Question

What is the ultimate financial goal of a company? In your answer you may include descriptions of the various possible goals of a company to demonstrate which is the most important

Answer in 500 -700 words

Answer 1

The ultimate financial goal of a company is “shareholders’/owners’ wealth maximization”. It is the only comprehensive goal that encompasses all aspects of financial decision making and its end result.

The maxiimization of shareholders' wealth as an objective, stands its test in all the three areas of decision making in financial managemeent, namely, investing decisions, financing decisions and dividend/share repurchase decisions.

Maximizing shareholders’ wealth is to be achieved by the maximization of present worth of decisions taken. It means that only alternatives that result in positive present worth are to be undertaken and where there are mutually exclusive alternatives, the one with the maximum present worth is to be preferred.

Present worth of an alternative is found out by netting the present value of the cash outflows and inflows of that alternative occurring at different points of time. The discount rate to be used is the rate relevant to the risks associated with the cash flows of the alternative.

Positive present worth means that there is ‘surplus’ left after the following payments/repayments:

*contracted return to the debt suppliers has been and repayment of their capital, and

*the normal return to the equity suppliers and the repayment of their capital.

As equity shareholders take the said surplus, their wealth is said to be increased to that extent.

Other possible goals:

1] Maximizing market share, sales etc:

These are desirable targets for marketing and may result in increase in profits. But these profits should be related to the investments made and should be on present value terms. Only then can there be sustainable investments.

2] Maximizing profits:

Profit is an accounting metric and is based on accounting estimates and assumptions. It considers non cash items and accruals of income/expenditure. Hence, it is not based on cash flows.

Further, the initial investment is not recognized at the time it is incurred, but it is prorated as an expenditure over its useful life.

Again, profit may be short term or long term.

Maximizing short term profits will lead to unethical accounting practices. Managers will tend to increase short term profits by not taking decisions with a long-term view. They may postpone expenditures needed to maintain operating capacity.

Profit suffers another major defect in that, it does not consider time value of money, which is vital to decision making.

All these defects make profit inadequate as a financial goal for decision making.

3] Increasing employee morale, employee productivity and so on.

Increasing employee morale, employee productivity are all desirable sub-goals that seek to achieve higher profits and cash flows.

To sum up:

The alternative possible goals are only derivative targets of shareholder wealth maximization. They increase cash inflows but the ultimate test is whether they result in increase in present worth.