There are two main objectives of financial management;
- Profit maximization
- Shareholders wealth maximization
There are two schools of thought in this favour
- Traditional Approach
- Modern Approach
The modern scholars favours shareholders wealth maximization as key objective of financial management, while tradition approach regards profit maximization as the key objective. Traditional scholars believe that profit is proper yardstick to measure operational efficiency of an enterprise. They are of the view that a firm/business should undertake only those activities that increase the profit.
Features/ Aspects of profit maximization:
- Profit is an unclear concept. Profit can be short term or long term, profit before Tax or after Tax, profit can be gross profit or operating profit etc. The accountants concept of profit is different than economists concept of profit.
- Profit motto may lead to exploitation of customers, employees, workers, and ignore ethical trade practices.
- Profit motive also overlooks social considerations or corporate social responsibility or public welfare.
- Profit always goes hand- to hand with risk. The owners of firm will not like to earn more and more profit by accepting more risk.
- The profit maximization was taken as objective when business was self-financed and self-controlled.
In view of above, modern scholars consider wealth maximization as key objective of financial management. This is also recognized as value maximization or net present worth maximizations. This shareholder’s wealth maximization is evident from growth in the price of shares in the market. They are of the view that wealth maximization is supposed to be superior over profit maximization due to following reasons:
Features/Aspects of wealth Maximization:
- This practice the concept of future expected cash flows rather than unclear term of profit.
- In takes in to accent time value of money.
- It also takes care of risk factors related with project as the discount rate used for calculating present value is generally a risk adjusted discount rate.
- It is consistent with the objective of maximizing owner’s welfare.
Equity shares of a firm are traded in stock market and stock market quotation of a share assists as an index of performance of the firm. The wealth of equity shareholders in maximized only when market value of equity share of the company is maximized. In this situation, the term wealth maximization is redefined as value maximization.
At macro level, a company has obligation to the society which is fulfilled by maximizing production of goods and services at minimum cost, thereby maximizing wealth of society.
October 02, 2017