View source for Finance:Corporate finance

{{Short description|Framework for corporate funding, capital structure, and investments}}
{{Corporate finance}}
{{Banking |related}}

'''Corporate finance''' is the area of [[Finance:Finance|finance]] that deals with the sources of funding, and the [[Finance:Capital structure|capital structure]] of [[Company:Corporation|corporation]]s, the actions that managers take to increase the [[Finance:Value investing|value]] of the firm to the [[Finance:Shareholder|shareholder]]s, and the tools and [[Philosophy:Analysis|analysis]] used to allocate financial resources. The primary goal of corporate finance is to [[Finance:Shareholder value|maximize]] or increase [[Finance:Valuation|shareholder value]].<ref>See [http://pages.stern.nyu.edu/~adamodar/New_Home_Page/AppldCF/other/Image2.gif Corporate Finance: First Principles], Aswath Damodaran, [[Organization:New York University|New York University]]'s Stern School of Business</ref>

Correspondingly, corporate finance comprises two main sub-disciplines. {{Citation needed|date=April 2011}} [[Finance:Capital budgeting|Capital budgeting]] is concerned with the setting of criteria about which value-adding projects should receive investment funding, and whether to finance that investment with equity or [[Finance:Debt|debt]] capital. [[Finance:Working capital|Working capital]] management is the management of the company's monetary funds that deal with the short-term [[Finance:Business operations|operating]] balance of current assets and current liabilities; the focus here is on managing cash, [[Social:Inventory|inventories]], and short-term borrowing and lending (such as the terms on credit extended to customers).

The terms corporate finance and '''corporate financier''' are also associated with [[Finance:Investment banking|investment banking]]. The typical role of an investment bank is to evaluate the company's financial needs and raise the appropriate type of capital that best fits those needs. Thus, the terms "corporate finance" and "corporate financier" may be associated with transactions in which capital is raised in order to create, develop, grow or acquire businesses. 

Although it is in principle different from [[Finance:Managerial finance|managerial finance]] which studies the financial management 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.
[[Finance:Financial management|Financial management]] overlaps with the financial function of the accounting profession. However, [[Finance:Financial accounting|financial accounting]] is the reporting of historical financial information, while financial management is concerned with the deployment of capital resources to increase a firm's value to the shareholders.

==History==

Corporate finance for the pre-industrial world began to emerge in the Italian city-states and the [[Place:Low Countries|low countries]] of Europe from the 15th century.

The Dutch East India Company (also known by the abbreviation "VOC" in Dutch) was the first publicly listed company ever to pay regular [[Finance:Dividend|dividend]]s.<ref>Freedman, Roy S.: ''Introduction to Financial Technology''. (Academic Press, 2006, {{ISBN|0123704782}})</ref><ref>DK Publishing (Dorling Kindersley): ''The Business Book (Big Ideas Simply Explained)''. (DK Publishing, 2014, {{ISBN|1465415858}})</ref><ref>Huston, Jeffrey L.: ''The Declaration of Dependence: Dividends in the Twenty-First Century''. (Archway Publishing, 2015, {{ISBN|1480825042}})</ref> 
The VOC was also the first recorded [[Social:Joint-stock company|joint-stock company]] to get a fixed [[Social:Financial capital|capital stock]]. Public markets for investment securities developed in the [[Place:Dutch Republic|Dutch Republic]] during the 17th century.<ref>[[Biography:Niall Ferguson|Ferguson, Niall]] (2002). ''Empire: The Rise and Demise of the British World Order and the Lessons for Global Power'', p. 15. "Moreover, their company [the Dutch East India Company] was a permanent joint-stock company, unlike the English company, which did not become permanent until 1650."</ref><ref>Smith, B. Mark: ''A History of the Global Stock Market: From Ancient Rome to Silicon Valley''. (University of Chicago Press, 2003, {{ISBN|9780226764047}}), p. 17. As Mark Smith (2003) notes, "the first joint-stock companies had actually been created in England in the sixteenth century. These early joint-stock firms, however, possessed only temporary charters from the government, in some cases for one voyage only. (One example was the Muscovy Company, chartered in England in 1533 for trade with Russia; another, chartered the same year, was a company with the intriguing title Guinea Adventurers.) 
The Dutch East India Company was the first joint-stock company to have a permanent charter."</ref><ref>Clarke, Thomas; Branson, Douglas: ''The SAGE Handbook of Corporate Governance''. (SAGE Publications Ltd., 2012 {{ISBN|9781412929806}}), p. 431. "The EIC first issued permanent shares in 1657 (Harris, 2005: 45)."</ref>

By the early 1800s, [[Place:London|London]] acted as a center of corporate finance for companies around the world, which innovated new forms of lending and investment; see {{slink|City of London#Economy}}. 
The twentieth century brought the rise of [[Philosophy:Managerialism#Economic|managerial capitalism]] and common stock finance, with [[Finance:Share capital|share capital]] raised through [[Finance:Initial public offering|listings]], in preference to other [[Finance:Capital structure|sources of capital]].

Modern corporate finance, alongside [[Social:Investment management|investment management]], developed in the second half of the 20th century, particularly driven by innovations in theory and practice in the United States and Britain.<ref>{{Cite book|url=https://books.google.com/books?id=qgAnuSzVHKkC&pg=PP1|title=A History of Corporate Finance|last1=Baskin|first1=Jonathan|last2=Baskin|first2=Jonathan Barron|last3=Miranti|first3=Paul J. Jr.|date=1999-12-28|publisher=Cambridge University Press|isbn=9780521655361|language=en}}</ref><ref>{{Cite journal|last1=Smith|first1=Clifford W.|last2=Jensen|first2=Michael C.|date=2000-09-29|title=The Theory of Corporate Finance: A Historical Overview|language=en|location=Rochester, NY|ssrn=244161}}</ref><ref name="Cassis 20062">{{Cite book|url=https://books.google.com/books?id=geEzo9s9QbUC&pg=PA75|title=Capitals of Capital: A History of International Financial Centres, 1780–2005|author=Cassis, Youssef|publisher=Cambridge University Press|year=2006|isbn=978-0-511-33522-8|location=Cambridge, UK|pages=1; 74–5}}</ref><ref>{{cite book|url=https://books.google.com/books?id=fPugmGG-ircC&pg=PT149|title=The Global Securities Market: A History|last1=Michie|first1=Ranald|date=2006|publisher=OUP Oxford|isbn=0191608599|pages=149}}</ref><ref name="Cameron & Bovykin 19913">{{Cite book|url=https://books.google.com/books?id=ItqhNQusviAC&pg=PA13|title=International Banking: 1870–1914|publisher=Oxford University Press|year=1991|isbn=978-0-19-506271-7|editor=Cameron, Rondo|location=New York, NY|pages=13|editor2=Bovykin, V.I.}}</ref><ref name="Roberts2008">{{cite book|url=https://books.google.com/books?id=J0vl6CltQjEC&q=the%20city%20richard%20roberts&pg=PA2|title=The City: A Guide to London's Global Financial Centre|last=Roberts|first=Richard|publisher=Economist|year=2008|isbn=9781861978585|pages=6; 12–13; 88–89}}</ref>
Here, see the later sections of History of banking in the United States and of [[Finance:History of private equity and venture capital|History of private equity and venture capital]].

==Outline==
The primary goal of financial management is to maximize or to continually increase shareholder value.<ref name="McMenamin2002">{{cite book|author=Jim McMenamin|title=Financial Management: An Introduction|url=https://books.google.com/books?id=stnjJx-sPjUC&pg=PA23|date=11 September 2002|publisher=Routledge|isbn=978-1-134-67624-8|pages=23–}}</ref> Maximizing shareholder value requires managers to be able to balance capital funding between investments in [[Social:Project|"projects"]] that increase the firm's long term profitability and sustainability, along with paying excess cash in the form of dividends to shareholders. Managers of growth companies (i.e. firms that earn high rates of return on invested capital) will use most of the firm's capital resources and surplus cash on investments and projects so the company can continue to expand its business operations into the future. When companies reach maturity levels within their industry (i.e. companies that earn approximately average or lower returns on invested capital), managers of these companies will use surplus cash to payout dividends to shareholders. Managers must do an analysis to determine the appropriate allocation of the firm's capital resources and cash surplus between projects and payouts of dividends to shareholders, as well as paying back creditor related debt.<ref name="McMenamin2002" /><ref name="CorreiaFlynn2007">{{cite book|author1=Carlos Correia|author2=David K. Flynn|author3=Enrico Uliana|author4=Michael Wormald|title=Financial Management|url=https://books.google.com/books?id=yClNbKM7hScC&pg=SA5-PA6|date=15 January 2007|publisher=Juta and Company Ltd|isbn=978-0-7021-7157-4|pages=5–}}</ref>

Choosing between investment projects will thus be based upon several inter-related criteria. (1) 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 in consideration of risk. (2) These projects must also be financed appropriately. (3) If no growth is possible by the company and excess cash surplus is not needed to the firm, then financial theory suggests that management should return some or all of the excess cash to shareholders (i.e., distribution via dividends).<ref>{{cite book|title=Financial Management; Principles and Practice|url=https://books.google.com/books?id=sSzpPWDSapoC&pg=PA265|year=1968|publisher=Freeload Press, Inc.|isbn=978-1-930789-02-9|pages=265–}}</ref>

This "[[Finance:Capital budgeting|capital budgeting]]" is the planning of value-adding, long-term corporate financial projects relating to investments funded through and affecting the firm's [[Finance:Capital structure|capital structure]].  Management must allocate the firm's limited resources between competing opportunities (projects).<ref>See: [http://www.duke.edu/~charvey/Classes/ba350_1997/vcf2/vcf2.htm Investment Decisions and Capital Budgeting], Prof. Campbell R. Harvey; [http://www.bus.lsu.edu/academics/finance/faculty/dchance/Instructional/FinancialManagementDecisions.ppt#257,2,Slide The Investment Decision of the Corporation] {{Webarchive|url=https://web.archive.org/web/20121012234632/http://www.duke.edu/~charvey/Classes/ba350_1997/vcf2/vcf2.htm#257,2,Slide |date=2012-10-12 }}, Prof. Don M. Chance</ref>

Capital budgeting is also concerned with the setting of criteria about which projects should receive investment funding to increase the value of the firm, and whether to finance that investment with equity or debt capital.<ref>Myers, Stewart C. "Interactions of corporate financing and investment decisions—implications for capital budgeting." The Journal of finance 29.1 (1974): 1-25.</ref> Investments should be made on the basis of value-added to the future of the corporation. Projects that increase a firm's value may include a wide variety of different types of investments, including but not limited to, expansion policies, or [[Social:Mergers and acquisitions|mergers and acquisitions]]. When no growth or expansion is possible by a corporation and excess cash surplus exists and is not needed, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program.<ref name="PetersonFabozzi2004">{{cite book|author1=Pamela P. Peterson|author2=Frank J. Fabozzi|title=Capital Budgeting: Theory and Practice|url=https://books.google.com/books?id=eW_rmXkRDg0C|date=4 February 2004|publisher=John Wiley & Sons|isbn=978-0-471-44642-2}}</ref><ref name="GitmanJoehnk1985">{{cite book|author1=Lawrence J. Gitman|author2=Michael D. Joehnk|author3=George E. Pinches|title=Managerial finance|url=https://archive.org/details/managerialfinanc00gitm|url-access=registration|year=1985|publisher=Harper & Row|isbn=9780060423360}}</ref>

A long-standing debate in corporate finance has focused on whether maximizing ''shareholder'' value or ''[[Social:Stakeholder (corporate)|stakeholder]]'' value should be the primary focus of corporate managers, with stakeholders widely interpreted to refer to shareholders, employees, suppliers and the local community.<ref>{{Cite journal |last=Smith |first=H. Jeff |date=2003-07-15 |title=The Shareholders vs. Stakeholders Debate |url=https://sloanreview.mit.edu/article/the-shareholders-vs-stakeholders-debate/ |journal=MIT Sloan Management Review |language=en-US}}</ref> In 2019, the Business Roundtable released a statement, signed by 181 prominent U.S. CEOs, which committed to lead their companies for "the benefit of all stakeholders".<ref>{{Cite web |last= |first= |last2= |first2= |title=Business Roundtable Redefines the Purpose of a Corporation to Promote 'An Economy That Serves All Americans' |url=https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans |access-date=2023-04-17 |website=www.businessroundtable.org |language=en}}</ref> Despite intense debate and recent momentum for the stakeholder theory, shareholder theory still dominates corporate world strategy.<ref>{{Cite journal |last1=Chuma |first1=Casius |last2=Qutieshat |first2=Abubaker |date=2023-03-30 |title=Where Does the Value of A Corporation Lie? A Literature Review |url=http://193.204.40.129/index.php/ea/article/view/2168 |journal=Economia Aziendale Online  |language=en |volume=14 |issue=1 |pages=15–32 |doi=10.13132/2038-5498/14.1.15-32 |issn=2038-5498}}</ref>
<!--  these topics are too specific for a corporate finance article
===Return on investment===
Return on investment is the concept of an investment in some resource or asset yielding an upward growth [[Finance:Market trend|trend]] or [[Finance:Capital appreciation|appreciation]] in value to the investor.  In purely economic terms, ROI is used to measure the profits gained in comparison to the capital invested.  ROI is a broad method for investment valuation, and may be employed using different valuation approaches.  One method is to compare the investment value and its [[Finance:Opportunity cost|opportunity cost]] to other forms of investments available (this method is generally known in finance as the cost of capital).  Alternative methods may include a cost-benefit analysis of the future profits from the investment.

===Leveraged buyout===
A [[Finance:Leveraged buyout|leveraged buyout]] is when a company or single asset (e.g., a real estate property) is purchased with a combination of equity, plus, significant amounts of borrowed money (debt heavy capital structure) – structured in such a way that the target's cash flows or assets are used as the collateral (or, "leverage") to secure and repay the money borrowed to purchase the target-company/asset. Since the debt (be it [[Finance:Senior debt|senior]] or [[Finance:Mezzanine capital|mezzanine]]) has a lower [[Finance:Cost of capital|cost of capital]] (until [[Finance:Bankruptcy|bankruptcy]] risk reaches a level threatening to the lender[s]), than the equity, the returns on the equity increase as the amount of borrowed money does – until the perfect [[Finance:Capital structure|capital structure]] is reached. As a result, the debt effectively serves as a ''lever'' to increase returns-on-investment.

LBOs are a very common occurrence in today's "Mergers and Acquisitions" (M&A) environment. The term LBO is usually employed when a [[Finance:Financial sponsor|financial sponsor]] acquires a company. However, many corporate transactions are partially funded by bank debt, thus effectively also representing an LBO. LBOs can have many different forms such as Management Buy-out (MBO), Management Buy-in (MBI), secondary [[Finance:Buyout|buyout]] and tertiary buyout, among others, and can occur in growth situations, restructuring situations and insolvencies. LBOs mostly occur in private companies, but can also be employed with public companies (in a so-called PtP transaction – Public to Private).

As [[Finance:Financial sponsor|financial sponsor]]s increase their returns by employing a very high leverage (i.e., a high [[Finance:Debt-to-equity ratio|ratio of debt to equity]]), they have an incentive to employ as much debt as possible to finance an acquisition. This has in many cases led to situations, in which companies were "overlevered", meaning that they did not generate sufficient cash flows to service their debt, which in turn led to insolvency or to debt-to-equity swaps in which the equity owners lose control over the business and the debt providers assume the equity.{{citation needed|date=July 2013}}


===Consumption of fixed capital===
{{Main|Finance:Consumption of fixed capital}}
Consumption of fixed capital (CFC) is a term used in business accounts, tax assessments and national accounts for depreciation of fixed assets. CFC is used in preference to "depreciation" to emphasize that fixed capital is used up in the process of generating new output, and because unlike depreciation it is not valued at historic cost but at current market value (so-called "economic depreciation"); CFC may also include other expenses incurred in using or installing fixed assets beyond actual depreciation charges. Normally the term applies only to producing enterprises, but sometimes it applies also to real estate assets.
CFC refers to a depreciation charge (or "write-off") against the gross income of a producing enterprise, which reflects the decline in value of fixed capital being operated with. Fixed assets will decline in value after they are purchased for use in production, due to wear and tear, changed market valuation and possibly market obsolescence. Thus, CFC represents a compensation for the loss of value of fixed assets to an enterprise.

===Growth Stock===
{{Main|Finance:Growth stock}}
A growth stock is a stock of a company that generates substantial and sustainable positive cash flow and whose revenues and earnings are expected to increase at a faster rate than the average company within the same industry.<ref>{{cite web | url = http://www.investingdaily.com/glp/32175/investing-in-growth-stocks-top-momentum-stocks-to-own-now.html | title= Top Growth Stocks | publisher = InvestingDaily.com | access-date = 2010-06-03}}</ref> A growth company typically has some sort of competitive advantage (a new product, a breakthrough patent, overseas expansion) that allows it to fend off competitors. Growth stocks usually pay smaller dividends, as the company typically reinvests retained earnings in capital projects.

===Efficient-market hypothesis===

The efficient-market hypothesis (EMH), or the joint hypothesis problem, asserts that financial markets are "informationally efficient". In consequence of this, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.
There are three major versions of the hypothesis: "weak", "semi-strong", and "strong". The weak form of the EMH claims that prices on traded assets (e.g., stocks, bonds, or property) already reflect all past publicly available information. The semi-strong form of the EMH claims both that prices reflect all publicly available information and that prices instantly change to reflect new public information. The strong form of the EMH additionally claims that prices instantly reflect even hidden or "insider" information. Critics have blamed the belief in rational markets for much of the late-2000s financial crisis.<ref>{{cite book | title=Myth of the Rational Market | last=Fox | first=Justin | year=2009 | publisher=Harper Business | isbn=0-06-059899-9}}</ref><ref name="nytimes.com">{{cite news |url=https://www.nytimes.com/2009/06/06/business/06nocera.html?scp=1&sq=efficient%20market&st=cse|title=Poking Holes in a Theory on Markets|work={{wipe|New York Times}} |access-date=8 June 2009 |date=5 June 2009 | first=Joe | last=Nocera}}</ref><ref name="washingtonpost.com">{{cite news |first=Roger |last=Lowenstein |url=http://www.washingtonpost.com/wp-dyn/content/article/2009/06/05/AR2009060502053.html |title=Book Review: 'The Myth of the Rational Market' by Justin Fox |work=Washington Post |access-date=5 August 2011 |date=7 June 2009}}</ref> In response, proponents of the hypothesis have stated that market efficiency does not mean having no uncertainty about the future, that market efficiency is a simplification of the world which may not always hold true, and that the market is practically efficient for investment purposes for most individuals.<ref>http://www.ifa.com/articles/2011/03/27/efficient-market-hypothesis/ {{Dead link|date=February 2022}}</ref>
-->

== Capital structure ==
{{Main|Finance:Capital structure}}
{{Further| Finance:Security}}
Achieving the goals of corporate finance requires that any corporate investment be financed appropriately.<ref>See: [http://www.bus.lsu.edu/academics/finance/faculty/dchance/Instructional/FinancialManagementDecisions.ppt#256,1,Slide The Financing Decision of the Corporation] {{Webarchive|url=https://web.archive.org/web/20121012234632/http://www.duke.edu/~charvey/Classes/ba350_1997/vcf2/vcf2.htm#256,1,Slide |date=2012-10-12 }}, Prof. Don M. Chance; [http://pages.stern.nyu.edu/~adamodar/pdfiles/ovhds/capstr.pdf Capital Structure], Prof. Aswath Damodaran</ref> The sources of financing are, generically, [[Finance:Internal financing|capital self-generated by the firm]] and capital from external funders, obtained by issuing new [[Finance:Corporate bond|debt]] and equity (and [[Finance:Hybrid security|hybrid-]] or [[Finance:Convertible security|convertible securities]]). However, as above, since both hurdle rate and cash flows (and hence the riskiness of the firm) will be affected, the financing mix will impact the valuation of the firm, and a considered decision is required here. See [[Finance:Balance sheet|Balance sheet]], [[Finance:Weighted average cost of capital|WACC]].
Finally, there is much theoretical discussion as to other considerations that management might weigh here.

=== Sources of capital ===
====Debt capital====
{{Further| Finance:Bankruptcy|Finance:Financial distress}}
Corporations may rely on borrowed funds (debt capital or credit) as sources of investment to sustain ongoing business operations or to fund future growth.  Debt comes in several forms, such as through bank loans, notes payable, or bonds issued to the public.  Bonds require the corporations to make regular [[Finance:Interest|interest]] payments (interest expenses) on the borrowed capital until the debt reaches its maturity date, therein the firm must pay back the obligation in full.  Debt payments can also be made in the form of sinking fund provisions, whereby the corporation pays annual installments of the borrowed debt above regular interest charges.  Corporations that issue callable bonds are entitled to pay back the obligation in full whenever the company feels it is in their best interest to pay off the debt payments.  If interest expenses cannot be made by the corporation through cash payments, the firm may also use [[Finance:Collateral|collateral]] assets as a form of repaying their debt obligations (or through the process of [[Finance:Liquidation|liquidation]]).

====Equity capital====
Corporations can alternatively sell shares of the company to investors to raise capital.  Investors, or shareholders, expect that there will be an upward trend in value of the company (or appreciate in value) over time to make their investment a profitable purchase.  Shareholder value is increased when corporations invest equity capital and other funds into projects (or investments) that earn a positive rate of return for the owners.  Investors prefer to buy shares of stock in companies that will consistently earn a positive rate of return on capital in the future, thus increasing the market value of the stock of that corporation.  Shareholder value may also be increased when corporations payout excess cash surplus (funds from retained earnings that are not needed for business) in the form of dividends.

====Preferred stock====
Preferred stock is an equity security which may have any combination of features not possessed by common stock including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. Preferreds are senior (i.e. higher ranking) to [[Finance:Common stock|common stock]], but subordinate to [[Finance:Corporate bond|bonds]] in terms of claim (or rights to their share of the assets of the company).<ref>Drinkard, T., A Primer On Preferred Stocks., [http://www.investopedia.com/articles/stocks/06/preferredstock.asp?viewed=1 Investopedia]</ref>

Preferred stock usually carries no voting rights,<ref>"Preferred Stock ... generally carries no voting rights unless scheduled dividends have been omitted." – [http://www.quantumonline.com/glossary.cfm Quantum Online] {{Webarchive|url=https://web.archive.org/web/20120623022006/http://www.quantumonline.com/glossary.cfm |date=2012-06-23 }}</ref> but may carry a [[Finance:Dividend|dividend]] and may have priority over common stock in the payment of dividends and upon [[Finance:Liquidation|liquidation]]. Terms of the preferred stock are stated in a "Certificate of Designation".

Similar to bonds, preferred stocks are rated by the major credit-rating companies. The rating for preferreds is generally lower, since preferred dividends do not carry the same guarantees as interest payments from bonds and they are junior to all creditors.<ref>Drinkard, T.</ref>

Preferred stock is a special class of shares which may have any combination of features not possessed by common stock.
The following features are usually associated with preferred stock:<ref name="Weygandt2007p738">{{Cite book |last1=Kieso |first1=Donald E. |last2=Weygandt |first2=Jerry J. |name-list-style=amp |last3=Warfield |first3=Terry D. |year=2007 |title=Intermediate Accounting |edition=12th |publisher=John Wiley & Sons |location=New York |isbn=978-0-471-74955-4 |page=738 }}.</ref>
* Preference in dividends
* Preference in assets, in the event of liquidation
* Convertibility to common stock.
* Callability, at the option of the corporation
* Nonvoting

===Capitalization structure===<!-- This section is linked from List of finance topics -->
[[File:2005private sector credit.PNG|thumb|350px|right|Domestic credit to private sector in 2005]]
As mentioned, the financing mix will impact the valuation of the firm: there are then two interrelated considerations here:
* Management must identify the "optimal mix" of financing – the capital structure that results in maximum firm value,<ref>[http://www.qfinance.com/mergers-and-acquisitions-best-practice/capital-structure-implications?full Capital Structure: Implications] {{Webarchive|url=https://web.archive.org/web/20120121165857/http://www.qfinance.com/mergers-and-acquisitions-best-practice/capital-structure-implications?full |date=2012-01-21 }}, Prof. John C. Groth, Texas A&M University; [http://rdcohen.50megs.com/genOCS.pdf A Generalised Procedure for Locating the Optimal Capital Structure], Ruben D. Cohen, [[Company:Citigroup|Citigroup]]</ref> - but must also take other factors into account (see trade-off theory below). Financing a project through debt results in a liability or obligation that must be serviced, thus entailing cash flow implications independent of the project's degree of success. Equity financing is less risky with respect to cash flow commitments, but results in a [[Finance:Stock dilution|dilution]] of share ownership, control and earnings. The ''[[Finance:Cost of equity|cost of equity]]'' (see [[Finance:Capital asset pricing model|CAPM]] and [[Finance:Arbitrage pricing theory|APT]]) is also typically higher than the ''cost of debt'' - which is, additionally, a deductible expense – and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk.<ref>See:[http://www.lawyersclubindia.com/articles/Optimal-Balance-of-Financial-Instruments-Long-Term-Management-Market-Volatility-Proposed-Changes-3765.asp Optimal Balance of Financial Instruments: Long-Term Management, Market Volatility & Proposed Changes], Nishant Choudhary, LL.M. 2011 (Business & finance), George Washington University Law School</ref><ref>{{cite journal |title=New issues in corporate finance |journal=European Economic Review |date=1988 |first=Colin |last=Mayer |volume=32 |issue=5 |pages=1167-1183 |doi=10.1016/0014-2921(88)90077-3 |url=https://www.academia.edu/3384676/New_issues_in_corporate_finance}}</ref>
* Management must attempt to match the long-term financing mix to the [[Finance:Asset|asset]]s being financed as closely as possible, in terms of both timing and cash flows. Managing any potential asset liability mismatch or [[Social:Duration gap|duration gap]] entails matching the assets and liabilities respectively according to maturity pattern ("[[Cashflow matching|cashflow matching]]") or duration ("[[Finance:Immunization|immunization]]"); managing this relationship in the ''short-term'' is a major function of working capital management, as discussed below. Other techniques, such as [[Finance:Securitization|securitization]], or [[Finance:Hedge|hedging]] using [[Finance:Interest rate derivative|interest rate-]] or [[Finance:Credit derivative|credit derivative]]s, are also common. See: Asset liability management; [[Finance:Treasury management|Treasury management]]; [[Credit risk]]; [[Finance:Interest rate risk|Interest rate risk]].

===Related considerations===
Much of the theory here, falls under the umbrella of the Trade-Off Theory in which firms are assumed to trade-off the [[Finance:Tax benefits of debt|tax benefits of debt]] with the [[Finance:Bankruptcy costs of debt|bankruptcy costs of debt]] when choosing how to allocate the company's resources. However economists have developed a set of alternative theories about how managers allocate a corporation's finances.

One of the main alternative theories of how firms manage their capital funds is the Pecking Order Theory (Stewart Myers), which suggests that firms avoid [[Finance:External financing|external financing]] while they have [[Finance:Internal financing|internal financing]] available and avoid new equity financing while they can engage in new debt financing at reasonably low interest rates.

Also, the [[Finance:Capital structure substitution theory|capital structure substitution theory]] hypothesizes that management manipulates the capital structure such that [[Finance:Earnings per share|earnings per share]] (EPS) are maximized. 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.

One of the more recent innovations in this area from a theoretical point of view is the [[Finance:Market timing hypothesis|market timing hypothesis]]. This hypothesis, inspired by the behavioral finance literature, states that firms look for the cheaper type of financing regardless of their current levels of internal resources, debt and equity.

==Investment and project valuation==
In general,<ref>See: [http://pages.stern.nyu.edu/~adamodar/New_Home_Page/lectures/val.html Valuation], Prof. Aswath Damodaran; [http://www.duke.edu/~charvey/Classes/ba350_1997/vcf1/vcf1.htm Equity Valuation], Prof. Campbell R. Harvey</ref> each "[[Social:Project|project]]'s" value will be estimated using a [[Finance:Discounted cash flow|discounted cash flow]] (DCF) valuation, and the opportunity with the highest value, as measured by the resultant [[Finance:Net present value|net present value]] (NPV) will be selected (first applied in a corporate finance setting by Joel Dean in 1951). This requires estimating the size and timing of all of the ''incremental'' [[Finance:Cash flow|cash flow]]s resulting from the project. Such future cash flows are then [[Finance:Discounts and allowances|discounted]] to determine their ''[[Finance:Present value|present value]]'' (see [[Time value of money]]). These present values are then summed, and this sum net of the initial investment outlay is the [[Finance:Net present value|NPV]]. See {{slink|Financial modeling#Accounting}} for general discussion, and [[Finance:Valuation using discounted cash flows|Valuation using discounted cash flows]] for the mechanics, with discussion re modifications for corporate finance.

The NPV is greatly affected by the [[Finance:Discounted cash flow|discount rate]]. Thus, identifying the proper discount rate – often termed, the project "hurdle rate"<ref>See for example [http://biz.yahoo.com/f/g/hh.html Campbell R. Harvey's Hypertextual Finance Glossary] or [http://www.investopedia.com/terms/h/hurdlerate.asp investopedia.com]</ref> – is critical to choosing appropriate projects and investments for the firm. The hurdle rate is the minimum acceptable [[Finance:Return on investment|return]] on an investment – i.e., the [[Finance:Capital asset pricing model#Asset-specific required return|project appropriate discount rate]]. The hurdle rate should reflect the riskiness of the investment, typically measured by [[Finance:Volatility|volatility]] of cash flows, and must take into account the project-relevant financing mix.<ref>Prof. Aswath Damodaran: [http://people.stern.nyu.edu/adamodar/pdfiles/acf3E/presentations/hurdlerate.pdf Estimating Hurdle Rates]</ref> Managers use models such as the [[Finance:Capital asset pricing model|CAPM]] or the [[Finance:Arbitrage pricing theory|APT]] to estimate a discount rate appropriate for a particular project, and use the [[Finance:Weighted average cost of capital|weighted average cost of capital]] (WACC) to reflect the financing mix selected. (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; see {{slink|Capital budgeting#Ranked projects}}. These are visible from the DCF and include discounted payback period, [[Finance:Internal rate of return|IRR]], Modified IRR, equivalent annuity, [[Finance:Profitability index|capital efficiency]], and [[Finance:Return on investment|ROI]]. Alternatives (complements) to NPV, which more directly consider economic profit, include [[Finance:Residual income valuation|residual income valuation]], [[Finance:Market value added|MVA]] / [[Finance:Economic value added|EVA]] (Joel Stern, Stern Stewart & Co) and [[Finance:Adjusted present value|APV]] (Stewart Myers). With the cost of capital correctly and correspondingly adjusted, these valuations should yield the same result as the DCF. See also ''list of valuation topics''.

===Valuing flexibility===
In many cases, for example R&D projects, a project may open (or close) various paths of action to the company, but this reality will not (typically) be captured in a strict NPV approach.<ref>See: [http://realoptions.org/papers2002/SchockleyOptionNPV.pdf Real Options Analysis and the Assumptions of the NPV Rule], Tom Arnold & Richard Shockley</ref> Some analysts account for this uncertainty by adjusting the discount rate (e.g. by increasing the [[Finance:Cost of capital|cost of capital]]) or the cash flows (using certainty equivalents, or applying (subjective) "haircuts" to the forecast numbers; see [[Finance:Penalized present value|Penalized present value]]).<ref name="Damodaran2">Aswath Damodaran: [http://pages.stern.nyu.edu/~adamodar/pdfiles/valrisk/ch5.pdf Risk Adjusted Value]; Ch 5 in ''Strategic Risk Taking: A Framework for Risk Management''. [[Company:Wharton School Publishing|Wharton School Publishing]], 2007. {{ISBN|0-13-199048-9}}</ref><ref name="SiegelShim1997">See: §32 "Certainty Equivalent Approach" & §165 "Risk Adjusted Discount Rate" in: {{cite book|author1=Joel G. Siegel|author2=Jae K. Shim|author3=Stephen Hartman|title=Schaum's quick guide to business formulas: 201 decision-making tools for business, finance, and accounting students|url=https://archive.org/details/schaumsquickguid00sieg|url-access=registration|access-date=12 November 2011|date=1 November 1997|publisher=McGraw-Hill Professional|isbn=978-0-07-058031-2}}</ref> Even when employed, however, these latter methods do not normally properly account for changes in risk over the project's lifecycle and hence fail to appropriately adapt the risk adjustment.<ref>Michael C. Ehrhardt and John M. Wachowicz, Jr (2006). [http://www.financialdecisionsonline.org/current/EhrhardtWachowicz.pdf Capital Budgeting and Initial Cash Outlay (ICO) Uncertainty]. ''Financial Decisions'', Summer 2006, Article 2</ref><ref name="Latimore">Dan Latimore: [http://www-935.ibm.com/services/uk/igs/pdf/esr-calculating-value-during-uncertainty.pdf ''Calculating value during uncertainty'']. IBM Institute for Business Value</ref>  Management will therefore (sometimes) employ tools which place an explicit value on these options. So, whereas in a DCF valuation the [[Expected value|most likely]] or average or [[Scenario planning|scenario specific]] cash flows are discounted, here the "flexible and staged nature" of the investment is [[Mathematical model|modelled]], and hence "all" potential [[Finance:Moneyness|payoffs]] are considered. See [[Finance:Real options valuation#Applicability of standard techniques|further]] under [[Finance:Real options valuation|Real options valuation]]. The difference between the two valuations is the "value of flexibility" inherent in the project.

The two most common tools are [[Decision tree|Decision Tree Analysis]] (DTA)<ref name="Shim & Siegel"/> and [[Finance:Real options valuation|real options valuation]] (ROV);<ref>See:[http://faculty.fuqua.duke.edu/~charvey/Teaching/BA456_2002/Identifying_real_options.htm Identifying real options], Prof. Campbell R. Harvey; [http://pages.stern.nyu.edu/~adamodar/New_Home_Page/lectures/opt.html Applications of option pricing theory to equity valuation], Prof. Aswath Damodaran; [http://www.expectationsinvesting.com/tutorial11.shtml How Do You Assess The Value of A Company's "Real Options"?] {{Webarchive|url=https://web.archive.org/web/20191020222316/http://www.expectationsinvesting.com/tutorial11.shtml |date=2019-10-20 }}, Prof. Alfred Rappaport [[Organization:Columbia University|Columbia University]] & Michael Mauboussin</ref> they may often be used interchangeably:

* DTA values flexibility by incorporating ''[[Event (probability theory)|possible events]]'' (or [[Finance:State prices|states]]) and consequent ''management decisions''. (For example, a company would build a factory given that demand for its product exceeded a certain level during the pilot-phase, and outsource production otherwise. In turn, given further demand, it would similarly expand the factory, and maintain it otherwise. In a DCF model, by contrast, there is no "branching" – each scenario must be modelled separately.) In the [[Decision tree|decision tree]], each management decision in response to an "event" generates a "branch" or "path" which the company could follow; the probabilities of each event are determined or specified by management. Once the tree is constructed: (1) "all" possible events and their resultant paths are visible to management; (2) given this "knowledge" of the events that could follow, and assuming [[Optimal decision|rational decision making]], management chooses the branches (i.e. actions) corresponding to the highest value path [[Probability|probability weighted]]; (3) this path is then taken as representative of project value. See {{slink|Decision theory#Choice under uncertainty}}.
* ROV is usually used when the value of a project is ''[[Finance:Contingent claim valuation|contingent]]'' on the ''[[Finance:Value (economics)|value]]'' of some other asset or [[Finance:Underlying|underlying variable]]. (For example, the [[Earth:Economic geology|viability]] of a mining project is contingent on the price of [[Chemistry:Gold|gold]]; if the price is too low, management will abandon the mining rights, if sufficiently high, management will develop the [[Earth:Ore|ore body]]. Again, a DCF valuation would capture only one of these outcomes.) Here: (1) using [[Finance:Option|financial option theory]] as a framework, the decision to be taken is identified as corresponding to either a [[Finance:Call option|call option]] or a [[Finance:Put option|put option]]; (2) an appropriate valuation technique is then employed – usually a variant on the binomial options model or a bespoke [[Finance:Monte Carlo methods in finance|simulation model]], while [[Black–Scholes model|Black–Scholes]] type formulae are used less often; see [[Finance:Contingent claim valuation|Contingent claim valuation]]. (3) The "true" value of the project is then the NPV of the "most likely" scenario plus the option value. (Real options in corporate finance were first discussed by Stewart Myers in 1977; viewing corporate strategy as a series of options was originally per Timothy Luehrman, in the late 1990s.)  See also [[Finance:Business valuation#Option pricing approaches|§ Option pricing approaches]] under [[Finance:Business valuation|Business valuation]].

===Quantifying uncertainty===
Given the [[Physics:Uncertainty|uncertainty]] inherent in project forecasting and valuation,
<ref name="Shim & Siegel">"Capital Budgeting Under Risk". Ch.9 in [https://books.google.com/books?id=_lnmxnhoAUEC&q=related:ISBN0070580316 Schaum's outline of theory and problems of financial management], Jae K. Shim and Joel G. Siegel.</ref>
<ref name="Damodaran_Risk">[http://www.stern.nyu.edu/~adamodar/pdfiles/papers/probabilistic.pdf Probabilistic Approaches: Scenario Analysis, Decision Trees and Simulations], Prof. Aswath Damodaran</ref>
<ref>[https://www.coursesidekick.com/finance/study-guides/boundless-finance/scenario-and-simulation-assessments The Role of Risk in Capital Budgeting - Scenario and Simulation Assessments], Boundless Finance</ref>

Using a related technique, analysts also run [[Scenario planning|scenario based]] forecasts of NPV. Here, a scenario comprises a particular outcome for economy-wide, "global" factors ([[Finance:Demand|demand for the product]], [[Finance:Exchange rate|exchange rate]]s, [[Finance:Commodity|commodity prices]], etc.) ''as well as'' for company-specific factors ([[Finance:Unit cost|unit cost]]s, etc.). As an example, the analyst may specify various revenue growth scenarios (e.g. -5% for "Worst Case", +5% for "Likely Case" and +15% for "Best Case"), where all key inputs are adjusted so as to be consistent with the growth assumptions, and calculate the NPV for each. Note that for scenario based analysis, the various combinations of inputs must be ''internally consistent'' (see [[Finance:Financial modeling#Accounting|discussion]] at [[Finance:Financial modeling|Financial modeling]]), whereas for the sensitivity approach these need not be so.  An application of this methodology is to determine an "[[Bias of an estimator|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; see [[Finance:First Chicago Method|First Chicago Method]]. (See also [[Finance:RNPV|rNPV]], where cash flows, as opposed to scenarios, are probability-weighted.)

A further advancement which "overcomes the limitations of sensitivity and scenario analyses by examining the effects of all possible combinations of variables and their realizations"<ref name="ClarkReedStephan ">Virginia Clark, Margaret Reed, Jens Stephan (2010). [http://findarticles.com/p/articles/mi_m0OOL/is_1_12/ai_n57086241/ Using Monte Carlo simulation for a capital budgeting project], Management Accounting Quarterly, Fall, 2010</ref> is to construct [[Stochastic|stochastic]]<ref name="Shimko">See David Shimko (2009). [https://web.archive.org/web/20100717072252/http://www.qfinance.com/financial-risk-management-best-practice/quantifying-corporate-financial-risk?full Quantifying Corporate Financial Risk]. archived 2010-07-17.</ref> or probabilistic financial models – as opposed to the traditional static and deterministic models as above.<ref name="Damodaran_Risk"/> For this purpose, the most common method is to use Monte Carlo simulation to analyze the project's NPV. This method was introduced to finance by [[Biography:David B. Hertz|David B. Hertz]] in 1964, although it has only recently become common: today analysts are even able to run simulations in [[Engineering:Spreadsheet|spreadsheet]] based DCF models, typically using a risk-analysis add-in, such as ''@Risk'' or ''Crystal Ball''. Here, the cash flow components that are (heavily) impacted by uncertainty are simulated, mathematically reflecting their "random characteristics". In contrast to the scenario approach above, the simulation produces several ''thousand'' random but possible outcomes, or trials, "covering all conceivable real world contingencies in proportion to their likelihood;"<ref name="savage">[http://www.analycorp.com/uncertainty/flawarticle.htm The Flaw of Averages] {{webarchive|url=https://web.archive.org/web/20111207025740/http://www.analycorp.com/uncertainty/flawarticle.htm |date=2011-12-07 }}, Prof. Sam Savage, [[Organization:Stanford University|Stanford University]].</ref> see [[Monte Carlo method#Monte Carlo simulation versus "what if" scenarios|Monte Carlo Simulation versus "What If" Scenarios]]. The output is then a [[Histogram|histogram]] of project NPV, and the average NPV of the potential investment – as well as its [[Finance:Volatility|volatility]] and other sensitivities – is then observed. This histogram provides information not visible from the static DCF: for example, it allows for an estimate of the probability that a project has a net present value greater than zero (or any other value).

Continuing the above example: instead of assigning three discrete values to revenue growth, and to the other relevant variables, the analyst would assign an appropriate [[Probability distribution|probability distribution]] to each variable (commonly [[Triangular distribution|triangular]] or [[Beta distribution|beta]]), and, where possible, specify the observed or supposed [[Correlation|correlation]] between the variables. These distributions would then be "sampled" repeatedly – [[Cholesky decomposition#Monte Carlo simulation|incorporating this correlation]] – so as to generate several thousand random but possible scenarios, with corresponding valuations, which are then used to generate the NPV histogram. The resultant statistics ([[Average|average]] NPV and [[Standard deviation|standard deviation]] of NPV) will be a more accurate mirror of the project's "randomness" than the variance observed under the scenario based approach. These are often used as estimates of the [[Finance:Underlying|underlying]] "spot price" and volatility for the real option valuation as above; see {{slink|Real options valuation#Valuation inputs}}. A more robust Monte Carlo model would include the possible occurrence of risk events (e.g., a [[Finance:Credit crunch|credit crunch]]) that drive variations in one or more of the DCF model inputs.

==Dividend policy==
{{Main|Finance:Dividend policy}}
Dividend policy is concerned with financial policies regarding the payment of a cash dividend in the present or paying an increased dividend at a later stage.  Whether <ref>Claire Boyte-White  (2023). [https://www.investopedia.com/articles/investing/101215/4-reasons-company-might-suspend-its-dividend.asp 4 Reasons a Company Might Suspend Its Dividend], [[Investopedia]]</ref> to issue dividends,<ref>See [http://pages.stern.nyu.edu/~adamodar/pdfiles/ovhds/divid.pdf Dividend Policy], Prof. Aswath Damodaran</ref> and what amount, is determined mainly on the basis of the company's unappropriated [[Finance:Profit (accounting)|profit]] (excess cash) and influenced by the company's long-term earning power. When cash surplus exists and is not needed by the firm, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program.

If there are no NPV positive opportunities, i.e. projects where [[Finance:Return on investment|returns]] exceed the hurdle rate, and excess cash surplus is not needed, then – finance theory suggests – management should return some or all of the excess cash to shareholders as dividends. This is the general case, however there are exceptions. For example, shareholders of a "[[Finance:Growth stock|growth stock]]", expect that the company will, almost by definition, retain most of the excess cash surplus so as to fund future projects internally to help increase the value of the firm.

Management must also choose the ''form'' of the dividend distribution, as stated, generally as cash [[Finance:Dividend|dividend]]s or via a [[Finance:Treasury stock|share buyback]]. Various factors may be taken into consideration: where shareholders must pay [[Finance:Dividend tax|tax on dividends]], firms may elect to retain earnings or to perform a stock buyback, in both cases increasing the value of shares outstanding. Alternatively, some companies will pay "dividends" from [[Finance:Treasury stock|stock]] rather than in cash; see [[Finance:Corporate action|Corporate action]].  Financial theory suggests that the dividend policy should be set based upon the type of company and what management determines is the best use of those dividend resources for the firm to its shareholders.

As a general rule, then, shareholders of [[Finance:Growth stock|growth companies]] would prefer managers to retain earnings and pay no dividends (use excess cash to reinvest into the company's operations), whereas shareholders of value- or secondary stocks would prefer the management of these companies to payout surplus earnings in the form of cash dividends when a positive return cannot be earned through the reinvestment of undistributed earnings.  A share buyback program may be accepted when the value of the stock is greater than the returns to be realized from the reinvestment of undistributed profits.  In all instances, the appropriate dividend policy is usually directed by that which maximizes long-term shareholder value.

==Working capital management==<!-- This section is linked from List of finance topics -->
{{Main|Finance:Working capital}}
Managing the corporation's [[Finance:Working capital|working capital]] position to sustain ongoing business operations is referred to as ''working capital management''.<ref>See [http://www.studyfinance.com/lessons/workcap/index.mv Working Capital Management] {{Webarchive|url=https://web.archive.org/web/20041107091859/http://www.studyfinance.com/lessons/workcap/index.mv |date=2004-11-07 }}, Studyfinance.com; [http://www.treasury.govt.nz/publicsector/workingcapital/chap2.asp Working Capital Management] {{webarchive|url=https://web.archive.org/web/20071017004224/http://treasury.govt.nz/publicsector/workingcapital/chap2.asp |date=2007-10-17 }}, treasury.govt.nz</ref><ref name="BuchmannJung"/> These involve managing the relationship between a firm's [[Finance:Asset#Current assets|short-term assets]] and its short-term liabilities.

In general this is as follows: As above, the goal of Corporate Finance is the maximization of firm value. In the context of long term, capital budgeting, firm value is enhanced through appropriately selecting and funding NPV positive investments. These investments, in turn, have implications in terms of cash flow and [[Finance:Cost of capital|cost of capital]].
The goal of Working Capital (i.e. short term) management is therefore to ensure that the firm is able to [[Social:Operations management|operate]], and that it has sufficient cash flow to service long-term debt, and to satisfy both maturing [[Finance:Money market|short-term debt]] and upcoming operational expenses. In so doing, firm value is enhanced when, and if, the [[Finance:Return on capital|return on capital]] exceeds the cost of capital; See [[Finance:Economic value added|Economic value added]] (EVA).  Managing short term finance and long term finance is one task of a modern CFO.

===Working capital===
Working capital is the amount of funds that are necessary for an organization to continue its ongoing business operations, until the firm is reimbursed through payments for the goods or services it has delivered to its customers.<ref>Security Analysis, Benjamin Graham and David Dodd</ref>  Working capital is measured through the difference between resources in cash or readily convertible into cash (Current Assets), and cash requirements (Current Liabilities). As a result, capital resource allocations relating to working capital are always current, i.e. short-term.

In addition to [[Finance:Time horizon|time horizon]], working capital management differs from capital budgeting in terms of [[Time value of money|discounting]] and profitability considerations; decisions here are also "reversible" to a much larger extent. (Considerations as to [[Risk appetite|risk appetite]] and return targets remain identical, although some constraints – such as those imposed by [[Finance:Loan covenant|loan covenant]]s – may be more relevant here).

The (short term) goals of working capital are therefore not approached on the same basis as (long term) profitability, and working capital management applies different criteria in allocating resources: the main considerations are (1) cash flow / liquidity and (2) profitability / return on capital (of which cash flow is probably the most important).
* The most widely used measure of cash flow is the net operating cycle, or [[Finance:Cash conversion cycle|cash conversion cycle]]. This represents the time difference between cash payment for raw materials and cash collection for sales. The 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. (Another measure is gross operating cycle which is the same as net operating cycle except that it does not take into account the creditors deferral period.)
* In this context, the most useful measure of profitability is [[Finance:Return on capital|return on capital]] (ROC). The result is shown as a percentage, determined by dividing relevant income for the 12 months by capital employed; [[Finance:Return on equity|return on equity]] (ROE) shows this result for the firm's shareholders. As above, firm value is enhanced when, and if, the return on capital exceeds the [[Finance:Cost of capital|cost of capital]].

===Management of working capital===
Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital.<ref>See [http://www.bus.lsu.edu/academics/finance/faculty/dchance/Instructional/PrinciplesofFinancialManagement.htm The 20 Principles of Financial Management] {{Webarchive|url=https://archive.today/20120731063449/http://www.bus.lsu.edu/academics/finance/faculty/dchance/Instructional/PrinciplesofFinancialManagement.htm |date=2012-07-31 }}, Prof. Don M. Chance, [[Organization:Louisiana State University|Louisiana State University]]</ref> These policies aim at managing the [[Finance:Asset#Current assets|''current assets'']] (generally cash and cash equivalents, [[Social:Inventory|inventories]] and [[Finance:Debtor|debtor]]s) and the short term financing, such that cash flows and returns are acceptable.<ref name="BuchmannJung">[http://www.qfinance.com/contentFiles/QF02/hbmpf5qp/12/0/best-practice-working-capital-management-techniques-for-optimizing-inventories-receivables-and-payables.pdf Best-Practice Working Capital Management: Techniques for Optimizing Inventories, Receivables, and Payables] {{Webarchive|url=https://web.archive.org/web/20140201174839/http://www.qfinance.com/contentFiles/QF02/hbmpf5qp/12/0/best-practice-working-capital-management-techniques-for-optimizing-inventories-receivables-and-payables.pdf |date=2014-02-01 }}, Patrick Buchmann and Udo Jung</ref>
* '''[[Finance:Cash management|Cash management]]'''. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.
* '''[[Finance:Inventory theory|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 discussion under [[Finance:Inventory optimization|Inventory optimization]] and [[Social:Supply chain management|Supply chain management]]. Note that "inventory" is usually the realm of [[Social:Operations management|operations management]]: given the potential impact on cash flow, and on the balance sheet in general, finance typically "gets involved in an oversight or policing way".<ref name = "Lasher">William Lasher (2010). Practical Financial Management. South-Western College Pub; 6 ed. {{ISBN|1-4390-8050-X}}</ref>{{rp|714}}  
* '''Debtors management'''. There are two inter-related roles here:  (1) Identify the appropriate credit policy, i.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 [[Finance:Discounts and allowances|Discounts and allowances]].  (2) Implement appropriate credit scoring policies and techniques such that the risk of default on any new business is acceptable given these criteria.
* '''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 [[Finance:Loan|loan]] (or overdraft), or to "convert debtors to cash" through "factoring"; see generally, [[Finance:Trade finance|trade finance]].

==Relationship with other areas in finance==

===Investment banking===
{{see|Investment banking #Corporate finance}}
Use of the term "corporate finance" varies considerably across the world. In the {{wipe|United States}} it is used, as above, to describe activities, analytical methods and techniques that deal with many aspects of a company's finances and capital. In the {{wipe|United Kingdom}} and [[Organization:Commonwealth of Nations|Commonwealth]] countries, the terms "corporate finance" and "corporate financier" tend to be associated with [[Finance:Investment banking|investment banking]] – i.e. with transactions in which capital is raised for the corporation or shareholders; the services themselves are often referred to as advisory, financial advisory, deal advisory and transaction advisory services.<ref>Shaun Beaney, Katerina Joannou and David Petrie [http://www.icaew.com/en/technical/corporate-finance/corporate-finance-faculty/what-is-corporate-finance-122299 What is Corporate Finance?], Corporate Finance Faculty, ICAEW, April 2005 (revised January 2011 and September 2020)</ref> See under {{slink|Investment banking#Corporate finance}} for a listing of the various transaction-types here, and {{slink|Financial analyst#Investment Banking}} for a description of the role.

===Financial risk management===
{| class="wikitable floatright" | width="250"
|- style="text-align:center;"
| Concerns
|-
|
*[[Credit risk]]
*[[Finance:Default|Default]]
*[[Finance:Financial risk|Financial risk]]
*[[Finance:Interest rate risk|Interest rate risk]]
*[[Finance:Insurance|Insurance]]
*[[Finance:Liquidity risk|Liquidity risk]]
*Operational risk
*[[Finance:Settlement risk|Settlement risk]]
*Value at Risk
*[[Finance:Volatility risk|Volatility risk]]
|}

[[Finance:Financial risk management|Financial risk management]], <ref name="Shimko"/><ref name= "Hampton"/> generically, is focused on measuring and managing  [[Market risk|market risk]], [[Credit risk|credit risk]] and operational risk.
Within corporates, <ref name= "Hampton">John Hampton (2011). ''The AMA Handbook of Financial Risk Management''. American Management Association. {{ISBN|978-0814417447}}</ref> the scope is broadened to overlap [[Enterprise risk management|enterprise risk management]], 
and then addresses risks to the firm's overall [[Strategic management|strategic objectives]],
focusing on the financial exposures and opportunities arising from business decisions, and their link to the firm’s [[Risk appetite|appetite for risk]], as well as their impact on [[Finance:Share price|share price]].
The discipline is thus related to corporate finance, both re operations and funding, as below; and in large firms, the risk management function then overlaps "Corporate Finance", with the [[Social:Chief risk officer|CRO]] consulted on capital-investment and other strategic decisions. 
#Both areas share the goal of enhancing, and preserving, the firm's economic value. <ref name="Dahlquist">[https://openstax.org/books/principles-finance/pages/20-why-it-matters Risk Management and the Financial Manager]. Ch. 20 in {{cite book  | title=Principles of Finance| year=2022| isbn=9781951693541 | author = Julie Dahlquist, Rainford Knight, Alan S. Adams |url = https://open.umn.edu/opentextbooks/textbooks/principles-of-finance}}</ref> Here, businesses actively manage any impact on profitability, cash flow, and hence firm value, due to credit and operational factors - this, overlapping "working capital management" to a large extent.  Firms then devote much time and effort to [[Finance:Financial forecast|forecasting]], analytics and [[Finance:Managerial finance#Managerial accounting techniques|performance monitoring]].  (See also FP&A, [[Social:Asset and liability management|"ALM"]] and [[Finance:Treasury management|treasury management]].)
#Firm exposure to market (and business) risk is a direct result of previous capital investments and funding decisions: where applicable here,<ref name="PRMIA">See "III.A.1.7 Market Risk Management in Non-financial Firms", in  Carol Alexander, Elizabeth Sheedy eds. "The Professional Risk Managers’ Handbook" 2015 Edition. PRMIA. {{ISBN|978-0976609704}}</ref><ref>David Shimko (2009). [http://www.qfinance.com/contentFiles/QF02/g1xtn5q6/12/0/dangers-of-corporate-derivative-transactions.pdf Dangers of Corporate Derivative Transactions]</ref> typically in large corporates and [[Finance:Investment banking#Sales and trading|under guidance from]] their investment bankers, firms actively manage and [[Finance:Hedge|hedge]]  these exposures using traded financial instruments, usually  [[Finance:Derivative#Over-the-counter derivatives|standard derivatives]], creating [[Finance:Hedge#Categories of hedgeable risk|interest rate-]], [[Finance:Hedge#Categories of hedgeable risk|commodity-]] and [[Finance:Foreign exchange hedge|foreign exchange hedge]]s; see [[Finance:Cash flow hedge|Cash flow hedge]].

==See also==
{{cols}}
* [[Finance:Outline of corporate finance|Outline of corporate finance]]
* {{slink|Financial economics#Certainty}}
* {{slink|Financial economics#Corporate finance theory}}
* {{slink|Outline of finance#Corporate finance theory}}
* [[Finance:Capital management|Capital management]]
* [[Finance:Corporate budget|Corporate budget]]
* [[Finance:Corporate governance|Corporate governance]]
* [[Finance:Corporate tax|Corporate tax]]
* FP&A
* [[Finance:Financial accounting|Financial accounting]]
* [[Finance:Financial analysis|Financial analysis]]
* [[Finance:Financial management|Financial management]] 
* Financial planning
** [[Finance:Financial ratio|Financial ratio]]
** [[Finance:Financial statement analysis|Financial statement analysis]]
* [[Finance:Growth stock|Growth stock]]
* [[Finance:Investment bank|Investment bank]]
* [[Finance:Private equity|Private equity]]
* [[Finance:Security|Security]]
* [[Finance:Stock market|Stock market]]
* [[Social:Strategic financial management|Strategic financial management]]
* [[Finance:Venture capital|Venture capital]]
* {{sectionlink|Professional certification in financial services#Corporate finance}}
{{colend}}

'''Lists:'''
* List of accounting topics
* List of finance topics
** List of corporate finance topics
** List of valuation topics

==References==
{{Reflist|35em}}

==Bibliography==
*{{cite book |author1=Jonathan Berk |author2=Peter DeMarzo | title=Corporate Finance | publisher= Pearson | year=2013| isbn=978-0132992473 |edition=3rd }}
*{{cite book | author= Peter Bossaerts |author2= Bernt Arne Ødegaard | title= Lectures on Corporate Finance| publisher= World Scientific | year=2006| isbn=978-981-256-899-1|edition= Second }}
*{{cite book | author= Richard Brealey |author2=Stewart Myers |author3=Franklin Allen| title=Principles of Corporate Finance | publisher= Mcgraw-Hill | year=2013| isbn=978-0078034763|title-link=Principles of Corporate Finance }}
*{{cite book  | title=Principles of Finance| year=2022| isbn=9781951693541 | author = Julie Dahlquist, Rainford Knight, Alan S. Adams |url = https://open.umn.edu/opentextbooks/textbooks/principles-of-finance}}
*{{cite book| author=Aswath Damodaran| title=Corporate Finance: Theory and Practice| publisher=Wiley| year=1996| isbn=978-0471076803| url=https://archive.org/details/corporatefinance0000damo| }}
*{{cite book | author= João Amaro de Matos  | title=Theoretical Foundations of Corporate Finance | publisher= Princeton University Press | year=2001| isbn=9780691087948}}
*{{cite book |author1=Joseph Ogden |author2=Frank C. Jen |author3=Philip F. O'Connor | title= Advanced Corporate Finance | publisher= Prentice Hall| year= 2002 | isbn= 978-0130915689}}
*{{cite book |author1= C. Krishnamurti  |author2=S. R. Vishwanath | title=Advanced Corporate Finance | publisher= MediaMatics | year=2010| isbn=978-8120336117|url=https://www.phindia.com/Books/BookDetail/9788120336117/advanced-corporate-finance-vishwanath-krishnamurti }}
*{{cite book |author1=Pascal Quiry |author2=Yann Le Fur |author3=Antonio Salvi |author4=Maurizio Dallochio |author5=Pierre Vernimmen | title=Corporate Finance: Theory and Practice| publisher=Wiley| year=2011| isbn=978-1119975588|edition=3rd }}
*{{cite book | author= Stephen Ross, Randolph Westerfield, Jeffrey Jaffe  | title=Corporate Finance| publisher= Mcgraw-Hill | year=2012| isbn=978-0078034770 | edition=10th}}
* {{cite book |editor=Joel M. Stern | title=The Revolution in Corporate Finance| publisher=[[Company:Wiley-Blackwell|Wiley-Blackwell]]| year=2003| isbn=9781405107815| edition=4th}}
*{{cite book | author= Jean Tirole  | title=The Theory of Corporate Finance| publisher= Princeton University Press | year=2006| isbn=0691125562| }}
*{{cite book | author= Ivo Welch  | title=Corporate Finance| year=2017| isbn=9780984004928|  edition=4th|url = https://book.ivo-welch.info/home/}}

==Further reading==
*{{cite book|title= The Theory of Corporate Finance: A Historical Overview|ssrn=244161 |author= Jensen, Michael C.  |author2= Smith. Clifford W.|date=29 September 2000 |author-link= Michael C. Jensen }} In ''The Modern Theory of Corporate Finance'', edited by Michael C. Jensen and Clifford H. Smith Jr., pp.&nbsp;2–20. McGraw-Hill, 1990. {{ISBN|0070591091}}
*{{cite journal |title=The Theory and Practice of Corporate Finance: Evidence from the Field |author=Graham, John R. |author2= Harvey, Campbell R.|journal=AFA 2001 New Orleans; Duke University Working Paper  |year=1999|ssrn=220251}}

==External links==
{{Library resources box 
|by=no 
|onlinebooks=no 
|others=no 
|about=yes 
|label=Corporate Finance
}}
* [https://corporatefinanceinstitute.com/resources/knowledge/finance/corporate-finance-industry/ Corporate Finance Overview - Corporate Finance Institute]

{{Corporate finance and investment banking}}

[[Category:Corporate finance| ]]

{{Sourceattribution|Corporate finance}}