Corporate finance

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The term corporate finance describes a special field of finance that deals with questions about the optimal capital structure , the company's dividend policy, the evaluation of investment decisions and the determination of the company's value . About this originating from the English-language literature and teaching term includes traditionally taught in German-speaking subjects investment analysis , corporate finance and evaluation and capital market theory . The term corporate finance is used as a synonym in German literature.

The discipline is divided into a long-term and short-term decision-making horizon and techniques with the primary goal of increasing company value by increasing the return on capital or reducing the cost of capital without taking risks that exceed one's own risk-bearing capacity.

Corporate finance is a part of financial management that has a slightly broader scope and, in addition to corporations under private law, also relates to all other forms of organizations.

In Germany, the journal Corporate Finance Law was published from 2010 to 2013 .

Investment decisions

The long-term financing decisions relate to the fixed assets and the capital structure and are referred to as capital investment decisions. These decisions are based on various interdependent criteria. In general, management needs to maximize company value by investing in projects with positive cash value . If the expected capital returns from these projects are valued at an appropriate discount rate , then these projects must also be funded at the same interest rate .

If there are no such options, management should distribute the excess liquidity to shareholders. The investment decisions thus include investment decisions, financing decisions and the dividend policy.

Investment decisions

The decision process, in which the management distributes the limited resources between competing business fields is as capital requirements calculation ( Capital budgeting hereinafter). In order to be able to make these capital allocation decisions, the value of every investment opportunity or project must be estimated depending on the capital volume, temporal distribution and the predictability or uncertainty of future cash flows .

Project evaluation

The current value of a project is usually determined by discounting all project-relevant payment flows to the current point in time. The project with the highest net present value ( Net value present , NPV) is implemented first. To do this, the amount and time of all future cash flows must be estimated. These are then discounted using the discount rate and added to the present value. The present value concept is the most widely used method today to determine the net present value of an investment.

The present value is significantly influenced by the choice of the discount rate. The choice of the correct interest rate largely determines the correctness of the decision to be made. The discount rate represents a lower limit for the project return. It corresponds to the risk-free interest rate plus a project-specific risk premium. The project risks are typically determined via the expected volatility of the cash flows. To estimate a discount rate for a specific project, managers use models such as CAPM or APT . To evaluate the chosen mode of financing, the weighted average will cost of capital ( weighted average cost of capital , WACC) used.

There are various other metrics in corporate finance that are used in conjunction with present value as secondary selection criteria. These are the present value method used and include the break even analysis , the internal rate of return ( internal rate of return , IRR), the Equivalent Annual-cost method (EAC) and the return on investment (ROI).

Flexible evaluation models

In many scenarios, e.g. B. Research and development projects can open up completely new courses of action for a company, but these possibilities are not taken into account in a present value analysis. For this reason, instruments are sometimes used here which assign an explicit value to these options. While in the present value method the most likely, average or scenario-specific cash flows are discounted, in the flexible assessment various status-dependent scenario developments with their potential, different capital returns are weighted and calculated with their probability. The difference to the simple present value method lies in the modeling and evaluation of different possible development paths. These can contain different option values ​​that are to be valued.

The two most frequently used instruments are the decision tree and the real options .

  • The decision tree analysis achieves the evaluation of various development scenarios by assessing exogenous events with probabilities and management decisions based on them. Every management decision in response to an event creates an edge or branch in the decision tree that a company can follow. (Example: The management will only go into phase 2 of a project if phase 1 has been successfully completed. Phase 3, however, depends on phase 2. The sequence of events and subsequent decisions lead to different end results and each form a development path in the decision tree. There are no conditional branches in the present value method - each phase must be modeled as a stand-alone scenario). The path with the highest probability-weighted present value gives the representative project value.
  • The approach of real options is used when the value of a project depends on another value variable. (Example: The feasibility of a gold mining project depends on the gold price on the market. The mining project will only be implemented if the gold price is high enough). Here the option price theory is used as a framework; the decision to be made is either an option to buy or an option to sell . The valuation is then carried out with the binomial model or - less often for this purpose - via Black-Scholes, see option price valuation . The value of the project determined in this way then corresponds to the present value of the most likely scenario plus its option value.

Financing decisions

Every business investment must be adequately financed. As mentioned above, the choice of financing affects both the discount rate and the future cash flows. The composition of the financing from equity and debt thus influences the value of an investment. Management must therefore determine the optimal financing mix, i.e. That is, the capital structure that leads to the maximum value is to be found (see: Balance sheet structure management , Fisher separation theorem , but also Modigliani-Miller theorem ).

When choosing corporate financing, many factors play a role in the decision. In the capital structure policy, the ratio of equity to debt capital or its change targets is determined. Depending on the circumstances , additional financing requirements are tapped via external or internal financing , i. This means that the additional capital required is raised as debt with a longer or shorter term or as equity . Measures such as the listing on the stock exchange, the capital increase or the reallocation of debt capital are mentioned. Project financing through outside capital (debt) represents a liability, the interest burden of which must be met. This results in interest outflows with a corresponding influence on the project cash value. Equity financing is less risky in terms of cash flow liabilities , but it will reduce the return on equity if the project's earnings targets are not met. The costs of equity are typically also higher than the costs of debt (see CAPM and WACC ), and so equity financing leads to an increased discount rate, which in the end far exceeds the interest rate risks of debt financing. The management must also ensure that the capital raised coincides as precisely as possible in terms of amount and timing with the cash flows of the investment expenses.

Distribution decision - dividend policy

In general, the management has to decide whether free capital should be distributed to further projects, to ongoing operations or as dividends to the capital owners. The dividend is calculated primarily on the basis of the undistributed net profit and the prospects for the course of business for the coming year. If there are no positive present value opportunities with returns above the risk-adjusted discount rate, management must distribute the excess cash to investors. These free liquid funds contain the money that is available after deducting all business expenses and the operationally necessary provisions .

If the company by the shareholder as a growth stock ( Growth-floor classified), so he expects definition that these free agents remain in the company and lead to eigenfinanziertem growth on which it participates by increasing the share value. In other cases, management will argue that the free funds should remain in the company, even if there are no investment opportunities with a cash value surplus in sight. You may point out possible future investment opportunities (e.g. possible future company takeovers). However, as the cash in hand increases, there is also the risk that the company itself, possibly involuntarily, becomes the target of an attempt to take over.

When repaying free funds, the management must decide whether this should be done by means of a dividend (see special dividend ) or by means of a share buyback. There are several factors to consider: While shareholders pay taxes on dividends, withholding free funds or buying back shares can increase the value of the shares. Some companies will distribute the "dividends" to shareholders as bonus shares. According to the Modigliani-Miller theorem, many investors today agree that dividend policy has no impact on company value.

Working capital management

The decisions about financing current assets and short-term financing are referred to as management of net working capital or short-term financial planning . The main focus is on monitoring and influencing the ratio of current assets to short-term liabilities . The aim is to ensure the continuation of business operations (going concern) and to ensure that sufficient liquid funds are available to both pay off all liabilities that become due and to cover ongoing business expenses.

Decision criteria

By definition, working capital management deals with short-term decisions with a time horizon of the next twelve months. These decisions are therefore not based on a present value view, but optimize the cash flows and returns on a period-oriented basis, without discounting.

  • The turnover cycle is a measure of the rate of turnover of money . This key figure measures the number of days between the payment of the preliminary work and receipt of payment based on the customer's own invoices. This key figure makes the interdependence visible between the procurement decision and inventory turnover, accounts payable and receivable, as well as the respective payment conditions. The key figure characterizes the length of time for which the capital is tied up in current assets and is not available for other uses. It is therefore tried to make the cycle duration as short as possible.
  • The best measure of profitability for in this context is the ROI (return on capital; ROC). The key figure is shown as a percentage by dividing the income of the last 12 months by the capital employed. The return on equity (ROE) shows the result for the shareholders. The company value increases precisely when the return on equity is higher than the cost of capital .
  • ROC is a sensible management indicator because it relates the short-term operative decisions related to the net working capital with the long-term decisions regarding the invested capital. See also Economic Value Added (EVA).

Cash management

On the basis of the above criteria, the management will use a combination of methodological principles and techniques to optimize the capital tied up in net working capital in such a way that all liabilities can be serviced with sufficient liquid funds at all times, but that as little capital as possible is tied up in current assets. Cash in hand, warehouse and outstanding accounts receivable (accounts receivable) should therefore be kept as small as possible, but buffered with sufficient reserves so that the ability to pay and deliver your own products is guaranteed at all times.

  • Cash management - identifies the cash balance to the day, which must be available for the invoices due on the key date, as well as the expected incoming payments. Liquidity that is not required in the short term can be invested in the capital market in the longer term and thus makes a contribution to the financial result.
  • To optimize stock turnover, the minimum stocks required for uninterrupted production are determined, after which the stocks of raw materials and intermediate products are reduced to these minimum stocks. This requires well-organized requirements planning, procurement and inventory management, see just-in-time production (JIT).
  • Accounts Receivable Management is concerned with establishing an appropriate credit policy, e.g. B. Payment terms that are so attractive for new customers that the negative effects of the increased capital commitment in net working capital are more than offset by the income from the increased sales (or vice versa).
  • Short-term refinancing: the assets tied up in the warehouse are ideally financed through supplier credits with a notice period based on the money turnover cycle. It may also be necessary to sell accounts receivable (so-called factoring) in order to create liquid funds in the short term.

Financial risk management

Under risk management refers to the identification and measurement of risks and the development and implementation of strategies to cope with these risks. Financial risk management focuses on financial risks such as raw material price, interest rate, exchange rate and share price changes (exchange rate risk ), which can be compensated ( hedged ) with appropriate financial instruments . Financial risks also play an important role in cash management. This area is closely related to corporate finance in two ways. On the one hand, a company's risk exposure is the direct consequence of previous investment and financing decisions. Second, both branches of knowledge share the same goal of creating and improving company value. All large companies have a risk management team, and small and medium-sized companies practice informal, if not formal, risk management.

The use of derivative instruments is a very common tool in financial risk management. Because derivative OTC transactions are very expensive to generate and monitor, the most cost-effective method is to use exchange-traded derivatives, which are traded on well-functioning financial markets. The standard instruments include options , futures , forwards and swaps .

Individual risk characteristics are financial engineering , financial risk , default risk , credit risk , interest rate risk , liquidity risk , market risk , operational risk , volatility risk or settlement risk .

Relation to other financial subjects

Corporate finance uses instruments from almost all areas of financial management. Some of the tools that have been developed for use in corporate finance have found widespread use elsewhere, e.g. B. in partnerships and cooperations, in NGO organizations, in government and administration, in investment funds and asset management. In other cases, certain instruments are used very limited or not at all in other areas of application. Because large corporations deal with amounts of money that are considerably larger than those of individual wealthy individuals, corporate finance-based analysis has developed into an independent discipline. It can be differentiated from personal finance and public finance .

See also

literature

  • Christof Schulte: Corporate Finance. The current concepts and instruments in financial management. Vahlen, Munich 2005, ISBN 3-8006-3201-2 ( innovative financial management ).
  • Richard A. Brealey, Stewart C. Myers, Franklin Allen : Corporate Finance. 8th edition. McGraw-Hill, Boston MA et al. 2005, ISBN 0-07-111551-X ( The McGraw-Hill / Irwin series in finance, insurance, and real estate ).
  • Aswath Damodaran: Corporate Finance. Theory and Practice. 2nd edition. John Wiley & Sons et al., New York NY 2001, ISBN 0-471-28332-0 ( Wiley series in finance ).

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