Module 1: Finance Foundations

The Role of Corporate Finance

Every business, from a family-owned supermarket in Nyeri to a listed bank in Nairobi, faces the same basic financial questions: what should we invest in, how should we pay for it, and how do we manage the money we need day to day? Corporate finance is the discipline that answers these questions in a structured way. Understanding it helps you make better decisions, speak confidently with lenders and investors, and avoid choices that look attractive but quietly destroy value.

The three core decisions

Corporate finance is usually organised around three decisions.

• Investment decisions (capital budgeting): which projects and assets should the business commit money to? Examples include buying a new machine, opening a branch, acquiring another company or launching a product.
• Financing decisions: how should those investments be funded? Options include retained profits, bank loans, bonds, new shareholders or leases. Each has a different cost and risk.
• Working capital and payout decisions: how much cash, inventory and customer credit should the business carry, and how much profit should be returned to owners as dividends or share buybacks rather than reinvested?

These decisions are connected. A big investment may require new financing; heavy borrowing may limit dividends; poor working capital management may force the business to borrow just to pay suppliers.

The goal: creating value

The standard objective in corporate finance is to maximise the value of the business for its owners over the long term. This is not the same as maximising this year's profit. A company could raise short-term profit by cutting maintenance, training or marketing, but that would reduce future cash flows and value. Value depends on three things: how much cash the business generates, when it generates it, and how risky those cash flows are. Most of the tools in this course, such as discounting and net present value, are ways of measuring those three things together.

Value maximisation should operate within the law and with fair treatment of employees, customers, lenders and communities. Businesses that mistreat stakeholders often lose value over time through lost customers, regulatory penalties or reputational damage.

Who does corporate finance?

In a large company, a chief financial officer leads a team that may include a treasurer (managing cash, banking and financing) and a controller (managing accounting and reporting). In a small business, the owner often does all of this alone, sometimes with an external accountant. The principles are the same regardless of size. A shop owner deciding whether to buy a delivery motorbike is making a capital budgeting decision; deciding whether to use savings or a SACCO loan is a financing decision.

Worked example: one decision, three questions

Imagine Kamau owns a printing business in Nairobi's industrial area. A supplier offers a new digital press for KES 4,000,000 (a hypothetical figure). Corporate finance helps him structure the decision:

1. Investment: Will the extra jobs and lower running costs generate enough cash over the press's life to justify KES 4,000,000 today, given the risk that demand may not materialise? He needs forecasts of extra revenue, costs, maintenance and the press's useful life, and a way to compare future cash with today's outlay.
2. Financing: Should he pay from retained cash, take an asset finance loan, or lease the press? A loan keeps cash available but adds interest and fixed repayments; paying cash avoids interest but may leave the business short if a large customer pays late.
3. Working capital: More printing jobs mean more paper stock and more customers on 30-day credit. How much extra cash will be tied up, and can the business carry it?

Answering only the first question, as many owners do, risks buying a good machine and still running out of cash.

Agency problems and incentives

When managers run a business on behalf of owners, their interests may differ: a manager may prefer an impressive new office or rapid expansion that increases their status, even if it does not increase value. These are called agency problems. Good governance, such as board oversight, clear budgets, performance measures linked to value rather than size, and transparent reporting, helps align decisions with owners' interests. Lenders face a similar issue with borrowers, which is why loan agreements include covenants.

Common mistakes to avoid

• Judging decisions only by accounting profit instead of cash flow, timing and risk.
• Treating investment and financing as one decision, for example approving a weak project because a cheap loan is available.
• Ignoring the working capital a new project will need.
• Chasing growth in size rather than growth in value.