3 Important questions in corporate finance


8/1/20231 min read

Financial managers around the world are concerned about three important questions and try to address them on a daily basis. These questions are:

  1. What long-term investments should the firm undertake? (capital budgeting decision)

    capital budgeting projects are generally large, require a significant amount of capital commitment, and tend to have a long-term impact on the firm's value. One can find these investments in the fixed assets sections of the balance sheet. This part of the balance sheet shows the capital budgeting projects that the firm has undertaken over the years. In fact, one can look at a firm as a portfolio of these assets. fixed assets do not necessarily have to be tangible. An R&D project in a pharmaceutical company that results in a patent (intangible fixed asset) can also be considered a capital budgeting decision.

  2. How should the firm raise money to fund these investments? (capital structure decision)

    After deciding on a project, the CFO of the firm should think about the ways to pay for the project. The rule of thumb for the CFO is to find the cheapest source of financing. This can be achieved by finding a mix of debt and equity that minimizes the cost of capital of the firm, which consequently maximizes the value of the firm.

  3. How can the firm best manage its cash flows as they arise in its day-to-day operations? (working capital management)

    CFOs might not be engaged in capital budgeting or capital structure decisions on a daily basis, but they do need to make sure that the firm remains in good financial health in the short run every day. One can see the effect of that on the current assets and current liabilities of the firm. This aspect of the job for the CFO deals with managing relationships with customers and suppliers ( and other providers of short-term capital). In short, the goal is to collect cash from customers as fast as possible and pay the suppliers as late as possible. in doing so, they cannot be too aggressive to the point of alienating the customers or angering the suppliers.