Corporate Financing: What is it, Types, Examples 2023
While we have previously talked about business loans, today we are going to take a step back to understand a little more about business financing. It does not only refer to borrowing, but to other mechanisms that organizations have to survive and generate profits or savings (depending on the health of each company). We remind you that there is oddcoll.com: a site to help you manage your debts and collections, in case you need help.
What is corporate finance?
Corporate finance refers to the planning, development and control of a company’s capital structure. Recall that capital is more than just current cash, but also assets, investments and receivables. The objective is to increase organizational value and profits through sound investment, financial and dividend decisions. It focuses on capital investments aimed at meeting a company’s financing needs to achieve a favorable capital structure.
- Corporate finance helps to predict results thanks to the constant detail that is maintained with performance measurement.
- They are concerned with improving the understanding of financial aspects so that decisions can be made with full knowledge of the subject or the investment to be made.
- This type of finance represents an approximation to the reality that companies live, since by worrying about the way in which funds are obtained, or the credit that is delivered to customers, they manage all the necessary information about the capital that is maintained by the business.
- Data will always be provided for business prediction and control. In this way, it is possible to know how and when to invest correctly, avoiding the risks involved in this action.
What are their main functions and why are they important?
- Corporate finance departments are responsible for governing and overseeing the financial activities and capital investment decisions of their companies, which include whether or not to proceed with a proposed investment.
- Management of liabilities, assets and capital investments.
- Risk management and financial control: Investments require constant monitoring. Risk management aims to reduce and mitigate the risks assumed with investments and is part of the continuous monitoring process.
- Distribution of dividends to shareholders: to grant, or not, dividends to shareholders.
- Research and bring proposals for investment options.
- Maximize business value.
Principles of corporate financing
- Time value of money: This principle states that the value of money varies over time. A dollar today is worth more than a dollar in the future because of the possibility of investing it and earning returns. Corporate finance considers the time value of money when evaluating investment projects and making financial decisions.
- Maximizing shareholder value: The main objective of corporate finance is to maximize the value of the company for shareholders. This involves making financial decisions that generate solid and sustainable returns, increase share price and distribute adequate dividends.
- Risk and return: There is a relationship between risk and return. Companies must assume a certain level of risk in order to obtain higher returns. Corporate finance evaluates and manages the company’s financial risks to achieve an appropriate balance between the risk assumed and the expected return.
- Diversification: Diversification is a key principle to reduce risk. Companies should diversify their sources of income, investments and risks to avoid overdependence on any one factor. Diversification helps mitigate the impact of negative events and provides financial stability.
- Cost of capital: The cost of capital represents the rate of return required by investors to finance a company. Corporate finance analyzes the cost of capital to determine the viability of investment projects and evaluate profitability.
What are the 4 pillars of corporate finance?
- Investment: The first pillar focuses on investment decision-making. This involves the evaluation and selection of projects and assets in which a company should invest its financial resources. Valuation techniques, such as discounted cash flow (DCF), are used to determine the profitability and viability of investment projects.
- Financing: The second pillar relates to how a company obtains the necessary funds to finance its activities and projects. This includes decisions on capital structure, i.e., how to combine debt and equity to finance the company’s operations. The choice of financing sources and the management of the cost of capital are key elements in this pillar.
- Dividends: The third pillar refers to dividend distribution policies and decisions. Companies must determine the amount of profits to be distributed to shareholders in the form of dividends and how much will be reinvested in the company for future investment and growth. Dividend management has implications for both shareholders and the company in terms of return on investment and value generation.
- Risk management: The fourth pillar focuses on identifying, assessing and managing the financial risks to which a company is exposed. This includes risks such as changes in interest rates, currency fluctuations, asset price volatility and operational risks. Risk management seeks to minimize the company’s exposure to these factors and ensure long-term financial stability.
Examples of corporate finance
- Issuance of shares: A company can raise financing by issuing shares and selling them to investors. This involves offering a portion of the company’s ownership in exchange for equity. The funds raised through the issuance of shares can be used to finance projects, expand operations or pay debts.
- Issuance of corporate bonds: Companies may issue corporate bonds to obtain financing. Corporate bonds are long-term debt instruments in which the company agrees to repay the principal along with interest payments over a specified period. Investors buy these bonds and receive regular interest payments.
- Bank loans: Companies may apply for loans from banks or other financial institutions. These loans may be short-term (lines of credit) or long-term, and the company agrees to repay the principal together with the agreed interest.
- Financial leasing: Instead of buying assets outright, companies can opt for financial leasing. This involves obtaining the use of an asset in exchange for periodic payments over a specified period. At the end of the contract, the company may have the option to purchase the asset.
- Venture Capital: Startups and early stage companies can obtain financing through venture capital investors. These investors provide capital in exchange for a stake in the company and are willing to assume the risk associated with the company’s growth and development.
- Internal financing: Companies can also finance themselves through internal sources, such as profits generated by the company itself. These funds can be reinvested in the company to finance projects or expansions.
The 3 types of corporate financing
- Equity financing: Also known as equity financing, refers to raising funds through the issuance and sale of company stock. Shareholders invest their capital in the company in exchange for partial ownership of the company. This type of financing does not involve an obligation to repay the capital invested, but shareholders expect to receive returns through dividends and appreciation in the value of the shares.
- Debt financing: This involves raising funds through the issuance of debt, such as corporate bonds or bank loans. In this case, the company commits to repay the principal together with the agreed interest over a specified period of time. Debt financing can be an efficient way of raising additional capital, but it also involves interest payments and the fulfillment of payment obligations.
- Hybrid financing: This type of financing combines elements of equity and debt financing. For example, companies may issue convertible bonds, which are debt instruments that can be converted into shares of the company at a predetermined future date. There are also other hybrid financial instruments, such as preferred shares, which have characteristics of both equity and debt.
Which method is best for us as a company?
This will depend on the needs of each company. If we have a good base of our own shareholders, the equity option may offer a rather low risk as long as the company’s stock improves after the investment. Debt financing can be an option when we have to face an obligation that has arisen unexpectedly, as long as we comply with the interests. We should always take good advice before executing any of these actions.
As we have seen, there are different methods for improving company finances, depending on the state of health of each company, its objectives and its possibilities. Let us remember that, in a changing world, we must always be willing to adapt. We can try different strategies depending on the moment of our business. First, if It’s a problem of cashflow, you should check to collect all past due invoices. Oddcoll is a commercial debt collection platform that pursues overdue payments and also works as an international debt collection agency.
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