Explained: What is corporate finance and what is its role in a business?

Explained: What is corporate finance and what is its role in a business?

Explained: What is corporate finance and what is its role in a business?

The corporate finance department in a company handles all the financials and investment decisions and is primarily focused on maximising shareholder value through long-term and short-term financial planning and implementation of various strategies.

Three primary functions 

The department governs and oversees the firm’s financial activities and capital investment decisions, which includes if the company should pursue a particular investment; pay for the investment through equity, debt or a hybrid of both; and whether the shareholders receive any dividends.

Apart from the said responsibilities, the corporate finance department also handles the current assets, liabilities and inventory control.

Firstly, a capital investment may be the most important task of the corporate finance department of a company and is primarily concerned with capital budgeting. Capital budgeting helps the department identify capital expenditures, future cash flow estimates from proposed projects, and compares the planned investments with potential projects and decides which ones to include.

However, the department may have to suffer severe implications if errors are made in capital investment. For example, poor capital budgeting may either result in excessive investing or under-funded investment. This can cause severe losses to the company because of increased financing costs or having inadequate funds to run the operating capacity.

Secondly, the department is also responsible for raising funds through debt, equity or both. It may borrow from a commercial bank or other financial intermediaries or may raise funds by issuing debt securities in the capital markets through investment banks. Capital financing provides the necessary funds for capital investment in a company.

For example, if a company wishes to raise long-term funds for business expansions, it may choose to sell stocks to equity investors.

Balancing act 

Corporate financing is nothing but a balancing act where one has to determine the weights between debt and equity. A rise in debt increases the default risk while relying too much on equity can dilute the earnings and value for early investors.

Thirdly, the corporate finance department also has additional responsibility for having enough short-term financial management where the goal is to ensure that there is enough liquidity or funds to run the day-to-day operations of the company.

Short-term financial management exclusively concerns the working capital or operating cash flows. A firm must be able to meet all its cash liability when it is due and have enough current assets that can be cash-ready which can help with the company’s operations. It may also involve getting additional credit lines or issuing commercial papers as liquidity back-ups.