Corporate Finance Definition
Corporate Finance is the process of matching capital needs to the operations of a business.
It differs from accounting, which is the process of the historical recording of the activities of a business from a monetized point of view.
Captial is money invested in a company to bring it into existence and to grow and sustain it. This differs from working capital which is money to underpin and sustain trade – the purchase of raw materials; the funding of stock; the funding of the credit required between production and the realization of profits from sales.
Corporate Finance can begin with the tiniest round of Family and Friends money put into a nascent company to fund its very first steps into the commercial world. At the other end of the spectrum it is multi-layers of corporate debt within vast international corporations.
Corporate Finance essentially revolves around two types of capital: equity and debt. Equity is shareholders’ investment in a business which carries rights of ownership. Equity tends to sit within a company long-term, in the hope of creating a return on investment. This can come either through dividends, which are payments, usually on an annual basis, related to one’s percentage of share ownership.
Dividends only tend to accrue within very large, long-established corporations which are already carrying sufficient capital to more than adequately fund their plans.
Younger, growing and less-profitable operations tend to be voracious consumers of all the capital they can access and thus do not tend to create surpluses from which dividends may be paid.
In the case of younger and growing businesses, equity is often continually sought.
In very young companies, the main sources of investment are often private individuals. After the already mentioned family and friends, high net worth individuals and experienced sector figures often invest in promising younger companies. These are the pre-start up and seed phases.
At the next stage, when there is at least some sense of a cohesive business, the main investors tend to be venture capital funds, which specialize in taking promising earlier stage companies through quick growth to a hopefully highly profitable sale, or a public offering of shares.
The other main category of corporate finance related investment comes via debt. Many companies seek to avoid diluting their ownership through ongoing equity offerings and decide that they can create a higher rate of return from loans to their companies than these loans cost to service by way of interest payments. This process of gearing-up the equity and trade aspects of a business via debt is generally referred to as leverage.
Whilst the risk of raising equity is that the original creators may become so diluted that they ultimately obtain precious little return for their efforts and success, the main risk of debt is a corporate one – the company must be careful that it does not become swamped and thus incapable of making its debt repayments.
Corporate Finance is ultimately a juggling act. It must successfully balance ownership aspirations, potential, risk and returns, optimally considering an accommodation of the interests of both internal and external shareholders.