What is Corporate Finance?
Corporate finance deals with the capital structure of a corporation including its funding and the actions that management takes to increase the value of the company. Corporate finance also includes the tools and analysis utilized to prioritize and distribute financial resources.
The ultimate purpose of corporate finance is to maximize the valueValue AddedValue Added is the extra value created over and above the original value of something. It can apply to products, services, companies, management, and other areas of business. In other words, value-added is the enhancement made by a company/individual to a product or service before offering it to the end customer. of a business through planning and implementing management resources while balancing risk and profitability.
Image: CFI’s free introduction to corporate finance course.
The 3 Important Activites that Govern Corporate Finance
#1 Investments & Capital Budgeting
Investing and capital budgeting includes planning where to place the company’s long-term capital assets in order to generate the highest risk-adjusted returns. This mainly consists of deciding whether or not to pursue an investment opportunity through extensive financial analysis.
By using financial accounting tools, a company identifies capital expendituresHow to Calculate CapEx - FormulaThis guide shows how to calculate CapEx by deriving the CapEx formula from the income statement and balance sheet for use in financial modeling and analysis. To calculate capital expenditures, use depreciation on the income statement, add current period PP&E and subtract prior period PP&E, estimates cash flowsValuationFree valuation guides to learn the most important concepts at your own pace. These articles will teach you business valuation best practices and how to value a company using comparable company analysis, discounted cash flow (DCF) modeling, and precedent transactions, as used in investment banking, equity research, from the proposed capital projects, compares planned investments with projected income, and decides which projects to include in the capital budget.
Financial modelingWhat is Financial ModelingFinancial modeling is performed in Excel to forecast a company's financial performance. Overview of what is financial modeling, how & why to build a model. A 3 statement model links income statement, balance sheet, and cash flow statement. More advanced types of financial models are built for valuation, plannnig, and is used to estimate the economic impact of an investment opportunity and compare alternative projects. An analyst will often use Internal Rate of Return (IRRInternal Rate of Return (IRR)The Internal Rate of Return (IRR) is the discount rate that sets the net present value of an investment equal to zero. This guide to calculating IRR will give several examples and who why it's used in capital budgeting, private equity and other areas of finance and investing. If IRR is greater than cost of capital,) in conjunction with Net Present Value (NPVNPV FormulaA guide to the NPV formula in Excel when performing financial analysis. It's important to understand exactly how the NPV formula works in Excel and the math behind it. NPV = F / [ (1 + r)^n ] where, PV = Present Value, F = Future payment (cash flow), r = Discount rate, n = the number of periods in the future) to compare projects and pick the optimal one.
#2 Capital Financing
This core activity includes decisions on how to optimally finance the capital investments (discussed above) through the business’ equityEquity ValueEquity value can be defined as the total value of the company that is attributable to shareholders. To calculate equity value follow this guide from CFI., debtMarket Value of DebtThe Market Value of Debt refers to the market price investors would be willing to buy a company's debt at, which differs from the book value on the balance sheet. A company’s debt isn't always publicly traded bonds, which have a specified market value. Companies own debt that can be classified as non-traded, or a mix of both. Long-term funding for major capital expenditures or investments may be obtained from selling company stocks or issuing debt securities in the market through investment banks.
Balancing the two sources (equity and debt) should be closely managed because having too much debt may increase the risk of default in repayment, while depending too heavily on equity may dilute earnings and value for original investors.
Ultimately, it’s the job of corporate finance professionals to optimize the company’s capital structure by lowering its Weighted Average Cost of Capital (WACCWACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. The WACC formula is = (E/V x Re) + ((D/V x Rd) x (1-T)). This guide will provide an overview of what it is, why its used, how to calculate it, and also provides a downloadable WACC calculator) to be as low as possible.
#3 Dividends & Return of Capital
This activity requires corporate managers to decide whether to retain a business’s excess earnings for future investments and operational requirements or to distribute the earnings to shareholders in the form of dividends or share buybacks.
Retained earningsRetained EarningsThe Retained Earnings formula represents all accumulated net income netted by all dividends paid to shareholders. Retained Earnings are part of equity on the balance sheet and represent the portion of the business’s profits that are not distributed as dividends to shareholders but instead are reserved for reinvestment that are not distributed back to shareholders may be used to fund a business’s expansion. This can often be the best source of funds, without incurring additional debts or diluting the value of equity by issuing more shares.
At the end of the day, if corporate managers believe they can earn a rate of return on a capital investment that’s greater than the company’s cost of capitalWACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. The WACC formula is = (E/V x Re) + ((D/V x Rd) x (1-T)). This guide will provide an overview of what it is, why its used, how to calculate it, and also provides a downloadable WACC calculator, they should pursue it, otherwise, they should return that capital to shareholders via dividends or share buybacksDividend vs Share Buyback/RepurchaseShareholders invest in publicly traded companies for capital appreciation and income. There are two main ways in which a company returns profits to its shareholders – Cash Dividends and Share Buybacks. The reasons behind the strategic decision on dividend vs share buyback differ from company to company.
How Important is a Company’s Capital Structure in Corporate Finance?
A company’s capital structure is crucial to maximizing the value of the business. Its structure can be a combination of long-term and short-term debt or common and preferred equity. The ratio between a firm’s liability and its equity is often the basis for determining how well balanced or risky capital financing is.
A company that is heavily funded by debts has a more aggressive capital structure and, therefore, potentially holds more risk for stakeholders; however, this risk is often the primary reason for a company’s growth and success.
Image: CFI’s free introduction to corporate finance course.
What are the Career Paths in Corporate Finance?
At the CFI, we specialize in helping you advance your corporate finance career.
The best place to start is by exploring our Career MapMapInteractive Career Map - discover your career path in corporate finance. Learn which job is right for you: salary, personality, skills, certifications etc. and discovering the various jobs and positions that exist in corporate finance.
MapInteractive Career Map - discover your career path in corporate finance. Learn which job is right for you: salary, personality, skills, certifications etc.
The main career paths in the corporate finance industry include Investment BanksBanking (Sell Side) CareersThe banks, also known as Dealers or collectively as the Sell Side, offer a wide range of roles like investment banking, equity research, sales & trading (the Sell-Side), InstitutionsBuy-SideInstitutional asset managers, known as the Buy Side offer a wide range of jobs including private equity, portfolio management, research. Learn about the job (the Buy-Side), CorporationsCorporate InformationLegal corporate information about Corporate Finance Institute (CFI). This page contains important legal information about CFI including registered address, tax number, business number, certificate of incorporation, company name, trademarks, legal counsel and accountant., and Public Accounting FirmsAccountingPublic accounting firms consist of accountants whose job is serving business, individuals, governments & nonprofit by preparing financial statements, taxes.
Additional Corporate Finance Resources
Thank you for reading CFI’s guide and overview of the corporate finance industry. To keep learning and advancing your career these additional resources will help you along your path:
- What is investment banking?JobsBrowse job descriptions: requirements and skills for job postings in investment banking, equity research, treasury, FP&A, corporate finance, accounting and other areas of finance. These job descriptions have been compiled by taking the most common lists of skills, requirement, education, experience and other
- Mergers & AcquisitionsMergers Acquisitions M&A ProcessThis guide takes you through all the steps in the M&A process. Learn how mergers and acquisitions and deals are completed. In this guide, we'll outline the acquisition process from start to finish, the various types of acquirers (strategic vs. financial buys), the importance of synergies, and transaction costs
- Financial modeling guideFree Financial Modeling GuideThis financial modeling guide covers Excel tips and best practices on assumptions, drivers, forecasting, linking the three statements, DCF analysis, Excel modeling and much more. Designed to be the best free modeling guide for analysts by using examples and step by step instructions. Investment banking, FP&A, research
- Valuation methodsValuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions. These methods of valuation are used in investment banking, equity research, private equity, corporate development, mergers & acquisitions, leveraged buyouts and finance
