What are the objectives of the Financial Management?

Objectives of the Financial Management

The main objective f a business is tom maximize the owner's economic welfare. Financial Management provides a framework for selecting a proper course of action and deciding a commercial strategy.

The objectives can be achieved by: (i) Profit maximization (ii) Wealth maximization

Profit Maximization: Profit earning is the main aim of every economic activity. A business being an economic institution must earn profit to cover its cists and provide funds for growth. No business ca survives without earning profit. Profit is a measure of efficiency of a business enterprise. Profit also serves as a protection against risks which cannot be ensured. 

Arguments in favor of Profit Maximization

1.When profit earning is the aim of the business then the profit maximization should be the obvious objective.

2.Profitability is the barometer for measuring the efficiency and economic prosperity of a business enterprise, thus profit maximization is justified on the ground of the rationality.

3.Profits are the main source of finance for the growth of the business. So a business should aim at maximization of the profits for enabling its growth and development.

4.Profitability is essential for  fulfilling the social goals also. A firm by pursuing the objectives of profits maximization also maximizes the socio economic welfare.

5.A business may be able to survive under unfavorable condition only if it had some past earnings to rely upon.

Arguments against of Profit Maximization

1.It is precisely defined. It means different things for different people. The term „Profit‟ is vague and it cannot be precisely defined. It means different things for different people. Should we mean (i) Short term profit or long term profit? (ii) Total profit or earning per share? (iii) Profit before tax or after tax? (iv) Operating profit or profit available for the shareholders?

2. It ignores the time value of money and does not consider the magnitude and the timing of earnings. It treats all the earnings as equal though they occur in different time periods. It ignores the fact that the cash received today is more important than the same amount if cash received after, say, three years.

3. It does not take into consideration the risk of the prospective earning stream. Some projects are more risky than others. Two firms may have same expected earnings per share, but if the earning stream in one is more risky the market share of its share will be comparatively less.

4.The effect of the dividend policy on the market price of the shares is also not considered in the objective of the profit maximization. In case, earnings per share is the only objective then the enterprise may not think of paying dividends at all because it retains profits in the business or investing them in the market may satisfy this aim.

Wealth Maximization

 Finance theory asserts that the wealth maximization is the single substitute for a stake holder's utility. When the firm maximizes the shareholder's wealth, the individual stakeholders can use this wealth to maximize his individual utility. It means that by maximizing stakeholder's wealth the firm is operating consistently toward maximizing stakeholder's utility. A stake solder's wealth in the firm is the product of the numbers of the shares owned, multiplied within the current stock price per share.

Stockholder’s current wealth in the firm = (No. Of shares owned) * (Current stock price per share)

Higher the stock price per share, the greater will be the shareholder's wealth. Thus a firm should aim at maximizing its current stock price, which helps in increasing the value of shares in the market.

Implication of the wealth maximization:

1.The Concept of wealth maximization is universally accepted, because it takes care of interest of Finance institution, owners, employees and society at large.

2.Wealth maximization guides the management in framing the consistent strong dividend policy to reach maximum returns to the equity holders.

3.Wealth maximization objective not only serves the interest of the shareholder's by increasing the value of their holdings but also ensures the security to the lenders.

Criticism of wealth maximization:

1. It is a prescriptive idea. The objective is not descriptive of what the firm actually does.

2. The objective of wealth maximization is not necessarily socially desirable.

3. There is some controversy as to whether the objective is to maximize the stockholder's wealth or the wealth of the firm, which includes other Finance claimholder's such as debenture holders, preference shareholders.

4. The objective of wealth maximization may also face difficulties when ownership and management are separated, as is the case in most of the corporate form of organizations. When managers act as the agents of the real owner, there is the possibility for a conflict of interest between shareholders and the managerial interests.