The role of finance in an organization is to make sure that money is at the right place at the right time. A company wants to have enough money to pay its bills, but also wants to invest so that it can grow in the future. The finance department is devoted to the task of figuring out how to allocate assets to do so, for the overarching goal of maximizing shareholder value.
There are two fundamental types of financial decisions that the finance team needs to make in a business: investment and financing. The two decisions boil down to how to spend money and how to borrow money. Recall that the overall goal of financial decisions is to maximize shareholder value, so every decision must be put in that context. An investment decision revolves around spending capital on assets that will yield the highest return for the company over a desired time period.
In other words, the decision is about what to buy so that the company will gain the most value. To do so, the company needs to find a balance between its short-term and long-term goals. On the other end of the spectrum is a purely long-term view. Companies thus need to find the right mix between long-term and short-term investment. The investment decision also concerns what specific investments to make. Since there is no guarantee of a return for most investments, the finance department must determine an expected return.
This return is not guaranteed, but is the average return on an investment if it were to be made many times. All functions of a company need to be paid for one way or another. It is up to the finance department to figure out how to pay for them through the process of financing.
Each has its advantages and disadvantages. There are two ways to raise money from external funders: by taking on debt or selling equity. Taking on debt is the same as taking on a loan. The loan has to be paid back with interest, which is the cost of borrowing. Selling equity is essentially selling part of your company.
When a company goes public, for example, they decide to sell their company to the public instead of to private investors. Going public entails selling stocks which represent owning a small part of the company. The company is selling itself to the public in return for money.
Every investment can be financed through company money or from external funders. It is the financing decision process that determines the optimal way to finance the investment. Corporate finance deals with monetary decisions that business enterprises make and the tools and analysis utilized to make the decisions.
Corporate finance is concerned primarily with making investment and financing decisions; that is, making sure that money is being used in the best way. The corporate finance department of a company is in charge of budgeting.
Management must allocate limited resources between competing opportunities; since a dollar cannot be used for more than one project at once, it is a challenge to determine how much money should be allocated to each part of the business. In determining how to allocate money, the finance group must also figure out where the money will be best utilized.
This requires valuing projects and business functions. A large element of finance is deciding how exactly to value a project. There are a number of variables — inflation, expected revenues, expected costs, length of time required — that are all incorporated into the valuation process.
Finding the true value of a project is often wrought with uncertainty, but without an accurate valuation, a company may allocate its resources sub-optimally. The corporate finance department must also determine how to finance projects.
A company can finance a project by using either internal funds money the company already has , borrowing, or selling equity. Each option carries a certain cost that can be quantified. One public job function of corporate finance is determining whether or not the company pays a dividend, and if so, how much. The company has a responsibility to maximize shareholder value, but that can be achieved in multiple ways. Paying a dividend puts cash directly in the hands of shareholders, increasing shareholder value.
However, paying a dividend means that money is not being reinvested in the company. The finance department determines which option maximizes shareholder value. Lastly, the finance department must also ensure that there is a good balance between long- and short-term goals. The company must have enough assets to cover short-term costs, referred to as working capital management, and enough invested to ensure the company has long-term growth.
Factory : Purchasing new machinery requires a valuation of all equipment, an accurate idea of the total cost over time, and a way to finance the purchase while leaving enough cash for other upcoming costs. The financial manager is responsible for budgeting, projecting cash flows, and determining how to invest and finance projects.
The role of a financial manager is a complex one, requiring both an understanding of how the business functions as a whole and specialized financial knowledge. The head of the financial operations is called the chief financial officer CFO.
The structure of the company varies, but a financial manager is responsible for the same general things across the board. The manager is responsible for managing the budget. This involves allocating money to different projects and segments so that the business can continue operating, but the best projects get the necessary funding.
The manager is responsible for figuring out the financial projections for the business. The development of a new product, for example, requires an investment of capital over time. This is a lot tougher than it sounds because there is no accurate financial data for the future. Collaboration : The finance manager must collaborate across business functions in order to determine how to best allocate and manage assets. There is a cost to investing money, either the opportunity cost of not investing it elsewhere, the cost of borrowing money, or the cost of selling equity.
The finance manager uses a number of tools, such as setting the cost of capital the cost of money over time, which will be explored in further depth later on to determine the cost of financing. At the same time that this is going on, the financial manager must also ensure that the business has enough cash to pay upcoming financial obligations without hoarding assets that could otherwise be invested.
This is a delicate dance between short-term and long-term responsibilities. The study of finance often feels a lot narrower than it really is. There is a lot of talk of issuing bonds or pricing projects which belies how relevant finance is to everyday life, regardless of whether or not you have any desire of working in finance.
Finance plays an involved role in the health of the overall economy, which impacts everyone, regardless of whether or not they have studied finance. The field of finance explains why the recession occurred; it is the reason why people care about how the stock market is doing each day; and it articulates why businesses and governments make some of the decisions they do. Finance plays a role in many of the stories in the news every day, which means that those who understand finance have a better grasp on how the events of the world affect them.
Each person will also have to manage his or her own personal finances. Like corporations, individuals are faced with investment and financing decisions. In order to invest, individuals must be able to do the same projections and valuations as companies in order to determine the best investment for their needs. Individuals cannot sell equity like corporations, but they can choose to either dip into their savings or take out loans.
Many take on debt in the form of student loans, mortgages, or through their credit cards; being able to properly compare options to leverage is just as important for individuals as it is for companies.
Of course, finance is an important field of study for those who have a desire of working in finance or accounting. Finance is heavily used in jobs ranging from investment banker to CFO to venture capitalist. However, finance is not segmented from the other functions in business. Every job from marketing to engineering has to be able to manage a budget and make a business case that it should get funding for a project.
This is especially true higher up in the organizational hierarchy: managers, directors, and vice presidents need to be able to articulate why their departments should get financial support from the company. Finance is a field of both hard analytical skill and personal judgement.
There are set processes and theories for determining which financial option is best, but in the real world, it is rare to have all of the information needed to be absolutely certain about what to do. Finance develops strong analytical skills, but also the degree of finesse required to operate in an environment of uncertainty.
Search for:. Introducing Finance. Defining Finance Finance is the study of fund management and asset allocation over time. Learning Objectives Explain the importance of time to the discipline of finance. Key Takeaways Key Points The two main drivers of finance are the time value of money and risk.
Since the value of assets changes over time, finance seeks to ensure the change is beneficial for the organization or individual. Financial professionals generally operate in an environment of uncertainty where they must make forecasts about future events. Key Terms investment : A placement of capital in expectation of deriving income or profit from its use. Elaborate and implement the actions of the financial plan : When you have already fixed your objectives and you know the actions to carry out, you only need to launch the project.
You should keep in mind that not always makes more money in less time is synonymous of a better financial plan. You must prioritize the objectives. Review and revise the financial plan : Evaluate how the project is operating relative to a forecast which was made previously. To make a good Financial Planning Process you have to follow these six steps :.
Determine current financial situation : To join all the information about the financial situation of the company, such as bank accounts, loans, taxes, utility bills, investments, insurance… Finally, with all this information analyzed, you can evaluate how the financial situation is.
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