Corporate Finance: Definition, Activities and Types

Corporate finance is a specialized field within the broader domain of finance that revolves around how corporations manage their financial resources, make decisions related to capital structure, accounting, and investments.

The primary goal of corporate finance is to maximize shareholder value through strategic long-term and short-term financial planning and the execution of various financial strategies. Corporate finance encompasses a wide range of activities, from making capital investments to handling tax considerations.

Understanding Corporate Finance

Corporate finance departments are responsible for overseeing the financial operations and investment decisions of their respective companies. These decisions include determining whether to proceed with a proposed investment and how to finance it, whether through equity, debt, or a combination of both.

Furthermore, corporate finance departments are involved in dividend distribution decisions, including the determination of dividend yield. Additionally, they manage current assets, current liabilities, and inventory control.

Corporate Finance Activities

Capital Investments:

One of the core activities in corporate finance is making capital investments and efficiently allocating a company's long-term capital. The process of capital investment decision-making is primarily known as capital budgeting. Through capital budgeting, a company identifies capital expenditures, forecasts future cash flows generated by proposed capital projects, compares potential returns to planned investments, and selects projects to be included in its capital budget.

Capital investments are among the most critical decisions in corporate finance, as they can significantly impact a company's financial health. Poor capital budgeting decisions, such as overinvestment or underinvestment, can result in increased financing costs or insufficient operating capacity.

Capital Financing:

Corporate finance also encompasses the acquisition of capital, which can take the form of debt or equity. A company might opt to borrow funds from commercial banks or other financial intermediaries, or issue debt securities in the capital markets through investment banks. Equity financing, such as selling shares to investors, is often chosen when substantial capital is needed for business expansions.

Deciding the right balance between debt and equity is crucial in capital financing. Excessive debt can increase the risk of default, while overreliance on equity may dilute earnings and value for early investors. Ultimately, capital financing must provide the necessary resources to carry out capital investments.

Short-Term Liquidity:

Corporate finance departments are responsible for managing short-term finances to ensure sufficient liquidity for day-to-day operations. This involves overseeing current assets and current liabilities, or managing working capital and operating cash flows.

The goal is to ensure that the company can meet all its immediate financial obligations without disrupting its operations. Short-term financial management may include securing additional credit lines or issuing commercial paper as backup sources of liquidity.