Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. Working capital, also known as net working capital, is a financial metric which represents operating liquidity available to a business Cash conversion cycle or CCC is the time duration in which a firm is able to convert its resources into cash Return on invested capital (ROIC is a financial measure that quantifies how well a company generates cash flow relative to the capital it has invested in its business In Corporate finance, Economic Value Added or EVA® is an estimate of true economic profit after making corrective adjustments to GAAP accounting including Just-in-time ( JIT) is an inventory strategy implemented to improve the Return on investment of a Business by reducing in-process Inventory and Economic order quantity is that level of inventory that minimizes the total of inventory holding cost and ordering cost Discounts and allowances are reductions to a basic Price of goods or services Factoring is a word often misused synonymously with accounts receivable financing. Capital budgeting (or investment appraisal is the planning process used to determine whether a firm's long term Investments such as new machinery replacement machinery new Corporate finance is an area of Finance dealing with the financial decisions Corporations make and the tools and analysis used to make these decisions Corporate finance is an area of Finance dealing with the financial decisions Corporations make and the tools and analysis used to make these decisions Corporate finance is an area of Finance dealing with the financial decisions Corporations make and the tools and analysis used to make these decisions Managerial finance is the branch of finance that concerns itself with the managerial significance of finance techniques Financial accountancy (or financial accounting) is the field of Accountancy concerned with the preparation of Financial statements for decision makers Management accounting is concerned with the provisions and use of Accounting information to managers within organizations to provide them with the basis to make informed business In Financial accounting, a balance sheet or statement of financial position is a summary of a person's or organization's balances A business plan is a formal statement of a set of business goals the reasons why they are believed attainable and the plan for reaching those goals A corporate action is an event initiated by a Public company that affects the securities ( Equity or Debt) issued by the company The field of finance refers to the concepts of Time, Money and Risk and how they are interrelated In Economics, a financial market is a mechanism that allows people to easily buy and sell ( Trade) financial Securities (such as stocks and bonds There are two basic financial market participant categories Investor vs Personal finance is the application of the principles of Finance to the monetary decisions of an individual or family unit Public finance is a field of economics concerned with paying for collective or governmental activities and with the administration and design of those activities A banker or bank is a Financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money Financial regulations are a form of Regulation or supervision which subjects Financial institutions to certain requirements restrictions and guidelines aiming to The field of finance refers to the concepts of Time, Money and Risk and how they are interrelated A corporation is a separate legal entity usually used to conduct business The primary goal of corporate finance is to maximize corporate value while reducing the firm's financial risks. In Finance, valuation is the process of estimating the Market value of a financial Asset or Liability. Risk is a Concept that denotes the precise probability of specific eventualities Although it is in principle different from managerial finance which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. Managerial finance is the branch of finance that concerns itself with the managerial significance of finance techniques
The discipline can be divided into long-term and short-term decisions and techniques. Capital investment decisions are long-term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. Investment or investing is a term with several closely-related meanings in Business management, Finance and Economics, related to saving In accounting terms after all liabilities are paid ownership equity is the remaining interest in Assets If valuations placed on assets do not exceed liabilities Debt is that which is owed usually referencing Assets owed but the term can cover other obligations Dividends are payments made by a Corporation to its Shareholder members A mutual shareholder or stockholder is an Individual or company (including a Corporation) that legally owns one or more shares of On the other hand, the short term decisions can be grouped under the heading "Working capital management". Working capital, also known as net working capital, is a financial metric which represents operating liquidity available to a business This subject deals with the short-term balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers). In Business and Accounting, assets are everything owned by a person or company (all tangible and intangible property that can be converted into cash. Inventory is a list for goods and Materials, or those goods and materials themselves held available in stock by a Business.
The terms Corporate finance and Corporate financier are also associated with investment banking. Investment banks profit from companies and governments by raising money through issuing and selling Securities in the Capital markets (both equity and The typical role of an investment banker is to evaluate investment projects for a bank to make investment decisions. Investment banks profit from companies and governments by raising money through issuing and selling Securities in the Capital markets (both equity and
Contents |
Capital investment decisions
Capital investment decisions[1] are long-term corporate finance decisions relating to fixed assets and capital structure. Fixed asset, also known as property plant and equipment (PP&E is a term used in Accountancy for Assets and Property which cannot easily be Decisions are based on several inter-related criteria. Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive net present value when valued using an appropriate discount rate. Net present value ( NPV) or net present worth ( NPW) is defined as the total Present value (PV of a Time series of Cash flows These projects must also be financed appropriately. If no such opportunities exist, maximizing shareholder value dictates that management return excess cash to shareholders. Capital investment decisions thus comprise an investment decision, a financing decision, and a dividend decision.
The investment decision
Management must allocate limited resources between competing opportunities ("projects") in a process known as capital budgeting. Capital budgeting (or investment appraisal is the planning process used to determine whether a firm's long term Investments such as new machinery replacement machinery new Capital budgeting (or investment appraisal is the planning process used to determine whether a firm's long term Investments such as new machinery replacement machinery new Making this capital allocation decision requires estimating the value of each opportunity or project: a function of the size, timing and predictability of future cash flows.
Project valuation
- Further information: stock valuation and fundamental analysis
In general, each project's value will be estimated using a discounted cash flow (DCF) valuation, and the opportunity with the highest value, as measured by the resultant net present value (NPV) will be selected (see Fisher separation theorem; John Burr Williams: Theory). Fundamental analysis of a business involves analyzing its Financial statements and health its management and competitive advantages and its Competitors and In Finance, the discounted cash flow (or DCF approach describes a method of valuing a project company or asset using the concepts of the Time value of money Net present value ( NPV) or net present worth ( NPW) is defined as the total Present value (PV of a Time series of Cash flows In Economics, the Fisher separation theorem asserts that the objective of a firm will be the maximization of its Present value, regardless of the preferences John Burr Williams (1899 - 1989 one of the first Economists to view stock prices as determined by “ intrinsic value ” is recognised as a founder and developer This requires estimating the size and timing of all of the incremental cash flows resulting from the project. These future cash flows are then discounted to determine their present value (see Time value of money). Discounts and allowancesIn Finance and Economics, discounting is the process of finding the present value of an amount of cash at some future date and along with Present value is the value on a given date of a future payment or series of future payments discounted to reflect the Time value of money and other factors such as Investment The time value of money is based on the premise that an Investor prefers to receive a payment of a fixed amount of money today rather than an equal amount in the future These present values are then summed, and this sum net of the initial investment outlay is the NPV. Net present value ( NPV) or net present worth ( NPW) is defined as the total Present value (PV of a Time series of Cash flows
The NPV is greatly influenced by the discount rate. Net present value ( NPV) or net present worth ( NPW) is defined as the total Present value (PV of a Time series of Cash flows For the interest rate charged to Banks for borrowing short-term funds directly from the Federal Reserve, see Discount window. Thus selecting the proper discount rate—the project "hurdle rate"—is critical to making the right decision. The hurdle rate is the minimum acceptable return on an investment—i. In Finance, rate of return ( ROR) also known as return on investment ( ROI) rate of profit or sometimes just return, is e. the project appropriate discount rate. In Finance, the Capital Asset Pricing Model ( CAPM) is used to determine a theoretically appropriate required Rate of return of an Asset, The hurdle rate should reflect the riskiness of the investment, typically measured by volatility of cash flows, and must take into account the financing mix. Managers use models such as the CAPM or the APT to estimate a discount rate appropriate for a particular project, and use the weighted average cost of capital (WACC) to reflect the financing mix selected. In Finance, the Capital Asset Pricing Model ( CAPM) is used to determine a theoretically appropriate required Rate of return of an Asset, Arbitrage pricing theory ( APT) in Finance, is a general Theory of Asset pricing, that has become influential in the pricing of shares The weighted average cost of capital (WACC is the rate that a company is expected to pay to finance its assets (A common error in choosing a discount rate for a project is to apply a WACC that applies to the entire firm. Such an approach may not be appropriate where the risk of a particular project differs markedly from that of the firm's existing portfolio of assets. )
In conjunction with NPV, there are several other measures used as (secondary) selection criteria in corporate finance. Net present value ( NPV) or net present worth ( NPW) is defined as the total Present value (PV of a Time series of Cash flows Decision making can be regarded as an outcome of mental processes ( cognitive process) leading to the selection of a course of action among several alternatives These are visible from the DCF and include payback period, IRR, Modified IRR, equivalent annuity, capital efficiency, and ROI; see list of valuation topics. Payback period in business and economics refers to the period of time required for the return on an investment to "repay" the sum of the original investment The internal rate of return (IRR is a Capital budgeting metric used by firms to decide whether they should make Investments It is an indicator of the efficiency Modified Internal Rate of Return (MIRR is a financial measure used to determine the attractiveness of an investment In finance the equivalent annual cost (EAC is the cost per year of owning and operating an asset over its entire lifespan In Finance, rate of return ( ROR) also known as return on investment ( ROI) rate of profit or sometimes just return, is Topics in Finance include Fundamental financial concepts Finance an overview Arbitrage
Valuing flexibility
In many cases, for example R&D projects, a project may open (or close) paths of action to the company, but this reality will not typically be captured in a strict NPV approach. In Corporate finance, real options analysis or ROA applies Put option and Call option valuation techniques to Capital budgeting decisions In Operations research, specifically in Decision analysis, a decision tree (or tree diagram is a decision support tool that uses a graph or The phrase research and development (also R and D or more often R&D) according to the Organization for Economic Co-operation and Development, refers Management will therefore (sometimes) employ tools which place an explicit value on these options. So, whereas in a DCF valuation the most likely or average or scenario specific cash flows are discounted, here the “flexibile and staged nature” of the investment is modelled, and hence "all" potential payoffs are considered. Scenario planning '''scenario thinking''' or '''scenario analysis''' is a Strategic planning method that some organizations use to make flexible long-term plans Note The term model has a different meaning in Model theory, a branch of Mathematical logic. "In the money" redirects here for the poker term see In the money (poker. The difference between the two valuations is the "option value" inherent in the project.
The two most common tools are Decision Tree Analysis (DTA) and Real options analysis:
- The DTA approach attempts to capture flexibility by incorporating likely events and consequent management decisions into the valuation. In Operations research, specifically in Decision analysis, a decision tree (or tree diagram is a decision support tool that uses a graph or In Corporate finance, real options analysis or ROA applies Put option and Call option valuation techniques to Capital budgeting decisions In Probability theory, an event is a set of outcomes (a Subset of the Sample space) to which a probability is assigned Decision making can be regarded as an outcome of mental processes ( cognitive process) leading to the selection of a course of action among several alternatives In the decision tree, each management decision in response to an "event" generates a "branch" or "path" which the company could follow. In Operations research, specifically in Decision analysis, a decision tree (or tree diagram is a decision support tool that uses a graph or (For example, management will only proceed with stage 2 of the project given that stage 1 was successful; stage 3, in turn, depends on stage 2. In a DCF model, on the other hand, there is no "branching" - each scenario must be modelled separately. ) The highest value path (probability weighted) is regarded as representative of project value
- The real options approach is used when the value of a project is contingent on the value of some other asset or underlying variable. Probability is the likelihood or chance that something is the case or will happen In Corporate finance, real options analysis or ROA applies Put option and Call option valuation techniques to Capital budgeting decisions Topics in Finance include Fundamental financial concepts Finance an overview Arbitrage The economic value of a good or service has puzzled economists since the beginning of the discipline In finance the underlying of a derivative is an Asset, basket of assets, index, or even another derivative such that the cash flows of the (For example, the viability of a mining project is contingent on the price of gold; if the price is too low, management will abandon the mining rights, if sufficiently high, management will develop the ore body. Economic geology is concerned with earth materials that can be utilized for economic and/or industrial purposes Mining is the extraction of valuable Minerals or other geological materials from the earth usually (but not always from an Ore body Gold (ˈɡoʊld is a Chemical element with the symbol Au (from its Latin name aurum) and Atomic number 79 Mineral rights, mining rights, oil rights or drilling rights, are the rights to remove Minerals Oil, or sometimes Water Underground hard rock Mining refers to various underground mining techniques used to excavate hard minerals such as those containing metals like Gold, An ore is a volume of rock containing components or Minerals in a mode of occurrence that renders it valuable for mining Again, a DCF valuation would capture only one of these outcomes. ) Here, using financial option theory as a framework, the decision to be taken is identified as corresponding to either a call option or a put option - valuation is then via the Binomial model or, less often for this purpose, via Black Scholes; see Contingent claim valuation. Options are financial instruments that convey the right but not the obligation to engage in a future transaction on some Underlying security, or in a Futures Example of a call option on a stock Buy a call The buyer expects that the price may go up Example of a put option on a stock Buy a Put A Buyer thinks price of a stock will decrease BOPM redirects here for other uses see BOPM (disambiguation. In Finance, the binomial options pricing model (BOPM provides a generalisable The term Black–Scholes refers to three closely related concepts The Black–Scholes model is a mathematical model of the market for an equity in which the equity's Topics in Finance include Fundamental financial concepts Finance an overview Arbitrage The "true" value of the project is then the NPV of the "most likely" scenario plus the option value.
Quantifying uncertainty
- Further information: Monte Carlo methods in finance
Given the uncertainty inherent in project forecasting and valuation, analysts will wish to assess the sensitivity of project NPV to the various inputs (i. In Finance and Mathematical finance, Monte Carlo methods are used to value and analyze (complex instruments portfolios and Investments Uncertainty is a term used in subtly different ways in a number of fields including Philosophy, Statistics, Economics, Finance, Insurance e. assumptions) to the DCF model. Note The term model has a different meaning in Model theory, a branch of Mathematical logic. In a typical sensitivity analysis the analyst will vary one key factor, while ceteris paribus holding constant all other inputs. Sensitivity analysis (SA is the study of how the variation (uncertainty in the output of a Mathematical model can be apportioned qualitatively or quantitatively to different la Cēterīs paribus is a Latin phrase literally translated as "with other things the same The sensitivity of NPV to a change in that factor is then observed (calculated as Δ NPV / Δ factor). For example, the analyst will set annual revenue growth rates at 5% for "Worst Case", 10% for "Likely Case" and 25% for "Best Case" - and produce three corresponding NPVs. In business revenue or revenues is Income that a company receives from its normal business activities usually from the sale of goods and services
Using a related technique, analysts may also run scenario based forecasts so as to observe the value of the project under various outcomes. Scenario planning '''scenario thinking''' or '''scenario analysis''' is a Strategic planning method that some organizations use to make flexible long-term plans Under this technique, a scenario comprises a particular outcome for economy-wide, "global" factors (exchange rates, commodity prices) as well as for company-specific factors (revenue growth rates, unit costs). In Finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how A commodity is anything for which there is demand but which is supplied without qualitative differentiation across a market Under the average-cost method, it is assumed that the cost of inventory is based on the average cost of the goods Available for sale during the period Here, extending the example above, key inputs in addition to growth are also adjusted, and NPV is calculated for the various scenarios. Analysts then plot these results to produce a "value-surface" (or even a "value-space"), where NPV is a function of several variables. In Mathematics, specifically in Topology, a surface is a Two-dimensional Manifold. Another application of this methodology is to determine an "unbiased NPV", where management determines a (subjective) probability for each scenario - the NPV for the project is then the probability-weighted average of the various scenarios. The weighted mean is similar to an Arithmetic mean (the most common type of Average) where instead of each of the data points contributing equally to the final average Note that for scenario based analysis, the various combinations of inputs must be internally consistent, whereas for the sensitivity approach these need not be so.
A further advancement is to construct stochastic or probabilistic financial models - as opposed to the traditional static and deterministic models as above. Stochastic (from the Greek "Στόχος" for "aim" or "guess" means Random. Probability is the likelihood or chance that something is the case or will happen Determinism is the philosophical Proposition that every event including human cognition and behaviour decision and action is causally determined For this purpose, the most common method is to use Monte Carlo simulation to analyze the project’s NPV (introduced to finance by David B. Hertz in 1964). Monte Carlo methods are a class of Computational Algorithms that rely on repeated Random sampling to compute their results David Bendel Hertz is known for his contributions to Operations research in general and specifically for pioneering Monte Carlo methods in finance. Here, the cash flow components that are (heavily) impacted by uncertainty are simulated, mathematically reflecting their "random characteristics". The simulation produces several thousand trials (in contrast to the scenario approach above) and outputs a histogram of project NPV. In Statistics, a histogram is a Graphical display of tabulated frequencies, shown as Bars It shows what proportion of cases fall into each of The average NPV of the potential investment - as well as its volatility and other sensitivities - is then observed. (Typically, an add-in such as Crystal Ball is used to run simulations in spreadsheet based DCF models. A spreadsheet is a Computer application that simulates a paper worksheet )
Here, continuing the above example, instead of assigning three discrete values to revenue growth, the analyst would assign an appropriate probability distribution (commonly triangular or beta). In Probability theory and Statistics, a probability distribution identifies either the probability of each value of an unidentified Random variable In Probability theory and Statistics, the beta distribution is a family of continuous Probability distributions defined on the interval 1 parameterized This distribution - and that of the other sources of uncertainty - would then be "sampled" repeatedly so as to generate the several thousand realistic (but random) scenarios, and the output is a realistic, representative set of valuations. The resultant statistics (average NPV and standard deviation of NPV) will be a more accurate mirror of the project's "randomness" than the variance observed under the traditional scenario based approach. In Mathematics, an average, or central tendency of a Data set refers to a measure of the "middle" or " expected " value of In Probability and Statistics, the standard deviation is a measure of the dispersion of a collection of values
The financing decision
Achieving the goals of corporate finance requires that any corporate investment be financed appropriately. As above, since both hurdle rate and cash flows (and hence the riskiness of the firm) will be affected, the financing mix can impact the valuation. Management must therefore identify the "optimal mix" of financing—the capital structure that results in maximum value. (See Balance sheet, WACC, Fisher separation theorem; but, see also the Modigliani-Miller theorem. In Financial accounting, a balance sheet or statement of financial position is a summary of a person's or organization's balances The weighted average cost of capital (WACC is the rate that a company is expected to pay to finance its assets In Economics, the Fisher separation theorem asserts that the objective of a firm will be the maximization of its Present value, regardless of the preferences The Modigliani-Miller theorem (of Franco Modigliani, Merton Miller) forms the basis for modern thinking on Capital structure. )
The sources of financing will, generically, comprise some combination of debt and equity. In Finance, a bond is a Debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and Interest Equity investment generally refers to the buying and holding of shares of Stock on a Stock market by individuals and funds in anticipation of income from Financing a project through debt results in a liability that must be serviced—and hence there are cash flow implications regardless of the project's success. Equity financing is less risky in the sense of cash flow commitments, but results in a dilution of ownership and earnings. The cost of equity is also typically higher than the cost of debt (see CAPM and WACC), and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk. In Finance, the Capital Asset Pricing Model ( CAPM) is used to determine a theoretically appropriate required Rate of return of an Asset, The weighted average cost of capital (WACC is the rate that a company is expected to pay to finance its assets
Management must also attempt to match the financing mix to the asset being financed as closely as possible, in terms of both timing and cash flows. In Business and Accounting, assets are everything owned by a person or company (all tangible and intangible property that can be converted into cash.
One of the main theories of how firms make their financing decisions is the Pecking Order Theory, which suggests that firms avoid external financing while they have internal financing available and avoid new equity financing while they can engage in new debt financing at reasonably low interest rates. In the theory of firm's Capital structure and financing decisions the Pecking Order Theory or Pecking Order Model was developed by Stewart C In the theory of Capital structure, External financing is the phrase used to describe Funds that firms obtain from outside of the firm In the theory of Capital structure Internal financing is the name for a firm using its Profits as a source of capital for new Investment, rather Interest is a fee paid on borrowed capital Assets lent include Money, Shares, Consumer goods through Hire purchase, major assets Another major theory is the Trade-Off Theory in which firms are assumed to trade-off the Tax Benefits of debt with the Bankruptcy Costs of debt when making their decisions. The trade-off theory of capital structure refers to the idea that a company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits In the context of Corporate finance, the Tax Benefits of Debt or Tax Advantage of Debt refers to the fact that from a tax perspective it is cheaper for firms and investors Within the theory of Corporate finance, Bankruptcy Costs of Debt are the increased costs of financing with Debt instead of equity that result from a higher An emerging area in finance theory is Right-financing whereby investment banks and corporations can enhance investment return and company value over time by determining the right investment objectives, policy framework, institutional structure, source of financing (debt or equity) and expenditure framework within a given economy and under given market conditions. The concept of right-financing was coined by English political economist Dr One last theory about this decision is the Market timing hypothesis which states that firms look for the cheaper type of financing regardless of their current levels of internal resources, debt and equity. The market timing hypothesis is a theory about how firms and Corporations in the economy decide whether to finance their investment with equity or with
The dividend decision
The dividend is calculated mainly on the basis of the company's unappropriated profit and its business prospects for the coming year. The Dividend Decision, in Corporate finance, is a decision made by the directors of a company If there are no NPV positive opportunities, i. e. where returns exceed the hurdle rate, then management must return excess cash to investors. In Finance, rate of return ( ROR) also known as return on investment ( ROI) rate of profit or sometimes just return, is Equity investment generally refers to the buying and holding of shares of Stock on a Stock market by individuals and funds in anticipation of income from These free cash flows comprise cash remaining after all business expenses have been met. Cash flow (also called net cash flow) is the balance of the amounts of Cash being received and paid by a business during a defined period of time sometimes tied
This is the general case, however there are exceptions. For example, investors in a "Growth stock", expect that the company will, almost by definition, retain earnings so as to fund growth internally. In Finance, Growth Stocks are Stocks that appreciate in value and yield a high Return on equity (ROE In other cases, even though an opportunity is currently NPV negative, management may consider “investment flexibility” / potential payoffs and decide to retain cash flows; see above and Real options. Corporate finance is an area of Finance dealing with the financial decisions Corporations make and the tools and analysis used to make these decisions In Corporate finance, real options analysis or ROA applies Put option and Call option valuation techniques to Capital budgeting decisions
Management must also decide on the form of the distribution, generally as cash dividends or via a share buyback. Dividends are payments made by a Corporation to its Shareholder members A treasury stock or reacquired stock is Stock which is bought back by the issuing Company, reducing the amount of Outstanding stock on the There are various considerations: where shareholders pay tax on dividends, companies may elect to retain earnings, or to perform a stock buyback, in both cases increasing the value of shares outstanding; some companies will pay "dividends" from stock rather than in cash. A dividend tax is an Income tax on dividend payments to the Stockholders (shareholders of a company A treasury stock or reacquired stock is Stock which is bought back by the issuing Company, reducing the amount of Outstanding stock on the (See Corporate action. A corporate action is an event initiated by a Public company that affects the securities ( Equity or Debt) issued by the company ) Today it is generally accepted that dividend policy is value neutral (see Modigliani-Miller theorem). The Modigliani-Miller theorem (of Franco Modigliani, Merton Miller) forms the basis for modern thinking on Capital structure.
Working capital management
Decisions relating to working capital and short term financing are referred to as working capital management. Working capital, also known as net working capital, is a financial metric which represents operating liquidity available to a business Working capital, also known as net working capital, is a financial metric which represents operating liquidity available to a business These involve managing the relationship between a firm's short-term assets and its short-term liabilities. In Business and Accounting, assets are everything owned by a person or company (all tangible and intangible property that can be converted into cash. In Accounting, current liabilities are considered Liabilities of the business that are to be settled in cash within the Fiscal year or the operating cycle The goal of Working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses. Operations management is an area of business that is concerned with the production of goods and services and involves the responsibility of ensuring that Business operations
Decision criteria
Working capital is the amount of capital which is readily available to an organization. That is, working capital is the difference between resources in cash or readily convertible into cash (Current Assets) and cash requirements (Current Liabilities). So the decisions relating to working capital are always current decisions, i. e. , short term decisions.
The short term decisions of the firm are similar to those of long term in terms of risk and return, but they differ in many other ways like time factor, discounting consideration, liquidity etc. So these decisions are not taken on the same basis as long term decisions. These decisions have different criteria like cash flow and profitability.
- The most important criterion for making short term decisions is cash flows. And the best measure of cash flow is net operating cycle or cash conversion cycle. It represents the time difference between cash payment for raw materials and cash collection for sales. Another aspect of cash conversion cycle is gross operating cycle which is same as net operating cycle except the fact that it does not take into account the creditors deferral period. Cash conversion cycle indicates the firm's ability to convert its resources into cash. Because this number effectively corresponds to the time that the firm's cash is tied up in operations and unavailable for other activities, management generally aims at a low net count.
- In this context, the most useful measure of profitability is Return on capital (ROC). Return on invested capital (ROIC is a financial measure that quantifies how well a company generates cash flow relative to the capital it has invested in its business The result is shown as a percentage, determined by dividing relevant income for the 12 months by capital employed; Return on equity (ROE) shows this result for the firm's shareholders. Return on Equity ( ROE, Return on average common equity, return on net worth) measures the rate of return on the ownership interest ( Shareholders' equity Firm value is enhanced when, and if, the return on capital, which results from working capital management, exceeds the cost of capital, which results from capital investment decisions as above. The cost of capital is an Expected return that the provider of capital plans to earn on their investment ROC measures are therefore useful as a management tool, in that they link short-term policy with long-term decision making. See Economic value added (EVA). In Corporate finance, Economic Value Added or EVA® is an estimate of true economic profit after making corrective adjustments to GAAP accounting including
Management of working capital
Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital. These policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are acceptable. In Business and Accounting, assets are everything owned by a person or company (all tangible and intangible property that can be converted into cash. Cash usually refers to Money in the form of Currency, such as Banknotes and Coins In Bookkeeping and Finance, Cash and cash equivalents are the most liquid Assets found within the asset portion of a company's Balance sheet. Inventory is a list for goods and Materials, or those goods and materials themselves held available in stock by a Business. In Economics a debtor is simply an entity that owes a Debt to someone else the entity could be an individual a firm a government or an organization
- Cash management. In United States Banking, cash management, or treasury management, is a Marketing term for certain services offered primarily to larger business Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.
- Inventory management. Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials - and minimizes reordering costs - and hence increases cash flow; see Supply chain management; Just In Time (JIT); Economic order quantity (EOQ); Economic production quantity (EPQ). Supply chain management (SCM is the process of Planning, implementing and Controlling the operations of the Supply chain as efficiently as possible Just-in-time ( JIT) is an inventory strategy implemented to improve the Return on investment of a Business by reducing in-process Inventory and Economic order quantity is that level of inventory that minimizes the total of inventory holding cost and ordering cost Economic Production Quantity model (also known as the EPQ model is an extension of the Economic Order Quantity model
- Debtors management. Identify the appropriate credit policy, i. Credit is the provision of resources (such as granting a Loan) by one party to another party where that second party does not reimburse the first party immediately thereby generating e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances. S T U V Tragedy of the commons --> Discounts and allowances are reductions to a basic Price of goods or services
- Short term financing. Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors to cash" through "factoring". A loan is a type of Debt. This article focuses exclusively on monetary loans although in practice any material object might be lent Factoring is a word often misused synonymously with accounts receivable financing.
Financial risk management
Risk management is the process of measuring risk and then developing and implementing strategies to manage that risk. Financial risk management is the practice of creating economic value in a firm by using Financial instruments to manage exposure to Risk, particularly For non-business risks see Risk or the disambiguation page Risk analysis. Risk is a Concept that denotes the precise probability of specific eventualities Financial risk management focuses on risks that can be managed ("hedged") using traded financial instruments (typically changes in commodity prices, interest rates, foreign exchange rates and stock prices). Financial risk management is the practice of creating economic value in a firm by using Financial instruments to manage exposure to Risk, particularly In Finance, a hedge is an investment that is taken out specifically to reduce or cancel out the Risk in another investment Financial instruments are cash evidence of an ownership interest in an entity or a contractual right to receive or deliver cash or another financial instrument A commodity is anything for which there is demand but which is supplied without qualitative differentiation across a market Interest is a fee paid on borrowed capital Assets lent include Money, Shares, Consumer goods through Hire purchase, major assets In Finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how Software for Fixed assets management and Stock control developed in 2004. Financial risk management will also play an important role in cash management. Cash usually refers to Money in the form of Currency, such as Banknotes and Coins In Bookkeeping and Finance,
This area is related to corporate finance in two ways. Firstly, firm exposure to business risk is a direct result of previous Investment and Financing decisions. Secondly, both disciplines share the goal of creating, or enhancing, firm value. The economic value of a good or service has puzzled economists since the beginning of the discipline All large corporations have risk management teams, and small firms practice informal, if not formal, risk management.
Derivatives are the instruments most commonly used in Financial risk management. Derivatives are Financial instruments whose values depend on the value of other underlying financial instruments Because unique derivative contracts tend to be costly to create and monitor, the most cost-effective financial risk management methods usually involve derivatives that trade on well-established financial markets. A contract is an exchange of promises between two or more parties to do or refrain from doing an act which is enforceable in a court of law In Economics, a financial market is a mechanism that allows people to easily buy and sell ( Trade) financial Securities (such as stocks and bonds These standard derivative instruments include options, futures contracts, forward contracts, and swaps. Options are financial instruments that convey the right but not the obligation to engage in a future transaction on some Underlying security, or in a Futures In Finance, a futures contract is a standardized Contract, traded on a Futures exchange, to buy or sell a certain Underlying instrument A forward contract is an agreement between two parties to buy or sell an asset at a specified point of time in the future For the Thoroughbred horse racing champion see Swaps (horse. In finance a swap is a derivative in which two counterparties
- See: Financial engineering; Financial risk; Default (finance); Credit risk; Interest rate risk; Liquidity risk; Market risk; Operational risk; Volatility risk; Settlement risk. Financial risk is normally any Risk associated with any form of financing. In Finance, default occurs when a debtor has not met its legal obligations according to the debt contract e Credit risk is the risk of loss due to a debtor's non-payment of a Loan or other line of credit (either the principal or Interest (coupon or both Faced Interest rate risk is the risk (variability in value borne by an interest-bearing asset such as a loan or a bond, due to variability of interest rates. In Finance, liquidity risk is the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit Market risk is the Risk that the value of an investment will decrease due to moves in market factors An operational risk is a risk arising from execution of a company's business functions Volatility risk in Financial markets is the Likelihood of Fluctuations in the Exchange rate of Currencies. Settlement risk is the Risk that a Counterparty does not deliver a security or its value in cash as per agreement when the security was traded
Relationship with other areas in finance
Investment banking
Use of the term “corporate finance” varies considerably across the world. In the United States it is used, as above, to describe activities, decisions and techniques that deal with many aspects of a company’s finances and capital. The United States of America —commonly referred to as the In the United Kingdom and Commonwealth countries, the terms “corporate finance” and “corporate financier” tend to be associated with investment banking - i. The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom, the UK or Britain,is a Sovereign state located Investment banks profit from companies and governments by raising money through issuing and selling Securities in the Capital markets (both equity and e. with transactions in which capital is raised for the corporation. [2]
Personal and public finance
Corporate finance utilizes tools from almost all areas of finance. Some of the tools developed by and for corporations have broad application to entities other than corporations, for example, to partnerships, sole proprietorships, not-for-profit organizations, governments, mutual funds, and personal wealth management. But in other cases their application is very limited outside of the corporate finance arena. Because corporations deal in quantities of money much greater than individuals, the analysis has developed into a discipline of its own. It can be differentiated from personal finance and public finance. Personal finance is the application of the principles of Finance to the monetary decisions of an individual or family unit Public finance is a field of economics concerned with paying for collective or governmental activities and with the administration and design of those activities
Related Professional Qualifications
Qualifications related to the field include:
- Finance qualifications: Masters degree in Finance (MSF), Chartered Financial Analyst (CFA), Corporate Finance Qualification (CF), Certified International Investment Analyst(CIIA), Association of Corporate Treasurers (ACT), Certified Market Analyst (CMA/FAD) Dual Designation, Master Financial Manager (MFM), Master of Finance & Control (MFC), . Master of Science in Finance ( MSF) is a Master's degree designed to prepare graduates for Careers in financial analysis, Investment management Chartered Financial Analyst ( CFA) is an international professional designation offered by the CFA Institute of USA (formerly known as AIMR to Financial Certified International Investment Analyst ( CIIA) is a designation offered by the Association of Certified International Investment Analysts (ACIIA to financial professionals The Association of Corporate Treasurers (or ACT for short was founded in 1979 The American Academy of Financial Management, or AAFM as it is known is a Board of Standards and Professional association dedicated to the Finance sector and finance
- Business qualifications: Master of Business Administration (MBA), Master of Commerce (M Comm), Doctor of Business Administration (DBA), Certified Business Manager (CBM)
- Accountancy qualifications:
- Qualified accountant: Certified Public Accountant (CPA), Chartered Certified Accountant(ACCA), Chartered Management Accountant (CIMA), Chartered Accountant (ACA)
- Non-statutory qualifications: Chartered Cost Accountant (CCA Designation from AAFM), Certified Management Accountant (CMA),
References
- ^ The framework for this section is based on Notes by Aswath Damodaran at New York University's Stern School of Business
- ^ Beaney, Shaun, "Defining corporate finance in the UK", The Institute of Chartered Accountants, April 2005
See also
- Financial modeling
- Business organizations
- Financial planning
- Investment bank
- Managerial economics
- Private equity
- Real option
- Venture capital
- Right-financing
- Factoring (finance)
- Related topics by category:
Dapyx Software network: MP3 Explorer | Ebook Manager | Zenithic