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Holger Turanskyj
Corporate Finance
Corporate finance is embedded in every corporate strategy. Every activity must be financed, capital must be used optimally, the value of the company must be increased and risks must be averted.
These are all key tasks of Corporate Finance. But how can goals such as return on investment, growth, solvency, improved company valuation and security be coordinated? What instruments are available and how can investments be assessed?
On this page we deal comprehensively with all relevant questions concerning corporate financing. In addition to a definition of the basic terms, we also show how SAP solutions contribute to the optimization of corporate finance.
What is Corporate Finance?
What is Corporate Finance?
Corporate finance can be translated as corporate finance. Using the two terms synonymously in business terminology is correct. The term "financial management", on the other hand, is not an appropriate synonym as it covers a broader field of application than private companies.
In terms of content, Corporate Finance is concerned with planning, controlling and monitoring the financing (procurement of funds) and investments (use of funds) in companies. The primary objective is to maintain the company's liquidity. Corporate financing therefore considers all cash flows and ensures that they are planned and managed in line with the situation. Control mechanisms provide information as to whether the planned values are adhered to and whether the financial situation is stable.
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What other goals does corporate financing have?
What other goals does corporate financing have?
In addition to maintaining a company's solvency, Corporate Finance pursues two other important objectives:maximizing returnsand minimizing financial risks. However, these two requirements may conflict with each other.
For example, high liquidity reduces profitability, as cash and cash equivalents do not "work". Rather, they usually lie in a low-interest bank account. However, as insufficient cash and cash equivalents can have consequences that threaten the existence of the company, liquidity regularly takes precedence over profitability. Corporate Finance is responsible for weighing these aspects and thus achieving an optimal ratio between liquidity and profitability.
In order to do justice to this task, Corporate Finance must operate a suitable risk management system. It is used to evaluate financial risks such as payment defaults or currency fluctuations. This can be done with statistical analyses based on past values as well as with future-oriented methods.
A future-oriented approach is the simulation of various scenarios on the basis of the current financial situation. The so-called "worst case scenario" is also often mentioned, since it is determined what could happen in the worst case.
The independence of the owner is also a goal of Corporate Finance. The connection here is relatively simple: companies that finance themselves purely from equity capital enjoy maximum independence. On the other hand, increasing borrowing reduces independence for several reasons:
- Collateral often has to be provided for borrowed capital. The corresponding assets will then only be available to a limited extent.
- It may be that the lender grants himself the right to control or even to have a say.
In its ultimate form, the dependency leads so far that the continued existence of the company is no longer guaranteed without the extension of loans by lenders.
Value enhancement in the context of corporate finance
Value enhancement in the context of corporate finance
Another focus of Corporate Finance is to maximize shareholder value. A good company valuation is not only relevant for ongoing business. It plays a particularly important role in the sale of companies.
When this is imminent, specialist advice on mergers & acquisitions (M&A) is often called in. These service providers introduce value-enhancing measures and at the same time minimize negative aspects in order to lay the foundation for a high price when selling a company.
The "opposite" of M&A is private equity. In particular, companies that want to grow can use this approach to attract investors who can optimally provide both capital and know-how. Private equity often also requires professional advice.
What is the process of corporate financing like?
What is the process of corporate financing like?
Corporate Finance follows a process of defined steps that are repeated on an ongoing basis. The financing process is never complete, as financial flows in the company are constantly in motion. The Corporate Finance division goes through the following phases in the rough presentation:
- Step 1: Determine capital requirements
- Step 2: Implement financing
- Step 3: Carry out investment
Step 1: Determining the need for borrowed capital
Step 1: Determining the need for borrowed capital
There can be several reasons for determining capital requirements. For the first time, this corporate finance activity is required when setting up a new company in order to define the necessary start-up capital. Existing companies may require financing for forthcoming investments. In detail, the following characteristics are to be distinguished:
- Growth financing: A company grows and has to invest in buildings, machinery, inventories or IT, for example.
- Acquisition financing: Capital is required for the acquisition of another company (Mergers & Acquisitions).
- Refinancing: For example, a company would like to become less dependent on bank loans. It issues corporate bonds to replace bank loans.
- Restructuring financing: The company needs capital for restructuring measures.
However, the determination of capital requirements in Corporate Finance must also be carried out in order to determine the need for cash and cash equivalents to cover current costs and short-term liabilities. The corresponding values are provided by the financial planning, as it compares expected revenues and expenditures. The balance represents the capital requirement (or liquidity surplus) of a period.
Step 2: Determine suitable type of financing
Step 2: Determine suitable type of financing
As soon as the capital requirement has been determined, it must be covered by suitable financing within the framework of Corporate Finance. A distinction must be made between several types of financing. They depend on the legal status of the investor and the origin of the capital.
With regard to the investor, a differentiation between equity and debt financing is possible. Self-financing is characterised by the fact that fresh money becomes equity and is therefore available without limit. In most cases, the donor receives a share in the profits and also has a direct influence on (strategic) decisions. The most common form of self-financing for corporate finance is the sale of company shares (private equity).
With debt financing, on the other hand, the fresh money counts as debt capital and is only available for a limited period of time. The investor normally has no say in business decisions. The financing fees are usually paid as fixed interest.
As far as the origin of capital is concerned, corporate finance distinguishes between internal financing and external financing. The most important form ofinternal financing is, of course, the profit generated on an ongoing basis. In addition, capital can be released through asset restructuring such as the sale of fixed assets.
In the case ofexternal financing, the necessary capital is procured via the capital market. This can be done by additional capital contributions from the existing owners or by the participation of third parties. The latter variant is often referred to as "private equity". The second usual way is to take out loans. Other forms of external financing for corporate finance include leasing, factoring and state subsidies.
Step 3: Implementation of investments
Step 3: Implementation of investments
The final focus of the corporate finance process is the use of capital. It is also called investment or capital allocation.
Investments should always be goal-oriented. This means that the return on investment should be higher than the financing costs in order to make investment decisions profitable.
To ensure this, the use of capital must be monitored on an ongoing basis.
Which areas belong to Corporate Finance?
Which areas belong to Corporate Finance?
In practice, corporate finance can be divided into several decision areas that can have either a short-term or a long-term decision horizon. However, the main goal is always to increase the return on capital or reduce the cost of capital in order to ultimately increase the value of the company. At the same time, no risks should be taken that exceed the company's capabilities. These are the main fields of activity:
- Decisions on capital expenditures
- Decisions on investments
- Decisions on financing
- Decisions on distributions (dividends)
- Short-term financial planning (working capital management)
Investment decisions
Investment decisions
Management has two basic ways of dealing with excess cash. It can invest long-term in the capital structure, in projects (e.g. research and development) or in fixed assets. The goal here is always to maximize the value of the company.
If there is no possibility of investing free liquidity in capital investments or contributing it to the capital structure, it should be distributed to the shareholders. Investment decisions in the area of corporate finance therefore include dividend policy as well as investment and financing decisions.
Decisions on investments
Decisions on investments
Naturally, the company has only limited resources at its disposal. Business areas and projects often compete for budgets. An important task of Corporate Finance is therefore to make sound investment decisions. To achieve this, the ROI of each investment opportunity must be assessed as accurately as possible. As a rule, projects with the highest return on capital are the first to be implemented. Other valuation methods are the break-even analysis, the present value method, the equivalent annual cost method (EAC) and the so-called internal rate of return.
The problem with purely monetary valuation methods is that "soft" factors are not included in the analysis. For example, research and development projects can open up completely new opportunities for a company, which of course cannot be ignored. Therefore, more flexible tools are used, which also evaluate aspects of this kind. Several possible developments are "simulated" or variables are inserted into the calculation.
Decisions on financing
Decisions on financing
The return on an investment is always influenced by whether it is financed from equity, debt or a mix of both. Corporate Finance's task here is to find the ideal financing mix. Many factors must be taken into account when choosing suitable corporate financing.
The framework is provided by the so-called capital structure policy. It determines the ratio of equity to debt capital over the long term. On this basis, additional capital requirements are then covered either by equity or debt financing (cf. section "Determining a suitable type of financing"). Furthermore, Corporate Finance has the task of planning the raising of capital as precisely as possible in terms of amount and date so that the expenses for investments are always covered.
Decisions on distributions (dividends)
Decisions on distributions (dividends)
If there are no possibilities for investments with a positive ROI, excess liquidity must be distributed to the investors. The dividend also depends on the expectations of the shareholders. In the case of growing companies (so-called growth stocks), for example, it is expected that free funds will be used in the company for self-financed growth, which will also increase the value of the shares.
Another reason for the retention of surpluses may be future investment opportunities (e.g. takeovers, mergers & acquisitions). Professional advice is often consulted here. In passing, it should be mentioned that too high a level of cash increases the risk of an external takeover attempt. Financial management must therefore ensure an adequate cash position.
Short-term financial planning (management of current assets)
Short-term financial planning (management of current assets)
Having dealt with strategic and long-term decisions in corporate finance, we are now looking at operational, short-term financial planning. This is also known as current asset management. The primary objective is to ensure that sufficient cash and cash equivalents are available at all times to cover current expenses and outstanding liabilities.
By definition, short-term financial management deals with decisions that affect the next twelve months at the most. The focus is on optimizing cash flows and returns in the next planning periods.
The net current assets should cover the liabilities at all times. At the same time, however, it must also be ensured that as little capital as possible is tied up in current assets. It is therefore important to keep cash on hand, inventories and open receivables as small as possible. Several instruments are available to achieve these objectives:
- Cash management: Cash management calculates the cash balance required to settle due invoices on a daily basis. It also takes into account the expected incoming payments. Short-term free liquidity is invested by cash management on the capital market in order to generate returns.
- Optimization of stock levels: In this case, inventories are reduced to a minimum without, however, restricting ongoing operations or production. A common approach, for example, is just-in-time delivery.
- Accounts Receivable Management: This area deals with the definition of optimal credit policies such as payment terms. Among other things, customers should be persuaded to settle outstanding receivables quickly or make additional purchases.
- Short-term refinancing: On the one hand, there is the possibility of using supplier credits. The payment terms granted are fully utilised, so that the capital tied up in the warehouse can ideally be fully financed. Another way of obtaining short-term liquidity is through factoring.
What role does risk management play in corporate finance?
What role does risk management play in corporate finance?
Several risks must be taken into account in corporate financing. In particular, the following should be mentioned:
- Fluctuations in raw material prices
- Changes in interest rates
- exchange rate movements
- Price risks (changes in share prices)
The risks must be compensated for with appropriate financial instruments. They also play an important role in cash management. They must be considered here in the form of a buffer. In addition, financial risks must be included in financing and investment decisions.
SAP and Corporate Finance: Opportunities and Opportunities
SAP and Corporate Finance: Opportunities and Opportunities
In the history of newly introduced SAP products, Corporate Finance has often been the first to benefit from the new opportunities. This also applies to the current SAP S/4 HANA product generation. Simple Finance 1.0" for SAP Business Suite powered by HANA was already available in 2014. However, this component still concentrated on cash and liquidity management. Since then, an impressive development has taken place.
Under the name "SAP S/4HANA Finance", the Walldorf-based software provider presented a solution package for all relevant areas of finance - including budgeting, planning, accounting and forecasts. Financial functions range from general financial planning and analysis to accounting, financial statements, consolidation, compliance and risk management.
The performance is remarkable, which is not only caused by the in-memory database HANA. The "S" in SAP S/4HANA does not stand for "simple" without reason. Behind this lies the guiding principle of a radical simplification of the software - also in the area of corporate finance. For this purpose, numerous elements were combined and made slimmer.
The most radical change is certainly the combination of the previously separate Financial Accounting (FI) and Controlling (CO) function modules. Cost elements no longer exist either. They are managed as G/L accounts. Financial accounting and controlling share a single document. All data from the master and subsidiary ledgers is stored in a central repository. Deviations and coordination problems are thus excluded. The evaluation of the information is also significantly simplified.
SAP S/4 HANA Finance: new user interface
SAP S/4 HANA Finance: new user interface
SAP S/4HANA Finance has also significantly simplified the user interface. The HTML-based Fiori interface is used, which runs on every mobile device. The frontend can be personalized.
For example, users can create customized reports and easily access planning, forecasting, and predictive analytics tools. Both operational and strategic key figures from corporate financing can be retrieved and combined in real time. If required, details can be tracked via drilldown.
Key SAP Functions for Corporate Finance
Key SAP Functions for Corporate Finance
SAP supports enterprise financial management with a wide range of intelligent solutions. This already begins with financial planning and budgeting, which takes place in real time in S/4HANA. In addition, "what-if" analyses can be carried out, with the help of which strategies can be adapted within a short period of time if necessary.
The company-wide treasury, i.e. the recording and control of payment flows, is also supported. For example, automated cash flow forecasts and real-time information on the daily financial status ensure this. If required, Big Data can also be used to improve financial forecasts and minimize risks. In the area of risk management, SAP software monitors risk positions and exchange rates, among other things.
With SAP Cash Management, companies create transparency regarding their liquidity. For example, cash balances can be analyzed by country, currency, company code or bank in real time. The system also provides global forecasts of liquidity and bank balances.
The so-called SAP Cash application is also worth mentioning. It implements an intelligent invoice comparison based on the SAP Leonardo machine learning technology. To learn more, the software captures numerous details of customer- and country-specific behaviors. This information is then combined with data on new incoming payments and open invoices from S/4HANA. All in all, this not only streamlines processes in receivables management. The knowledge gained also contributes to the optimisation of short-term financial planning.
Continuing education in Corporate Finance
Continuing education in Corporate Finance
For a career in corporate finance, various training and further education options are available. Most of the offers are aimed at managing directors and employees from the financial accounting and financing departments. The target group also includes employees from the consulting and financial sectors. The course contents can include both strategic and operational aspects. This includes in particular:
- Structure and analysis of balance sheets
- business valuation
- Significance and interpretation of financial ratios
- Budgeting methods (for example, net present value method, internal interest rate method)
- financial instruments (various types of financing and loans, legal aspects of credit agreements)
In addition to basic principles and traditional financing options such as bank loans, the focus is increasingly on modern financing instruments. This includes, for example, mezzanine financing, a mixed form of equity and debt financing. Methods such as these play an important role not only in corporate finance, but also in consulting.
In addition to certificate courses and courses, Bachelor's and Master's programmes are also available in the field of Corporate Finance. In addition to corporate financing, these often include related areas of knowledge such as controlling, management or financial services.
Outlook: Will crypto currencies and blockchain technologies change future corporate finance?
Outlook: Will crypto currencies and blockchain technologies change future corporate finance?
Blockchain technologies can not only be used for payment processing in crypto currencies. They also have the potential to optimize corporate financing processes. This is mainly due to the fact that the blockchain eliminates the need for intermediate stations and reduces the cost of transactions. Claims could also be assigned to a specific holder via the blockchain trade repositories. Due to the decentralized storage on distributed computers, the register is also very forgery-proof. The authenticity of each transaction is thus confirmed. Contracts, so-called smart contracts, can also be concluded via the block chain. The most important prerequisites for the illustration of financing transactions between companies are thus given. Blockchain thus forms a new perspective in corporate finance.
To date, however, there has been a lack of legal certainty for investors and borrowers. Numerous questions from the data protection law, the general law of obligations and substantive law and the banking supervision law are still unsettled here. In short: As long as there are no binding regulations on the part of the state, the potential of Blockchain for the area of corporate financing cannot be tapped.
