s not a complete picture. Some companies with negative cash flows may still be good investments.
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What’s more important—market capitalization or equity?
Both are important, but equity—the company’s assets minus liabilities—is a more accurate way to estimate what a company is worth. Market capitalization is the total worth of all a company’s outstanding shares; it can fluctuate daily, if not hourly, with the share price on the stock market.
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Why is corporate finance strategy important to all managers?
Strategic financial management is how companies make money—and that is the ultimate report card for a manager. Skilled managers focus on long-term success (strategic management), though they may also use tactical management tools to position the company for the short term. Key elements include planning, budgeting, risk assessment and management, establishing ongoing procedures and strategies targeted to the industry/sector in which the company operates.
Learn More: Strategic Financial Management
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Equity
A company’s total assets minus liabilities, equity is what shareholders would get once all assets were liquidated and all debts paid. The ultimate bottom line, it shows what each investor’s stake is worth.
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Cost of Capital
How big a return would a company need to justify borrowing the money it would take to make a capital investment? Figuring it requires calculating both equity and debt.
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Capital Markets
The primary and secondary markets where entities that need capital meet potential investors. The stock market and the bond market are the two most common ones. New securities are issued and sold on primary markets; investors seeking existing securities use the secondary market.
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Generally Accepted Accounting Principles (GAAP)
U.S. companies issuing financial statements must use this group of accounting principles, issued by the Financial Accounting Standards Board (FASB). These 10 key concepts ensure that financial documents allow for apples-to-apples comparisons among U.S. companies, and that statements are complete and consistent. The international equivalent is called International Financial Reporting Standards (IFRS), issued by the International Accounting Standards Board (IASB).
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Payback Period
How long will it take to recover the cost of your investment? That’s its payback period. To calculate the payback period, divide the cost of the investment by the annual cash flow. Obviously, the shorter the breakeven point, the better.
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Capital Structure
The way a company combines debt and equity to fund its overall operations is its capital structure. Analysts use its debt-to-equity (D/E) ratio to assess the risk level of a company’s borrowing choices. Companies can be high leverage or low leverage.
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Implicit Cost
When a company uses its own resources to pay expenses instead of using them to earn money, there is no exchange of money to be measured through accounting. Examples: A company uses a building it owns instead of renting it out. Or a small business owner takes no salary in the early years of a business.
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