Corporate Finance as an Important Aspect of Business Management - Book Report/Review Example

Corporate Finance Facilitator Corporate finance is an important aspect of business management that analyzes the finances of a business from their point of entry into the business to their point of exit through econometric analysis. The management must undertake financing decisions, investment decisions, and the dividend policy decisions. These decisions precisely spell the flow of money through the business from the point of entry to the points of investment and capital division among the investors. Cash flow management can help the business in managing the working capital because through it, the business will develop avenues that ensure the projects run while the business generates enough cash to meet the short time liabilities. Corporate finance deals with managing the financial situation of the business including all the risks of the business. One of the major financial risks for the business is the investors losing faith in it due to dividend issues. The dividend policy decisions determine the percentage of the revenue to reserve and the percentage to give out as dividends. The business must make appropriate issues to mitigate this. This paper analyzes corporate finance in detail uncovering all aspect that a manager needs to know about it. Introduction-What is Corporate Finance? Business finance is an integral part of a business as it determines the direction of the business and its strength. Business finance helps the firm to plan and execute its activities while the managers derive satisfaction and gratification from availability of business finance. Corporate finance, therefore, analyzes the sources of finance to a business, the strategies that the business puts in place to derive the funds, and planning for the resources (Asvanunt 2007, 19). The corporate finance concept also analyzes the capital structure of the business and the steps undertaken by managers to increase the value of the business. It refers to finance of the business at the strategic level including acquisition, planning, and expenditure or corporate capital. Introduction-Areas of Corporate Finance Corporate finance thus deals with the use of finance in a business to create value for the owners of the business. while delivering quality products and maintaining top-level business performance. It thus deals with a range of areas. Investment analysis is undertaken within the business in order to set the criteria and stages through which projects that are targeted to earn revenue within the business will receive funding (Tudose 2012, 279-280). This process prioritizes the projects in a way that the most important projects to the business receive financing ahead of the other projects. Investment analysis involves mathematical valuation of the projects in order to know the best project in different perspectives and fund it fully. Eventually, the least productive projects receive few or no finances. Corporate finance also entails all the steps that the business takes to plan for the finances of the entire organization and allot it to different departments in order to enhance profitability and performance of the business (Tudose 2012, 279-280). Budgeting is a function studied in corporate while it is analyzed from different angles of budgeting. It includes the percentage of sales method of budgeting and use of cash budgets in the process. Budgeting and capital planning is important because it dictates the future of the business in terms of the areas where the organization will invest its funds with the possibility of reaping high returns. Corporate finance also deals with the financing problem in a business. The financing problem in a business mainly underlines the sources of finance for the business, which forms part of the capital budget (Becker 2011, 48). Moreover, it also deals with the liquidity of money hence corporate finance in a business determines the state in which money will be held to increase the liquidity of the business. Through the financing problem analysis in corporate finance, the organization identifies the possible sources of financing which include investors and incentives hence the management can set structures to take advantage of the shift in the market. The last problem that corporate finance answers in the business is the dividend policy problem, which deals with the owners or investors in the business. Through financial analysis, the business determines the return in capital terms and decides the amount that will be retained by the business (Becker 2011, 48). The dividend policy problem deals with the amount remaining as dividends for the shareholders. It determines the policy of dividend allocation including the percentage payout and the dividend policy. The dividend policy problem in a business sets precedence for it because it can rely upon the policy to pay returns to the investors and advise new ones. Corporate Finance Concepts The business must make decisions at three levels that affect corporate finance within the business. The management must undertake financing decisions, investment decisions, and the dividend policy decisions. These decisions precisely spell the flow of money through the business from the point of entry to the points of investment and capital division among the investors. Financing decision A business is faced with a number of financing options, which prompts the management to develop models and processes that will benefit the firm maximally while increasing its stability. The first source of funds that faces the business is equity financing. This is the cheapest form of financing that the business considers. On equity financing, the business pays no interest on the investment (Esmer2011, 39-41). The pressure faced by the business from the equity shareholders is also minimal thus; the business would prefer this form of financing. However, the process of obtaining equity capital is long with many legal requirements that take a long time. More so, equity holders have a level of control over the business meaning they can affect the investment decisions of the business (Moeinaddin and Mohsen 2012, 499-500). This scares management from opting for equity financing hence the business will normally keep equity share capital at advisable levels so that the business does not run bankrupt while also avoiding excess effects from such financing channels. Businesses run away from equity shareholders as a method of financing because they have ownership rights in the business. This means that they try to explore the next cheap financing method, which includes preferred shares. Preferential share capital facilitates financing of the business with no ownership rights within the business (Liu 2007, 149). However, preferential share capital has one shortcoming in the sense that it attracts higher returns in terms of dividends compared to the ordinary share capital in the business. Nevertheless, in proper corporate finance planning, a business would balance the capital they have so that they maintain a sustainable level of ordinary and preferential share capital. This helps in maintaining balance in the business, as well as keeping the financial state of the business in a stable position with no risk of future challenges. Debt financing is the most commonly used in businesses because of its accessibility and liquidity that it extends to the business. Businesses borrow different types of loans from financial institutions in order to invest in viable ventures and pay it back with interest. Financial institutions extend loan facilities to businesses under varied conditions for different loan facilities, which include mortgages, working capital loans, overdrafts, and asset financing. The business possesses the money extended in loan form and invests it with the view that it will get enough returns to repay the loan and interest and retain the profits. Borrowing is determined by the cost of debt (Kd) valued against the cost of equity (Ke) and the prevailing interest rate in the market (r) (Kuhnen 2006, 29). The Beta (risk rate) in the market must be evaluated for different financing options before taking a financing decision. The formula below is used to calculate the risk. Beta = COVAR (E2:E99,D2:D99)/VAR(D2:D99) Where; Beta is the financial risk COVAR is covariance E is the first option B is the second option VAR is variance Calculation of the risk of holding the first option over the second option of financing gives light into the best financing to use in the business. Investment and Capital Budgeting Decisions A business will always have multiple projects demanding its attention in terms of time and money. The business has to make decisions on the projects that are viable and decide the amount of money that they wish to invest in the ventures while considering the return expected from the businesses versus the amount of money that the business would pump into the project. The management must make a decision on the most viable investment opportunity hence the need for making investment decisions and capital budgeting strategies. Investment decisions involve those on the projects that are most viable for investment and the available funds raised properly to maximize the returns on the business (Gao 2007, 44). Capital budgeting decisions are made through analysis done in economic terms using figures and percentages to determine the best ventures to invest in. A business can determine the best projects to invest in through a number of ways. A decision tree enables a business to decide between competing projects and invest money in the most viable option. It ranks the projects based on net return percentages and the interest rates in the market. Evaluating the business based on decision tree variables is important because the decision tree uses the current market conditions and the availability of opportunities for the money to calculate the success and viability of a venture for investment. A business may also decide on the investment opportunity with Net Present value (NPV) and other discounting methods of calculating the future and present values of money. Investment is essentially putting money in a certain venture with a goal of retaking it in future with some interest. Using NPV, one can determine whether the return on the investment aids a gain or a loss to the business. Discounting the returns on the investment shows a businessperson whether they should consider the investment or consider alternative investments. The general rule when using the discounted methods is that when the NPV is higher in one project compared to the other, the project is valued higher hence it is selected for the investment capital (Gao 2007, 44). The business could also evaluate the opportunities through payback methods that look at the period that the investment takes to recover the capital while investing in the businesses that take shorter periods to recover the investment. A business can also undertake a real option analysis and sensitivity analysis in order to know the level of risk that a business is exposed to. The risk may be huge to a point that it can cause the business to fail. In such cases, the business will want to understand how sensitive the business investment is to the future of the organization. More so, the firm needs to make these decisions for various corporate finance reasons. First, the business has scarce resources for investment in the available ventures. It also needs to understand the risks that are prevalent in different investment situations because once the business commits its money in a project; it can affect the overall value (Kumpan and Eilis 2010, 149-150). Capital budgeting is also important because the business has to understand the role of the investment opportunities in increasing the wealth of the investors hence the need to evaluate the investments carefully. Investment decisions affect the long terms valuation of the business for the investors and other stakeholders. The stakeholders include the government and tax agencies. In case the investment is not received well, the business can land itself into costs that do not make any economic sense. More so, the business can easily enter mergers that enable it to run at a cost hence the need to investigate such investments well. Dividend policy decisions Dividend policy decisions are made by the management on what percentage of the returns for the business should be given out as dividends to the investors. The dividend policy decisions determine the percentage of the revenue to reserve and the percentage to give out as dividends. However, the most important decisions involve the dividend policy that the business will use. The management has several options at their disposal. Some of the businesses adopt a residual policy hence corporate finance would demand that the business pays dividends from the money left after investing in the opportunities available. The residual policy may benefit or hurt the investors hence most of them oppose it. However, some of the investors prefer it when the business has good returns. Many investors prefer a stable dividend policy. Suppose an imaginary business earns $150,000 as net revenue annually. The business may decide that 20% of the revenue will be given to the investors as dividends (Miyakawa 2008, 10). This amount will be calculated and maintained irrespective of whether the revenue increases or decreases. The business may also opt for a percentage based dividend policy. Through this policy, the investors earn a certain percentage of the earnings of the business. Suppose an imaginary business earns $150,000 as net revenue annually. The business may decide that 20% of the revenue will be given to the investors as dividends (Jeon2009, 78). The percentage will remain constant hence when the revenue increases, dividends increase and vice versa. However, most of the managers prefer hybrid dividend policies. Hybrid dividend policies combine two or more of the policies in order to give the investors a better bargain when the business performs poorly. Working Capital Management The working capital of a business is the amount the business needs in order to continue with their operations without fail. Corporate finance aims at investing their money in projects that will generate revenue for the business in future (Morii 2008, 56-57). Corporate finance aims at investing in all viable opportunities with the available funds. However, it is the role of corporate finance to ensure that the business does not end up with insufficient working capital. This means that the investments of the business should be effectively managed to enhance carefulness and clarity in the investment decisions of the business. Corporate finance recommends various strategies to ensure working capital management in the business. Cash flow management can help the business in managing the working capital because through it, the firm will develop avenues that ensure the projects run, while the business generates enough cash to meet the short time liabilities when the fall is due (Morii 2008, 56-57). The business can also undertake investment diversification, which is a trick that will ensure the business investments are well spread out to protect it from bankruptcy and cash flow issues. Inventory management can also help in working capital management, as the business will ensure that it has enough inventory to run its activities during the investment period. The management may also undertake creditor and debtor management in order to ensure that the business does not run into unnecessary debts. Conclusion Business finance helps the business to plan and execute its activities, while the managers derive satisfaction and gratification from availability of business finance. Investment analysis is undertaken within the business to set the criteria and stages through which projects that are targeted to earn revenue within the firm will receive funding. Through the financing problem analysis in corporate finance, the organization identifies the possible sources of financing which include investors and incentives hence the management can set structures to take advantage of the shift in the market. On equity financing, the business pays no interest on the investment. The pressure faced by the business from the equity shareholders is also minimal thus; the business would prefer this form of financing. Businesses borrow different types of loans from financial institutions in order to invest in viable ventures and pay it back with interest. Investment is essentially putting money in a certain venture with a goal of retaking it in future with some interest. Using NPV, one can determine whether the return on the investment aids a gain or a loss to the business. Corporate finance aims at investing their money in projects that will generate revenue for the business in future. Corporate finance aims at investing in all viable opportunities with the available funds. Reference list Asvanunt, Attakrit. 2007. Applications of dynamic optimization to strategic pricing and corporate finance.Columbia University Becker, Mary Joy. 2011.Essays in corporate finance.University of Pittsburgh, http://search.proquest.com/docview/927752987?accountid=45049 Esmer, Burcu. 2011. Essays in empirical corporate finance: Covenant violations, market timing and product market competition.The University of Iowa. Gao, Wenlian. 2007. Essays on corporate finance. The University of Wisconsin - Milwaukee, http://search.proquest.com/docview/304779541?accountid=45049 Jeon, Jin Q. 2009. Three essays in corporate finance. The University of Alabama, http://search.proquest.com/docview/304825497?accountid=45049 Kuhnen, Cameila M. 2006. 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