Understanding Corporate Finance


The Basics
Corporate finance is the body of knowledge that dictates the decisions a company makes about its finances. The scope and implication of this is very broad, since just about any decision that affects the company is ultimately a financial decision. First of all, the company has to define its objectives. The company is designed to make a profit through the sale of its products or services. The objective is defined as: which product(s), which service(s), to which market(s), with which products or materials and through which means. The decision makers in a company (board of directors, CEO, CFO and other senior managers) must address these financial decisions on a number of levels. There are three basic decision levels that all corporate finance attempts to address. They are the Financing Decision, the Investment Decision and the Dividend Decision.

The Financing Decision
Obtaining the right mix of initial capital is one of the first financial decisions to be made by a corporation. Deciding which type of financing matches the needs of the company, marketing the corporation for this financing and matching each type of financing to a specific need of the company in a way that such financing will be most intelligently used is crucial to long term success.

The Investment Decision
The company next decides upon its investment decision. This does not necessarily mean how it will invest its profits, although that forms a part of the investment decision; it also means how the company will decide to invest its resources. Its initial capital, whether built by investments by the principals, sales of shares, or debt must be allocated intelligently to the various needs of the business. Manufacturing infrastructure, salaries for sales, engineer or design personnel, research and development, marketing and many other areas compete for each investment dollar of a corporation.

The Dividend Decision
A corporation must then examine the decision of distribution of profits. Further investment in the assets of the company is important, especially in dynamic fields where new product development is the life line to continued success, but this must be balanced with the need for stability. Capital reserves, bonus structures, and of course, dividend distribution need to be funded if the company intends continue growth, keep vital staff and maintain market value.

The ultimate value of the corporation will be a reflection of how successfully it makes its decisions in each of these areas. If a firm chooses the proper allocation of resources, if the most appropriate types of financing are secured, and finally, if it can determine the proper proportion between how much gets plowed back into operations versus how much will be distributed as profit, the firm will build higher value than firms that make poor decisions in these areas.

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