Definition of corporate finance
Corporate finance is the process of matching capital needs with the operations of a business.
It differs from accounting, which is the process of historically recording the activities of a business from a monetized perspective.
Captial is money invested in a company to create it and to grow and sustain it. This differs from working capital, which is money to support and maintain trade – buying raw materials; the financing of the shares; financing the necessary credit between production and the realization of sales profits.
Corporate finance can start with the tiniest bit of money family and friends put into a fledgling company to finance its first steps into the commercial world. At the other end of the spectrum are multi-layered corporate debt in huge international corporations.
Corporate finance essentially revolves around two types of capital: equity and debt. Equity is a shareholder’s investment in a business that carries ownership rights. Equity tends to sit in the company for the long term, hoping to create a return on investment. This can come either through dividends, which are payments, usually on an annual basis, related to one’s percentage of stock ownership.
Dividends usually accrue only in very large, long-established corporations that already have sufficient capital to more than adequately finance their plans.
Younger, growing and less profitable operations tend to be voracious consumers of all the capital they have access to and thus are reluctant to build surpluses from which dividends can be paid.
In the case of younger and growing businesses, equity is often sought on an ongoing basis.
In very young companies, the main sources of investment are often private individuals. After the aforementioned family and friends, high net worth individuals and experienced industry figures often invest in promising younger companies. These are the pre-launch and start-up phases.
At the next stage, when there is at least some sense of a cohesive business, the main investors tend to be venture capital funds that specialize in taking promising early-stage companies through rapid growth to a hopefully very profitable sale or public offering. shares.
The other major category of investment related to corporate finance comes through debt. Many companies seek to avoid diluting their ownership through ongoing equity offerings and decide that they can generate a higher rate of return on loans for their companies than the cost of servicing those loans through interest payments. This process of enhancing the capital and trading aspects of a business through debt is commonly referred to as leverage.
Although the risk of raising equity capital is that the original founders can become so diluted that they end up getting precious little return for their efforts and success, the main risk of debt is corporate – the company must be careful not to be deluged and thus unable to pay its debt.
Corporate finance is ultimately a juggling act. It must successfully balance ownership aspirations, potential, risk and return, optimally considering the interests of both internal and external shareholders.
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