9 Corporate Finance Principles
Corporate Finance
It is a branch of finance, which deals with methodologies for obtaining sources of finance, investment decisions, maximisation of equity and how capital is structured.
Principles of Corporate Finance:
1. The time value of money
This principle stipulates that a sum of capital is worth more now than an equal sum in the future.
This principle is based on the fact that money can generate a return and therefore, if you have capital now, you can use it to make investments and potentially earn more money in the future.
Large companies, investors and governments use this principle to make decisions and assess the potential return on investments.
2. Risk Analysis
The set of processes used to identify and analyse all potential issues that could negatively impact on any key business initiatives or projects for investors.
Risk Analysis involves considering how project outcomes and goals could be changed by the impact of a risk event; and once these risks are defined, their likelihood and severity are assessed in order to prioritise and mitigate them.
Risk analysis also involves assessing the likelihood of a risk materialising, its potential impact and the strategies needed to control it.
3. The Opportunity Cost
This principle consists of evaluating the cost of the next best alternative that is foregone when making a decision.
For example, when deciding between two jobs, the opportunity cost is the salary and benefits of the job that is not chosen. It also applies to any other choice where two or more options are available, such as choosing between two investments or different manufacturing methods.
In general, it is the cost of missed opportunities in making a decision.
4. Capital Structure
This is the sum of debt and equity that the company allocates to finance its activities and expansion. Typically, a company uses a combination of debt and equity to finance its operations.
Debt is typically used to finance short-term projects or to purchase assets, while equity is usually used to finance long-term projects or to expand the company.
The amount of debt and equity used to finance a company is a function of its risk profile, its growth expectations and the cost of capital.
5. Investment Project Appraisal
Typically involves the analysis of the potential benefits, risks and costs associated with a given project. This analysis usually includes performing a financial analysis to assess the expected benefits, calculating the costs associated with the project and assessing the potential risks associated with the project.
Stakeholders may also consider qualitative factors such as the impact the project will have on the environment and local communities.
Its potential to create jobs or stimulate the local economy can also be assessed.
6. The Budget
The budget is an estimate of a company's income and expenses for a given fiscal period. It is a valuable financial planning tool, as it allows the most efficient allocation of funds and other business assets.
The budget should be based on reliable data and assumptions, and should be periodically reviewed and updated to reflect changes in the company's financial reality.
The budget should also include planned investments and other expenditures, as well as the long-term financial objectives of the company.
A corporate budget is essential for companies to plan their finances and achieve their objectives.
7. Cash Flow
In corporate finance, cash flow refers to the net balance of cash flowing in and out of a company at a given point in time. Cash flow is usually divided into operating, investing and financing activities and is an important measure of a company's financial health.
Cash flow is used to measure a company's solvency in meeting its short-term obligations, as well as to assess its profitability and liquidity.
Cash flow is also used to assess a company's ability to pay dividends, finance capital projects and repay debt.
8. The Dividend Policy
A dividend policy is the policy a company uses to structure its distribution of profits to shareholders.
Generally, the dividend policy will determine the percentage of profits to be distributed to shareholders in the form of dividends, as well as the frequency of dividend payments.
Companies may also have other conditions that must be met for dividends to be paid, such as reaching a minimum level of earnings or that a certain amount of time has elapsed since the last dividend was paid.
There are cases where they may choose to reinvest their profits instead of distributing them to shareholders, or they may decide to do both.
Image by 9. Financial Strategies
Financial strategies in corporate finance involve a number of different elements, from liquidity management to the analysis of financial statements and the constitution of an emergency fund.
Liquidity management is important to ensure that the company has enough money to cover its expenses, while analysis of the financial statements allows the company to assess its profits and losses.
It is important to have an emergency fund to cover unforeseen expenses and financial losses. In addition, businesses should explore different financing alternatives, such as funds from family and friends, revenue-based venture capital, crowdfunding and personal or commercial loans.
Ultimately, the aim is to maximise the return on investment for stakeholders and create long-term benefits for the company.
Conclusion
All of these principles serve as a basis for good financial decision-making, and thus help us to maximise shareholder value.