What Are the Four Elements of Corporate Finance?
Corporate finance means planning, organising, developing and managing the capital structure of a business enterprise. Its main objective is to augment the profit and organisational value of the company by making effective decisions on finances, investments, and dividends.
It emphasises capital investments that focus on meeting the financial needs of a business to achieve a substantial capital structure. The corporate financial plans are categorised into a few elements. Keep reading to know more about them.
4 Key Elements of Corporate Finance
Four crucial elements involved in corporate finance include operating cash flows, cost of capital, invested capital, and return on invested capital. Let’s discuss these elements in further detail:
- Operating Cash Flow (OCF)
Operating Cash Flow (OCF) signifies the total amount of cash produced by an organisation owing to its business operations. This indicates whether an entity can generate substantial positive cash flow in order to maintain and enlarge its operational activities, or else, require external financing for capital growth. Operating cash flow helps generate funds through various activities like:
- Cumulative sales of products and services within a particular period.
- Payments made to employees or other expenditures incurred during production.
- Payments to the suppliers of goods and services.
- Invested Capital
Invested capital refers to the amount of investment made by shareholders and debtholders in an organisation. When an organisation requires increasing capital, the company can attain it by issuing bonds or selling stock shares. For an entity, invested capital serves as a foundation of funding by which they can expand their operation.
The invested capital is used for purchasing fixed assets like buildings, land or equipment. Secondly, it helps cover the day-to-day expenses like paying for stock, paying workers’ salaries, etc.
- Return on Invested Capital (ROIC)
Return on invested capital measures how efficiently an organisation is allocating capital to be profitable and how they are generating substantial income. The return on invested capital is calculated by taking into consideration the cost of investment and the amount of returns generated. ROIC is calculated by dividing the net profit after tax by the invested capital. If an organisation is facing losses, it can consult business advisors for their betterment.
- Cost of Capital
The cost of capital (COC) refers to the least possible return required by the two main sources of capital, i.e. equity and debt. Both debtholders and equity holders take an active part in contributing capital to a business with the expectation of earning a good return.
COC is computed by adding an organisation’s total interest expenditure for each debt in a year and dividing it by the total number of debts. The cost of capital of a company is divided into two parts: explicit cost and implicit cost.So, this was everything about the four important elements involved in corporate finance. While running an organisation, you must give extra attention to these four factors to ensure the smooth functioning of your company. If you face any problem, feel free to take expert assistance from business consultants.