Objectives of Corporate

Finance
-Aaditya Desai

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Primary Objectives of Corporate Finance
• In 21st Century, these below mentioned are treated as primary objectives of corporate finance:
1. For publicly traded companies in efficient markets, where bondholders (lenders) are
protected: Optimize Stock Price: This will indirectly maximize company’s value.
2. For publicly traded companies in inefficient markets, where bondholders are protected:
Maximize Wealth of Shareholder: This will maximize company’s value, but may not optimize
the company’s stock price.
3. For publicly traded companies in inefficient markets, where bondholders are not fully
protected: Maximize company’s value, though Shareholder wealth and company’s stock prices
may not be optimizing at the same point.
4. For private companies during any kind of market circumstances: Optimize Shareholder wealth
(assuming lenders are protected) or company’s value (assuming they are not protected).

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Objective of Corporate Finance

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Functions of Corporate Finance
1. Separation of Management and Ownership
2. Collaboration between Capital Markets and Company
3. Finance Decisions
4. Investment Choice
5. Acquisition of Resources
6. Allocation out of Resources

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Finance Decision
• Considering that company has access to capital market for fulfill their funding specifications.
• But, the company confronts numerous options about funding. That the company could firstly
decide whether that it wants to increase debt capital or perhaps equity capital.
• Even there are various choices when selecting either equity or debt capital for a company.
• They may choose corporate loans, public fixed deposits, bank loan, debentures to raise
capital from the market.
• Financial innovation then securitization, has provided vary of instruments your company can
easily use to increase capital.
• The functions of corporate finance manager so are promising that the company has possible
capital and appropriate capital structure.
• They have each appropriate combination concerning equity and debts along with other
financial devices. 

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 Investment Choice
• When the company has raised required capital from various sources, their financial manager deals with the following big
move.
• Your decision is deploy that the funds in a manner so it yields the best returns for shareholders.
• Company needs to be aware of its cost of capital.
• After that they see their cost of capital, they can deploy his or her funds in a way that each returns in which accrue are
more than the cost of capital which the company maintains in order to pay.
• Looking for these investments plus deploying each funds effectively your investment decision.
• It’s also recognized when cost management and it is a fundamental functions of corporate finance.
• Money cost management possesses theoretical presumption that the company has access toward unlimited financing as
long they’ve feasible projects. the difference of this choice was capital rationing.

• Investing and financing choices is like two different sides of the identical coin. Your company must raise funds only when
it’s ideal avenues to deploy them.
• The functions of corporate financing have varieties of equipment as well as methods that allow supervisors / managers to
evaluate funding plus investing choices. It’s thus essential for the financial stability and growth of the company.

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 Balance Sheet
• In financial accounting, a balance sheet or statement of financial
position is a summary of the financial balances of an individual or
organization, whether it be a sole proprietorship, a business
partnership, a corporation, private limited company or other
organization such as Government or not-for-profit entity. 
• Assets, liabilities and ownership equity are listed as of a specific
date, such as the end of its financial year.
• A balance sheet is often described as a "snapshot of a company's
financial condition".
• Of the four basic financial statements, the balance sheet is the only
statement which applies to a single point in time of a business'
calendar year.
• A standard company balance sheet has two sides: assets, on the left
and financing, which itself has two parts, liabilities and ownership
equity, on the right.
• The main categories of assets are usually listed first, and typically in
order of liquidity.
• Assets are followed by the liabilities. The difference between the
assets and the liabilities is known as equity or the net assets or
the net worth or capital of the company and according to
the accounting equation, net worth must equal assets minus
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liabilities.
 Profit and Loss Account
• This is often called the P&L for short, and it shows
your business’s income, less its day-to-day running
costs, over a given period of time – often a year,
month, or quarter.
• The day-to-day running costs divide up into direct
costs, which are costs that relate immediately to
sales, and overheads, which are general running
costs.
• For example, the cost of buying materials to make
goods to sell, and the cost of delivering finished
goods to customers, would be direct costs.
• Rent of an office would be an overhead. If your
business sells services, it may not have any direct
costs.
• Your business’s income from sales is called turnover.
Turnover less direct costs gives a figure called gross
profit.
• A business’s total income, less all its day-to-day
running costs, is its net profit.
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 Cash Flow Statement
• In financial accounting, a cash flow statement, also known as statement of
cash flows, is a financial statement that shows how changes in balance
sheet accounts and income affect cash and cash equivalents, and breaks the
analysis down to operating, investing, and financing activities. Essentially, the
cash flow statement is concerned with the flow of cash in and out of the
business.
• The statement captures both the current operating results and the
accompanying changes in the balance sheet. As an analytical tool, the
statement of cash flows is useful in determining the short-term viability of a
company, particularly its ability to pay bills. International Accounting Standard
7 (IAS 7), is the International Accounting Standard that deals with cash flow
statements.
• People and groups interested in cash flow statements include:
1. Accounting personnel, who need to know whether the organization will be
able to cover payroll and other immediate expenses
2. Potential lenders or creditors, who want a clear picture of a company's ability
to repay
3. Potential investors, who need to judge whether the company is financially
sound
4. Potential employees or contractors, who need to know whether the
company will be able to afford compensation
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5. Shareholders of the business.
Purpose of Financial Ration Analysis
• A ratio analysis is a quantitative analysis of information contained in a company’s
financial statements.
• Ratio analysis is used to evaluate various aspects of a company’s operating and
financial performance such as its efficiency, liquidity, profitability and solvency.
• When investors and analysts talk about fundamental or quantitative analysis, they are
usually referring to ratio analysis.
• Ratio analysis involves evaluating the performance and financial health of a company
by using data from the current and historical financial statements.
• The data retrieved from the statements is used to - compare a company's
performance over time to assess whether the company is improving or deteriorating;
compare a company's financial standing with the industry average; or compare a
company to one or more other companies operating in its sector to see how the
company stacks up.
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Liquidity Ratios
• Liquidity Ratios measure a company's ability to pay off its short-term
debts as they come due using the company's current or quick assets.
• Liquidity ratios include current ratio, quick ratio, and working capital
ratio.

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Solvency Ratios
• Also called financial leverage ratios, solvency ratios compare a
company's debt levels with its assets, equity, and earnings to evaluate
whether a company can stay afloat in the long-term by paying its
long-term debt and interest on the debt.
• Examples of solvency ratios include debt-equity ratio, debt-assets
ratio, and interest coverage ratio.

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Profitability Ratios
• These ratios show how well a company can generate profits from its
operations.
• Profit margin, return on assets, return on equity, return on capital
employed, and gross margin ratio are examples of profitability ratios.

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Efficiency Ratios
• Also called activity ratios, efficiency ratios evaluate how well a
company uses its assets and liabilities to generate sales and maximize
profits.
• Key efficiency ratios are the asset turnover ratio, inventory turnover,
and days' sales in inventory.

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Coverage Ratios
• These ratios measure a company's ability to make the interest
payments and other obligations associated with its debts. 
• Times interest earned ratio and debt-service coverage ratio are two
examples of coverage ratios.

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Market Prospect/Stock Market Ratios
• These are the most commonly used ratios in fundamental analysis.
• Investors use these ratios to determine what they may receive in earnings
from their investments and to predict what the trend of a stock will be in the
future.
• For example, if the average P/E ratio of all companies in the S&P 500 index is
20, with the majority of companies having a P/E between 15 and 25, a stock
with a P/E ratio of 7 would be considered undervalued, while one with a P/E
of 50 would be considered overvalued.
• The former may trend upwards in the future, while the latter will trend
downwards until it matches with its intrinsic value.
• e.g. dividend yield, P/E ratio, earnings per share, and dividend payout ratio.
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Capital structure ratio
• The short and long term debt ratio of a company should also be
considered while examining the capital structure.
• Capital structure is most commonly referred as a firm's debt-to-
equity ratio, which gives an insight into the level of risk of a company
for the potential investors.

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Limitation of Ratio Analysis
• Historical. All of the information used in ratio analysis is derived from actual historical results. This does not
mean that the same results will carry forward into the future. However, you can use ratio analysis on pro
forma information and compare it to historical results for consistency.
• Historical versus current cost. The information on the income statement is stated in current costs (or close to
it), whereas some elements of the balance sheet may be stated at historical cost (which could vary
substantially from current costs). This disparity can result in unusual ratio results.
• Inflation. If the rate of inflation has changed in any of the periods under review, this can mean that the
numbers are not comparable across periods. For example, if the inflation rate was 100% in one year, sales
would appear to have doubled over the preceding year, when in fact sales did not change at all.
• Aggregation. The information in a financial statement line item that you are using for a ratio analysis may
have been aggregated differently in the past, so that running the ratio analysis on a trend line does not
compare the same information through the entire trend period.
• Operational changes. A company may change its underlying operational structure to such an extent that a
ratio calculated several years ago and compared to the same ratio today would yield a misleading conclusion.
For example, if you implemented a constraint analysis system, this might lead to a reduced investment
in fixed assets, whereas a ratio analysis might conclude that the company is letting its fixed asset base
become too old.

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 Limitation of Ratio Analysis
• Accounting policies. Different companies may have different policies for recording the same accounting transaction. This means
that comparing the ratio results of different companies may be like comparing apples and oranges.
•For example, one company might use accelerated depreciation while another company uses straight-line depreciation, or one
company records a sale at gross while the other company does so at net.
• Business conditions. You need to place ratio analysis in the context of the general business environment.
• For example, 60 days of sales outstanding for receivables might be considered poor in a period of rapidly growing sales, but might
be excellent during an economic contraction when customers are in severe financial condition and unable to pay their bills.
• Interpretation. It can be quite difficult to ascertain the reason for the results of a ratio.
• For example, a current ratio of 2:1 might appear to be excellent, until you realize that the company just sold a large amount of
its stock to bolster its cash position. A more detailed analysis might reveal that the current ratio will only temporarily be at that
level, and will probably decline in the near future.
• Company strategy. It can be dangerous to conduct a ratio analysis comparison between two firms that are pursuing different
strategies.
• For example, one company may be following a low-cost strategy, and so is willing to accept a lower gross margin in exchange for
more market share. Conversely, a company in the same industry is focusing on a high customer service strategy where its prices
are higher and gross margins are higher, but it will never attain the revenue levels of the first company.
• Point in time. Some ratios extract information from the balance sheet. Be aware that the information on the balance sheet is only
as of the last day of the reporting period. If there was an unusual spike or decline in the account balance on the last day of the
reporting period, this can impact the outcome of the ratio analysis.

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