Corporate Finance Fundamentals

Corporate finance manages how companies raise and use capital to create value. Before any finance-related assistance, establish: (1) the company stage (startup vs mature), (2) the time horizon (short-term operating decisions vs long-term strategic investments), and (3) the decision context (operational budgeting, capital allocation, treasury management, or investor reporting). Corporate finance bridges accounting (what happened) with strategy (what should happen). While universal concepts like NPV, budgeting cycles, and working capital apply broadly, early-stage companies face distinct challenges around burn rate and runway that mature companies don't—see Startup Finance Primer for startup-specific guidance.

Core Concepts

Financial planning creates forward-looking financial models to guide decisions. Budgeting allocates resources for a specific period (typically annual) with monthly or quarterly detail. Forecasting projects future performance based on current trends and assumptions—distinct from budgets which are commitments. Working capital (current assets minus current liabilities) represents the capital tied up in day-to-day operations. Managing working capital directly impacts cash flow without requiring external financing.

Capital allocation determines how limited capital gets deployed across competing uses: organic growth investments, acquisitions, dividends, share repurchases, or debt paydown. Allocation decisions create or destroy value based on expected returns relative to the cost of capital. Hurdle rates (minimum required returns) typically range from 10-15% for most companies, adjusted for risk and strategic importance. Projects below the hurdle rate destroy value even if profitable.

Time value of money means a dollar today is worth more than a dollar tomorrow due to opportunity cost and risk. Investment evaluation metrics (NPV, IRR) account for this by discounting future cash flows. The discount rate represents the opportunity cost of capital—what could be earned on alternative investments of similar risk.

Cash vs profit confusion destroys companies. Profit is an accounting construct (revenue minus expenses). Cash is money in the bank. Profitable companies run out of cash when receivables grow faster than collections, inventory accumulates, or capital expenditures exceed cash generation. Cash flow statements reconcile profit to cash by showing how balance sheet changes impact cash.

Financial Planning and Budgeting

Budgeting cycles typically run annually with quarterly or monthly detail. The process starts 3-4 months before the fiscal year with top-down targets (revenue growth, margin goals) and bottom-up department plans. Budgets serve multiple purposes: resource allocation, performance evaluation, cash flow planning, and investor commitments. Annual budgets get updated quarterly through rolling forecasts that extend the planning horizon.

Top-down budgeting sets targets from executive leadership based on strategic goals, market conditions, and investor expectations. Bottom-up budgeting builds from department managers who understand operational realities. Effective budgeting combines both—top-down ensures strategic alignment, bottom-up ensures operational feasibility. Mismatches get resolved through negotiation and scenario planning.

Budget vs forecast distinction matters. Budgets are committed plans used for performance evaluation—missing budget targets triggers accountability. Forecasts are updated projections based on actual performance and changing conditions—they reflect current expectations, not commitments. Companies typically maintain annual budgets while updating quarterly forecasts. Budget variance analysis explains differences between actual and budgeted results, identifying operational issues, planning errors, or external changes.

Variance analysis decomposes differences into volume, price, mix, and efficiency components. Volume variance shows impact of selling more or fewer units. Price variance shows impact of different pricing. Mix variance shows impact of selling different product combinations. Efficiency variance shows impact of productivity changes. Understanding which component drove variance enables targeted responses—volume shortfalls require sales actions, efficiency problems require operational fixes.

Forecasting Methods

Driver-based forecasting links financial outcomes to operational drivers. Instead of assuming "revenue grows 10%," driver-based models use "new customers × average deal size × win rate" or "website traffic × conversion rate × average order value." Driver-based forecasts are more accurate because they're grounded in measurable activities and can be updated as drivers change. They also enable scenario planning by changing driver assumptions.

Statistical forecasting uses historical patterns to project future performance. Time series methods (moving averages, exponential smoothing, regression) identify trends and seasonality from past data. Statistical methods work well when historical patterns are stable and external factors don't change dramatically. They fail during disruptions, new product launches, or market shifts where past doesn't predict future.

Scenario planning models multiple futures to understand range of outcomes and key uncertainties. Base case represents most likely outcome. Upside case models favorable conditions. Downside case models unfavorable conditions. Scenario planning forces explicit assumption documentation and prepares companies for different futures rather than anchoring on single-point forecasts that prove wrong.

Rolling forecasts extend planning horizons continuously—each quarter, drop the oldest quarter and add a new future quarter, maintaining 12-18 month forward visibility. Rolling forecasts avoid the "end-of-year cliff" where companies operate blind until next year's budget is set. They enable faster response to changes because forecasts update quarterly rather than annually.

Assumptions management documents and validates forecast assumptions explicitly. Key assumptions include: revenue growth rates, margin assumptions, working capital ratios, capital expenditure plans, and financing assumptions. Tracking assumption changes over time reveals forecast accuracy issues and helps refine future assumptions. Assumptions should be grounded in data, benchmarks, or logical reasoning—not guesses.

Working Capital Management

Working capital equals current assets (cash, receivables, inventory) minus current liabilities (payables, accrued expenses). Positive working capital means short-term assets exceed short-term liabilities, providing operating liquidity. Negative working capital means short-term liabilities exceed assets, requiring external financing or careful cash management. Working capital isn't free—capital tied up in receivables and inventory has opportunity cost.

Cash conversion cycle measures days from cash outlay (paying suppliers) to cash receipt (collecting from customers). Formula: Days Sales Outstanding (DSO) + Days Inventory Outstanding (DIO) - Days Payable Outstanding (DPO). Shorter cycles free cash faster. Typical cycles: negative for retailers (collect before paying suppliers), 30-60 days for manufacturers, 90-120 days for project-based businesses.

Days Sales Outstanding (DSO) measures average collection period for receivables. Formula: (Accounts Receivable / Revenue) × Days in Period. Lower DSO means faster collections. DSO benchmarks vary by industry: 30-45 days for SaaS, 45-60 days for B2B services, 60-90 days for manufacturing. Rising DSO indicates collection problems, customer payment issues, or credit policy problems.

Days Payable Outstanding (DPO) measures average payment period to suppliers. Formula: (Accounts Payable / Cost of Goods Sold) × Days in Period. Higher DPO preserves cash longer but strains supplier relationships if extended beyond terms. DPO optimization balances cash preservation with vendor relationships—paying early may get discounts, paying late may damage relationships.

Inventory management balances having enough stock to meet demand without tying up excessive capital. Key metrics: Days Inventory Outstanding (DIO), inventory turnover (COGS / Average Inventory), and stockout rates. Excess inventory ties up cash and risks obsolescence. Insufficient inventory causes lost sales and customer dissatisfaction. Just-in-time (JIT) inventory reduces holding costs but requires reliable suppliers and accurate demand forecasting.

Working capital optimization strategies include: accelerating receivables (faster invoicing, payment terms, collections process), extending payables (within reason), reducing inventory (better forecasting, JIT systems), and managing timing of expenses (capitalizing vs expensing). Optimization requires cross-functional coordination—finance sets targets, sales manages receivables, operations manages inventory, procurement manages payables.

Capital Allocation Frameworks

Capital allocation determines how companies deploy limited capital across competing uses. Strategic framework: (1) maintain existing operations, (2) fund organic growth with attractive returns, (3) pursue acquisitions that create value, (4) return excess capital to shareholders (dividends, buybacks), or (5) strengthen balance sheet (debt paydown). Allocation decisions should maximize long-term value per share, not just growth or profit.

Hurdle rates set minimum required returns for investment approval. Typical ranges: 10-12% for low-risk projects, 12-15% for average risk, 15-20% for high-risk. Hurdle rates should reflect cost of capital (WACC) plus risk premium. Public companies often use stock price implied returns—if stock trades at certain multiples, that implies required returns. Private companies use comparable company or venture capital return expectations.

Portfolio approaches recognize that not all investments need same returns. Strategic investments (entering new markets, R&D) may have lower near-term returns but create options and strategic value. Financial investments (expanding existing profitable businesses) require returns above hurdle rates. Balanced portfolios combine both—high-return financial investments fund strategic bets that may take longer to pay off.

Decision criteria for capital allocation include: expected return (NPV, IRR), strategic importance, risk profile, resource requirements, timing (quick wins vs long-term), and fit with existing capabilities. No single metric should drive decisions—NPV-positive projects with poor strategic fit may be rejected, while strategic projects with marginal returns may be approved for strategic reasons.

Strategic vs financial returns represent different value creation mechanisms. Financial returns (expanding profitable product lines, efficiency improvements) generate measurable ROI quickly. Strategic returns (entering new markets, building capabilities, acquiring options) may take years to materialize and are harder to quantify. Both matter—overemphasizing financial returns prevents strategic positioning, overemphasizing strategic returns wastes capital.

Investment Evaluation

Net Present Value (NPV) calculates investment value by discounting future cash flows to present value and subtracting initial investment. Positive NPV means investment creates value. NPV directly measures dollar value created, accounts for time value of money and risk, and aggregates all cash flows into single metric. Limitations: requires discount rate estimation, sensitive to terminal value assumptions, doesn't show payback timing.

Internal Rate of Return (IRR) calculates discount rate that makes NPV equal zero—the effective return on investment. IRR above hurdle rate indicates value creation. IRR advantages: intuitive percentage return, comparable across different-sized investments, doesn't require explicit discount rate. Limitations: assumes reinvestment at IRR (often unrealistic), multiple IRRs possible for unconventional cash flows, ranking conflicts with NPV for mutually exclusive projects.

Payback period measures years until cumulative cash flows recover initial investment. Shorter payback means faster capital recovery. Payback is simple and emphasizes liquidity/risk—projects that pay back quickly reduce exposure. Limitations: ignores time value of money (no discounting), ignores cash flows after payback, no profitability measure. Use payback as risk indicator, not primary decision metric.

Return on Investment (ROI) calculates percentage return: (Gain - Cost) / Cost. ROI is simple and widely understood but ignores timing and risk. ROI doesn't discount future returns, making long-term projects look artificially attractive. Use ROI for quick screening, not final decisions.

Metric selection depends on context. Use NPV for value creation decisions—it directly measures dollar value added. Use IRR for return-focused analysis or comparing different-sized investments. Use payback as risk screen for projects with uncertain long-term cash flows. Never use single metric alone—triangulate with multiple methods and qualitative factors.

Assumptions sensitivity recognizes that investment metrics depend on uncertain assumptions. Sensitivity analysis shows how NPV/IRR change as key assumptions vary (revenue, margins, discount rates). Scenario analysis models different futures (base, upside, downside). Understanding assumption sensitivity prevents overconfidence in point estimates and identifies critical assumptions that drive investment value.

Treasury Basics

Cash management optimizes cash balances across accounts, currencies, and time horizons. Objectives: maintain sufficient liquidity for operations, minimize idle cash (invest excess), maximize investment returns on cash balances, and manage banking relationships. Cash management balances safety (FDIC limits, credit risk), liquidity (accessibility), and return (interest earned).

Banking relationships provide credit facilities, payment processing, treasury services, and strategic advice. Key products: operating accounts, sweep accounts (automatic investment of excess cash), credit lines (standby liquidity), and cash concentration (aggregating balances across entities). Strong banking relationships provide flexibility during difficult periods and better terms during normal operations.

Debt management structures borrowing to optimize cost, risk, and flexibility. Considerations: fixed vs floating rates (fixed provides certainty, floating may be cheaper), short-term vs long-term (short-term cheaper but refinancing risk), secured vs unsecured (secured cheaper but requires collateral), and covenants (restrictions vs flexibility). Debt capacity depends on cash flow generation, asset base, and lender risk appetite.

Liquidity planning forecasts cash needs and sources to avoid shortfalls. Components: operating cash flow projections, capital expenditure timing, debt service requirements, working capital changes, and contingency buffers. Liquidity crises destroy companies even if profitable—running out of cash forces desperate financing or bankruptcy regardless of business quality.

Cash forecasting projects cash balances weeks or months ahead using driver-based or statistical methods. Forecasts should include: operating cash flows, investing activities (capex, M&A), financing activities (debt, equity), and working capital changes. Forecast accuracy improves with shorter horizons—weekly forecasts are more accurate than monthly. Regular forecast updates enable proactive liquidity management.

Board and Investor Reporting

Key metrics vary by company stage and industry but typically include: revenue growth, profitability (gross margin, operating margin, net margin), cash generation (operating cash flow, free cash flow), efficiency (customer acquisition cost, payback period, unit economics), and returns (ROIC, ROE). Metric selection should align with business model and strategic priorities—SaaS companies emphasize ARR and NRR, manufacturing emphasizes margins and inventory turnover.

Reporting cadence typically monthly for internal management, quarterly for boards and investors. Monthly reports provide operational visibility and early warning signals. Quarterly reports provide strategic context and forward-looking guidance. Annual reports provide comprehensive review and long-term perspective. Regular cadence enables trend analysis and early problem identification.

Variance analysis explains differences between actual and planned results. Effective variance analysis: decomposes variance into components (volume, price, mix, efficiency), identifies root causes (operational issues vs external factors), quantifies financial impact, and recommends actions. Variance explanations should be clear, quantitative, and actionable—not excuses.

Narrative construction provides context beyond numbers. Effective narratives: explain what happened and why (not just numbers), highlight key insights and implications, acknowledge problems honestly, present corrective actions, and maintain forward-looking perspective. Narratives should be concise (executives are busy), specific (avoid vague generalities), and balanced (don't hide bad news or overemphasize good news).

Executive summaries distill complex financial information into key messages. Structure: financial highlights (3-5 key metrics with comparisons), major variances (what changed and why), forward-looking outlook (updated forecasts, risks, opportunities), and action items (decisions needed, initiatives to approve). Summaries should enable quick understanding and decision-making without requiring full report reading.

Terminology

FP&A (Financial Planning & Analysis) combines budgeting, forecasting, and analysis to support decision-making. FP&A teams create financial models, analyze performance, explain variances, and provide forward-looking insights.

Free cash flow equals operating cash flow minus capital expenditures. Free cash flow represents cash available for dividends, debt paydown, acquisitions, or share repurchases after funding operations and growth investments.

Cost of capital (WACC - Weighted Average Cost of Capital) represents required return on capital from both debt and equity sources. WACC serves as hurdle rate for investment evaluation—projects must return more than cost of capital to create value.

Cash conversion cycle measures days from cash outlay to cash receipt. Formula: DSO + DIO - DPO. Negative cycles (common in retail) mean collecting cash before paying suppliers, creating financing benefit.

Operating leverage measures how profit changes relative to revenue changes due to fixed costs. High operating leverage means small revenue changes create large profit changes—profitable but risky during downturns.

Capital intensity measures capital required per dollar of revenue (capex / revenue). High capital intensity businesses (manufacturing, infrastructure) require significant investment, limiting free cash flow generation.

Working capital days convert working capital ratios into days (DSO, DPO, DIO) for easier interpretation and comparison. Days metrics show operational efficiency and cash cycle length.

Key Numbers

Budgeting timelines: Annual budgets typically start 3-4 months before fiscal year. Quarterly forecasts update within 2-4 weeks after quarter-end. Rolling forecasts maintain 12-18 month forward visibility.

Hurdle rates: Typical ranges: 10-12% for low-risk projects, 12-15% for average risk, 15-20% for high-risk. Public companies often use WACC (typically 8-12%) plus risk premium. Private equity targets 20-25%+ IRRs.

DSO benchmarks by industry: SaaS (30-45 days), B2B services (45-60 days), manufacturing (60-90 days), construction (90-120 days). DSO significantly above industry benchmarks indicates collection problems.

Cash conversion cycles: Negative for retailers (collect before paying), 30-60 days for manufacturers, 90-120 days for project-based businesses. Shorter cycles free cash faster.

Forecast accuracy: Monthly forecasts typically ±5-10% accuracy. Quarterly forecasts ±10-15%. Annual forecasts ±15-25%. Accuracy degrades with longer horizons and higher uncertainty.

Working capital ratios: Typical current ratio (current assets / current liabilities) targets: 1.5-2.0 for most businesses. Below 1.0 indicates liquidity risk. Above 3.0 suggests inefficient capital use.

Common Misconceptions

"NPV and IRR always agree"—They conflict for mutually exclusive projects when cash flow timing differs. NPV correctly ranks projects by value created. IRR can misrank because it assumes reinvestment at IRR rate (often unrealistic). Use NPV for decisions, IRR for return communication.

"Working capital equals cash"—Working capital includes receivables and inventory that aren't cash. Companies can have positive working capital but negative cash if receivables are uncollectible or inventory is obsolete. Working capital optimization focuses on converting assets to cash faster.

"Budget equals forecast"—Budgets are committed plans for performance evaluation. Forecasts are updated projections reflecting current expectations. Companies maintain annual budgets while updating quarterly forecasts. Missing budget targets triggers accountability; forecast updates reflect learning.

"All profitable investments should be funded"—Capital is limited. Funding all positive-NPV projects may exceed available capital or management capacity. Capital allocation requires ranking projects by return and strategic importance, not just approving everything profitable.

"Payback period determines value"—Payback ignores time value of money and post-payback cash flows. Projects with 2-year payback and 10 years of cash flows may create more value than projects with 1-year payback and 2 years of cash flows. Use payback as risk indicator, NPV as value measure.

"Forecasting is guessing"—Good forecasts are grounded in drivers, data, and assumptions. Driver-based models link financial outcomes to measurable activities. Statistical methods identify patterns from history. Scenario planning models different futures. Poor forecasts lack grounding; good forecasts are informed estimates.

Context Variations

Corporate finance practices differ significantly by company stage. Universal concepts (budgeting, forecasting, NPV, working capital, capital allocation) apply broadly, but early-stage companies face distinct challenges around burn rate, runway, and fundraising timing that mature companies don't encounter. Mature/public companies deal with earnings guidance, dividend policy, and capital markets considerations that startups don't face.

Startup finance emphasizes survival and growth funding—burn rate management extends runway until next fundraising, unit economics validate business model before scale, and fundraising timing connects financial metrics to investor readiness. Mature company finance emphasizes optimization and returns—earnings guidance manages investor expectations, dividend policy balances returns with reinvestment, and capital allocation maximizes shareholder value.

For startup/early-stage finance specifics (burn rate, runway, unit economics, fundraising milestones, cash flow planning for pre-revenue companies), see Startup Finance Primer.

Related Knowledge

Financial statements provide the foundation for budgeting, forecasting, and analysis. Understanding how income statements, balance sheets, and cash flow statements connect is essential for FP&A work. For financial statement fundamentals, see Accounting Primer.

Fundraising mechanics (term sheets, valuations, investor dynamics) complement startup finance planning, but are distinct domains. This primer focuses on financial planning and readiness; fundraising primer (when it exists) focuses on deal structure and investor relations.