Objectives of Financial Management

Principle & Practice of Management

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Objectives of Financial Management

The financial management objectives can be broadly classified into two categories:

Basic Financial Management Objectives

Traditionally, the basic financial management objectives have been (1) Maintenance of liquid assets and (2) Maximisation of profitability of the firm. However, these days, there is a greater emphasis on (3) Shareholders’ wealth maximisation rather than on profit maximisation.

1. Maintenance of Liquid Assets: Financial Management Objectives

Financial management aims at maintenance of adequate liquid assets with the firm to meet its obligations at all times. However, investment in liquid assets has to be adequate – neither too low nor too excessive. The finance manager has to maintain a balance between liquidity and profitability.

2. Maximisation of Profit: Financial Management Objectives

“Profit maximisation” is a term which denotes the maximum profit to be earned by an organisation in a given time period. The profit maximisation goal implies that the investment, financing and dividend policy decision of the enterprise should be oriented to profit maximisation. The term “Profit” can be used in two senses – first, as the owner-oriented concept and the second, as the operational concept.
Profit as the owner-oriented concept refers to the amount of net profit, which goes in the form of the dividend to the shareholders. Profit as the operational concept means profitability, which is an indicator of the economic efficiency of the enterprise.
Profitability-maximization implies that the enterprise should select assets, projects and decisions that are profitable and reject the non-profitable ones. It is in this sense, that the term profit-maximization is used in financial management.

Merits of Profit-Maximization

(a) Best Criterion on Decision-making: The goal of profit-maximization is regarded as the best criterion of decision making as it provides a yardstick to judge the economic performance of the enterprises.
(b) Efficient Allocation of Resources: It leads to efficient allocation of scarce resources as they tend to be diverted to those uses which, in terms of profitability, are the most desirable.
(c) Optimum Utilisation: Optimum utilisation of the available resource is possible.
(d) Maximum Social Welfare: It ensures maximum social welfare in the form of a maximum dividend to shareholders, timely payment of creditors, higher wages, better quality and lower prices, more employment opportunities to the society and maximisation of capital to the owners.

Financial Management Objectives

However, the profit-maximization objective suffers from several drawbacks which are as follows:
(a) Time Factor Ignored: The term ‘Profit’ does not speak anything about the period of profit whether it is short-term profit or long-term profit.
(b) It is Vague: The term ‘Profit’ is very vague. It is not clear in what exact sense the term profit is used. Whether it is Accounting profit or Economic profit or profit after tax or profit before tax.
(c) The Term ‘Maximum’ is also Ambiguous: The term ‘maximum’ is also not clear. The concept of profit is also not clear. It is, therefore, not possible to maximise what cannot be known.
(d) It Ignores Time Value: The profit maximisation objective fails to provide any idea regarding the timing of expected cash earnings. The choice of a more worthy project lies in the study of the time value of future inflows of cash earnings. It ignores the fact that the rupee earned today is more value able than a rupee earned later.
(e) It Ignores the Risk Factor: According to economists, profit is a reward for risk and uncertainty-bearing. It is also a dynamic surplus or profit is a reward for innovation. But when can the organisation maximise profits? Profit – maximisation objective does not make this clear.

3. Wealth Maximization: Financial Management Objectives

It is now widely and universally accepted that the objective of the enterprise should suitable and operationally feasible. Precise and clear cut and should give weight age to the time value and risk factors. Owing to the various drawbacks of the profit maximisation objective, Professor Ezar Solomon rejected it as inappropriate and unsuitable and suggested the adoption of wealth maximisation objective which removes all the drawbacks of the profit maximisation objective.
Wealth maximisation is also called value maximisation. The wealth or ‘net present worth’ of a course of action is the difference between gross present worth and the amount of capital investment required to achieve the benefits. Gross Present-worth represents the present value of expected cash benefits.
In simple words, wealth-maximization means maximising the present value of a course of action (i.e. NPV = GPC of benefits – Investment). Any financial action which results in positive NPV creates and adds to the existing wealth of the organisation and the course of action which has a negative NPV, reduces the existing wealth and hence be given up. All positive actions can be adopted, as they add to the existing wealth and help in wealth-maximization.

Significance of Wealth Maximization

The company, although it cares more for the economic welfare of the shareholders, cannot forget the others who directly or indirectly work for the overall development of the company. Thus, Wealth-Maximization takes care of:
(a) Lenders or Creditors
(b) Workers or Employees
(c) Public or Society
(d) Management or Employer
Other Objectives
Besides the above basic objectives, the following are the other objectives of financial management:
1. Ensuring a fair return to shareholders.
2. Building up reserves for growth and expansion.
3. Ensuring maximum operational efficiency by efficient and effective utilisation of finance.
4. Ensuring financial discipline in the management.