Importance and Functions of Corporate Finance

3. Importance and Functions of Corporate Finance

Why corporate finance matters. Sound corporate finance is central to a company's survival and growth:

1. No business can start or run without finance. Whether it is buying land and machinery, purchasing raw material, or paying wages, every business activity needs money — corporate finance ensures this money is available when needed.
2. It enables expansion and modernisation. A company that manages its finance well can accumulate the resources needed to expand its operations, diversify into new products, or modernise its plant and machinery.
3. It helps maintain solvency and liquidity. Careful financial planning ensures the company can meet its short-term obligations (wages, suppliers, taxes) as well as its long-term obligations (loan repayment, debenture redemption) as they fall due.
4. It supports better decision-making. Corporate finance provides the framework — capital budgeting, cost of capital, and financial analysis — within which the company evaluates alternative projects and financing choices.
5. It protects and rewards shareholders. Because share capital ultimately belongs to the shareholders, sound corporate finance ensures their investment is used productively and that they receive a fair and regular return in the form of dividend.
6. It builds the company's credibility. A company with a healthy financial position and a track record of sound financial decisions finds it easier to raise further capital, on better terms, from investors, banks, and the public.

Functions of corporate finance — the three core financial decisions. Modern corporate finance is organised around three inter-related decisions every company's finance function must make:

1. The Financing Decision. This decision concerns how the company should raise the funds it needs — what mix of share capital, debentures, public deposits, and loans should make up the company's capital structure. The financing decision must balance cost (borrowed funds are usually cheaper than owned funds because interest is a fixed, tax-deductible charge, while dividend is not) against risk (too much borrowed capital increases the fixed burden of interest and principal repayment, raising the risk of default).
2. The Investment Decision. Once funds are raised, this decision concerns where those funds should be deployed — the mix between long-term investment (fixed assets such as land, buildings, plant and machinery) and short-term investment (current assets such as stock, debtors, and cash needed to run day-to-day operations). The investment decision is guided by expected returns and the risk attached to each option, and directly determines how much fixed capital and how much working capital the company will require (examined in the sections below). …