Basic Principles of Corporate Finance

Corporate Finance is a field of finance that deals with the capital structure of entities and sources of funding, in order to maximize Shareholders’ value. The main objective of corporate finance is to understand how to enhance company's value by making better decisions about three factors; financing, investment and dividend. Hence, the study of corporate finance provides answers to the following questions:

• How should a business acquire its financial resources – either through equity or debt?

• How should the business allocate its scarce financial resources among different projects/investments in order to optimize its returns?

• What should a business do with the profits it earned? Should it retain them for future use or payout to the owner in the form of a dividend?

The three basic principles of corporate finance, that every SME owner should know, are:

The Investment Principle:

According to this principle, an entity should invest its funds in projects or investments that give maximum Return on Investment (ROI). Before investing in any project, the finance team should prepare its financial feasibility study to assess future costs, revenues and estimated profits.

The Financing Principle:

Most of the businesses are funded by a financing mix i.e. shareholders’ funds or equity and borrowed funds or loan. The financing principle states that a business owner should select such a financing mix so as to maximize the value of the investment and minimize the cost of financing.

The Dividend Principle:

If there are not enough investment opportunities to invest surplus cash and earn an acceptable hurdle rate (the minimum rate that a company expects to earn while investing in a project); the money should be returned to the owner. So, the basic question is whether the excess cash should be retained in the business or given away to the owner/investor. Public listed companies pay off such cash in the form of a dividend or buy back their own shares. The CreditBPO Rating Report© is the partner you need in analyzing the financial performance of your business. It provides you with an assessment of your company's profitability, solvency, and liquidity in 24-48 hours using financial technology. It is a Robo-advisory to your business. Confidentiality assured.

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