Corporations live or die based on their ability to successfully navigate their needs for financing. The Small Business Association (SBA) reports that 20% of new businesses fail within the first year of operations. Within five years, about half of the new businesses fail. Only about one-third of the businesses survive to last longer than ten years.
One of the main causes of business failure is undercapitalization. This is when a company runs out of money. It is not able to continue operations and pay creditors. This can even happen when business is going well. For example, having too many orders and being unable to finance the inventory and/or raw materials needed to fulfill them, can cause a company to fail.
Business owners, C-level finance executives, and corporate finance professionals need to pay careful attention to the needs of corporate finance. It is the lifeblood of the company.
Types of Corporate Finance
Corporate finance considers all the potential sources of funds and then creates a finance strategy to make sure the corporation does not run out of money. The sources of funds include raising capital, borrowing money, selling assets.
Corporate Finance Principles
There are ten main categories of corporate finance principles to consider, which are:
- Stock Value: Payout Policy for Dividends, Share Buy-Backs
- Cost of Capital: Raise Money Before Need, Hedge Currency Risk
- Capital Deployment: Expenses, Investments
- Investment Criteria: Project Analysis, Net Present Value, Risk and Reward
- Debt Policy: Interest Rates, Credit Lines, Loan Terms, Credit Default Swaps
- Taxes: Global Tax Strategy, Tax Credits, and Other Incentives
- Mergers and Acquisitions: Valuations Methods, Market Share, Anti-Trust Laws
- Financial Instruments: Stock Options, Debentures, Warrants
- Employee Benefits: Retirement Funds, Contribution Matching, 401k Plans etc.
- Corporate Restructuring: Asset Liquidation, Chapter 11 Reorganization, Bankruptcy
#1. Stock Value
Increasing stock value is a critical function of corporate finance efforts. Corporations are formed with the intent to reward investors and owners with increased stock valuations over time. Investors and owners receive benefits in the form of capital gains, which comes from these increased share values and from dividends, which are a partial distribution of profits paid directly to the shareholders.
Improving corporate profits and having a steady payout policy for dividends makes owning shares in a company more attractive to investors. This helps increase share value. A company may also use some profits or a windfall to buy back its own shares. Share buy-backs reduce the shares available for sale on the market and thereby put upward pressure on the share price.
#2. Cost of Capital
The goal of corporate finance is to pay the least amount for the most financing. Principles that help this process include raising money before need, establishing credit lines and taking loans at lowest interest rates, and accessing the capital markets in the most cost-efficient ways. Enterprises with international operations need to hedge currency risk to manage capital costs.
#3. Capital Deployment
A comprehensive finance strategy for a corporation includes making decisions about capital deployment that considers the needs for covering operational expenses, taking advantage of investment opportunities, and provides a safety net for any unexpected problems.
#4. Investment Criteria
Investments are considered by using rigorous analysis and conducting thorough due diligence, which values the opportunities properly. The finance staff makes a calculation of the net present value (NPV) of the project and compares the projected return on investment (ROI) with the cost of capital. A balance is struck between taking investment risks and potential rewards.
#5. Debt Policy
A corporation needs to use debt prudently in order to receive the most benefit. The debt policy includes managing the amount of debt-to-value that is acceptable. Interest rates need to be managed to lower the cost of borrowed funds. Loan terms need to be for a sufficient period, not have onerous call provisions, and not expire at damaging times. Credit lines should be established, actively used, paid back on time, and continuously expanded for additional capacity. Credit default swaps may be used to insure those who loan money to the corporation against the risk of not being paid and thereby lower the loan interest rate.
Corporations with international operations can use a tax strategy to legally minimize their tax burden. Tax credits and other incentives are advantageous if they reduce the capital needs of the corporation.
#7. Mergers and Acquisitions
When a company merges with another one or acquires another corporation, the goals usually include increasing share value, improving market share, lowering operational costs, capturing innovations, and more. The financing needed for a merger and acquisition (M&A) deal is usually the main concern. A corporation needs to be careful not to over-extend itself by taking on too much debt from an M&A deal and not run afoul of any anti-trust regulations.
#8. Financial Instruments
The finance department of a corporation is responsible for the issuance of many kinds of financial instrument that may include stock options, warrants, debentures, and more. C-level finance executives are called upon to make recommendations regarding these financial instruments to the CEO, Chairman, and the corporate board.
#9. Employee Benefits
Programs for retirement funds, such as 401k plans and others, may include a corporate contribution as part of the employee benefits. These obligations need to be funded by the corporation. They are managed by the finance department for regulatory compliance and to reduce the risk of losses in the portfolio value of the investments that support these programs.
#10. Corporate Restructuring
In the unfortunate event of a severe financial challenge or the need for a corporate shutdown, the finance executives may need to be able to handle the affairs of a Chapter 11 reorganization under the supervision of a bankruptcy court. They may also need to supervise the liquidation of assets to pay off or partially pay off creditors and/or close the company completely with a final bankruptcy.
The responsibilities of business owners, C-level finance executives, and the finance department staff are extensive. Financial modeling and analysis are applied extensively to make better decisions. Stochastic (randomized) predictive methodologies are used to implement a finance plan that covers all possible contingencies, which include worst-case scenarios. Considerable proactive measures need to be taken to manage the financial needs of a corporation. The successful efforts of the finance department are one of the critical pillars of strength that make a corporation survive and thrive.