Definition of corporate finance

Corporate finance is the process of matching capital requirements to a company’s operations.

It differs from accounting, which is the process of historically recording a company’s activities from a monetized perspective.

Capital is money invested in a business to start, grow and sustain it. This differs from working capital, which is money to support and sustain trade – the purchase of commodities; equity financing; financing the credit required between production and the realization of sales profits.

Corporate finance can begin with the smallest round of money from family and friends poured into a budding company to fund its very first steps into the business world. At the other end of the spectrum is multi-layered corporate debt within giant international corporations.

Corporate finance essentially revolves around two types of capital: equity and debt. Equity is the investment made by shareholders in a company that has ownership rights. Equity typically remains in a company for the long term in hopes of generating a return. This can be done either through dividends, which are usually annual payments related to the proportion of share ownership.

Dividends tend to accrue only at very large, long-established companies that already have enough capital to more than adequately fund their plans.

Younger, growing, and less profitable operations tend to consume voraciously all the capital they can access, and thus tend not to create surpluses from which to pay dividends.

Younger and growing companies are often constantly looking for equity.

In very young companies, the main sources of investment are often private individuals. After the families and friends already mentioned, wealthy private individuals and experienced industry experts often invest in promising younger companies. These are the pre-seed and seed phases.

In the next phase, when there is at least some sense of a cohesive business, the primary investors are typically venture capital funds that specialize in taking promising early-stage companies through rapid growth to a hopefully highly profitable sale or IPO of shares.

The other major category of investments related to corporate finance is through debt. Many companies try to avoid diluting their ownership with ongoing stock offerings, deciding that by paying interest they can earn a higher return on loans to their companies than those loans cost to service. This process of upgrading the equity and trading aspects of a company via debt is commonly referred to as leverage.

While the risk of raising equity is diluting the original creators so that they end up receiving very little return on their efforts and success, the primary risk of indebtedness is corporate risk – the company must be mindful that it will not be swamped thereby unable to repay its debt.

Corporate finance is ultimately a juggling act. It must successfully balance ownership, potential, risk and return while optimally considering the interests of internal and external shareholders.