Question

Question:

a) Explain clearly why working capital management is very important in finance?

b) Discuss the statement that wealth maximization is a better corporate objective than profit maximization.

Answer 1

a]

Working capital is a very important part of financial management. Efficient use of working capital can improve the return on capital and return on assets. Good working capital management ensures that there is not excessive capital tied up in working capital, while ensuring that there is adequate working capital for smooth running of business without interruptions.

b]

The ultimate goal of any investment is to create wealth. From a corporate finance viewpoint, wealth maximization should be the ultimate goal. This fulfills the objective of investors, whose end goal is wealth maximization. Profit maximization should not be the ultimate objective because profit maximization does not directly translate into wealth maximization. This is because profits are calculated on accrual basis and not cash basis. For wealth to be maximized, cash flows should be maximized and cost of capital minimized. Hence, wealth maximization is a better objective than profit maximization from a corporate finance viewpoint.