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Objectives of Financial Management

The two main objectives of financial management are profit maximization and wealth maximization. Profit maximization aims to earn profits in order to cover costs and fund growth. However, it ignores risks, financing aspects, and the time value of money. Wealth maximization aims to maximize shareholder wealth through dividends and share price appreciation. It considers risks, the time value of money, and long-term cash flows rather than short-term profits.

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25 views

Objectives of Financial Management

The two main objectives of financial management are profit maximization and wealth maximization. Profit maximization aims to earn profits in order to cover costs and fund growth. However, it ignores risks, financing aspects, and the time value of money. Wealth maximization aims to maximize shareholder wealth through dividends and share price appreciation. It considers risks, the time value of money, and long-term cash flows rather than short-term profits.

Uploaded by

Amandeep Kaur
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Objectives of financial

management
Two objectives of Financial Management
• Profit maximization
• Wealth maximization
Profit maximization
• Earning profit is the main aim of every business organization.
• A business organization must earn profit in order to cover the costs
and provide the funds for growth.
• No business can survive without earning profits.
• Profit is measure of efficiency of the firm.
• Every business organization must not only earn profits but also try to
maximize the same.
Arguments in favor of profit maximization
• While profit earning is the main objective, then every organization must
strive to maximize the same.
• Profitability is the barometer to measure the efficiency and economic
prosperity of the business enterprise, thus, profit maximization is justified
on grounds of rationality.
• Economic and business conditions does not remain same all the times.
There may be adverse business conditions such as recession, depression
and severe competition. A business organization will be able to survive
under unfavourable situations only if it has past earnings to rely upon.
• Profits are the main sources of finance for the growth of business. So a
business organization should aim at maximization of profits for its’ growth
and development.
• Profitability helps in fulfilling the social goals also. A firm by pursuing the
objective of profit maximization also maximizes socio – economic welfare.
Arguments against profit maximization
1. It ignores risk
• Profit maximization does not take into account the amount of risk
which a firm undertakes in an attempt to increase the profits.
• The business organization may undertake all the profitable
investment opportunities regardless of associated risk, where the
investment returns may not be worth the risk undertaken.
2. The profit maximization concentrates on the profitability only and
ignores the financing aspect of that decision and the risk associated
with that financing.
For example:- in order to finance a profitable investment, a firm may
even borrow beyond capacity.
3. It ignores the timings of cost and returns and thereby ignores the
time value of money.
In the objective of profit maximization, all the monetary benefits and
costs are considered in absolute value terms without adjusting the time
value.
4. The objective of profit maximization is vague and ambiguous.
It is not clear the exact meaning of the term profit. Does it refers to
short term profit or long term profit, after tax profit or before tax
profit, profit from the point of view of total funds employed or profits
from point of view of shareholders only.
5. The objective of profit maximization widens the gap between
perception of management and the shareholders.
Since the profit maximization is not directly related to any measure of
shareholders’ benefits, this principle seems to be self – centered at the
cost of loosing the attention from the interest of shareholders, which
should be given utmost importance in any firm.
6. The profit maximization borrows the concept of profit from the field
of accounting and thus tends to concentrate on the immediate effect of
a financial decision as reflected in increase in the profit of that year or
in near future.
This will not necessarily be correct because many organization’s
decisions have their costs and benefits scattered over many years.
Wealth maximization
• It implies that financial decisions must be taken in the company that
shareholders receive the high dividends + increase in the market price
of share.
• In order words, shareholder’s proportional ownership in a firm
represented by a share should be maximized.
• The wealth is measured by finding the present value of future cash
flows (in the form of dividends) received by shareholders.
• The market price of the share reflects this value.
Arguments in favor of wealth maximization
• The objective of wealth maximization is based upon cash flows and
not profits. Unlike profits, cash flows are exact and definite.
• It considers time value of money which states that rupee today has
more value than the same rupee to received in near future. In this
objective, cash flows are discounted at discount rate to find their
present value.
• It considers risk and uncertainty at the time of finding the present
value of cash flows.
• It presents the long term view by considering the factors such as time
value of money along with risk and uncertainty.
Difference b/w two approaches
Basis of difference Profit maximization Wealth maximization

1. Concept Main objective is to earn higher Main objective is to increase the


profits market price of shares.

2. Emphasizes on Achieving short term objectives Achieving long term objectives

3. Consideration of risks and No Yes


uncertainty

4. Advantage Acts as yardstick for computing Increase in wealth and market price
operational efficiency of firm of share

5. Recognition of time value No Yes

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