Definition of 'Corporate Finance'

1) The financial activities related to running a corporation.

2) A division or department that oversees the financial activities of a company. Corporate finance is primarily concerned with maximizing shareholder value through long-term and short-term financial planning and the implementation of various strategies. Everything from capital investment decisions to investment banking falls under the domain of corporate finance.

Among the financial activities that a corporate finance department is involved with are capital investment decisions. Should a proposed investment be made? How should the company pay for it; with equity or with debt, or combination of both? Should shareholders be offered dividends on their investment in the company? These are just some of the questions a corporate financial officer attempts to answer on a consistent basis. Short-term issues include the management of current assets and current liabilities, inventory control, investments and other short-term financial issues. Long-term issues include new capital purchases and investments.

Corporate finance is the area of finance dealing with the sources of funding and the capital structure of corporations and the actions that managers take to increase the value of the firm to the shareholders, as well as the tools and analysis used to allocate financial resources. The primary goal of corporate finance is to maximize or increase shareholder value.[1] Although it is in principle different from managerial finance which studies the financial management of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms.

Investment analysis (or capital budgeting) is concerned with the setting of criteria about which value-adding projects should receive investment funding, and whether to finance that investment with equity or debt capital. Working capital management is the management of the company's monetary funds that deal with the short-term operating balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers).[citation needed]

The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the company's financial needs and raise the appropriate type of capital that best fits those needs. Thus, the terms “corporate finance” and “corporate financier”

may be associated with transactions in which capital is raised in order to create, develop, grow or acquire businesses.

Financial management overlaps with the financial function of the Accounting profession. However, financial accounting is the reporting of historical financial information, while financial management is concerned with the allocation of capital resources to increase a firm's value to the shareholders.

Types of transactions Raising seed, start-up, development or expansion capital Mergers, demergers, acquisitions or the sale of private companies Mergers, demergers and takeovers of public companies, including public-to-private deals Management buy-out, buy-in or similar of companies, divisions or subsidiaries - typically

backed by private equity Equity issues by companies, including the flotation of companies on a recognised stock

exchange in order to raise capital for development and/or to restructure ownership Raising capital via the issue of other forms of equity, debt and related securities for the

refinancing and restructuring of businesses Raising capital for specialist corporate investment funds, such as private equity, venture

capital, real estate and infrastructure funds Financing joint ventures, project finance, infrastructure finance, public-private partnerships

and privatisations Secondary equity issues, whether by means of private placing or further issues on a stock

market, especially where linked to one of the transactions listed above Raising debt and restructuring debt, especially when linked to the types of transactions

listed above

Outline of corporate finance[edit]

Investment analysis[edit]

Investment analysis (or capital budgeting) is the planning of value-adding, long-term corporate financial projects relating to investments funded and affecting the firm's capital structure. Management must allocate the firm's limited resources between competing opportunities (projects), which is one of the main focuses of capital budgeting.[2] Capital budgeting is also concerned with the setting of criteria about which projects should receive investment funding to increase the value of the firm, and whether to finance that investment with equity or debt capital. Investments should be made on the basis of value-added to the

future of the corporation. Projects that increase a firm's value may include a wide variety of different types of investments, including but not limited to, expansion policies, or mergers and acquisitions. When no growth or expansion is possible by a corporation and excess cash surplus exists and is not needed, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program.

Choosing between investment projects may be based upon several inter-related criteria. (1) Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive net present value when valued using an appropriate discount rate in consideration of risk. (2) These projects must also be financed appropriately. (3) If no growth is possible by the company and excess cash surplus is not needed to the firm, then financial theory suggests that management should return some or all of the excess cash to shareholders (i.e., distribution via dividends).

When analyzing a company, investors are advised to compare and contrast their investments in corporate stock against competing businesses in the same industry, and to evaluate strengths and weaknesses of the company in terms of qualitative factors controlling the financial aspects of the company (i.e. profitability, growth, sustainability, etc).

Maximizing shareholder value[edit]

The primary goal of financial management is to maximize or to continually increase shareholder value. Maximizing shareholder value requires managers to be able to balance capital funding between investments in projects that increase the firm's long term profitability and sustainability, along with paying excess cash in the form of dividends to shareholders. Managers of growth companies (i.e. firms that earn high rates of return on invested capital) will use most of the firm's capital resources and surplus cash on investments and projects so the company can continue to expand its business operations into the future. When companies reach maturity levels within their industry (i.e. companies that earn approximately average or lower returns on invested capital), managers of these companies will use surplus cash to payout dividends to shareholders. Managers must do an analysis to determine the appropriate allocation of the firm's capital resources and cash surplus between projects and payouts of dividends to shareholders, as well as paying back creditor related debt.

Return on investment[edit]

Return on investment is the concept of an investment in some resource or asset yielding an upward growth trend or appreciation in value to the investor. In purely economic terms, ROI is used to measure the profits gained in comparison to the capital invested. ROI is a broad method for investment valuation, and may be employed using different valuation approaches. One method is to compare the investment value and its opportunity cost to other forms of investments available (this method is generally known in finance as the cost of capital). Alternative methods may include a cost-benefit analysis of the future profits from the investment.

Leveraged buyout[edit]

A leveraged buyout is when a company or single asset (e.g., a real estate property) is purchased with a combination of equity, plus, significant amounts of borrowed money (debt heavy capital structure) – structured in such a way that the target's cash flows or assets are used as the collateral (or, "leverage") to secure and repay the money borrowed to purchase the target-company/asset. Since the debt (be it senior or mezzanine) has a lower cost of capital (until bankruptcy risk reaches a level threatening to the

lender[s]), than the equity, the returns on the equity increase as the amount of borrowed money does – until the perfect capital structure is reached. As a result, the debt effectively serves as a lever to increase returns-on-investment.

LBOs are a very common occurrence in today's "Mergers and Acquisitions" (M&A) environment. The term LBO is usually employed when a financial sponsor acquires a company. However, many corporate transactions are partially funded by bank debt, thus effectively also representing an LBO. LBOs can have many different forms such as Management Buy-out (MBO), Management Buy-in (MBI), secondary buyout and tertiary buyout, among others, and can occur in growth situations, restructuring situations and insolvencies. LBOs mostly occur in private companies, but can also be employed with public companies (in a so-called PtP transaction – Public to Private).

As financial sponsors increase their returns by employing a very high leverage (i.e., a high ratio of debt to equity), they have an incentive to employ as much debt as possible to finance an acquisition. This has in many cases led to situations, in which companies were "overlevered", meaning that they did not generate sufficient cash flows to service their debt, which in turn led to insolvency or to debt-to-equity swaps in which the equity owners lose control over the business and the debt providers assume the equity. [citation

needed]

Further information: Trade Off Theory

Consumption of fixed capital[edit]Main article: Consumption of fixed capital

Consumption of fixed capital (CFC) is a term used in business accounts, tax assessments and national accounts for depreciation of fixed assets. CFC is used in preference to "depreciation" to emphasize that fixed capital is used up in the process of generating new output, and because unlike depreciation it is not valued at historic cost but at current market value (so-called "economic depreciation"); CFC may also include other expenses incurred in using or installing fixed assets beyond actual depreciation charges. Normally the term applies only to producing enterprises, but sometimes it applies also to real estate assets. CFC refers to a depreciation charge (or "write-off") against the gross income of a producing enterprise, which reflects the decline in value of fixed capital being operated with. Fixed assets will decline in value after they are purchased for use in production, due to wear and tear, changed market valuation and possibly market obsolescence. Thus, CFC represents a compensation for the loss of value of fixed assets to an enterprise.

Growth Stock[edit]Main article: Growth stock

A growth stock is a stock of a company that generates substantial and sustainable positive cash flow and whose revenues and earnings are expected to increase at a faster rate than the average company within the same industry.[1] A growth company typically has some sort of competitive advantage (a new product, a breakthrough patent, overseas expansion) that allows it to fend off competitors. Growth stocks usually pay smaller dividends, as the company typically reinvests retained earnings in capital projects.