Corporate finance is a basic subject in finance that is deeply rooted in our daily lives. The majority of us work for corporations or aspire to establish our own startups. How to raise and deploy capital for business management is studied in corporate finance.
Introduction to Corporate Finance
Businesses acquire funding through many sources. There are many capital markets these days which serve the dual purpose of providing startups and corporations with funding and the general public with investment options.
The following are fundamental rules of corporate finance you should be aware of:
- The timing of cash flow is important. As the value of money is always fluctuating, it is better to have funds in cash because of rapid inflation. In this way you are likely to get less product and inventory for a certain amount of money in the future than in the present. Another way you can lose out on cash is through debt owed you. Had you been paid immediately, the amounts owed to you could have been invested in risk-free securities to earn you interest in the meantime. Not receiving it means your money is loaned out without any interest.
- Risk-free cash flow is more important than a risky investment. This is a fundamental rule of corporate finance. There are numerous modes of cash flow these days, but it is important to understand that not all of them will be profitable. Hence, your investments should be chosen well, and uncertain or risky investments, like the stock market, should be avoided under most circumstances. The key is to choose a higher rate of return on your capital with high risk investment to avoid losing all your capital in a critical situation. In cases where the risk is less, the company can focus more on maximizing returns on capital.
6 Best Sources of Corporate Finance
There are two main types: long-term and short-term corporate finance. Long-term financing consists of loans paid over one year or more, generally through monthly instalments. The primary benefits of this type of corporate finance are low interest rates and minimum monthly payments. Short-term corporate finance usually has a payment tenure of less than a year and often consists of one-time loans available to those unable to acquire long-term options. The following are the most popular types of long and short-term corporate finance that businesses rely on:
- Bank loan
This is the most common way to finance your business. There are different types of loans that a seasoned business owner or aspiring entrepreneur can get from the bank, and these are usually long-term or medium-term finance options. There is a fixed period for paying off the loan which can be anywhere between 3 and 20 years. The time depends on the amount of the loan and the interest rate. The longer you take to pay off, of course, the more interest that accumulates.
To be eligible for a bank loan, you need a good credit score and enough assets or a steady income to show you can pay it off.
- Stock dilution
Commonly known as equity dilution, this method decreases the current shareholders’ stake in the company as new equity is issued. New equity helps to improve each of the complete shares and dilutes the effect on the ownership percentage to previous investors.
- Merchant loan
This is the oldest form of loan. These days there are many institutions providing such funding but as shared ownership rather than loans. This makes it easier for the company to make the most of the money without having to worry about having a debt to pay.
- Outright purchase
This may seem like a good way to invest in products and equipment essential to your business, but you should think about other types of finance in parallel. Leasing or renting equipment can be a more cost-effective strategy in the long run. It depends on the owners’ attitude towards assets ownership. Companies with an even cash flow over the period of a lease cycle usually choose to rent. Some assets that are better rented than purchased are those related to transportation and shipping, like cars and trucks.
- Trade credit
Trade credit is usually observed in B2B agreements. In this case, the client purchase goods and raw materials without making an upfront payment. Instead they pay at a later date, generally after delivery of the product. The time limit to make payments is usually 30, 60 or 90 days. This kind of corporate finance is at its core a credit system between two companies trading with each other.
- Bank overdrafts
An overdraft is generated after money is withdrawn from your bank account and there is zero balance available. When this happens, the account is considered overdrawn. This type of corporate finance can only happen with the prior agreement of the bank, and when the amount overdrawn is within the authorized overdrawn limit, the amount of interest charged is also within the agreed-to rate. If the withdrawal balance exceeds the agreed-upon terms, extra charges apply.
There are other corporate finance sources available, but these are among the most popular. Business owners who have already availed themselves of these options will also need help from accountants and bookkeepers to manage their capital. This is where a virtual bookkeeping company can come to your aid. However, before that, it is best to understand the working of these forms of corporate finance to make the most out of them.