The Goal of Financial Management

Posted: August 26th, 2021

The Goal of Financial Management

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The Goal of Financial Management

Introduction

Every company should manage its finance, irrespective of its shareholding capacity, size, or profitability. The overall company objectives cannot be accomplished without a sound financial management system as it will result in failures in all the company operations. Therefore, financial management is a necessary process in a company as it determines the procedures and strategiesan organization should adopt in making financial decisions(Bhasin, 2017). Equally, it helps critical evaluation and interpretation of financial information to accomplishthe objectives of an organization. As such, three major financial decisions should be an outcome of proper financial management. These are; investment, financial, and dividend policy decisions(Heminway, 2017). In this case, it implies that the main objectives of financial management in a company should bethe maximization of the owner’s equity achieved through profit and wealth optimization. Thus, the subsequent sections underscore a detailed analysis of the aim of financial management in maximizing the organization’s profits and shareholder’s finances.

Shareholder’s Profit Maximization

            The fundamental objective of monetary management is to maximize the long-term profits made by a company achieved through the effective allocation of resources. Besides, a company’s profitability is demonstrated through sound financial performance besidessafeguarding the interests of various stakeholders,including creditors, employees, and shareholders (Debnath et al., 2018). These groups of stakeholders expect reasonable returns from a company exhibited through maximum returns on their investment. As a result, the policies formulated by a business are directly affected by their goals(Bhasin, 2017). Besides, it is imperative to adopt policies that will increase the earnings per share (EPS) by determining the optimum output and price levels that generate the maximum profits (Debnath et al., 2018). Therefore, if a company does not generate substantial profits and distribute dividends to the shareholders, it is likely to lose potential investors.

            Wealth Maximization

            The objective is also known as net worth or value maximization. It relates to maximizing the wealth of the shareholders and considers dividends, future cash flows, business risk, and earning per share(Bhasin, 2017). The goal directly affects a company’s policy decisions on preferred investment projects to undertake and sources of funds to finance the investments (Heminway, 2017). More so, a company’s shareholders are interested in maximizing their wealth, which depends on the company’s stock market price. Thus, an increase in the share market price results in a subsequent rise in the shareholders’ capital, while a decrease in the shares market price results in a decline in the owners’ equity (Heminway, 2017). Hence, the principal goal of wealth maximization is increasing the stock market price, which in turn improves the value of an organization, as well, the shareholder’s net-worth. 

            Such a goal can be achieved when the present value of the discounted future cash flows is more than the cost of undertaking for the company’s financial investment or project. As such, an increase in the wealth of a company equates to the net present value of financial decisions(Bhasin, 2017). Also, the economic value addition (EVA) is a tool that indicates an increase in the shareholders’ wealth through a positive and higher value as disclosed in the company’s annual reports (Bhasin, 2017). Thus, shareholders,wealth maximization is achieved through adopting projects that have a higher internal rate of return (IRR) than the cost of capital in capital investment decisions. At the same time, the sources of wealth creation can either be industry attractiveness in the internal environment or competitive advantage in the external environment.

Conclusion

            The company stakeholders’ objectives are to safeguard their financial interests. This is achieved by generating maximum returns and simultaneously increasing the owners’ equity. The purpose catersto the organization’s survival, going-concern, as well as economic value addition. Hence, this is achieved through the profit and wealth maximization goals of a competentfinancial management team.       

References

Bhasin, M. L. (2017). A study of value-added economic disclosures in the annual reports: Is EVA a superior measure of corporate performance. East Asian Journal of Business Economics, 5(1), 10-26.

Debnath, S. C., Tandon, S. R., & Lee, B. B. (2018). Profit Maximization versus Stakeholders¡¯ View of Corporate Social Responsibility: An Experiential Exercise on Ethics and Social Responsibility for Business School Courses. International Journal of Business Administration, 9(6), 69-75.

Heminway, J. M. (2017). Shareholder wealth maximization as a function of statutes, decisional law, and organic documents. Wash. & Lee L. Rev., 74, 939.