1.2 Corporate Financial Management: The Issues
The corporation, and by assignment, the corporate financial manager, are responsible for establishing the strategic (i.e., long-term) financial direction of the company. This involves numerous tasks.
The corporation must decide how it shall achieve growth in order to provide an increasing financial return – or profit – to its shareholders. In order to grow, the firm must raise capital, or financial resources (“money”), and use those resources in a productive, profitable manner. The firm raises capital in order to invest in assets that will produce products for sale and profit. In the process of capital budgeting, the manager examines the prospective investment projects available to the firm and chooses the most promising from amongst this set. This requires an evaluation of all relevant costs and resulting profits. This is a complex process.
To the extent that the corporation may not generate sufficient funds to meet all its investment needs on its own, it will have to rely on outsiders to provide “external” financing. This often constitutes the bulk of its sources of funds. Some of these funds will come from borrowing. Some of the funds will come from equity.
The proportion of how much capital shall be sourced from debt and how much from equity is a matter of the firm’s capital structure policies. The company will attempt both to minimize its overall cost of capital, while, at the same time, to minimize its financial risks. Some capital sources present greater financial risks to the corporation than others.
In addition to managing its long-term financial affairs, the company must manage its short-term financial affairs as well. This includes the profitable handling of its cash, inventory, accounts receivable, and other critical short-term assets. Each of these areas requires expert care.
To summarize, corporate financial management is all about capital budgeting, capital structure, and short-term financial management. The objectives are to provide profits, minimize risk, and thereby enhance shareholders’ wealth by maximizing the market value of the corporation’s shares (and perhaps by providing dividends). We will cover Capital Budgeting first. Here is the Capital Budgeting process:
Capital Budgeting Stages:
- Find potential investment projects.
- Estimate (i.e., project) Free Cash Flows (“FCF” is discussed immediately below).
- Evaluate the investment project candidates using Capital Budgeting techniques.
- Implement and monitor the chosen project.
