Careers in Corporate Finance
What is Corporate Finance?
Corporate finance is the study of how a company evaluates strategic opportunities and raises and deploys capital to develop them. All capital budgeting and outlay decisions are generally handled by the firm’s corporate finance department.
When using the term ‘corporate finance’, we are typically referring to larger companies, often publicly traded. This is because these companies have the capabilities to tap established capital markets. Smaller and mid-size companies fall into the ‘business finance’ category, where access to capital is a little tougher.
There are a multitude of decisions that must be made within the oversight of the corporate finance department. But essentially all of these decisions within Corporate Finance can be broken into three distinct principles, according to a study by New York University’s Stern Business School. They are the:
- Investment Principle
- Financing Principle
- Dividend Principle
The investment principle determines where the company places its resources. The financing principle deals with how to fund these investments. Finally, the dividend principle has to do with deciding how much capital is reinvested into the business and how much is returned to the owners.1
The Investment Principle
Within the investment principle, the focus is on deciding which projects or ventures to allocate capital to. This could be the construction of a new factory for a manufacturer, a new marketing campaign for a soft drink company or acquiring new routes for an airliner. Companies only have a limited amount of funds to work with, so it’s their job to determine which ideas have the best chance of making the firm money. Corporate finance professionals must determine the minimum rate of return to justify the effort for undertaking the project. This is known as the ‘hurdle rate’ and it depends on the amount of capital and the riskiness of the project.2
There are a few different tried and true methods used to determine the viability of a new project. These include Net Present Value (NPV), Internal rate of Return (IRR), the Payback Period and Profitability Index.
Using multiple capital budgeting formulas helps identify the most profitable opportunities from a set of potential projects given a constrained budget that most businesses can identify with in the real world.
Net Present Value is by far the most widely-used method and is really a cornerstone of financial theory. In simplest terms, it’s the difference between the market value of a project and its cost. The market value is determined by discounting projected cash flows from the project back to the present (to determine the market value) and subtracting that from the cost. If the resulting number is positive, it should be undertaken (or at least evaluated against other projects to determine the most likely to be profitable). It should be noted that net present value formulas involve pro forma or forward looking estimates which can be imprecise. Corporate finance professionals should always evaluate potential side effects from projects to see how all stakeholders are affected.
If you are pursuing a career in finance and corporate finance especially, get used to these concepts, Net Present Value especially, because you’ll probably come across these in some fashion during your tenure in finance.
The Financing Principle
Determining a firm’s optimal capital structure is a major theme in corporate finance. Using the optimal mix of debt and equity will keep the company profitable without excessive risk. The right capital structure should result in the lowest cost of capital to fund the company’s operations. All else equal, debt is a cheaper source of financing than equity given the fact that the debt interest is tax deductible. But companies must careful because taking on too much debt could the company’s creditors to demand higher coupon rates if the leverage ratio gets too high.
Corporate finance professionals must determine which type of debt should be pursued. Considerations include short versus long term debt and fixed versus variable rates of interest.
While equity issuance offers an easier and quicker financing alternative, every subsequent offering dilutes the holdings of all other stockholders. It also reduces earnings per share (all else equal) and can place downward pressure on key profitability ratios such as Return on Equity, or ROE. Since management compensation is often tied to such profitability ratios and the fact that interest rates are so low, debt issuance is the preferred method of capital raising by most corporate finance managers.
The Dividend Principle
At some point a business starts to mature and the number of ventures and opportunities subside. When this occurs, companies tend to hoard cash on their balance sheets. At some point, there must be a determination on when to return excess cash to shareholders in the form of dividends. Mature companies with lots of cash are often the targets of shareholder activists like Carl Icahn. These ‘corporate raiders’ often take large equity stakes in companies so they can appoint members to the board of directors who are sympathetic to ‘maximizing shareholder value’. In other words, increased dividend payouts.
What is the Compensation in Corporate Finance?
There are a variety of different positions in a corporate finance department including financial analyst, financial controller, business analyst and finance manager. For these finance professionals who also have an MBA, the compensation can be quite lucrative.
According to Payscale, MBA-wielding financial controllers enjoy salaries averaging $99,526, while finance manager salaries range from $81,349 to $132,950.2 It’s not surprising that the high end of these corporate finance jobs to be in New York City ($157,622) with Boston not far behind ($154,123).3
How to land a position in Corporate Finance?
A Master’s degree is typically crucial to landing a position in corporate finance. Because so much of corporate strategy is top-down, you have to see the bigger picture to perform successful in this department. Without a Master’s degree, a bachelor’s degree in finance is a requirement to get into almost any corporate finance department. The basic financial skills and background must be apparent.
Equally important to financial acumen are computer skills. Prepare to become intimate with Microsoft Excel. The formulas embedded in this, and other spreadsheet software, turn normal financial professionals into financial analysts. For example, by simply typing in ‘=NPV(discount rate, values)+initial investment’ unlocks a world of analytic opportunity where you can dazzle your bosses. The same goes for statistical analysis where you can look and sound like a real ‘quant’.
You may not need a CFA designation (Chartered Financial Analyst) for a corporate finance position (except if you’re gunning for CFO) because in many cases, it’s the skill with a spreadsheet that matters. Professionals with a CFA designation often go onto become portfolio managers and investment analysts, not financial analysts.
This next part is equally important to the number crunching using Excel- learning how to interpret and present conclusions regarding the data to your bosses in a clear and persuasive manner. This is often done with some type of presentation software, often PowerPoint. Hiring for corporate finance department may ebb and flow with general economic conditions, but is an exciting career which offers a look at the inner workings of a company’s operations.