The followings are included in corporate finance:

Transcription

1 Corporate Finance Corporate finance is a broad term that is used to collectively identify the various financial dealings undertaken by a corporation. Generally, the term also applies to the various methods, procedures, and configurations of the financial operations employed by a given company. In most instances, corporations will have a specific financial division that is charged with the task of managing corporate finance in all aspects of financial operation. One of the core functions of responsible corporate finance is to make wise use of the financial resources available to the company. As part of this action, the financial arm of the corporation will attempt to develop an operating budget that addresses all the needs of the company in terms of expenses, as well as work with other departments to track income generated from various operations and investments currently in place. Ultimately, the goal is to ensure that the corporation is achieving the maximum benefit from available financial resources, while incurring the minimum amount of expenditure required to attain those benefits. Corporate finance may take on many different aspects as part of the overall management of the finances of the company. The functions may include the management of investments such as acquiring and selling stocks, bonds, and other investment ventures related to other companies. Corporate finance can also involve creating and managing the process for issuing shares of stock or offering corporate bonds to generate resources for expansion projects. When acquisitions of property or other companies, mergers, corporate restructures, or the selling of company assets is involved, the actions are considered to be part of the corporate finance function. Under the best of circumstances, responsible corporate finance activities promote the wise use of all financial resources, actively look for ways to enhance the financial picture of the corporation, and in general make sure there are assets on hand to maintain

2 company operations. Chief financial officers and their immediate staff often have the authority to approve or deny various uses of corporate finance, although some issues may be deferred to a board of directors, or are subject to a vote by the shareholders of the company. The followings are included in corporate finance: 1. Planning the finance: The finance manager plans the finance of the company. He takes decisions on questions like:- o How much finance is required by the company? o What are the sources of finance? o How to use the finance profitably? 2. Raising the finance: The finance manager raise (collects) finance for the company. Finance can be collected from many sources, viz., shares, debentures, banks, financial institutions, creditors, etc. 3. Investing the finance: The finance manager uses the finance to achieve the objectives of the company. There are two types of corporate finance, viz., fixed capital and working capital. Fixed capital is used to purchase fixed assets like land, buildings, machinery, etc. While working capital is used to purchase raw materials. It is also used to pay the day-to-day expenses like salaries, rent, taxes, electricity bills, etc. 4. Monitoring the finance: The finance manager monitors (i.e. controls and manages) the finance of the company. He has to minimize the cost of finance. He has to minimize the wastage and misuse of finance. He has to minimize the risk of investment of finance. He also has to get maximum return on the finance. Monitoring the finance is an art and science. It is a very complex job. There are new tools & techniques for monitoring funds.

3 Corporate Finance Functions Raising Funds From Investors Professionals who help firms raise funds by issuing equity or debt products work in corporate finance departments. Organizations may issue three types of securities to fund their operating needs: equity products, bonds and quasi-debt products or convertible bonds. Stock-buyers are paid dividends and also gain from increases in share prices. They also may vote on management decisions. Bondholders receive periodic interest payments and get the initial amount loaned at maturity. Trading Traders use the firm's capital to buy, hold or sell securities. This type of trading is referred to as proprietary trading. They also may trade on behalf of customers. They use statistical tools to value securities and appraise risk. They also may use econometric formulas to measure security risks, such as bond risks due to changes in interest rates or stock volatility, on foreign and domestic exchanges. For example, traders might use customized math formulas to appraise Chinese bond indexes. Trading Support Traders' assistants help investment managers and clients appraise securities correctly. They may use mathematical programs to appraise such securities. For instance, a dealer in Hungarian government bond options must correctly appraise such bonds to avoid losses due to erroneous appraisal. Wealth Management Wealth managers help university endowments, high net worth individuals, pension funds and philanthropic institutions preserve and accumulate wealth.they are also called private

4 bankers. They may advise clients on financial analysis, investment tools and short-term and long-term risk hedging. For example, a policeman's retirement fund might seek a private banker's expertise in selecting investments while maintaining adequate risk levels. Research Researchers analyze specific securities, such as stocks, bonds, indexes and futures, and assist clients or traders develop investment strategies. They rate such securities by applying proprietary rating methodologies. They might assess regulatory and financial data to corroborate ratings or recommendations. Asset Management, Venture Capital and Private Equity Finance professionals also work for private equity, venture capital or asset management companies. They help select portfolio investments or trade on behalf of customers. They also research specific industries and help senior managers decide on corporate acquisitions or mergers. Risk Management and Financial Analysis Risk managers and financial analysts help track credit and market risks in trading activities, and provide timely financial reporting. The risk of loss arising from changes in security prices is referred to as market risk. It may be computed daily or weekly by mathematical tools such as VaR (Value at Risk) and scenario simulation. The risk of loss due to a counter-party default is called credit risk, and is measured by customized rating tools. For example, risk managers at a collateralized debt obligations trading desk might rank Spanish counter-parties in structured deals by using proprietary methods.

5 Capital Structure Meaning of Capital Structure Capital Structure is referred to as the ratio of different kinds of securities raised by a firm as long-term finance. The capital structure involves two decisions- a. Types of securities to be issued are equity shares, preference shares and long term borrowings (Debentures). b. Relative ratio of securities can be determined by process of capital gearing. On this basis, the companies are divided into twoa. Highly geared companies - Those companies whose proportion of equity capitalization is small. b. Low geared companies - Those companies whose equity capital dominates total capitalization For instance - There are two companies A and B. Total capitalization amounts to be USD 200,000 in each case. The ratio of equity capital to total capitalization in company A is USD 50,000, while in company B, ratio of equity capital is USD 150,000 to total capitalization, i.e, in Company A, proportion is 25% and in company B, proportion is 75%. In such cases, company A is considered to be a highly geared company and company B is low geared company. Factors Determining Capital Structure 1. Trading on Equity- The word equity denotes the ownership of the company. Trading on equity means taking advantage of equity share capital to borrowed funds on reasonable basis. It refers to additional profits that equity shareholders earn because of issuance of debentures and preference shares. It is based on the thought that if the rate of dividend on preference capital and the rate of interest on borrowed capital is lower than the general rate of company s earnings, equity

6 shareholders are at advantage which means a company should go for a judicious blend of preference shares, equity shares as well as debentures. Trading on equity becomes more important when expectations of shareholders are high. 2. Degree of control- In a company, it is the directors who are so called elected representatives of equity shareholders. These members have got maximum voting rights in a concern as compared to the preference shareholders and debenture holders. Preference shareholders have reasonably less voting rights while debenture holders have no voting rights. If the company s management policies are such that they want to retain their voting rights in their hands, the capital structure consists of debenture holders and loans rather than equity shares. 3. Flexibility of financial plan- In an enterprise, the capital structure should be such that there is both contractions as well as relaxation in plans. Debentures and loans can be refunded back as the time requires. While equity capital cannot be refunded at any point which provides rigidity to plans. Therefore, in order to make the capital structure possible, the company should go for issue of debentures and other loans. 4. Choice of investors- The company s policy generally is to have different categories of investors for securities. Therefore, a capital structure should give enough choice to all kind of investors to invest. Bold and adventurous investors generally go for equity shares and loans and debentures are generally raised keeping into mind conscious investors. 5. Capital market condition- In the lifetime of the company, the market price of the shares has got an important influence. During the depression period, the company s capital structure generally consists of debentures and loans. While in period of boons and inflation, the company s capital should consist of share capital generally equity shares. 6. Period of financing- When company wants to raise finance for short period, it goes for loans from banks and other institutions; while for long period it goes for issue of shares and debentures. 7. Cost of financing- In a capital structure, the company has to look to the factor of cost when securities are raised. It is seen that debentures at the time of profit

7 earning of company prove to be a cheaper source of finance as compared to equity shares where equity shareholders demand an extra share in profits. 8. Stability of sales- An established business which has a growing market and high sales turnover, the company is in position to meet fixed commitments. Interest on debentures has to be paid regardless of profit. Therefore, when sales are high, thereby the profits are high and company is in better position to meet such fixed commitments like interest on debentures and dividends on preference shares. If company is having unstable sales, then the company is not in position to meet fixed obligations. So, equity capital proves to be safe in such cases. 9. Sizes of a company- Small size business firms capital structure generally consists of loans from banks and retained profits. While on the other hand, big companies having goodwill, stability and an established profit can easily go for issuance of shares and debentures as well as loans and borrowings from financial institutions. The bigger the size, the wider is total capitalization.

8 Importance of Capital structure Planning Capital structure planning is very important to survive the business in long run. After simple watching the balance sheet of company, you see two sides of balance sheet. One side is liability side and other side is asset side. Liability side is the mixture of finance of company which company has collected from internal and external sources and it has been used or will be used for development of company. Liability side of balance sheet is made under perfect capital structure planning. Finance manager and other promoters decide which source of fund or funds should be selected after monitoring the factors affecting capital structures. So, capital structure planning makes strong balance sheet. The right capital structure planning also increases the power of company to face the losses and changes in financial markets. Following points shows the importance of capital structure and its planning.

9 To reduce the overall risk of company When we make capital structure before actual getting money from money supplier, we can do many adjustments for reducing our overall risk. Suppose, we have made capital structure in which we add three sources of fund, one is equity share, and other is debenture and last is preference shares because we know that we have to pay debt at its maturity at any cost and its interest at fixed rate. So, we try to get minimum debt in new business because in new business our rate of return will be less than rate of interest and for getting more loan means taking high risk of return more amount of interest even there is no profit. But, if our business will be succeeded, at that time, we can increase estimated amount of debt by just changing the value of debt in capital structure (written just for planning). We can easily pay the interest because our ROI is very high. At that time, Company can enjoy the trading on equity. But finance manager should also careful watch whether shareholders are more expected regarding dividend or not because high expectation will also against the development of our company. To do adjustment according to Business Environment Company also adjusts different sources expected amount according to business environment. Suppose in future, if government of India cuts off his relation with China, from where our company is getting fund, it will definitely tough for us to get more money from China. But proper planning of capital structure of future sources will be helpful for us to enlarge our area for getting money. In finance, it is called maneuverability. It means to create mobility of sources of fund by including maximum alternatives in planned capital structure. Suppose, if RBI increases the interest rate, it means your cost for getting debt will be high, at that time, you can choose any other cheap source of fund.

10 Idea generation of new source of fund Good planning of capital structure will make versatile to finance manager for getting money from new sources. If you have studied Wikipedia s page of venture capital orprivate equity sources, you would precisely understand that how finance managers of company are generating new and new idea for getting money from public at low risk.

11 Resham A. Mansukhani S.Y.B.Com. A Roll No. : 001 Principles of Management and Finance Seva Sadan College of Arts, Science and Commerce