CORPORATE FINANCE



Corporate finance pertains to the acquisition and allocation of a company's resources to maximize shareholder wealth. More simply, it is the process of obtaining funds and investing them in a manner that will maximize profits and build value for shareholders. This process entails planning and implementing a capital structure that satisfies both operating objectives (money needed to pay current bills and finance future growth) and shareholder expectations (profitability that translates into return on shareholder investment, e.g., stock price growth or return on equity).

ACQUIRING CAPITAL

Resource acquisition and allocation—especially capital—is typically carried out by a finance department headed by a chief financial officer. Finance departments are charged with raising all needed funds as cheaply as possible and using funds as wisely as possible. Since shareholders are a key source of capital, for publicly traded companies having a stable and rising stock price can greatly reduce the cost of obtaining capital. But there are often limits on how much cash can be obtained through issuing stock. Over the long term, markets generally are loathe to support rising share prices and to absorb large additional stock issues at current prices without some evidence that the company is (or will be) worth the money. Thus, corporations frequently turn to other sources, such as venture capital, loans, bonds, investments, and some types of joint ventures and other strategic alliances. Corporate finance departments likewise manage cash flow generated from operations (e.g., product sales), and typically perform at least some financial and managerial accounting duties as well.

MANAGING CAPITAL

Resource allocation, the second corporate finance function, is the investment of funds in order to support operations and increase shareholder wealth over time. Or, put simply, it is deciding how best to spend (or save) the money the business has acquired. Usually this requires developing a capital budget to allocate funds for long-term investments like new equipment, new product development, and other major financial commitments outside day-to-day expenses. Naturally, new resource acquisition must be reconciled with present and projected cash flows. The company must choose the capital investments that are likely to earn the highest returns in the long term, considering the discounted cash flow and other factors. Resource allocation decisions have a profound effect on a business's profitability and cash flow, which, in turn, affect the firm's future cost of capital.

CHANGES IN CORPORATE FINANCE

Corporate finance has evolved considerably over time. Historically, businesses relied much more on debt and cooperative ventures (often between groups of wealthy individuals) than they do today, and the methods and strategies of capital acquisition and management were fairly rudimentary until the early 20th century. The first decades of the 20th century saw the growth of common stock financing and the rise of professional management techniques, which blossomed by the second half of the century into a massive and complex—yet efficient—market system of corporate finance.

Most recently, corporate finance departments have emphasized the alignment of finance functions closely with business strategy. Formerly, many finance departments were concerned almost solely with handling day-to-day transactions, financial accounting, and reporting; their involvement in operational decisions was often limited to granting approval to new projects based strictly on the numbers. The trend has been toward making finance operations themselves more efficient and less costly to run, including via the outsourcing of routine tasks.

Finance departments, moreover, are increasingly being asked to participate as partners in operational tasks by sharing information technology and decentralizing finance activities that are most useful to particular production areas of the company. These measures attempt to cut costs and increase the organizational contributions of finance activities. This demands that finance managers work more with managers of other areas of the business, particularly the operating departments. For example, finance managers might be asked to make a decision to purchase new equipment based on business objectives (product quality, market strategy, customer service) rather than just on the monetary implications of the decision. Such collaborations are intended to harness the re-sources and skills of finance areas to advance the broader business strategy, as opposed to mere fiscal tracking and reporting.

FURTHER READING:

Baskin, Jonathan B., and Paul J. Miranti, Jr. A History of Corporate Finance. New York: Cambridge University Press, 1997. Brealey, Richard A., and Stewart C. Myers. Principles of Corporate Finance. 5th ed. New York: McGraw-Hill, 1996. Chew, Donald H., Jr., ed. The New Corporate Finance: Where Theory Meets Practice. Boston: Irwin/McGraw-Hill, 1999. Kelly, Jim. 'How to Cash In." Financial Times, 24 January 1997.

Landesman, Earl. Corporate Financial Management: Strategies for Maximizing Shareholder Wealth. New York: John Wiley & Sons, 1997.



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