Role of Finance in an Organization

The primary role of corporate finance is to determine how best to maximize shareholder value.

Corporate finance is the area of finance dealing with monetary decisions that business enterprises make. When finance is discussed in the context of business decisions, it is called corporate finance (technically, corporate finance deals only with corporations, while managerial finance deals with all types of companies, but we will use the terms interchangeably). There are other branches of finance, such as personal finance (individuals taking care of their money) and public finance (the finances of the government).

The primary goal of corporate finance is to maximize shareholder value. Maximizing shareholder value can be done over the long term or the short term, so the job of the finance department is to determine how best to do both. Sometimes, the goals may appear to compete with one another. For example, a company can choose to pay dividends (a small payment to each person who owns a company's stock), which increases short-term shareholder wealth. However, paying dividends means that the money is not being invested in long-term investments, which may cause the stock price to increase more in the future, thereby increasing long-term shareholder wealth.

The technique behind maximizing shareholder value is the management of assets. This means that the finance department figures out how to best invest its money.

For example, a company could have two proposals from the R&D department to develop different products but only enough money to fund one. The finance department will project out the future revenues and costs of each product and figure out which one, if either, is worth the money.

iPod Touch

iPod Touch Apple used financial analysis to decide to fund the development of the iPod. The money allocated for development could not be used for another project, but the finance department determined the iPod was the best option.


Also, the finance department will determine when a company should take on a liability. For example, suppose both projects are absolute home runs, but the company still only has enough money to fund one. The finance department will figure out if the company should borrow money so it can fund both.

The role of finance in an organization is to make sure that money is in the right place at the right time. A company wants to have enough money to pay its bills but also wants to invest so that it can grow in the future. The finance department is devoted to the task of figuring out how to allocate assets to do so for the overarching goal of maximizing shareholder value.

Key Points

  • Maximizing shareholder value can be done over the long-term or the short-term, so the job of the finance department is to determine how best to do both. Sometimes, the goals may appear to contradict each other.

  • The finance department is devoted to the task of figuring out how to allocate assets for the overarching goal of maximizing shareholder value. They must ensure that the right assets are in the right place at the right time.

  • The finance department must also manage the company's liabilities so that all projects are financed in an optimal way without taking on too much risk.

Terms

  • Liability – An obligation, debt or responsibility owed to someone.

  • Asset – Something or someone of any value; any portion of one's property or effects so considered.

  • Shareholder – One who owns shares of stock.
Back to '1.1: Introduction to Concepts in Finance\'