Principle of Corporate Finance constitute the theories and their implementations by the managers of the companies in the practical field for maximization of profit.
Corporate Finance deals with a company's financial or monetary activity (promotion, financing, investment, organization, capital budgeting etc.).
All these activities are accomplished with the sole objective of profit maximization.
For meeting the fund requirements for any project of a corporation, a company can get it from various sources such as internal, external or equities at the lowest cost possible. This fund is then used for investment purposes for the production of the desirable asset.
Principle of Corporate Finance show how the different corporate financial theories help to formulate the policies for the growth of a company.
Finance is a science of managing money and other assets. It is the process of channelization of funds in the form of invested capital, credits, or loans to those economic agents who are in need of funds for productive investments or otherwise. Eg. On one hand, the consumers, business firms, and governments need funds for making their expenditures, pay their debts, or complete other transactions. On the other hand, savers accumulate funds in the form of savings deposits, pensions, insurance claims, savings or loan shares, etc which becomes a source of investment funds. Here, finance comes to the fore by channeling these savings into proper channels of investment.
Broadly, finance can be classified into three fields:-
- Public Sector Finance :
Financing in the government or public level is known as public sector finance. Government meets its expenditures mainly through taxes. Government budget generally don't balance, hence it has to borrow for these deficits which in turn gives rise to public debt.
- Corporate or Business Finance :
It tries to optimize the goals (profit, sales, etc.) of a corporation or other business organization by estimating future asset requirements and then allocating funds in accordance to the availability of funds.
- Personal Finance :
It basically deals with the optimization of finances in the individual (single consumer, family, personal savings, etc.) level subjected to the budget constraint. Eg. A consumer can finance his/her purchase of a car by taking a loan from any bank or financial institutions.
Corporate or business finance is all about raising and allocation of funds for increasing profit. Senior management chalks out long-term plan for fulfilling future objectives. Value of the company's stock is a very important issue for the management because it is directly related to the wealth of the share-holders of the company.
Some of the terms important in principle of Corporate finance are :-
Net Present Value (NPV)
Net Present Value = (Present Value of Inflow of Cash) – (Present Value of
Outflow of Cash)
NPV helps to measure the value of a currency today with that of the future, after taking into consideration returns and inflation.
Positive Net Present Value for a project means that the project is viable because cash flows will be positive for the same.
Senior managements always target to maximize the value of the firm by investing in positive NPV (Net Present Value) projects. If such opportunities don't arise then reinvestment of profits should be stalled and the excess cash should be returned to the shareholders in the form of dividends.
Financial Risk management
According to Financial Economics, those projects which increases the value of the shareholders wealth should be taken on. Financial Risk Management is the creation of value of the shareholders of a firm by managing the exposure to risk by the use of financial instruments (loans, deposits, bonds, equity stocks, future and options, etc.). Financial risk management involves :-
- Identification of the source of risk
- Risk measurement
- Chalking out of plans to manage the risks
Financial Risk Management always tries to find out viable opportunity to hedge the costly risk exposures by using financial instruments.
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