The Ins and Outs of Corporate Finance
At HMT, corporate finance is at the heart of everything we do. But what is it?
Corporate finance is a critical aspect of business, encompassing a wide range of activities related to managing and enhancing a company’s financial resources and value.
Whether you’re a seasoned entrepreneur, an aspiring CFO, or would just like to learn more about how successful businesses operate financially, understanding the fundamentals of corporate finance is essential.?
In this blog, we’ll walk you through the key components, strategies and roles within corporate finance, providing a comprehensive overview of this fascinating field.?
Table of Contents
What is Corporate Finance?
Put simply, corporate finance focuses on maximising the shareholder value of a business through long-term and short-term financial planning, as well as implementing strategies to manage financial risks.
In other words, corporate finance is the planning, managing and controlling of a company’s finances to achieve its strategic goals.
Corporate Finance: The Key Components?
Capital Budgeting?
Capital budgeting is the process of evaluating and selecting long-term investments that are in line with maximising the value of a business. It involves analysing potential projects or investments to determine whether they are likely to result in profit, and if that potential profit comes at an acceptable risk.?
Techniques such as Net Present Value (NPV) , Internal Rate of Return (IRR) , and Payback Period are commonly used in this process.?
Net Present Value (NPV)
When considered in the context of corporate finance, NPV is a metric used to evaluate the profitability of an investment or project. It represents the difference between the present value of cash inflows and outflows over a specified time period.?
Net Present Value is calculated by discounting future cash flows to their present value, using a discount rate. This discount rate seeks to reflect the cost of capital
A positive NPV indicates that the expected earnings (adjusted for time and risk) exceed the costs, suggesting that the investment is likely to be profitable. Conversely, a negative NPV implies that the project is expected to generate losses, and thus, it should be avoided. NPV is widely used in capital budgeting to assess the potential profitability of new projects, investments, or business ventures. The choice of an appropriate discount rate is somewhat subjective and can materially impact the outcome of NPV analysis.?
EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization)
EBITDA is a financial metric used to evaluate a company's operating performance. It is calculated by adding back interest, taxes, depreciation, and amortization to net income. This measure provides insight into the profitability of a company's core business operations by excluding the effects of capital structure, tax rates, and non-cash accounting items like depreciation and amortization.
EBITDA is often used in valuations and comparing companies within the same industry.
Capital Structure
Capital structure refers to the mix of debt and equity that a company uses to finance its operations and growth. It includes elements such as common stock, preferred stock, bonds, and other forms of debt.
The capital structure is crucial as it influences the risk and return profile of the company. A well-balanced capital structure optimizes the cost of capital, maximizing the company's value and ensuring long-term financial stability. Managing the capital structure involves making decisions about the proportions of debt and equity, which can affect the company's leverage, financial flexibility, and overall risk.
In 2024 there is a wide range of debt and equity instruments which might form part of a company’s capital structure, from ordinary share capital, through preference shares, warrants, subordinated loan stock and revolving credit facilities, via asset finance, term debt and bonds, the available quantum and type of finance available deserves careful analysis.
Corporate Finance : Useful Terminology
Working Capital Management
Working capital management focuses on managing a company's short-term assets and liabilities to ensure sufficient liquidity to carry out its day-to-day operations. This includes managing inventory levels, accounts receivable, and accounts payable. Efficient working capital management helps maintain smooth operations and avoid liquidity crises.?
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Financial Planning and Analysis (FP&A)
Financial planning involves forecasting future financial performance and analyzing historical data to inform strategic decision-making. This includes budgeting, financial modelling, and variance analysis. FP&A helps companies set financial goals, measure performance, and make informed decisions.
Risk Management
Risk management in corporate finance involves identifying, assessing, and mitigating financial risks that could adversely affect the company's value. This includes market risk, credit risk, operational risk, and liquidity risk. Effective risk management ensures that the company can withstand financial shocks and uncertainties.
Strategies in Corporate Finance
Mergers and Acquisitions (M&A)
Mergers and acquisitions are strategies used by companies to achieve growth, enter new markets, or to acquire new technologies and capabilities. M&A activities require careful financial analysis to ensure that the transactions genuinely add value to the company. Due diligence, valuation, deal structuring, deal-funding and post-merger integration are critical financial components of successful M&A deals. In addition, cultural fit and management motivation are key non-financial elements of success.
Capital Raising
Companies need capital to fund their operations and growth initiatives, including M&A. Capital raising can be done through equity financing (issuing shares) or debt financing (issuing bonds or taking loans). The choice between equity and debt financing depends on the company's capital structure strategy, market conditions, and financial health as well as its appeal to the equity and debt markets.? The debt capacity of a business will depend on its ability to generate free cash flow to service interest and repay capital.?
Capital can be raised either on a stock exchange through a public offer of shares (a process that is highly regulated) or by raising private equity from an investment house or a private investor or investors.
Investors in a private company are likely to seek significant returns and to require protections and board representation. Debt providers will protect their position through the agreement of financial covenants and a regime of reporting against those covenants to ensure early flagging of any financial under performance.
Relinquishing equity is more expensive for the shareholders of a business than borrowing debt. The term “leverage” which is routinely used in Corporate Finance, means the amount of debt that can safely and sensibly be deployed in a business. Historically many businesses were over-leveraged, meaning that when there was a financial downturn and financial performance suffered, those businesses were unable to service their debt. This led to high levels of business failure. Both Debt and Equity providers are now more circumspect about the level of leverage they will permit in a business and considerable effort is invested in sensitising forecasts and considering downside scenarios before debt facilities are put in place.?
Dividend Policy
A company's dividend policy determines how much of its earnings will be distributed to shareholders as dividends and how much will be retained for reinvestment. For listed businesses, a dividend policy can signal a company's financial health and growth prospects to investors. Companies must balance providing returns to shareholders and retaining earnings for future growth. Private equity backed companies or those with high levels of external debt are unlikely to pay dividends since private equity is focussed on achieving long term growth in capital value and will retain cash in the business or deploy it to further develop the business. Debt repayments and interest servicing will usually limit the capacity for dividend payments. Dividends can only be paid to shareholders where the company has built up distributable reserves.?
Share Buybacks
Share buybacks, or repurchases, occur when a company buys back its own shares from the market or, in private companies,? from individual shareholders. This can be a strategy to return excess cash to shareholders, improve financial ratios, and increase shareholder value by reducing the number of outstanding shares.
It can also be a way of providing an exit for an individual shareholder or shareholders without needing to deliver an exit of the entire company.
Share buybacks need to be carefully evaluated to ensure they align with the company's long-term strategy.
Roles in Corporate Finance
Chief Financial Officer (CFO)
The CFO is the top financial executive responsible for overseeing the company's financial activities. This includes financial planning, risk management, record-keeping, and financial reporting. The CFO plays a crucial role in shaping the company's financial strategy and ensuring its financial health. A strong CFO will have a broad strategic and commercial understanding and will be able to provide clear input, challenge and support to the CEO.?
Treasurer
A treasurer is responsible for managing the company's cash flow, liquidity, and financial risk. This includes overseeing a company's investments, capital raising activities, and relationships with financial institutions. A treasurer can be particularly important in managing foreign currency holdings and ensuring that currency risk is managed in businesses that trade and operate overseas. The treasurer ensures that the company has enough cash to meet its obligations and fund its operations.
Financial Controller
The controller oversees the day to day running of the accounting department and is responsible for ensuring the accuracy of the company's statutory financial statements. This includes managing the accounting processes, internal controls, and regulatory compliance. The controller plays a key role in maintaining the integrity of the company's financial reporting.
Financial Analyst
Financial analysts support the CFO, treasurer, and controller by providing financial analysis and insights. They create financial models, conduct market research, and assist in budgeting and forecasting. Financial analysts help inform strategic decisions by providing data-driven recommendations.
Financial analysts can be particularly key in supporting due diligence during M&A activities and ensuring that key data points in a transaction are identified and shared with the wider team.?
Conclusion
Corporate finance is a complex and dynamic field that plays a crucial role in the success of any business. By understanding the key components, strategies, and roles within corporate finance, companies can effectively manage their financial resources, mitigate risks, and achieve their strategic goals. Whether you're managing a startup or working in a large corporation, a solid grasp of corporate finance is essential for making informed financial decisions and driving business growth.?