Corporate finance and business funding

Learn how a business keeps enough cash to operate, chooses between borrowing and selling ownership, and decides whether a project is worth its cost.

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Basic percentages are helpful. Accounting and financial analysis introduces profit, financial statements, and the difference between earning money and collecting it. New terms are bold, explained on first use, and linked to the glossary.

All businesses, dollar amounts, rates, and forecasts below are invented teaching examples. Rates are annual unless stated otherwise. Assume no taxes, fees, or cash movements beyond those specified. Project cash flows occur at year-end and are stated in future dollars, without a separate inflation adjustment. Actual financing terms and tax treatment depend on the business, contract, and jurisdiction; these examples do not describe a specific funding offer.

In this lesson

1. What business finance decides
2. Forecast cash before raising money
3. Compare debt and equity
4. Understand startup funding and dilution
5. Estimate the cost of capital
6. Evaluate a project
7. Test assumptions and funding needs
8. Consider acquisitions and capital allocation
9. Check your understanding

What business finance decides

A repair shop wants to buy equipment, hire another technician, and still pay next month’s rent. Each choice uses money that cannot simultaneously serve another purpose.

Corporate finance concerns how organizations obtain funding, invest it, and manage the financial consequences. The same basic questions apply to a small business and a large company. Capital allocation means choosing where to commit financial resources: operations, new projects, acquisitions, debt repayment, or payments to owners.

Separate three questions:

• Value: Will the activity’s expected benefits justify its costs and risk?
• Funding: Where will the money come from, and what rights or obligations come with it?
• Timing: Will money be available when bills fall due?

A worthwhile project can still create a cash shortage. An available loan does not establish that a project is worthwhile.

Forecast cash before raising money

A financial forecast estimates future results using stated assumptions. A forecast should change when evidence changes; a budget is a plan for spending and other financial activity. Cash flow describes money moving in and out over time. Treasury is the business function that manages cash, funding, and related financial risks.

The repair shop forecasts the following month before any new borrowing or owner investment:

Ending cash = $3,000 + $6,000 − $7,000 = $2,000. If the shop wants a $3,000 minimum cash balance, it has a $1,000 funding gap relative to that target. It could speed up collections, defer a discretionary purchase, or arrange funding. Each response has practical costs and constraints.

Monthly totals can hide a shortage halfway through the month. Put receipts and payments on their expected dates, then check the lowest balance. A customer’s promise to pay is not cash already available for payroll.

Working capital is current assets minus current liabilities: broadly, short-term resources less short-term obligations. Accounts receivable are amounts customers owe for goods or services already provided. Accounts payable are amounts owed to suppliers for goods or services already received.

Suppose the shop has $3,000 cash, $4,000 receivables, and $5,000 inventory, with $6,000 of current liabilities. Working capital is $12,000 − $6,000 = $6,000. Yet a $4,000 bill due today exceeds its cash by $1,000. Stock on a shelf and unpaid invoices cannot automatically settle today’s bill. See OpenStax on working capital.

Compare debt and equity

Debt is money owed that must be repaid under agreed terms. Equity financing raises money by giving investors an ownership interest. A business’s capital structure is its mix of debt and equity funding.

For an interest-only $20,000 loan at 8% for one year, interest is $20,000 × 0.08 = $1,600. If principal and interest are both due at year-end, the payment is $21,600. Comparing $1,600 with the value of an ownership stake would miss the obligation to return $20,000.

Collateral is property pledged to support repayment. A loan covenant is a contractual requirement or restriction, such as maintaining a specified financial ratio or limiting further borrowing. Read payment dates, security, personal guarantees, restrictions, and breach consequences together. A personal guarantee can make an owner personally responsible under its terms.

Funding should fit the use: a brief seasonal gap differs from a machine expected to operate for years. Repeatedly renewing short-term borrowing for a long-lived investment creates a risk that replacement funding will be unavailable. The SBA explains debt and equity investment capital; Banking, credit, and lending explains borrowing costs and repayment structures.

Understand startup funding and dilution

A new business may lack the predictable customer payments that support loan repayment. Funding routes differ in both eligibility and what providers expect.

• Bootstrapping means building a business mainly with founders’ resources and cash generated by the business. It preserves ownership but limits spending and exposes personal resources used.
• An angel investor is an individual who invests their own money in early-stage businesses, often for ownership.
• Venture capital is professionally managed investment, typically in young businesses with high growth potential. Investors usually seek a substantial eventual gain, which can shape expansion and sale decisions.
• Crowdfunding raises money from many contributors, usually through a platform. A donation, a promised product, a loan, and an ownership investment create different obligations.

Grants can fund eligible activities without selling ownership, but applications, permitted uses, reporting, and repayment conditions vary. Customer prepayments can help fund delivery, but the business still owes the promised goods or services. Funding availability depends on the business and its circumstances. The SBA’s business planning guidance discusses funding routes; the SEC’s crowdfunding investor bulletin explains investment risks, including limited resale opportunities.

Follow the ownership calculation

Valuation is an estimate of what a business or investment is worth. Pre-money valuation is the negotiated value of the existing ownership before new investment. Post-money valuation includes the new investment in a simple funding round.

Suppose a founder owns 800 ordinary shares. An investor agrees to an $80,000 pre-money valuation and puts $20,000 into the company for 200 newly issued shares at $100 each. Assume identical share rights and no options, convertible securities, or other changes.

• Post-money valuation = $80,000 + $20,000 = $100,000.
• Total shares after the investment = 800 + 200 = 1,000.
• Investor ownership = 200 ÷ 1,000 = 20%.
• Founder ownership = 800 ÷ 1,000 = 80%, down from 100%.

Dilution is a reduction in an existing owner’s percentage ownership when additional shares are issued. Here the founder owns a smaller percentage of a company that has received new cash. That percentage change alone does not establish a loss in the dollar value of the founder’s stake. The negotiated valuation is not a guarantee of a future sale price.

If the investor instead bought existing shares from the founder, the founder would receive the purchase money; the company would receive no new funding from that purchase. Voting rights and priority payments can also make equal ownership percentages economically different. The SEC’s small-business glossary explains funding-round valuations and ownership terminology.

Estimate the cost of capital

Equity has a cost even when investors receive no scheduled interest payment. The cost of capital is the return capital providers require for committing funds to a business at a given level of risk.

The weighted average cost of capital (WACC) combines the costs of debt and equity using their shares of total capital value. In a simplified, tax-free example, assume market-value weights of 40% debt and 60% equity, a 6% debt cost, and a 12% required equity return:

WACC = (0.40 × 6%) + (0.60 × 12%) = 2.4% + 7.2% = 9.6% per year.

The 12% is an assumed required return, not a promised payment. In practice, calculations commonly adjust debt cost for usable interest tax deductions and require estimates of market values. More debt can raise financing risks and required returns, so changing the weights does not leave costs fixed indefinitely.

A company’s WACC is a starting point for projects with comparable risk and financing characteristics. It is not automatically the right rate for every project. See OpenStax’s WACC explanation.

Evaluate a project

Capital budgeting is the process of evaluating major investments whose benefits and costs extend into the future. Start by comparing the business with the project against the business without it.

An incremental cash flow is the difference in cash caused by a decision. Include installation, training, additional inventory, effects on existing sales, and eventual disposal or cleanup when relevant. Accounting profit alone does not show all these cash movements.

A sunk cost has already been incurred and cannot be recovered. A $500 study paid for last month should not be added as a new cost of approving equipment today. An opportunity cost is the value of the best alternative given up. Using space that could otherwise earn rent has a cost even if no rent is paid to another party.

Work through the equipment decision

The shop can spend $10,000 today on equipment. Assume it produces additional net operating cash of $6,000 at the end of each of two years, after all additional operating costs, with no resale value, extra working capital, or other cash flows. Evaluate the equipment separately from how it is financed. Use an independently assumed 10% annual discount rate suitable for this example.

A discount rate converts future cash amounts to equivalent values today. Present value is that today’s-money equivalent. Net present value (NPV) is the sum of discounted cash inflows less discounted cash outflows, including the initial investment.

NPV = −$10,000 + ($6,000 ÷ 1.10) + ($6,000 ÷ 1.21) = $413.22. Calculate with unrounded values and round only the final answer; adding the rounded table entries gives a one-cent difference. Positive NPV indicates expected value above the required return embedded in the discount rate. It does not guarantee the forecast cash or prove that funding is available. See OpenStax on NPV.

For project cash flows available to both lenders and owners, financing costs are reflected in the appropriate discount rate. Subtracting loan interest again from those cash flows would count that financing cost twice. Cash forecasts used to plan actual bank balances must still include loan receipts and repayments. Real analyses also need consistent tax, currency, and inflation assumptions.

The payback period is how long it takes cumulative undiscounted project cash flows to recover the initial investment. Here recovery occurs at the end of year 2, because receipts arrive only at year-end. Payback ignores the time value of money and cash flows after recovery, so it cannot substitute for a value calculation. See OpenStax’s capital budgeting summary.

Test assumptions and funding needs

Sensitivity analysis changes one assumption at a time to see its effect. If equipment cash receipts fall to $5,000 in each year, with all other assumptions unchanged:

NPV = −$10,000 + ($5,000 ÷ 1.10) + ($5,000 ÷ 1.21) = −$1,322.31.

The original positive result depends on achieving enough benefit. Testing different sales volumes, costs, useful lives, or discount rates shows where the decision is fragile.

Scenario analysis changes a set of assumptions together to represent a possible outcome. A downside scenario might combine slower sales, late customer payments, and higher material costs. It should feed both the project valuation and the dated cash forecast.

For a business using more cash than it generates, the cash burn rate measures how quickly cash is being consumed. State whether the figure is gross outflow or net outflow after receipts. Cash runway estimates how long available cash can support that spending pattern.

With $30,000 available cash, monthly receipts of $4,000, and monthly outflows of $10,000, net burn is $6,000 per month. Simple runway is $30,000 ÷ $6,000 = 5 months. If management needs to retain $6,000, cash above that minimum lasts ($30,000 − $6,000) ÷ $6,000 = 4 months. Both estimates assume constant flows and no new funding; a large bill due early can shorten the usable time.

Consider acquisitions and capital allocation

An acquisition occurs when one business buys another business or a controlling interest in it. A merger combines businesses into one organization through an agreed transaction structure. The terminology and legal form can vary. See OpenStax on mergers and acquisitions.

A synergy is an expected benefit from combining businesses beyond what they could achieve separately, such as eliminating duplicated costs. A buyer must also allow for integration expenses, lost customers, and execution risk. Due diligence means investigating and checking an investment before committing: for a business purchase, this can include finances, contracts, obligations, operations, and customer concentration.

Suppose a target’s operations are worth $50,000 on their own. Additional benefits have an estimated present value of $10,000, and integration costs have a present value of $4,000. The combined value attributable to the purchase is $56,000. Paying $60,000 for those operations implies −$4,000 of value for the buyer before any other transaction costs. Assume no target debt or excess cash in this simplified example. A promising combination can still be overpriced.

The choice need not be expansion. A business can retain cash, repay debt, or distribute money to owners. A dividend is a payment by a company to shareholders. Cash used for a distribution is unavailable for other uses; retaining cash also has an opportunity cost. Compare alternatives against operating needs, financing commitments, risk, and the organization’s objectives.

Check your understanding

Questions

1. A business starts a month with $4,000, collects $9,000, and pays $11,000. What is its ending cash and its gap relative to a $3,000 minimum?
2. A business has $15,000 of current assets and $9,000 of current liabilities. Does its working capital prove it can pay a $7,000 bill today?
3. An investor puts $30,000 into a company at a $120,000 pre-money valuation. Assuming identical share rights and no other changes, what percentage does the investor own afterward?
4. A business has market-value funding weights of 25% debt costing 8% and 75% equity requiring 12%. Ignoring taxes, what is its WACC?
5. A project costs $5,000 today and pays $5,500 once at the end of one year. At a 10% discount rate, what is its NPV? Does the result mean the project earns nothing?
6. A business already spent a nonrefundable $800 on research. A new project would also prevent it from receiving $1,200 of rent next year. Which amount belongs in the incremental project evaluation?
7. A startup has $24,000 available and constant monthly net cash outflow of $4,000. How long until cash reaches a required $8,000 minimum?
8. Why might a buyer reject an acquisition even when combining the businesses would reduce costs?

Answers and explanations

1. Ending cash is $4,000 + $9,000 − $11,000 = $2,000. The gap relative to the minimum is $3,000 − $2,000 = $1,000. Check timing within the month too.
2. Working capital is $15,000 − $9,000 = $6,000. It does not prove cash is available today: current assets can include inventory and unpaid customer invoices. Check available cash and payment dates.
3. Post-money valuation is $120,000 + $30,000 = $150,000. Investor ownership is $30,000 ÷ $150,000 = 20%; existing owners together retain 80%.
4. WACC is (0.25 × 8%) + (0.75 × 12%) = 2% + 9% = 11% per year under the stated assumptions.
5. NPV is ($5,500 ÷ 1.10) − $5,000 = $0. The project earns exactly the assumed 10% required return if the cash arrives as forecast; it creates no additional value above that requirement.
6. The $800 is a sunk cost, already incurred regardless of today’s choice. The $1,200 foregone rent is an opportunity cost caused by the decision. Include it as a negative year-one cash flow and discount it appropriately.
7. Cash above the minimum is $24,000 − $8,000 = $16,000. Dividing by $4,000 per month gives 4 months. This is an estimate based on the assumed constant spending pattern.
8. The purchase price and integration costs can exceed the value of the target and expected savings. Savings may also arrive late or fail to materialize. Evaluate the full incremental cash flows and funding needs.

Terms introduced in this lesson

• Accounts payable

• Accounts receivable

• Acquisition

• Angel investor

• Bootstrapping

• Capital allocation

• Capital budgeting

• Capital structure

• Cash burn rate

• Cash flow

• Cash runway

• Collateral

• Corporate finance

• Cost of capital

• Crowdfunding

• Debt

• Dilution

• Discount rate

• Dividend

• Due diligence

• Equity financing

• Financial forecast

• Incremental cash flow

• Loan covenant

• Merger

• Net present value (NPV)

• Opportunity cost

• Payback period

• Post-money valuation

• Pre-money valuation

• Present value

• Scenario analysis

• Sensitivity analysis

• Sunk cost

• Synergy

• Treasury

• Valuation

• Venture capital

• Weighted average cost of capital (WACC)

• Working capital

Keep learning

Use Accounting and financial analysis to connect these decisions to financial statements. Banking, credit, and lending develops borrowing and repayment choices. Financial markets and instruments explains how businesses issue shares and bonds and how those instruments trade afterward.

Investing and portfolio management considers decisions from an investor’s perspective. Explore Books for open textbooks and additional reading.