Corporate Finance. What They Are, Objective, Key Concepts.

On the other hand, the term corporate finance is often associated with investment banking, assessing a company’s financial needs, and raising the appropriate type of capital to meet those needs. Corporate finance can be associated with transactions in which capital is raised to create, develop, grow, and acquire businesses.

Abstract

The information presented and described corporate finance focuses on business decisions and tools and analysis used to make these decisions the main objective of corporate finance is the study of finance that apply to problems of any financial company. Decisions are based on the decision-making for investment in the capital of the company projected.

Moreover, the term is often associated with corporate finance investment banking often assesses the financial needs of a business and raises the appropriate type of capital to meet those needs. Corporate finance can be associated with transactions in which capital is raised to create, develop, grow and acquire businesses.

What are finances?

Finance is the activities related to the exchange of different capital goods between individuals, companies, or States and with the uncertainty and risk that these activities entail. It is considered one of the branches of the economy. It is dedicated to the study of obtaining capital for investment in productive assets and the investment decisions of savers. It is related to transactions and money management. In this framework, the obtaining and management, by a company, an individual, or the State itself, of the funds, it needs to meet its objectives, and the criteria with which it disposes of its assets is studied; in other words, everything related to obtaining and managing money, as well as other securities or substitutes for money, such as titles, bonds, etc.

According to Bodie and Merton, finance “studies how scarce resources are allocated over time.” Finance deals, therefore, with the conditions and opportunities with which capital is obtained, its uses, and the returns that an investor obtains from its investment.

The academic study of finance is mainly divided into two branches, which reflect the respective positions of those who need funds or money to make an investment, called corporate finance, and those who want to invest their money by giving it to someone who wants to use it for invest, called asset valuation. The area of corporate finance studies how it is best for an investor to obtain money, for example, if selling shares, borrowing from a bank, or selling debt in the market. The area of asset valuation studies how it is more convenient for an investor to invest his money, for example, if buying shares, lending/buying debt, or accumulating cash.

These two branches of finance are divided into others. Some of the most popular areas within the study of finance are Financial Intermediation, Behavioral Finance, Microstructure of Financial Markets, Financial Development, International Finance, and Consumer Finance. A recently created discipline is microfinance, a branch of neuroeconomics, responsible for the study of brain biases related to managing the economy.

What is the company?

A company is an organization, institution, or industry, dedicated to activities or pursuit of economic or commercial purposes, to meet the needs of goods or services of the applicants, at the same time ensuring the continuity of the productive-commercial structure as well as its necessary investments.

Adam Smith is among the first to theorize about it. For him, a company is an organization that allows the “internationalization” of the forms of production: on the one hand, it allows the factors of production (capital, labor, resources) to meet, and, on the other, it allows the division of labor. Even though for Smith the “natural” and efficient form of such organization was that motivated by private interest – for example: “It is thus that the private interest and passions of individuals naturally dispose them to return their possessions (stock in the original ) towards employment that in the ordinary case are more advantageous for the community”6 – Smith proposes that there is also a need or area that demands public action: “According to the system of Natural Liberty, the Sovereign has only three duties to attend to, third,

What is corporate?

A corporation or corporate partnership is a legal entity created under the laws of a State as a legal entity recognized as a legal person and protected by company law. It has its privileges and responsibilities different from those of its members (natural persons).

Company finances

One of the company’s missions is to create value, but also to maximize it as best as possible, through the efficient use of financial resources. Shareholders must know how to manage their business and prevent crises since, when they are surprised, their assets could be harmed.

To avoid this situation, it is advisable to carry out a valuation plan so that each partner is aware of the decisions made regarding investment, sale of shares, financing, operations, and dividends, among other aspects.

What does finance mean?

In every facet of our life, we need to know how to manage our money. In the case of business, the owners of a company must develop and carry out planning techniques to ensure the future existence of the company. Investors must seek performance and perceive returns, without the need to take risks.

Running a business successfully means making the best use of the money received. That is why shareholders must provide the appropriate financing for investments, both short and long-term. One way to increase the profits of the company is through the “good use” of the resources of another, that is, through the technique of “leverage”: borrowed funds are received and contributed to a business that yields more. percentage.

Corporate finance measures the level of return on investment studies the real assets (tangible and intangible) and the obtaining of funds, the rate of growth of the company, the size of the credit granted to clients, compensation of employees, indebtedness, and acquisition of companies, among other areas.

Risk and benefit: Investors act in different markets trying to get the best return for their money while trying to minimize the risk of their investment. The capital market offers an efficient frontier at all times, which relates a given return to a given level of risk or volatility. The investor obtains a higher expected return in exchange for bearing greater uncertainty. The price of uncertainty is the difference between the profitability of the investment and the interest rate of those securities that are considered safe. We know this difference as the risk premium.
The value of money over time: Given the same amount of money, an investor prefers to have it in the present than in the future. For this reason, the intertemporal transfer of money has a discount factor (if we exchange future income for present capital, for example, in a mortgage loan), or a return (if we exchange present income for future income, for example, in a Pension plan).
Interest rate: It is defined as the price paid for the funds requested in a loan, in a period. It is usually expressed as a percentage and represents an exchange rate between the price of money today in terms of future money.

The interest rate directly affects consumption, trade, and investment, since part of the consumption is paid by credit cards, part of the merchandise bought and sold by businesses is bought on credit, and investments are always supported by bank loans. o Issuance of debt through bonds: When the interest rate rises, consumption, and investment decrease, as individuals and companies find it more difficult to pay their debts; By lowering the interest rate, consumption and investment increase due to the stimulus represented by paying less interest.

The relationship between liquidity and investment: The need to have liquid money both for the exchange of goods and services and to invest means that the commodity-money market has its supply and demand, and its costs and prices.
Opportunity costs: Refers to the sacrifice that any agent participating in a market must make when deciding to do without consumption or investment to use their resources, these being scarce by definition, in another project.
Leverage: As a general concept, it refers to the action of using indebtedness to finance an investment. Financial leverage refers to the investment from debt, which affects the fixed costs of the company. This debt generates a financial cost.
Inflation: Economic process that consists of a continuous rise in the prices of most products and services, and, therefore, of a loss of the value of money to be able to acquire those goods and services. Inflation has a direct impact on the interest rate: since inflation reduces the value of money, the higher the inflation, the higher the interest rate needed to compensate a saver for lending their money.

Corporate finance

Corporate finance is an area of finance that focuses on the monetary decisions that companies make and the tools and analysis used to make those decisions. The main objective of corporate finance is to maximize shareholder value. Although in principle it is a different field from financial management, which studies the financial decisions of all companies, and not just corporations, the main concepts of study in corporate finance apply to the financial problems of any type of company.

The discipline can be divided into long-term and short-term decisions and techniques. Equity investment decisions are long-term choices about which projects should receive financing, whether to finance investment with equity or debt, and whether to pay dividends to shareholders. On the other hand, short-term decisions focus on balancing short-term reactions and liabilities. The focus here is on cash management, inventory, and short-term financing.

Key concepts in finance

The dilemma between risk and benefit

In corporate finance, the more return an investor expects, the more risk they are willing to take. Investors are risk averse, that is, for a given level of risk they seek to maximize return, which can also be understood as for a given level of return seeking to minimize risk.

The value of money at the time

It is preferable to have one amount of money now than the same amount in the future. The owner of a financial resource has to be paid something to dispense with that resource. In the case of the saver, it is the interest rate. In the case of the investor, it is the rate of return or return.

The dilemma between liquidity and the need to invest

Cash is necessary for daily work (working capital) but at the cost of sacrificing larger investments.

Opportunity costs

Consider that there are always several investment options. Opportunity cost is the rate of return on the best available investment alternative. It is the highest return that will not be earned if the funds invested in a particular project are not obtained. It can also be considered as the loss that we are willing to assume, for not choosing the option that represents the best alternative use of money.

Appropriate financing

Long-term investments must be financed with long-term funds, and similarly, short-term investments must be financed with short-term funds. In other words, the investments must be matched with adequate financing for the project.

Leverage (use of debt)

The good use of funds acquired by debt serves to increase the profits of a company or the investor. An investor who receives borrowed funds at 15%, for example, and contributes them to a business that yields 20% in theory, is increasing his profits with the good use of another’s resources, however, he also increases the level of risk of the investment. investment, typical of a financial simulation exercise or financial projections.

Efficient diversification

The prudent investor diversifies his total investment, spreading his resources among several different investments. The effect of diversifying is to spread risk and thus reduce total risk.

Main areas

The field of study of finance covers both the valuation of assets and the analysis of financial decisions aimed at creating value. The objective of the management team of a company must be the maximum possible value creation, that is, maximizing profits for the shareholders or owners, maximizing the value of the investment projects that the company is taking on, and getting the highest possible return.

Companies create value when invested capital generates a rate of return that is greater than its cost.

The value of the company is represented by the market value of its assets; As is logical, this must be equal to the market value of its liabilities, which, in turn, is equal to the sum of the market value of its shares plus the market value of its debts.

the legal structure of a corporation
capital structure. Financial and investment models
venture capital
cost of capital and financial leverage
fusions and acquisitions
investment banking
equity and debt issuance techniques: dividend policy
financial difficulties: business restructuring
ethics and corporate social responsibility

Risk

Risk is the possibility that actual results will differ from those expected or the possibility that some unfavorable event will occur.

Total risk: Systematic risk + Unsystematic risk

Systematic risk (non-diversifiable or unavoidable): Affects the returns of all securities in the same way. There is no way to protect investment portfolios from such risk, and it is very useful to know the degree to which an asset’s returns are affected by such common factors, for example, a political decision affects all securities equally.

Unsystematic risk (diversifiable or avoidable or idiosyncratic): This risk derives from the variability of the returns of the securities not related to the movements of the market as a whole. It is possible to reduce it through diversification.

Corporate finance focuses on four types of decisions:

Investment decisions focus on the study of real assets (tangible or intangible) in which the company should invest.
Financing decisions, which study obtaining funds (from investors who acquire the financial assets issued by the company) so that the company can acquire the assets in which it has decided to invest.
Decisions about dividends must balance crucial aspects of the entity. On the one hand, it implies remuneration of share capital and on the other hand, it means depriving the company of financial resources.
Management decisions, which concern day-to-day operational and financial decisions.

Starting from the basic objective of corporate finance, which is to maximize value or wealth for shareholders or owners, one of the fundamental questions focuses on measuring the contribution of a certain decision to shareholder value. To answer this question, valuation or asset valuation techniques have been created.

Corporate Finance vs Accounting

Unlike accounting, which aims to reflect, as accurately as possible, the company’s transactions; finance focuses on the future of it, but through the study of value. However, is corporate finance necessary? The answer is yes. Here are some advantages of this process:

Help prevent outcomes
Improve understanding of financial aspects
They drive good investor decisions
They represent an approximation of the reality of the company
They provide data for the prediction and control of the business

The most important mission of the directors of a company is to generate the maximum possible value creation for it, that is, to make the company worth more and more. When the capital that is invested generates a rate of return higher than its cost, then the value will be generated.

Working Capital Fund Management

Working capital is the amount of capital that is available to an organization. That is to say, it is the difference between the resources in cash or easily convertible into cash (current assets), and the cash needs (Current Liabilities).

In addition to time horizon, working capital decisions differ from capital investment decisions in terms of discounting and profitability considerations, but they are also “reversible” to some extent.

Working capital management decisions are not made under the same conditions as long-term decisions, and management follows different criteria in making decisions: the main considerations are cash and liquidity flow and profitability and return on investment. capital (of which cash flow is probably the most important).

The most widely used measure of cash flow is the average period of maturity, the net operating cycle, or the cash conversion cycle. This represents the time difference between the cash payment for the raw materials and the sales receipts. The cash conversion cycle indicates the company’s ability to convert its resources into cash. Another measure is the gross operating cycle, which is the same as the net operating cycle, except that it does not take into account the creditors’ deferral period.

Long-term investment decisions

Investment decisions are made in the long term and are related to fixed assets and capital structure. Decisions are based on several interrelated criteria. Corporate management seeks to maximize the value of the firm by investing in projects that produce a positive net present value when valued at an appropriate discount rate. These projects must also be adequately financed. If there are no such opportunities, shareholder value maximization dictates that management must return excess cash to shareholders (ie distribution through dividends). For all these reasons, companies must make decisions about:

What investments to undertake through the investment valuation
What financing structure to use through its capital structure and the Modigliani-Miller Theorem
The amount of the dividend to be paid to shareholders

Leverage

In finance, leverage is a general term used to refer to techniques that allow profits and losses to be multiplied. The most common ways to achieve this multiplier effect are by borrowing money, buying fixed assets, and using derivatives. Important examples are:

A business entity can tap into its income by purchasing fixed assets. This will increase the ratio of fixed to variable costs, meaning that a change in revenue will translate into a larger change in profit.

Operating Leverage

A business can leverage its capital to borrow money. The more that is borrowed, the more profits or losses are spread over a proportionately smaller base and are proportionately larger as a result.

Financial appeceament

Both effects are produced by the effect of indebtedness that causes a difference between economic profitability and financial profitability.

Financial risk management

Risk management is the process of measuring risk and developing and implementing strategies to manage that risk. Financial risk management focuses on risks that can be managed (“hedged”), using the financial instruments exchanged (typically changes in commodity prices, interest rates, foreign exchange rates, and prices of securities). the actions). Financial risk management will also play an important role in treasury management.

This field is related to corporate finance in two ways. First, the company’s risk exposure is a direct result of past investment and financing decisions. Second, both disciplines share the goal of enhancing or preserving company value. All large companies have risk management teams.

Derivatives are the most widely used instruments in financial risk management. As creating single derivative contracts is expensive to create and control, the most profitable financial risk management methods generally involve derivatives that are traded on well-established financial markets. These standard derivative instruments include options, futures contracts, forwards, and swaps. Despite this, derivatives can also be contracted outside the market by direct agreement between the contracting parties, this type of derivative is called OTC or Over Counter.

Conclusion

Finance focuses on how companies can create and maintain value through the efficient use of financial resources.

Corporate finance is one approach to managing the capital budgeting process. Likewise, corporate finance seeks to maximize value or wealth for shareholders or owners. One of the fundamental issues in corporate finance focuses on measuring the contribution of a given decision to shareholder value. Asset valuation or asset valuation (accounting) techniques have been created.