Maharashtra Board Class 12 Secretarial Practice Chapter 1 Introduction To Corporate Finance PDF Download

Introduction To Corporate Finance

Introduction:

The term finance is related to money and money management. It is related to inflow and outflow of money. Success of any business organisation depends upon the efficiency with which it is able to generate and use funds.

Henry Ford rightly said, "Money is an arm or leg - use it or lose it." This statement clearly brings out the significance of finance for the success of a business.

1.1 Corporate Finance: Meaning

Corporate finance deals with the raising and using of finance by a corporation. It deals with financing the activities of the corporation, capital structuring and making investment decisions.

Meaning: Definition

Henry Hoagland expresses the view that "corporate finance deals primarily with the acquisition and use of capital by business corporation."

The term corporate finance also includes financial planning, study of capital market, money market and share market. It also covers capital formation and foreign capital. Even financial organisations and banks play vital role in corporate financing.

The finance manager of any corporation has to ensure that:

a) the firm has adequate finance.

b) they are using the right source of funds that have minimum cost.

c) the firm utilises raised funds effectively.

d) they are generating maximum returns for it's owners.

The following two decisions are the basis of corporate finance.

1) Financing Decision: The business firm has access to capital market to fulfill it's financial needs. The firm has multiple choices of sources of financing. The firm can choose whether it wants to raise equity capital or debt capital. Firm can even opt for bank loan, public deposits, debentures etc. to raise funds. The finance manager ensures that the firm is well capitalised i.e. they have right amount of capital and that the firm has right combination of debt and equity.

Capital market is a market for long term debt instruments and equity shares. In this market, equity and debt instruments are issued and traded.

2) Investment Decision: Once the business firm has gained access to capital, the finance manager has to take decision regarding the use of the funds in systematic manner so that it will bring maximum return for its owners. For this, the firm has to take into consideration the cost of capital. Once they know the cost of capital, firm can deploy or use the funds in such a way that returns are more than cost of capital.

Cost of capital is minimum return expected by it's investors.

Finding investments and deploying them successfully in the business is known as investing decision. It is also called as 'capital budgeting'.

Teacher's Note

Finance is like the blood of a business. Just like your body needs blood to work, a company needs money to run. Without finance, a business cannot even pay its workers or buy materials.

Exam Trick

Remember: Two main decisions = Financing (where to get money) and Investment (how to use money). Think of it like getting pocket money from parents (financing) and deciding what to buy with it (investment).

Points to Remember

Finance is about managing money in a business.
Financing decision means choosing the right way to get money.
Investment decision means using that money wisely in the business.
Capital market helps companies get long-term money.
Cost of capital means the minimum profit we must earn on invested money.

1.2 Importance Of Corporate Finance

In the functional management of business enterprise, importance is given to production, finance, marketing and personnel activities. Among all these activities, utmost importance is given to financial activities. The importance of corporate finance may be discussed as follows:

1. Helps in decision making: Most of the important decisions of business enterprise are determined on the basis of availability of funds. It is difficult to perform any function of business enterprise independently without finance.

Every decision in the business is needed to be taken keeping in view of it's impact on profitability. There may be number of alternatives but the management is required to select the best one which will enhance profitability. Business organisation can give green signal to the project only when it is financially viable. Thus corporate finance plays significant role in decision making process.

2. Helps in Raising Capital for a project: Whenever a business firm wants to start a new venture, it needs to raise capital. Business firm can raise funds by issuing shares, debentures, bonds or even by taking loans from the banks.

3. Helps in Research and Development: Research and Development must be undertaken for the growth and expansion of business. Detailed technical work is essential for the execution of projects. Research and Development is lengthy process and therefore funds have to be made available through out the research work. This would require continuous financial support.

Many a time, Company has to upgrade its old product or develop new product to attract the consumers. For this company has to conduct survey, market analysis, etc. which again requires financial support.

4. Helps in smooth running of business firm: A smooth flow of corporate finance is needed so that salaries of employees are paid on time, loans are cleared on time, raw material is purchased whenever required, sales promotion of existing products is carried out smoothly and new products can be launched effectively.

5. Brings co-ordination between various activities: Corporate finance plays significant role in control and co-ordination of all activities in an organisation. For e.g. Production will suffer, if finance department does not provide adequate finance for the purchase of raw materials and meeting other day-to-day financial requirements for smooth running of production unit. Due to this, sales will also suffer and consequently the income of concern as well as rate of profit will be affected. Thus efficiency of every department depends upon the effective financial management.

6. Promotes expansion and diversification: Modern machines and modern techniques are required for expansion and diversification. Corporate finance provides money to purchase modern machines and technologies. Therefore finance becomes mandatory for expansion and diversification of a company.

7. Managing Risk: Company has to manage several risks, such as sudden fall in sales, loss due to natural calamity, loss due to strikes, etc. Company needs financial aid to manage such risks.

8. Replace old assets: Assets such as plant and machinery become old and outdated over the years. They have to be replaced by new assets. Finance is required to purchase new assets.

9. Payment of dividend and interest: Finance is needed to pay dividend to shareholders, interest to creditors, banks, etc.

10. Payment of taxes/fees: Company has to pay taxes to Government, such as Income Tax, Goods and Service Tax (GST) and fees to Registrar of Companies on various occasions. Finance is needed for paying these taxes and fees.

Teacher's Note

Think of finance as the fuel for a car. Without fuel, the car cannot run. Similarly, without finance, a business cannot do anything - no salaries, no buying materials, no growth. Finance makes everything possible in business.

Exam Trick

Remember: Corporate finance has 10 important uses. The most important ones are: decision making, raising capital, and smooth running. These three words are key - Decide, Raise, Run.

Points to Remember

Finance helps in making business decisions.
Finance helps a company get money for new projects.
Finance is needed for research and new products.
Finance pays workers and other costs on time.
Finance helps in company growth and new businesses.
Finance is needed to replace old machines and equipment.

1.3 Capital Requirements

When a business entrepreneur conceives an idea of setting up a business enterprise, the commercial viability of the idea is investigated. Once the entrepreneur is satisfied with the feasibility of the project, serious steps are taken to start the project. The first and foremost step is to take decision on the amount of capital requirement to start and run the business. This task has to be performed with utmost care. Therefore financial plan should be drafted keeping in mind present and future requirement of the business. Thus while deciding about the volume of capital requirement, an entrepreneur has to take into consideration - fixed capital requirement and working capital requirement. We shall now discuss these capital requirements in detail.

Financial plan refers to assessment of financial requirement and arranging sources of capital.

(A) Fixed Capital: Fixed capital is the capital which is used for buying fixed assets which are used for a longer period of time in the business. These assets are not meant for resale.

In simple words fixed capital refers to capital invested for acquiring fixed assets. It stays in the business for long period almost permanently. Examples of fixed capital are - capital used for purchasing land and building, furniture, plant and machinery, etc. Such capital is required usually at the time of establishment of a new company. However, existing companies may also need such capital for their expansion and development, replacement of equipments, etc.

Teacher's Note

Fixed capital is like buying a school building. Once you buy it, it stays with the school for many years. A company needs fixed capital to buy land, buildings, and machines that will be used for a long time.

Exam Trick

Remember: Fixed = Does not move, stays permanently. Just like your house stays with your family for years, fixed capital stays with the company for years. Land, building, machinery = Fixed capital.

Points to Remember

Fixed capital is used to buy long-term assets like land and machines.
Fixed assets stay in the business for many years.
Fixed capital is needed when starting a new company.
Existing companies also need fixed capital for growth and improvement.
Fixed assets cannot be easily sold or changed into cash.

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