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Wednesday, April 22, 2009

Financial Goals of Organization

The two important financial goals of organization can be profit maximization and wealth maximization. Out of this wealth maximization is most important because it is based on cash flows of the organizations. On the other profit maximization can be vague as there can be multiple interpretations of profits. Moreover profits do not take care of time value of money and ignore risk attached to the returns. Also profit maximization focus on short term profitability which may not lead to long term wealth creation. Hence financial management is concerned with value maximization.

Management's efforts are for increasing the value of the company for the shareholders. This requires investing in projects that are likely to provide positive returns to the company. Hence wealth maximization accounts for the timing and risk of the expected benefits.

Earnings are valued by deducting the total costs from total income. Hence Net Earnings = Total Income - Total costs. Cash flows will only take cash inflows and cash outflows. Increase in cash flows can lead to improvement in wealth maximization. Management decisions affect the stockholder wealth greatly. They can affect the wealth by following decisions:

• Present and future earnings per share
• Investment decision: This is related to deciding about the composition of fixed assets
• Financing decision: This is deciding about the mix of sources of funds
• Working capital managements
• Profit allocation decisions

We must understand that the firms' primary objective is maximizing the welfare of owners, but, in operational terms, they focus on the satisfaction of its customers through the production of goods and services needed by them. Firms state their vision, mission and values in broad terms. Wealth maximization is more appropriately a decision criterion, rather than an objective or a goal.

Pandey, I.M. Financial Management. (IXth edition, Vikas Publications)

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