In this post, we’ll unpack all you need to know about corporate finance, defining exactly what it is, what it concerns, its purpose, the rules that guide it and more.
What Is Corporate Finance?
Corporate finance (CF) is the discipline of how companies should allocate resources in ways that maximise long-term value for shareholders.
What It Concerns
Corporate finance concerns 3 core areas:
- How a company should raise capital from investors (financial decisions).
- How it should use capital (investment decisions).
- How it should distribute capital it doesn’t need (dividends and buybacks).
The Objective
The objective of CF is to maximise the value of a company.
Put another way, the objective of CF is maximising the value of the company’s share price.
The 3 Rules of Corporate Finance
The objective of maximising shareholder value is achieved by following the 3 rules of corporate finance:
- Leverage low-cost debt.
- Invest in high return assets.
- Return excess capital to investors if there are no suitable opportunities for reinvesting profits into high return assets.
Analysing A Company Through The Lens Of Corporate Finance
When analysing a company, investors should evaluate the extent to which the company follows the 3 rules of CF by considering:
- How high the return is on their assets.
- How low the cost is of their debt.
- Their framework for returning capital to investors.
How Investors Can Leverage Corporate Finance
Investors can leverage CF by using its principles as a framework to evaluate how companies raises, use and distribute capital.
In doing so, investors can make more informed decisions about effectively management is creating long-term value and then allocate capital to the businesses with the strongest financial discipline.
Summary (TL;DR)
Corporate finance is the discipline of allocating resources in a way that maximises shareholder value.
The 3 rules of CF are one, leverage low-cost debt, two, invest in high return assets and three, return excess capital.
Investors can leverage CF by evaluating companies through these rules to identify those best positioned to create long-term value.
