Goals of Financial Management

The goals of financial management can be classified in many ways. Official goals, operative goals and operational goals are one classification. Official goals are the general aims of the organization. Maximization of return on investment and market value per share may be termed as official goals of financial management. Operative goals indicate what the organization is really attempting to do. They are focused and help in choice making. Expected return on investment, cost of capital, debt-equity norms, etc dong with time horizon are specified or their acceptable ranges/limits are static keeping in view the official goals. The operational goals of financial management are more directed quantitative and verifiable. The scale, mix and timing of specific form of finance are detailed. The official, operative and operational goals are structured with a pyramidal shape, the official goals at the top (concerned with the top executives), operative goals at the middle (concerned with middle management) and operational goals at the base.

The financial management goals can also be classified in a functional way. Return related goals, solvency related goals, liquidity related goals, valuation related goals, risk related goals, cost related goals and so on. Return related goals refer to the aims on minimum, average and, maximum returns. What should be the minimum return from a project in order to accept the same, what should be average return the firm should settle for and what is the maximum return possible (for risk increases with return). Similarly, goals as to solvency, liquidity, market value etc., can be thought of you have to state to what extent the stated goal factor is important and be actively pursued/and the extent of the goal factor required; the minimum, average and the maximum levels be specified.

1. Profit Maximization

Profit maximization is a stated goal of financial management. Profit is the excess of revenue over expenses. Profit maximization is therefore maximizing revenue given the expenses, or minimizing expenses given the revenue or a simultaneous maximization of revenue and minimization of expenses. Revenue maximization is possible through pricing and scale strategies. By increasing the selling price one may achieve revenue maximization, assuming demand does not fall by a commensurate scale. By increasing quantity sold by exploiting the price-elasticity of the demand factor, revenue can be maximized. Expenses minimization depends on variability of costs with volume, cost consciousness and market conditions for inputs. So, a mix of factors is called for profit maximization.

This objective of financial management is a favored one for the following reasons:

  1. Profit is a measure of success in business. Higher the profit greater is the degree of success.
  2. Profit is a measure of performance. Performance efficiency is indicated by the quantum of profit.
  3. Profit making is essential for the growth and survival of any undertaking. Only profit making business can think of tomorrow and beyond. It can only think of renewal and replacement of its equipment and can go for modernization and diversification. Profit is an engine doing away the odds threatening the survival of the business.
  4. Profit making is the basic purpose of business. It is accepted by society. A losing concern is a social burden. The sick business undertakings cause a heavy burden to all concerned, we know. So, profit criterion brings to the light operational inefficiency. You cannot conceal your inefficiency, if profit is made the criterion of efficiency.
  5. Profit making is not a sin. Profit motive is a socially desirable goal, as long as your means are good.

However, profit maximization is not very much favored. Certain limitations are pointed out. First, concept of profit is vague. There are several concepts of profit like gross profit, profit before tax, profit after tax, net profit, divisible profit and so on. So the reference to the profit has to be clear. Second, profit maximization in the long-run or in the short-run is to be stated clearly. Long-run or in the short-run profit orientations differ in the nature, emphasis and strategies. Third, profit maximization does not consider the scale factors. Size of business and level of profit have to be related. Otherwise no sensible interpretation of performance or efficiency is possible. Fourth, profit has to be related to the time factor. Inflation eats up money value. A rupee today is worthier today than tomorrow and day after. Time value of money is not considered in profit maximization.

2. Profitability Maximization

Profit as an absolute figure conveys less and conceals more. Profit must be related to either sales, capacity utilization, production or capital invested. Profit when expressed in relation to the above size or scale factors it acquires greater meaning. When so expressed, the relative profit is known as profitability. Profit per rupee sales, profit per unit production, profit per rupee investment, etc., are more specific. Hence, the superiority of this goal to the profit maximization goal.

Further profit per rupee investment or return on investment, (ROI) is a comprehensive measure. ROI = Return or Profit / Average Capital invested.

Profit divided by sales measures the profit per rupee of sales and sales divided by investment measures the number of times the capital is turned over. The former is an index of profit earning capacity and the latter is an index of activeness of the business. Maximization of profitability (ROI) is possible through either the former or the latter or both.

The favorable scores of this objective are the same as those of the profit maximization objective. The unfavorable scores of this objective again are the same as those of the profit maximization objective except one aspect. Profit maximization goal does not relate profit to any base. But profitability maximization relates profit to sales and/or investment. Hence it is a relative measure. So it is better than profit maximization goal on this score. But as other limitations continue, this objective too gets only a ‘qualified’ report as to its desirability.

3. EPS Maximization

Maximization Earnings Per Share (EPS) involves maximizing earnings after tax given the number of outstanding equity shares. This goal is similar to profitability maximization in respect of merits and demands. It is very specific both as to the type of profit and the base to which it is compared. One disadvantage is that EPS maximization may lead to value depletion too, because effect of dividend policy on value is totally discarded.

4. Liquidity Maximization

Liquidity refers to the ability of a business to honor its short-term liabilities as and when these become due. This ability depends on the ratio of current assets to current liabilities, the maturity patterns of currents assets and ‘the current liabilities, the composition of current assets, the quality of non-cash current assets; the relations with the short-term creditors; the relations with bankers and the like. A higher current ratio, a perfect match between the maturity of current assets and current liabilities, a well balanced composition of current assets, healthy and ‘moving current assets, i.e., those that can be converted into liquid assets with much ease and no loss, understanding creditors and ready to help bankers would help maintaining a high-liquidity level for a business. All these are not easy to obtain and these involve costs and risks.

How far is it a good goal? It is a good goal, though not a wholesome one. Every business has to generate sufficient liquidity to meet its day-to-day obligations. Last, the business would suffer. A liquidity rich business can exploit some rare opportunities like buying inventory in large quantity when price is lower, lend to the call money borrowers when the interest rate is high, retire short-term-creditors taking advantage of cash discounts and so on. So many benefits accrue. But, high liquidity might result in idle cash resources and this should be avoided. Yes, excess liquidity and profitability move in the opposite directions, they are conflicting goals and have to be balanced.

About Abey Francis

Abey Francis is the founder of MBAKnol - A Blog about Management Theories and Practices - and he's always happy to share his passion for innovative management practices. You can found him on Google+ and Facebook. If you’d like to reach him, send him an email to: [email protected]
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