Goals of Financial Management - Profit Maximization & Value Maximization | Financial Management (2024)

Financial Management

➦ In any organization, financial management is a vital activity. In order to achieve organizational goals and objectives, it involves planning, organizing, controlling, and monitoring financial resources.

➦ It is a useful method for controlling the financial activities of an organization, including the procurement of funds, the utilization of funds, accounting, payments, risk assessments, and so on.

➦ In other words, Financial Management refers to the application of management principles to a business’s financial assets.

➦ In order for an organization to function efficiently, its finances need to be managed correctly to ensure quality fuel and regular service. An organization’s growth and development might be hampered if finances are not properly handled.

➦ In order for an organization to be successful, it needs to have regular and uninterrupted cash flow. Financial management ensures your company to continue functioning at its best ability with the best results at the end.

➦ Working capital, current assets, liabilities, cash flow, debtor management, etc. These are all critical areas to monitor. Business owners can understand their company’s financial health with help from sound financial planning.

➦ Various financial activities, including procurement and utilization of funds, are managed through financial management, which includes planning, organizing, directing, and controlling.

➦ Fundamentally, sound financial management involves the application of general management principles to the enterprise’s financial resources.

What are the goals and objectives of financial management?

➦ Financial Management focuses on decisions relating to how much and what types of assets to acquire, how to raise the capital needed to purchase assets, how to run the firm so as to maximize its value.

➦ Financial Management is one of the areas of finance which deals with the management of all the financial resources of the organization for the smooth functioning of the organization’s goals.

➦ Generally, a firm or corporation is the purpose for which the finance functions are carried out. Financial management emphasizes the practical significance of financial numbers.

➦ Financial management creates value and organizational agility through the allocation of scarce resources among competing business opportunities. It helps implement and monitor business strategies and achieve business objectives.

➦ In order for a business to be financially successful, financial management is crucial. The general management of an organization should consider financial management as a key component.

➦ Strategic and tactical goals related to financial resources are part of financial management. Accounts payable and receivable, investments, and risk management are some of the specific roles played by banking administration systems.

➦ Among the responsibilities of business leaders and owners is financial management. It is imperative that they consider how their decisions may impact profits, cash flow, and the company’s financial condition.

➦ It is the owner’s responsibility to assess and control the activities of every aspect of the business so as to ensure it performs well financially.

➦ They provide criteria for financial decision-making and are essential for the right financial decision, Financial manager takes goals of a firm as guidelines for financial decisions. Hence, the goals of firms are also called a goal of financial management or financial goal.

Goals of Financial Management

Financial Management has mainly two goals. They are

1. Profit maximization and
2. Value maximization (Shareholder wealth maximization)

1) Profit Maximization

Concept:

➦ The primary goal of financial management is to maximize profit. Profit Maximization Goal considers that those actions that increase profits should be undertaken and those that decrease profits are to be avoided.

➦ According to this goal, finance functions should be oriented towards the maximization of profit. The financial managers select assets, projects and the decisions that are profitable and reject, which are not.

➦ Financial management’s primary objective is to maximize profits for businesses. An increasing Earning Per Share (EPS) is achieved by maximizing profits in financial management. All investments and financing, for example, are intended to maximize profits at the optimum level.

➦ Maximizing profits is the traditional approach and the primary objective of financial management. In other words, it implies that every business decision is evaluated in light of profits.

➦ Profitability and profitability impacts are considered when making decisions about new projects, asset acquisitions, raising capital, etc. An employee who perceives a decision as having a positive impact on profits is encouraged to implement the decision.

Advantages of Profit Maximization

The major advantages of profit maximization are mentioned below:

➨ Those people or financial managers who follow profit maximization goal believe that

➨ Test of economic efficiency is determined by profit

➨ Profit leads to the effective utilization of scarce economic resources in every business firm

➨ Profit leads to total economic welfare since it increases the economic efficiency of every individual firm.

➨ Economic Existence: For any business or company to survive, profits are essential for survival. Profit maximization theory is premised on this concept.

➨ Performance Standard: A company’s profitability determines its performance level. Businesses that fail to earn profits fail to achieve their main goal, and their existence is at risk.

➨ Economic and Social Welfare: Economic and social welfare are indirectly affected by profit maximization. Businesses that make a profit make proper use and allocation of resources that result in capital, fixed assets, labor and payments. In this way, economic and social welfare is achieved.

➨ Prediction of Real-World Behavior: In real-world situations, using leverage maximization allows you to predict company behavior. Business deals are generally not difficult and are reasonably accurate. Because of this, profit maximization is an effective means of explaining and predicting business behavior.

➨ Knowledge of Business Firms: Business firms rely most heavily on profit motives in their dealings. In order to avoid competition, small companies that face strong competition must use profit maximization as a strategy to increase sales.

2) Value Maximization

Concept:

➦ Value maximization goal considers that managers should take decisions that maximize the value of the firm, which is a total of the firm. The value of a firm is the total of the market value of equity and the market value of debt.

➦ Debt holders have fixed claims to the firm. So if the value of the firm is maximized, the market value of equity will increase. Thus, maximizing the firm’s value is consistent with maximizing stock price or maximizing shareholder wealth.

➦ The difference between Shareholder wealth is maximized when a decision generates a net present value. The net present value is the difference between the present value of the benefits of a project and the present value of its costs.

➦ Therefore, only those projects which have positive net present value should be accepted.

➦ Shareholder value maximization is a function of what corporate governance is thought to do.

➦ Corporate governance involves the regulatory and market mechanisms and the role and relationship between an organization’s board of directors, its management, its shareholders, its other stakeholders, as well as the goals by which the organization is governed.

➦ The principal–agent problem arises between upper-management (the “agent”) and investors (the “principals”) in large firms where ownership and management are separate.

➦ Boards of directors could become insulated from shareholders and beholden to management rather than overseeing management for the benefit of shareholders.

➦ Consequently, one interpretation of proper financial management is that the agents tend to increase the wealth of the shareholders by paying dividends or causing the stock price or market value to rise.

Advantages of Value Maximization

➦ This goal mainly focuses on maximizing the market price of shares of the firm. Value maximization goal as a financial management decision criterion is considered a superior goal to profit maximization goal because:

➨It is a clear goal

➨It considers the timing of cash flows

➨It considers the quality of benefits

➨It reduces the conflict of interest among the stakeholders of a firm.

Objectives of Financial Management

The objectives of financial management are given below:

a) To maximize Profit

➦ The main objective of any type of economic activity is to earn profit. The primary purpose of any business concern is to earn profit.

➦ In the short-term and long-term, the finance manager strives to earn maximum profits for the company. Profit is one measurement of the efficiency of the business. Because of business uncertainties, he cannot guarantee profits for the long run.

b) To maximize Wealth

➦ Financial management also aims to maximize the value of shareholders (wealth maximization). Gaining maximum wealth for shareholders is called wealth maximization.

➦ In other words, the finance manager tries to maximize shareholder dividends. It is also his objective to increase the market value of the company’s shares. Shares’ market value is directly proportional to the performance of the company.

➦ A company’s performance determines its share price, and vice versa. Finance managers must maximize shareholder value by managing the company’s performance.

c) To estimate total financial requirements properly

➦ It is very important for financial management to correctly estimate total financial requirements. Financial managers need to estimate a company’s total financial requirements. For the company to start and run, he must determine the amount of financing required.

➦ The company must determine both its fixed capital and working capital requirements. He must be accurate in his estimation. Otherwise, the company will have shortfalls or surpluses of funds. The task of estimating financial requirements is very challenging.

➦ There are many factors that a finance manager has to consider, such as the kind of technology employed by the company, the number of employees employed, the scope of operations, and legal requirements.

d) To mobilize finances properly

➦ Financial management is concerned with mobilizing (collecting) finance. Finance managers must decide on the source of finance after estimating the financial needs.

➦ Shares, debentures, and bank loans are some of the many sources of finance that he can access. A proper balance must be maintained between owned and borrowed finance. The company must borrow money at a low rate of interest.

e) To utilize finance properly

➦ Proper utilization of finance is an important objective of financial management. It is important that the financial manager utilizes finance as effectively as possible.

➦ The money should be used in a profitable way. The company’s finances should not be wasted. Unprofitable investments should not be made with company funds.

➦ The finance of the company should not be blocked by inventory. There should be a short credit period.

f) To Maintain proper cash flow

➦ In short-term financial management, the goal is to maintain proper cash flow. In order to pay for day-to-day expenses such as buying raw materials, paying wages and salaries, paying rent, and paying for electricity, the company must have a good cash flow.

➦ The company can take advantage of many opportunities if it has a healthy cash flow, such as getting cash discounts on purchases, making large purchases, giving credit to customers, etc. Companies with healthy cash flows are more likely to survive and succeed.

g) To support for Survival of company

➦ Financial management should focus on survival. In this competitive business world, it is necessary for the company to survive.

➦ Therefore, financial decisions made by the finance manager should be taken very carefully. Making a mistake can ruin the company and cause it to collapse.

h) To Create reserves

➦ The goal of financial management is to create reserves. Shareholders should not receive the full profits as dividends.

➦ The company should retain part of its profits as reserves. These reserves can be used for future expansion and growth. Furthermore, they can be used for contingencies in the future.

i) To Create goodwill

➦ Financial management should be proactive in creating goodwill for the business. It should improve its image and reputation.

➦ In the short term, goodwill helps the company survive, while in the long term, it helps the company succeed. Furthermore, it can help the company during difficult times.

j) To Increase efficiency

➦ All the departments in the company are also expected to increase their efficiency under financial management. It will improve the efficiency of the entire company if finances are distributed properly among all departments.

k) To maintain Financial discipline

The financial management department tries to maintain financial discipline. Financial discipline includes:

• Making sure that investment funds are directed to productive activities. The company will see a high return on its investment (profits).
• This will prevent waste and misuse of funds.

l) To Reduce cost of capital

➦ The objective of financial management is to lower the cost of capital. The company borrows money at a low rate of interest.

➦ Planning the capital structure in such a way that the cost of capital is minimized is the responsibility of the finance manager.

m) To Reduce operating risks

➦ Finance managers also strive to reduce operational risks. There are many risks involved in running a business.

➦ The finance manager should take steps to reduce these risks. High-risk projects should be avoided. An adequate insurance plan should also be in place.

n) To Prepare capital structure

➦ Capital structure is prepared by the financial management department. This determines how much is owned and how much is borrowed.

➦ A balance is then created between the various sources of capital. In order to maintain liquidity, economy, flexibility, and stability, this balance is necessary.

References

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