Understanding Corporate Finance: Key Concepts & Strategies
Forward Market vs. Futures Market
The forward market is the over-the-counter (OTC) financial market for contracts of future delivery, known as forward contracts. Forward contracts are personalized agreements between parties, meaning the delivery time and amount are determined between the seller and the buyer. The term “forward market” describes the informal setting where these contracts are made. Standardized forward contracts are called futures contracts and are traded on a futures exchange.
A futures market, or derivatives exchange, is a central financial exchange where individuals can trade standardized futures contracts. These contracts involve buying specific quantities of a commodity or financial instrument at a specified price, with delivery set at a specified time in the future.
Why Firms Invest in Net Working Capital
Firms need to invest in net working capital because it represents the surplus working capital remaining after paying current liabilities. A higher net working capital indicates the company has surplus funds for its day-to-day operations, ensuring smooth business continuity.
Optimal Dividend Policy for a Firm
Most managers believe the best dividend policy is one that minimizes the weighted average cost of capital (WACC). Such a policy should:
- Provide stable payments.
- Maintain investor confidence.
- Give positive signals to investors about the firm’s ability to maintain and increase its wealth.
Equity Financing: Advantages and Disadvantages
Advantages
The right business angels or venture capitalists can guide and steer the business towards profits and growth. They add significant value to existing projects, offering expertise, experience, valuable suggestions, advice, and contacts. They can assist in decision-making and strategic planning. Investors are equally concerned and responsible, as their money is at stake, and any progress reflects in their equity value.
Disadvantages
Raising equity finance is time-consuming and expensive. It requires spending valuable time satisfying investor background checks, project understanding, and convincing them to risk their capital. Once involved, investors exercise some control over business management, primarily due to their investment rights. Equity finance dilutes ownership, and the associated legal and regulatory rules are cumbersome and delicate. Significant time must be allocated to explaining business progress to financiers for monitoring purposes.
Current Asset Management: Large vs. Small Holdings
Advantages of Large Current Assets
- Reduced risk of shortages and interruptions.
- Minimized loss of sales due to the availability of funds for loan payments, purchases, and inventory.
- Higher liquidity, leading to a better credit rating.
Advantages of Small Current Assets
- Less investment in current assets means less money is tied up in assets that generate no immediate return, resulting in a lower opportunity cost of capital.