Question

1. Accounting is subject to the rules of Generally Accepted Accounting Principles (GAAP), which sets provisions for how accounting information is presented. Sometimes, GAAP requires actions that affect reported financial results, think revemue recognition, reserves for doubtful accounts, alternative depreciation methods, accounting for taxes. Do accounting profits provide a good measure of business performance? Why or why not?
2. The goal of financial management is to maximize the wealth of the shareholders. Do you think management should focus more on generating profit or cash flow?

3. While value is a word we alll use, what we mean by value is not always consistent. When you think about "value," what does it mean?

Answer 1

1. Profit is understood to be the main indicator for measuring the performance of the business entity but profits are not the only way or even the best way to measure business performance. Profit is a short sighted gauge of success. There are several other elements to consider that may be even more important than profit. Sustainability is the characteristic of being able to exist indefinitely with optimum utilisation of resurces. This includes employees, availability of raw materials, machinery and other value-adding elements.

An organisation rather than maintaining unsustainable processes in order to increase the profit margin, a company would be better off optimizing efficiency. In order for business processes to become more efficient, the manager must have the ability to effect change. This is not only a characteristic dependent on the manager but it reflects on the entire workforce. The ability to effect change can mean the difference between one batch of defective products and an entire shipment of them.

The manager must be aware of the risks involved in the changes that he puts into effect. Making changes to a business process always has pros and cons. The assessment of risks is part of being a manager. Risk is another element to consider when measuring business performance.

2. Wealth maximization goal states that an organisation should seek to maximize the present value of the expected future returns to the owners (that is, shareholders) of the firm. These returns can take the form of periodic dividend payments or proceeds from the sale of the common stock.

Warren Buffett, CEO of Berkshire Hathaway, an outspoken advocate concept, ” says it this way:

Our long-term economic goal is to maximize the average annual rate of gain in intrinsic business value on a per -share basis.We do not measure the economic significance or performance of Berkshire by its size; we measure by per-share progress.

Shareholder wealth is measured by the market value of the shareholders’ common stock holdings. Market value is defined as the price at which the stock trades in the market place, such as on the New York Stock Exchange. Thus, total shareholder wealth equals the number of shares outstanding times the market price per share.

The objective of shareholder wealth maximization has a number of distinct advantages-

a. This objective explicitly considers the timing and the risk of the benefits expected to be received from stock ownership.

b. It is conceptually possible to determine whether a particular financial decision is consistent with this objective. If a decision made by a firm has the effect of increasing the market price of the firm’s stock, it is a good decision. If it appears that an action will not achieve this result, the action should not be taken (at least not voluntarily).

c. Shareholder wealth maximization is an impersonal objective. Stockholders who object to a firm’s policies are free to sell their shares under more favorable terms (that is, at a higher price) than are available under any other strategy and invest their funds elsewhere.

The management should focus on the profit with minimum payback period to maximise the shareholder wealth.

3. Value is something worthwhile and worthy of committment and efforts. It could be monetary, pride, object, animal to which once could ascribe value. e.g. for someone a dog may have more value than millions of dollar.

In finance world, more the price of the shares, more is value of the Company. Every company aims to increase profit or shareholder value by maximising the prices of the shares.