What is corporate finance?
Corporate finance is the field of finance that deals with the financial decisions of businesses and the general economic environment in which they operate. Corporate finance has a significant impact on the performance of a corporation and its ability to compete in the market.
The major components of corporate finance require an understanding of everything from rules of accounting to corporate financial planning, business management, risk management, capital budgeting, mergers and acquisitions, and debt financing. A company’s financial statements are a major part of its public disclosure.
Most important concepts of corporate finance
Let’s look at some of the most basic yet crucial concepts of corporate finance
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Capital budgeting
Capital budgeting is a process of allocating capital between projects, to maximize firm value. The term “capital budget” refers to all funds available for investment, including operating profits and retained earnings. Capital budgeting is used by companies and governments to determine how to use their resources, especially their cash and investments.
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Risk management
Risk management is the process of identifying, assessing, measuring and controlling risk to reduce its impact on organizations or individuals. Risk management can be applied to a wide range of situations where there are potential losses associated with potential gains. These losses may include physical damage such as fire or theft; financial damage such as bankruptcy; reputational damage such as bad press; employee safety issues; environmental impacts; quality issues and legal liabilities.
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Mergers and aquisitions
Mergers and acquisitions (M&A) are the most common ways that companies acquire other companies. The acquirer first obtains financing to pay for the assets and then uses cash from operations to buy the target company. M&A can be an effective way for a company to expand its market share, but it can also be costly and risky. The benefits usually outweigh the costs, but managers must weigh the risks carefully before making an acquisition decision.
Fundamental principles of corporate finance
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Investment Principle
The investment principle states that a firm should only invest in any particular asset when the expected return from investing in the asset exceeds its opportunity cost. In other words, if an investor is offered an opportunity to invest in an asset with a known rate of return and given a choice between two assets and only one can be held, the decision must be made to hold the better asset and not both. This principle applies to all types of investments, whether they are physical assets or financial instruments like stocks or bonds.
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Financing Principle
The financing principle is one of the most important principles in corporate finance. It states that a company can only be financed by its assets or those of its shareholders. This means that the company must have enough equity to cover its debts and other liabilities. The financing principle is essential because it ensures that a company has enough cash to pay its bills on time. If a company does not have enough cash to pay its bills, it may not be able to operate and could even go bankrupt. To fulfil the requirements of the financing principle accountants and advisers in a company take into account things like indirect and direct expenses lists, balance sheets, sales and revenue reports and other annual reports.
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Dividend principle
The dividend principle states that all profits should be paid as dividends to shareholders. When a company’s profits exceed its costs, this excess profit should be distributed as dividends to shareholders. This keeps investors happy and increases their confidence in the company’s prospects, which will attract more capital into the market from other investors who want to participate in the return on their investment.
