Corporate finance
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Corporate finance is the area of
finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of Production (economics), production, Distribution (economics), distribution, and Consumption (economics) ...
that deals with the sources of funding, the
capital structure In corporate finance, capital structure refers to the mix of various forms of external funds, known as Financial_capital, capital, used to finance a business. It consists of shareholders' equity, debt (borrowed funds), and preferred stock, and is ...
of corporations, the actions that managers take to increase the value of the firm to the
shareholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a Trust law, trust or partnership) that is registered by the corporation as the ...
s, and the tools and
analysis Analysis (plural, : analyses) is the process of breaking a complexity, complex topic or Substance theory, substance into smaller parts in order to gain a better understanding of it. The technique has been applied in the study of mathematics a ...
used to allocate financial resources. The primary goal of corporate finance is to maximize or increase
shareholder value Shareholder value is a business term, sometimes phrased as shareholder value maximization. It became prominent during the 1980s and 1990s along with the management principle value-based management or "managing for value". Definition The term "shar ...
. Correspondingly, corporate finance comprises two main sub-disciplines.
Capital budgeting Capital budgeting in corporate finance is the planning process used to determine whether an organization's long term capital investments such as new machinery, replacement of machinery, new plants, new products, and research development projects ...
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
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The de ...
capital.
Working capital Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
management is the management of the company's monetary funds that deal with the short-term operating balance of
current asset In accounting, a current asset is any asset which can reasonably be expected to be sold, consumed, or exhausted through the normal operations of a business within the current fiscal year or operating cycle or financial year (whichever period is ...
s and
current liabilities In accounting Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, whic ...
; the focus here is on managing cash,
inventories Inventory (American English) or stock (British English) refers to the goods and materials that a business holds for the ultimate goal of resale, production or utilisation. Stock management, Inventory management is a discipline primarily about s ...
, 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
investment banking Investment banking pertains to certain activities of a financial services company or a Corporate structure, corporate division that consist in advisory-based financial transactions on behalf of individuals, corporations, and governments. Tradition ...
. 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 managerial finance which studies the financial management of all firms, rather than
corporations A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal ...
alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms.
Financial management Financial management is the business function concerned with profitability, expenses, cash and credit, so that the "organization may have the means to carry out its objective as satisfactorily as possible;" the latter often defined as maximizi ...
overlaps with the financial function of the
accounting profession Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been calle ...
. However,
financial accounting Financial accounting is the field of accounting concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of Financial statement audit, financial statements available for p ...
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 The Italian city-states were numerous political and independent territorial entities that existed in the Italian Peninsula from the beginning of the Middle Ages until the proclamation of the Kingdom of Italy, which took place in 1861. After the ...
and the
low countries The term Low Countries, also known as the Low Lands ( nl, de Lage Landen, french: les Pays-Bas, lb, déi Niddereg Lännereien) and historically called the Netherlands ( nl, de Nederlanden), Flanders, or Belgica, is a coastal lowland region in N ...
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 A public company is a company whose ownership is organized via shares of share capital, stock which are intended to be freely traded on a stock exchange or in Over-the-counter (finance), over-the-counter markets. A public (publicly traded) comp ...
ever to pay regular
dividend A dividend is a distribution of Profit (accounting), profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed ...
s. The VOC was also the first recorded
joint-stock company A joint-stock company is a business entity in which shares of the company's capital stock, stock can be bought and sold by shareholders. Each shareholder owns company stock in proportion, evidenced by their share (finance), shares (certificates ...
to get a fixed
capital stock A corporation's share capital, commonly referred to as capital stock in the United States, is the portion of a corporation's Shareholders' equity, equity that has been derived by the issue of Share (finance), shares in the corporation to a shareh ...
. Public markets for investment securities developed in the
Dutch Republic The United Provinces of the Netherlands, also known as the (Seven) United Provinces, officially as the Republic of the Seven United Netherlands (Dutch language, Dutch: ''Republiek der Zeven Verenigde Nederlanden''), and commonly referred to in ...
during the 17th century. By the early 1800s,
London London is the capital and List of urban areas in the United Kingdom, largest city of England and the United Kingdom, with a population of just under 9 million. It stands on the River Thames in south-east England at the head of a estuary dow ...
acted as a center of corporate finance for companies around the world, which innovated new forms of lending and investment; see . The twentieth century brought the rise of managerial capitalism and common stock finance, with
share capital A corporation's share capital, commonly referred to as capital stock in the United States, is the portion of a corporation's Shareholders' equity, equity that has been derived by the issue of Share (finance), shares in the corporation to a shareh ...
raised through listings, in preference to other sources of capital. Modern corporate finance, alongside
investment management Investment management is the professional asset management of various Security (finance), securities, including shareholdings, Bond (finance), bonds, and other assets, such as real estate, to meet specified investment goals for the benefit of inv ...
, developed in the second half of the 20th century, particularly driven by innovations in theory and practice in the United States and Britain. Here, see the later sections of History of banking in the United States and of History of private equity and venture capital.


Outline

The primary goal of financial management is to maximize or to continually increase shareholder value. Maximizing shareholder value requires managers to be able to balance capital funding between investments in "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. 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). This "
capital budgeting Capital budgeting in corporate finance is the planning process used to determine whether an organization's long term capital investments such as new machinery, replacement of machinery, new plants, new products, and research development projects ...
" is the planning of value-adding, long-term corporate financial projects relating to investments funded through and affecting the firm's
capital structure In corporate finance, capital structure refers to the mix of various forms of external funds, known as Financial_capital, capital, used to finance a business. It consists of shareholders' equity, debt (borrowed funds), and preferred stock, and is ...
. Management must allocate the firm's limited resources between competing opportunities (projects). 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. 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
mergers and acquisitions Mergers and acquisitions (M&A) are business transactions in which the ownership of Company, companies, other business organizations, or their operating units are transferred to or Consolidation (business), consolidated with another company or b ...
. 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.


Capital structure

Achieving the goals of corporate finance requires that any corporate investment be financed appropriately. The sources of financing are, generically, capital self-generated by the firm and capital from external funders, obtained by issuing new
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The de ...
and equity (and hybrid- or 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
Balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a busine ...
, WACC. Finally, there is much theoretical discussion as to other considerations that management might weigh here.


Sources of capital


Debt capital

Corporations may rely on borrowed funds (debt capital or
credit Credit (from Latin verb ''credit'', meaning "one believes") is the Trust (social sciences), trust which allows one Party (law), party to provide money or resources to another party wherein the second party does not reimburse the first party im ...
) 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
interest In finance and economics, interest is payment from a debtor, borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is ...
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 collateral assets as a form of repaying their debt obligations (or through the process of
liquidation Liquidation is the process in accounting by which a company (law), company is brought to an end in Canada, United Kingdom, United States, Republic of Ireland, Ireland, Australia, New Zealand, Italy, and many other countries. The assets and p ...
).


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
common stock Common stock is a form of corporate equity (finance), equity ownership, a type of security (finance), security. The terms voting share and ordinary share are also used frequently outside of the United States. They are known as equity shares or or ...
, but subordinate to bonds in terms of claim (or rights to their share of the assets of the company). Preferred stock usually carries no voting rights, but may carry a
dividend A dividend is a distribution of Profit (accounting), profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed ...
and may have priority over common stock in the payment of dividends and upon
liquidation Liquidation is the process in accounting by which a company (law), company is brought to an end in Canada, United Kingdom, United States, Republic of Ireland, Ireland, Australia, New Zealand, Italy, and many other countries. The assets and p ...
. 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. 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:. * 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

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, - 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 dilution of share ownership, control and earnings. The '' cost of equity'' (see CAPM and
APT Apt. is an abbreviation for apartment. Apt may also refer to: Places * Apt Cathedral, a former cathedral, and national monument of France, in the town of Apt in Provence * Apt, Vaucluse, a commune of the Vaucluse département of France * Arr ...
) 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. * Management must attempt to match the long-term financing mix to the
asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that c ...
s being financed as closely as possible, in terms of both timing and cash flows. Managing any potential asset liability mismatch or duration gap entails matching the assets and liabilities respectively according to maturity pattern (" cashflow matching") or duration ("
immunization Immunization, or immunisation, is the process by which an individual's immune system becomes fortified against an infectious agent (known as the antigen, immunogen). When this system is exposed to molecules that are foreign to the body, called ...
"); managing this relationship in the ''short-term'' is a major function of working capital management, as discussed below. Other techniques, such as
securitization Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling ...
, or hedging using interest rate- or credit derivatives, are also common. See:
Asset liability management Asset and liability management (often abbreviated ALM) is the practice of managing financial risks that arise due to mismatches between the assets and liability (financial accounting), liabilities as part of an investment strategy in financial acc ...
;
Treasury management Treasury management (or treasury operations) includes management Management (or managing) is the administration of an organization, whether it is a business, a nonprofit organization, or a government body. It is the art and science of managi ...
;
Credit risk A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased ...
;
Interest rate risk In finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of Production (economics), production, Distribution (economics), distribution, and Consumpt ...
.


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 tax benefits of debt with the 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 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 An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, th ...
. Also, the
capital structure substitution theory In finance, the capital structure substitution theory (CSS) describes the relationship between earnings, stock price and capital structure of public companies. The CSS theory hypothesizes that managements of public companies manipulate capital stru ...
hypothesizes that management manipulates the capital structure such that
earnings per share Earnings per share (EPS) is the monetary value of earnings per outstanding share of common stock for a company. It is a key measure of corporate profitability and is commonly used to price stocks. In the United States, the Financial Accounting S ...
(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 market timing hypothesis. This hypothesis, inspired in 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, each "
project A project is any undertaking, carried out individually or collaboratively and possibly involving research or design, that is carefully planned to achieve a particular goal. An alternative view sees a project managerialism, managerially as a se ...
's" value will be estimated using a
discounted cash flow The discounted cash flow (DCF) analysis is a method in finance of valuing a security (finance), security, project, company, or financial asset, asset using the concepts of the time value of money. Discounted cash flow analysis is widely used in ...
(DCF) valuation, and the opportunity with the highest value, as measured by the resultant
net present value The net present value (NPV) or net present worth (NPW) applies to a series of cash flows occurring at different times. The present value of a cash flow depends on the interval of time between now and the cash flow. It also depends on the discount ...
(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''
cash flow A cash flow is a real or virtual movement of cash, money: *a cash flow in its narrow sense is a payment (in a currency), especially from one central bank account to another; the term 'cash flow' is mostly used to describe payments that are exp ...
s resulting from the project. Such future cash flows are then
discounted Discounting is a financial mechanism in which a debtor obtains the right to delay payments to a creditor, for a defined period of time, in exchange for a charge or fee.See "Time Value", "Discount", "Discount Yield", "Compound Interest", "Efficient ...
to determine their ''
present value In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
'' (see
Time value of money The time value of money is the widely accepted conjecture that there is greater benefit to receiving a sum of money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, ...
). These present values are then summed, and this sum net of the initial investment outlay is the NPV. See for general discussion, and
Valuation using discounted cash flows Valuation using discounted cash flows (DCF valuation) is a method of estimating the current value of a company based on projected future cash flows adjusted for the time value of money. The cash flows are made up of those within the “explici ...
for the mechanics, with discussion re modifications for corporate finance. The NPV is greatly affected by the discount rate. Thus, identifying the proper discount rate – often termed, the project "hurdle rate" – is critical to choosing appropriate projects and investments for the firm. The hurdle rate is the minimum acceptable return on an investment – i.e., the project appropriate discount rate. The hurdle rate should reflect the riskiness of the investment, typically measured by volatility of cash flows, and must take into account the project-relevant financing mix. Managers use models such as the CAPM or the
APT Apt. is an abbreviation for apartment. Apt may also refer to: Places * Apt Cathedral, a former cathedral, and national monument of France, in the town of Apt in Provence * Apt, Vaucluse, a commune of the Vaucluse département of France * Arr ...
to estimate a discount rate appropriate for a particular project, and use the
weighted average cost of capital The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is commonly referred to as the firm's cost of capital. Importantly, it is dictated by t ...
(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 . These are visible from the DCF and include discounted payback period, IRR, Modified IRR, equivalent annuity, capital efficiency, and ROI. Alternatives (complements) to NPV, which more directly consider
economic profit In economics, profit is the difference between the revenue In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business. Commercial revenue may also be ...
, include
residual income valuation Residual income valuation (RIV; also, residual income ''model'' and residual income ''method'', RIM) is an approach to equity valuation that formally accounts for the cost of equity capital. Here, "residual" means in excess of any opportunity cos ...
, MVA / EVA (
Joel Stern Joel M. Stern was chairman and chief executive officer of Stern Value Management, formerly Stern Stewart & Co, and the creator and developer of economic value added. He was a recognised authority on financial economics, corporate performance measure ...
, Stern Stewart & Co) and 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. Some analysts account for this uncertainty by adjusting the discount rate (e.g. by increasing the
cost of capital In economics and accounting, the cost of capital is the cost of a company's funds (both debt and Equity (finance), equity), or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is use ...
) or the cash flows (using certainty equivalents, or applying (subjective) "haircuts" to the forecast numbers; see Penalized present value).Aswath Damodaran
Risk Adjusted Value
Ch 5 in ''Strategic Risk Taking: A Framework for Risk Management''. Wharton School Publishing, 2007.
See: §32 "Certainty Equivalent Approach" & §165 "Risk Adjusted Discount Rate" in: 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.Dan Latimore
''Calculating value during uncertainty''
IBM Institute for Business Value
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 "flexible and staged nature" of the investment is modelled, and hence "all" potential payoffs are considered. See further under
Real options valuation Real options valuation, also often termed real options analysis,Adam Borison (Stanford University Stanford University, officially Leland Stanford Junior University, is a Private university, private research university in Stanford, Californi ...
. The difference between the two valuations is the "value of flexibility" inherent in the project. The two most common tools are Decision Tree Analysis (DTA) and
real options valuation Real options valuation, also often termed real options analysis,Adam Borison (Stanford University Stanford University, officially Leland Stanford Junior University, is a Private university, private research university in Stanford, Californi ...
(ROV); they may often be used interchangeably: * DTA values flexibility by incorporating '' possible events'' (or 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 Outsourcing is an agreement in which one company hires another company to be responsible for a planned or existing activity which otherwise is or could be carried out internally, i.e. in-house, and sometimes involves transferring employees and ...
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 A decision tree is a decision support tool that uses a tree-like model of decisions and their possible consequences, including chance event outcomes, resource costs, and utility As a topic of economics Economics () is the so ...
, 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 rational decision making, management chooses the branches (i.e. actions) corresponding to the highest value path probability weighted; (3) this path is then taken as representative of project value. See . * ROV is usually used when the value of a project is '' contingent'' on the '' value'' of some other asset or underlying variable. (For example, the viability of a
mining Mining is the Extractivism, extraction of valuable minerals or other geological materials from the Earth, usually from an ore body, lode, vein (geology), vein, coal mining, seam, quartz reef mining, reef, or placer deposit. The exploitation of ...
project is contingent on the price of
gold Gold is a chemical element with the Symbol (chemistry), symbol Au (from la, aurum) and atomic number 79. This makes it one of the higher atomic number elements that occur naturally. It is a Brightness, bright, slightly orange-yellow, dense, s ...
; if the price is too low, management will abandon the mining rights, if sufficiently high, management will develop the ore body. Again, a DCF valuation would capture only one of these outcomes.) Here: (1) using financial option theory as a framework, the decision to be taken is identified as corresponding to either a
call option In finance, a call option, often simply labeled a "call", is a contract between the buyer and the seller of the call Option (finance), option to exchange a Security (finance), security at a set price. The buyer of the call option has the righ ...
or a
put option In finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of Production (economics), production, Distribution (economics), distribution, and Consumpti ...
; (2) an appropriate valuation technique is then employed – usually a variant on the binomial options model or a bespoke simulation model, while Black–Scholes type formulae are used less often; see 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 § Option pricing approaches under
Business valuation Business valuation is a process and a set of procedures used to estimate the valuation (finance), economic value of an owner's interest in a business. Here Valuation (finance), various valuation techniques are used by financial market participants ...
.


Quantifying uncertainty

Given the
uncertainty Uncertainty refers to Epistemology, epistemic situations involving imperfect or unknown information. It applies to predictions of future events, to physical measurements that are already made, or to the unknown. Uncertainty arises in partially ...
inherent in project forecasting and valuation,See: "Capital Budgeting Under Risk". Ch.9 i
Schaum's outline of theory and problems of financial management
Jae K. Shim and Joel G. Siegel.
Se
Probabilistic Approaches: Scenario Analysis, Decision Trees and Simulations
Prof. Aswath Damodaran
analysts will wish to assess the ''sensitivity'' of project NPV to the various inputs (i.e. assumptions) to the DCF
model A model is an informative representation of an object, person or system. The term originally denoted the Plan_(drawing), plans of a building in late 16th-century English, and derived via French and Italian ultimately from Latin ''modulus'', a mea ...
. In a typical
sensitivity analysis Sensitivity analysis is the study of how the uncertainty Uncertainty refers to Epistemology, epistemic situations involving imperfect or unknown information. It applies to predictions of future events, to physical measurements that are already ...
the analyst will vary one key factor while holding all other inputs constant, ''
ceteris paribus ' (also spelled '; () is a Latin Latin (, or , ) is a classical language belonging to the Italic languages, Italic branch of the Indo-European languages. Latin was originally a dialect spoken in the lower Tiber area (then known as Latium) ...
''. The sensitivity of NPV to a change in that factor is then observed, and is calculated as a "slope": ΔNPV / Δfactor. For example, the analyst will determine NPV at various growth rates in annual revenue as specified (usually at set increments, e.g. -10%, -5%, 0%, 5%...), and then determine the sensitivity using this formula. Often, several variables may be of interest, and their various combinations produce a "value-
surface A surface, as the term is most generally used, is the outermost or uppermost layer of a physical object or space. It is the portion or region of the object that can first be perceived by an observer using the senses of Visual perception, sight ...
" (or even a "value-
space Space is the boundless Three-dimensional space, three-dimensional extent in which Physical body, objects and events have relative position (geometry), position and direction (geometry), direction. In classical physics, physical space is often ...
"), where NPV is then a function of several variables. See also
Stress testing Stress testing (sometimes called torture testing) is a form of deliberately intense or thorough testing used to determine the stability of a given system, critical infrastructure or entity. It involves testing beyond normal operational capacity, ...
. Using a related technique, analysts also run scenario based forecasts of NPV. Here, a scenario comprises a particular outcome for economy-wide, "global" factors ( demand for the product,
exchange rate In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of t ...
s, commodity prices, etc.) ''as well as'' for company-specific factors (
unit cost The unit cost is the price incurred by a company to produce, store and sell one unit of a particular product. Unit costs include all Fixed cost, fixed costs and all Variable cost, variable costs involved in production. Cost unit is a form of meas ...
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
discussion Conversation is interactive communication between two or more people. The development of conversational skills and etiquette is an important part of socialization. The development of conversational skills in a new language is a frequent focus ...
at
Financial modeling Financial modeling is the task of building an abstraction, abstract representation (a mathematical model, model) of a real world finance, financial situation. This is a mathematical model designed to represent (a simplified version of) the perfor ...
), whereas for the sensitivity approach these need not be so. An application of this methodology is to determine an "
unbiased Bias is a disproportionate weight ''in favor of'' or ''against'' an idea or thing, usually in a way that is closed-minded, prejudicial, or unfair. Biases can be innate or learned. People may develop biases for or against an individual, a group ...
" 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 First Chicago Method. (See also 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"Virginia Clark, Margaret Reed, Jens Stephan (2010)
Using Monte Carlo simulation for a capital budgeting project
Management Accounting Quarterly, Fall, 2010
is to construct
stochastic Stochastic (, ) refers to the property of being well described by a random probability distribution. Although stochasticity and randomness are distinct in that the former refers to a modeling approach and the latter refers to phenomena themsel ...
See David Shimko (2009)
Quantifying Corporate Financial Risk
archived 2010-07-17.
or
probabilistic Probability is the branch of mathematics concerning numerical descriptions of how likely an Event (probability theory), event is to occur, or how likely it is that a proposition is true. The probability of an event is a number between 0 and ...
financial models – as opposed to the traditional static and
deterministic Determinism is a Philosophy, philosophical view, where all events are determined completely by previously existing causes. Deterministic theories throughout the history of philosophy have developed from diverse and sometimes overlapping motive ...
models as above. For this purpose, the most common method is to use
Monte Carlo simulation Monte Carlo methods, or Monte Carlo experiments, are a broad class of computational algorithms that rely on repeated random sampling to obtain numerical results. The underlying concept is to use randomness to solve problems that might be determini ...
to analyze the project's NPV. This method was introduced to finance by David B. Hertz in 1964, although it has only recently become common: today analysts are even able to run simulations in
spreadsheet A spreadsheet is a computer application for computation, organization, analysis and Data storage, storage of data in table (information), tabular form. Spreadsheets were developed as computerized analogs of paper accounting Worksheet#Accounting, ...
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 In common usage, randomness is the apparent or actual lack of pattern or predictability in events. A random sequence of events, symbols or steps often has no :wikt:order, order and does not follow an intelligible pattern or combination. Ind ...
but possible outcomes, or trials, "covering all conceivable real world contingencies in proportion to their likelihood;"The Flaw of Averages
, Prof. Sam Savage,
Stanford University Stanford University, officially Leland Stanford Junior University, is a Private university, private research university in Stanford, California. The campus occupies , among the largest in the United States, and enrolls over 17,000 students. S ...
.
see Monte Carlo Simulation versus "What If" Scenarios. The output is then a
histogram A histogram is an approximate representation of the frequency distribution, distribution of numerical data. The term was first introduced by Karl Pearson. To construct a histogram, the first step is to "Data binning, bin" (or "Data binning, buck ...
of project NPV, and the average NPV of the potential investment – as well as its 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 In probability theory and statistics, a probability distribution is the mathematical Function (mathematics), function that gives the probabilities of occurrence of different possible outcomes for an Experiment (probability theory), experiment. ...
to each variable (commonly
triangular A triangle is a polygon with three Edge (geometry), edges and three Vertex (geometry), vertices. It is one of the basic shapes in geometry. A triangle with vertices ''A'', ''B'', and ''C'' is denoted \triangle ABC. In Euclidean geometry, an ...
or
beta Beta (, ; uppercase , lowercase , or cursive Greek, cursive ; grc, βῆτα, bē̂ta or ell, βήτα, víta) is the second letter of the Greek alphabet. In the system of Greek numerals, it has a value of 2. In Modern Greek, it represents th ...
), and, where possible, specify the observed or supposed
correlation In statistics, correlation or dependence is any statistical relationship, whether causality, causal or not, between two random variables or bivariate data. Although in the broadest sense, "correlation" may indicate any type of association, in ...
between the variables. These distributions would then be "sampled" repeatedly – 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 In colloquial, ordinary language, an average is a single number taken as representative of a list of numbers, usually the sum of the numbers divided by how many numbers are in the list (the arithmetic mean). For example, the average of the numbers ...
NPV and
standard deviation In statistics, the standard Deviation (statistics), deviation is a measure of the amount of variation or statistical dispersion, dispersion of a set of values. A low standard deviation indicates that the values tend to be close to the mean (al ...
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 underlying "
spot price In finance, a spot contract, spot transaction, or simply spot, is a contract of buying or selling a commodity, security (finance), security or currency for immediate Settlement (finance), settlement (payment and delivery) on the spot date, whic ...
" and volatility for the real option valuation as above; see . A more robust Monte Carlo model would include the possible occurrence of risk events (e.g., a
credit crunch A credit crunch (also known as a credit squeeze, credit tightening or credit crisis) is a sudden reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from banks. A credit cr ...
) that drive variations in one or more of the DCF model inputs.


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 to issue dividends, and what amount, is determined mainly on the basis of the company's unappropriated
profit Profit may refer to: Business and law * Profit (accounting) Profit, in accounting, is an income distributed to the ownership , owner in a Profit (economics) , profitable market production process (business). Profit is a measure of profi ...
(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
returns Return may refer to: In business, economics, and finance * Return on investment (ROI), the financial gain after an expense. * Rate of return, the financial term for the profit or loss derived from an investment * Tax return, a blank document or t ...
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 " 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
dividend A dividend is a distribution of Profit (accounting), profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed ...
s or via a share buyback. Various factors may be taken into consideration: where shareholders must pay 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
stock In finance, stock (also capital stock) consists of all the Share (finance), shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which owners ...
rather than in cash; see
Corporate action A corporate action is an event initiated by a public company that brings or could bring an actual change to the Security (finance), securities—Stock, equity or debt—issued by the company. Corporate actions are typically agreed upon by a co ...
. 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
growth companies In finance, 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. A growth c ...
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

Managing the corporation's
working capital Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
position to sustain ongoing business operations is referred to as ''working capital management''. These involve managing the relationship between a firm's 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
cost of capital In economics and accounting, the cost of capital is the cost of a company's funds (both debt and Equity (finance), equity), or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is use ...
. The goal of Working Capital (i.e. short term) management is therefore to ensure that the firm is able to operate, and that it has sufficient cash flow to service long-term debt, and to satisfy both maturing short-term debt and upcoming operational expenses. In so doing, firm value is enhanced when, and if, the
return on capital Return on capital (ROC), or return on invested capital (ROIC), is a ratio used in finance, Valuation (finance), valuation and accounting, as a measure of the profitability and value-creating potential of companies relative to the amount of capital i ...
exceeds the cost of capital; See 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. 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
time horizon Time is the continued sequence of existence and event (philosophy), events that occurs in an apparently irreversible process, irreversible succession from the past, through the present, into the future. It is a component quantity of various me ...
, working capital management differs from capital budgeting in terms of
discounting Discounting is a financial mechanism in which a debtor obtains the right to delay payments to a creditor, for a defined period of time, in exchange for a charge or fee.See "Time Value", "Discount", "Discount Yield", "Compound Interest", "Efficient ...
and profitability considerations; decisions here are also "reversible" to a much larger extent. (Considerations as to risk appetite and return targets remain identical, although some constraints – such as those imposed by
loan covenant A loan covenant is a condition in a commercial loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a ...
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
cash conversion cycle In management accounting In management accounting or managerial accounting, managers use accounting information in decision-making and to assist in the management and performance of their control functions. Definition One simple definition of ...
. 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
return on capital Return on capital (ROC), or return on invested capital (ROIC), is a ratio used in finance, Valuation (finance), valuation and accounting, as a measure of the profitability and value-creating potential of companies relative to the amount of capital i ...
(ROC). The result is shown as a percentage, determined by dividing relevant income for the 12 months by capital employed;
return on equity The return on equity (ROE) is a measure of the profitability of a business in relation to the equity. Because shareholder's equity can be calculated by taking all assets and subtracting all liabilities, ROE can also be thought of as a return on '' ...
(ROE) shows this result for the firm's shareholders. As above, firm value is enhanced when, and if, the return on capital exceeds the
cost of capital In economics and accounting, the cost of capital is the cost of a company's funds (both debt and Equity (finance), equity), or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is use ...
.


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 In economics, cash is money in the physical form of currency, such as banknotes and coins. In bookkeeping and financial accounting, cash is current assets comprising currency or currency equivalents that can be accessed immediately or near-immed ...
and
cash equivalents Cash and cash equivalents (CCE) are the most liquid current assets found on a business's balance sheet. Cash equivalents are short-term commitments "with temporarily idle cash and easily convertible into a known cash amount". An investment normal ...
,
inventories Inventory (American English) or stock (British English) refers to the goods and materials that a business holds for the ultimate goal of resale, production or utilisation. Stock management, Inventory management is a discipline primarily about s ...
and
debtor A debtor or debitor is a legal entity, legal entity (legal person) that owes a debt to another entity. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor. When the counter ...
s) and the short term financing, such that cash flows and returns are acceptable.Best-Practice Working Capital Management: Techniques for Optimizing Inventories, Receivables, and Payables
, Patrick Buchmann and Udo Jung
* Cash management. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs. *
Inventory management Field inventory management commonly known as inventory management is the function of understanding the stock mix of a company and the different demands on that stock. The demands are influenced by both externality, external and Internality, inter ...
. 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 Inventory optimization and
Supply chain management In commerce Commerce is the large-scale organized system of activities, functions, procedures and institutions directly and indirectly related to the exchange (buying and selling) of goods and services among two or more parties within lo ...
. Note that "inventory" is usually the realm of 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".William Lasher (2010). Practical Financial Management. South-Western College Pub; 6 ed. * 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
Discounts and allowances Discounts and allowances are reductions to a basic price of goods or services. They can occur anywhere in the distribution channel, modifying either the manufacturer's list price (determined by the manufacturer and often printed on the package) ...
. (2) Implement appropriate
credit scoring A credit score is a numerical expression based on a level analysis of a person's credit files, to represent the creditworthiness of an individual. A credit score is primarily based on a credit report :''This article deals with the general con ...
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
loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that de ...
(or overdraft), or to "convert debtors to cash" through " factoring"; see generally,
trade finance Trade finance is a phrase used to describe different strategies that are employed to make international trade easier. It signifies financing for trade, and it concerns both domestic and international trade transactions. A trade transaction require ...
.


Relationship with other areas in finance


Investment banking

Use of the term "corporate finance" varies considerably across the world. In the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...
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
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the European mainland, continental mainland. It comprises England, Scotlan ...
and
Commonwealth A commonwealth is a traditional English term for a political community founded for the common good In philosophy, economics, and political science, the common good (also commonwealth, general welfare, or public benefit) is either what is share ...
countries, the terms "corporate finance" and "corporate financier" tend to be associated with
investment banking Investment banking pertains to certain activities of a financial services company or a Corporate structure, corporate division that consist in advisory-based financial transactions on behalf of individuals, corporations, and governments. Tradition ...
– i.e. with transactions in which capital is raised for the corporation. See under for a listing of the various transaction-types here, and for a description of the role.


Financial risk management

Financial risk management Financial risk management is the practice of protecting Value (economics), economic value in a business, firm by using financial instruments to manage exposure to financial risk - principally operational risk, credit risk and market risk, with more ...
, generically, is focused on measuring and managing
market risk Market risk is the risk of losses in positions arising from movements in market variables like prices and volatility. There is no unique classification as each classification may refer to different aspects of market risk. Nevertheless, the most ...
,
credit risk A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased ...
and operational risk. Within corporates, John Hampton (2011). ''The AMA Handbook of Financial Risk Management''.
American Management Association The American Management Association (AMA) is an American non-profit educational membership organization for the promotion of management, based in New York City. Besides its headquarters there, it has local head offices throughout the world. It o ...
.
the scope is broadened to overlap
enterprise risk management Enterprise risk management (ERM) in business includes the methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives. ERM provides a framework for risk management, which typica ...
, and then addresses risks to the firm's overall strategic objectives, focusing on the financial exposures and opportunities arising from business decisions, and their link to the firm’s appetite for risk, as well as their impact on
share price A share price is the price of a single share of a number of saleable equity shares of a company. In layman's terms, the stock price is the highest amount someone is willing to pay for the stock, or the lowest amount that it can be bought for. B ...
. 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 CRO consulted on capital-investment and other strategic decisions. #Both areas share the goal of enhancing, and preserving, the firm's
economic value In economics, economic value is a measure of the benefit provided by a goods, good or service (economics), service to an Agent (economics), economic agent. It is generally measured through units of currency, and the interpretation is therefore ...
. Risk Management and the Financial Manager
Ch. 20 in
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
forecasting Forecasting is the process of making predictions based on past and present data. Later these can be compared (resolved) against what happens. For example, a company might Estimation, estimate their revenue in the next year, then compare it against ...
,
analytics Analytics is the systematic computational analysis of data or statistics. It is used for the discovery, interpretation, and communication of meaningful patterns in data. It also entails applying data patterns toward effective decision-making. It ...
and performance monitoring. (See also
FP&A A financial analyst is a professional, undertaking financial analysis Financial analysis (also known as financial statement analysis, accounting analysis, or analysis of finance) refers to an assessment of the viability, stability, and profita ...
, "ALM" and
treasury management Treasury management (or treasury operations) includes management Management (or managing) is the administration of an organization, whether it is a business, a nonprofit organization, or a government body. It is the art and science of managi ...
.) #Firm exposure to market (and business) risk is a direct result of previous capital investments and funding decisions: where applicable here,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. David Shimko (2009)
Dangers of Corporate Derivative Transactions
/ref> typically in large corporates and under guidance from their investment bankers, firms actively manage and
hedge A hedge or hedgerow is a line of closely spaced shrubs and sometimes trees, planted and trained to form a barrier or to mark the boundary of an area, such as between neighbouring properties. Hedges that are used to separate a road from adjoini ...
these exposures using traded
financial instruments Financial instruments are monetary Contract, contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership interest in an entity or a contractual right to receive or deliver in ...
, usually standard derivatives, creating cash flow-, commodity- and foreign exchange hedges. (See
Hedge accounting Hedge accounting is an accountancy Accounting, also known as accountancy, is the measurement Measurement is the quantification (science), quantification of variable and attribute (research), attributes of an object or event, which c ...
, Hedging irrelevance proposition.)


See also

* * *
Corporate tax A corporate tax, also called corporation tax or company tax, is a direct tax imposed on the income or capital of corporations or analogous legal entities. Many countries impose such taxes at the national level, and a similar tax may be imposed at ...
*
Corporate governance Corporate governance is defined, described or delineated in diverse ways, depending on the writer's purpose. Writers focused on a disciplinary interest or context (such as accounting Accounting, also known as accountancy, is the measuremen ...
*
Financial accounting Financial accounting is the field of accounting concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of Financial statement audit, financial statements available for p ...
*
Financial management Financial management is the business function concerned with profitability, expenses, cash and credit, so that the "organization may have the means to carry out its objective as satisfactorily as possible;" the latter often defined as maximizi ...
*
Financial planning In general usage, a financial plan is a comprehensive evaluation of an individual's current pay and future financial state by using current known variables to predict future income, asset values and withdrawal plans. This often includes a bud ...
**
Financial ratio A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial ...
** Financial statement analysis * Growth stock *
Investment bank Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing is ...
*
Private equity In the field of finance, the term private equity (PE) refers to investment funds, usually limited partnerships (LP), which buy and restructure financially weak companies that produce goods and provide services. A private-equity fund is both a typ ...
*
Security (finance) A security is a tradable financial asset A financial asset is a non-physical asset whose value is derived from a contractual claim, such as deposit (finance), bank deposits, bond (finance), bonds, and participations in companies' share capital ...
*
Stock market A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses; these may include ''securities'' listed on a public stock exchange, as ...
* Strategic financial management *
Venture capital Venture capital (often abbreviated as VC) is a form of private equity financing that is provided by venture capital firms or funds to start-up company, startups, early-stage, and emerging companies that have been deemed to have high growth poten ...
* Lists: *
List of accounting topics This page is an index of accounting topics. {{AlphanumericTOC, align=center, nobreak=, numbers=, references=, externallinks=, top=} A Accounting ethics - Accounting information system An accounting as an information system (AIS) i ...
*
List of finance topics The following Outline (list), outline is provided as an overview of and topical guide to finance: Finance – addresses the ways in which individuals and organizations raise and allocate monetary factors of production, resources over time, ta ...
** List of corporate finance topics ** List of valuation topics


References


Further reading

* In ''The Modern Theory of Corporate Finance'', edited by Michael C. Jensen and Clifford H. Smith Jr., pp. 2–20. McGraw-Hill, 1990. *


Bibliography

* * * * * * * * * * * *


External links


Corporate Finance Overview - Corporate Finance Institute
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