Question

Efforts to maximize the value of a company are considered by many to be the major financial goal of business organizations. Describe other business goals, and explain how these other goals are likely to contribute to increased company value. (typing please, thank you.)

Answer 1

Financial management of any business firm has to set goals for itself and to interpret them in relation to the objective of the firm. Broadly, there are only two alternative objectives a business firm can pursue viz.

(a) Profit maximisation;

(b) Wealth maximisation.

(a) Profit Maximisation

Profit maximisation is considered as an important goal in financial decision-making in an organisation. It ensures that firm utilizes its available resources most efficiently under conditions of competitive markets. But in recent years, under the changed corporate environment, profit maximisation is regarded as unrealistic, difficult, unappropriate and socially not much preferred goal for business organisation. Profit maximisation as corporate goal is criticised by scholars mainly on the following grounds:

(i) It is vague conceptually.

(ii) It ignores timing of returns.

(iii) It ignores the risk factor.

(iv) It may tempt to make such decisions which may in the long run prove disastrous.

(v) Its emphasis is generally on short run projects.

(vi) It may cause decreasing share prices.

(vii) The profit is only one of the many objectives and variables that a firm considers.

(b) Wealth Maximisation/Value Maximisation:

Presently, maximisation of present value (or wealth) of a course of action is considered appropriate operationally flexible goal for financial decision-making in an organisation. The management of an organization maximises the present value not only for shareholders but for all including employees, customers, suppliers and community at large. This goal for the maximum present value is generally justified on the following grounds:

(i) It is consistent with the object of maximising owners economic welfare.

(ii) It focuses on the long run picture.

(iii) It considers risk.

(iv) It recognises the value of regular dividend payments.

(v) It takes into account time value of money.

(vi) It maintains market price of its shares.

(vii) It seeks growth in sales and earnings.

However, profit maximisation can be part of a wealth maximisation strategy. Quite often two objectives can be pursued simultaneously but the maximisation of profit should never be permitted to overshadow the objectives of wealth maximisation. The objective of the firm provides a framework for optimal decision making in the area of business management.

The term ‘objective’ should be used in the sense of ‘decision criteria’ for taking decisions involved in financial management. It means that what is relevant is not overall objective of the business but operationally useful criterion against which the investment, financing and dividend policy decisions are to be judged. Another point to note in this context is that objective provide a ‘normative’ framework. In other words, it implies that the focus is on what a firm should try to achieve and on policies that it should follow if the objectives are to be achieved.

Profit maximization is basically a single-period or, at the most, a short-term goal. It is usually interpreted to mean the maximization of profits within a given period of time. A firm may maximize its short-term profits at the expense of its long-term profitability and still realize this goal. In contrast, shareholder wealth maximization is a long-term goal shareholders are interested in future as well as present profits. Wealth maximization is generally preferred because it considers (1) wealth for the long-term, (2) risk or uncertainty, (3) the timing of returns, and (4) the shareholders’ return. The following table provides a summary of the advantages and disadvantages of these two often conflicting goals.

Above Explanation is based on the Concept of Financial management Explained in the book Financial Treasury And Forex Management(The Institute of Comapny Secretaries of India).