Goals of Financial Management
Finacial Management | Fundamentals of Corporate Finance
BBA | BBA-BI
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 goals.
Generally , firm or corporation are the purposes for which the finance functions are carried out. They provide criteria for financial decision-making and are essential for right financial decision , Financial manager takes goals of a firm as guidelines for financial decisions. Hence, goals of firms are also called as goal of the financial management or financial goal.
Financial Management has mainly two goals. They are
- Profit maximization and
- Value maximization (Shareholder wealth maximization)
1) Profit Maximization Goal:
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 maximization of profit. The financial managers select assets, projects and the decisions that are profitable and reject, which are not.
Those people or financial managers who follow profit maximization goal believe that
- Test of economic efficiency is determined by profit
- Profit leads to effective utilization of scarce economic resources in every business firm
- Profit leads total economic welfare since it increases the economic efficiency of every individual firm.
Although profit is considered as a basic criterion for financial decision-making, this goal has been criticized because on the following basis:
- Ignores time value of the benefits
- Ignores the Quality of benefits
- Unsuitable in modern business environment.
2) Value Maximization goal:
Value maximization goal considers that managers should take decisions that maximize the value of the firm, which is 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 claim to the firm. So if value of the firm is maximized, the market value of equity will increase. Thus, maximizing firm’s value is consistent to maximizing stock price or maximizing shareholder wealth.
The difference between Shareholder wealth is maximized when a decision generates net present value. The net present value is the difference between present value of the benefits of a project and present value of its costs. Therefore, only those projects which have positive net present value should be accepted.
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 superior goal to profit maximization goal because:
- It is a clear goal
- It considers the timing of cash flows
- It considers quality of benefits
- It reduces the conflict of interest among the stakeholders of a firm.