Gujarat BoardEnglish MediumSTD 12 CommerceOCMFINANCIAL MANAGEMENT3 Marks
Question
Explain the objectives of Financial Management.
✓
Answer
The objective of financial management is maximization of the owner’s economic welfare.
To achieve this objective, the financial management adopts following two approaches:
$(A)$ Objective of profit maximization and
$(B)$ Objective of wealth maximization
$(A)$ Objective of profit maximization:
The objective of maximizing income of the company is called profit maximization.
In market, investors purchase the shares of company with a hope of earning maximum dividend. As a result, company should earn maximum profit out of its available resources. Moreover, its dividend policy should be based on maximization of profit.
In addition, this approach suggests that company should take up only those business projects which can earn good profits i.e. which aims at profit maximization.
This approach increases the share price of the company. This in turn increases company’s per-share earning.
$(B)$ Objective of wealth maximization:
The concept of increasing the value of the business in order to increase the value of the shares held by the shareholders is called wealth maximization.
A term called Net Present Value $(NPV)$ is used to measure the profit of the company. Profit under $NPV$ is obtained by subtracting the present value of wealth from the investment required over a period of time.
Wealth maximization focuses on building a profitable $NPV.$ The net present value creates wealth for the shareholders.
Owing to this calculation, the organization should take up only such decisions which increase the net present value and hence the wealth.
A drawback of wealth maximization approach is that it is based only on the concept of cash flow. It does not consider actual profit booked by the business.
Only cash flow is considered as a measurement and the accounting profit is ignored.
The net present value of wealth is the difference between present value of wealth and investment required.
Net present value of wealth $=$ Present value of wealth $–$ Investment required
Financial management should take such financial decisions by which wealth of the company is maximized. If the wealth of the company is maximized, it will be reflected in the price of the share of the company in the stock exchange.
Market price,of the share will increase in the share market. This will result in maximization of the wealth of shareholders.
The objective of wealth maximization is appropriate and universally accepted. Moreover, it is considered superior to profit maximization. Prof. Solomon has favoured the objective of wealth maximization.
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