Fundamental Principles of Corporate Finance

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Table of Contents

Introduction
Investment Principle
Financing Principle
Dividend Principle
The interpretation of the objectives of firm value maximization
Assessing how low cost strategy can benefit a company’s financial goals
Conclusion
References

Introduction

In corporate and business finance, there are three fundamental principles that have been studied and utilized over years. The principles take into account the capital flows intended to offer support to various business ventures. In fact, from global corporations to the small and medium sized enterprises, it is apparent that each commercial venture ought to make two distinct decisions.

First, as investment matures, a corporation should make the preeminent decision concerning how capital must be restored to corporate financiers or business owners. Second, decisions ought to be made concerning how finance can be used to discover, utilize and allocate the available resources.

The organization should control places where the resource support originates and the manner through which they recuperate to be utilized (Berman and Knight, 2008). These require the application of various interrelated and fundamental principles.

This paper describes the fundamental principles constituting the basis of corporate finance including the dividend, financing, and investment principles. The paper also interprets the objectives of firm value maximization and assesses how low cost strategy can benefit a company’s financial goals.

Investment Principle

According to Aaker (2001), the investment principle of economics specifies where an organization should commit its resources. An organization might generate supplies and offers supplies, which bring revenue and realize processes that assist in the lowering of costs. However, the management of an organization must classify ventures that must bring income at a superior level compared to what the venture utilizes in terms of resources.

The symmetry point also referred to as the hurdle rate significantly depends on the degree of risk involved. The hurdle rate also depends on the manner in which it will be financed and the projected speed at which the income will be generated to cover the expenses and generate significant turnover.

Financing Principle

According to Knon and Barnes (2010), organizations should be able to recognize how resources should be supported in the best way possible. In this regard, it is imperative to finance projects that are viable and likely to have return on investment (ROI). There are two types of financing. These entail debt or amount overdue and equity. The amount overdue that is a mode corporate funding consists of government securities such as bonds and depository credit.

Equity is composed of cash and stock. The issues that should be considered under this principle include the duration for carrying the debt such as short or long term. The amount of money the organization is willing to budget for financing is also an important aspect to consider.

To finance a project effectively, the company must consider the amount of equity that should be tied up on the project. The number of shares to be sold so that the project can be fully financed should also be considered. This will ensure that the project is financed sufficiently.

Dividend Principle

This principle entails the channels where any additional income is created from successful projects. The revenues need to be ploughed back to the business in terms of new property. Alternatively, it can be given back to the financiers of the project. The amount to be given back or ploughed back is dependent on the quantity and kind of new property available.

The extent of financial risks the shareholders could be prepared to undertake might as well be considered. Additionally, the arrangement of the financing used is also given significant consideration. A small company may pay a loan early. On the other hand, a large organization may opt to distribute the revenue to the shareholders through bonuses.

The interpretation of the objectives of firm value maximization

The principles namely the investment, financing and dividend principles collaborate to influence the value of the company. The efficiency of an organization in utilizing the assets to meet the contemporary competitive market and create income defines the degree of risk in specific ventures. The symmetry point stipulates the cost of financing.

These include loan interest rates and the value of stock. The amount of cash put into financing influences the amount of capital accessible for a property to function. Subsequently, the income generated by the property is limited. The aspect facilitates the determination of the general worth of the organization.

Assessing how low cost strategy can benefit a company’s financial goals

Aaker (2001) asserts that it is imperative for the management to ensure the integration of the three principles for the organization to benefit optimally. Appropriate consideration of the investment principle drives the decision makers to consider the most inexpensive methods of producing goods and offering services (Aaker, 2001).

When the costs attached to the delivery of service and goods are lower, the organization will have the capacity to offer its customers the services and goods at a low price. Low costs translate to lower risks involved in the delivery of service and sale of goods. In this regard, the return on investment may not be as high as when the risk is high (Kono and Barnes, 2010).

Conclusion

From the discussions, it is important for companies to consider the three principles of finance as they significantly impacts the profitability of a company. Companies should be keen when deliberating investment as it affects directly on the revenue generated that in turn determines the amount of financing required.

Consequently, the financing determines the revenue generated hence the surplus that will be available for sharing among the shareholders. The integration of the three principles is important as it determines the competitiveness of the company. Effective collaboration of the principles results in the acquisition of more assets and the ability of the company to give dividends to the investors.

References

Aaker, D. (2001). Developing business strategies. New York, NY: John Wiley & Sons, Inc.

Berman, K. & Knight, J. (2008). Financial intelligence for hr professionals. Boston, MA: Harvard Business Press.

Knon, P. & Barnes, B. (2010). The role of finance in the strategic-planning and decision-making process. Retrieved from https://gbr.pepperdine.edu/2010/08/the-role-of-finance-in-the-strategic-planning-and-decision-making-process/

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