Assignment OF Financial Management bcom sem -5 PDF

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Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise....

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ASSIGNMENT OF FINANCIAL MANAGEMENT

SUBMITTED BY DRISHTI KALRA

201810 B.COM (HONOURS) SEM-5

Is profit maximisation and wealth maximisation the ultimate objective of financial management. Comment Financial management may be defined as the area or function in an organization which is concerned with profitability, expenses, cash and credit, so that the "organization may have the means to carry out its objective as satisfactorily as possible. “Financial management is that area of business management devoted to a judicious use of capital and a careful selection of the source of capital in order to enable a spending unit to move in the direction of reaching the goals.” – J.F. Brandley

OBJECTIVES OF FINANCIAL MANAGEMENT : Every organisation is formed with a set of specific objectives to achieve and goals to pursue during its continued operations. There are several objectives for the enterprises that safeguard the interests of all these groups , but it is argued that the achievement of the central goal of maximisation of the owner’s economic welfare depends upon the adoption of two criteria - profit maximisation and wealth maximisation.

PROFIT MAXIMISATION Profit earning is the main aim of every economic activity. Profits also serve as a protection against risks which cannot be ensured. The accumulated profits enable a business to face risks like fall in prices, competition from other units, adverse government policies etc. Thus, profit maximisation is considered as the main objective of business. Features of Profit Maximization: Profit Maximization consists of the following features:

❖ Profit Maximization is also known as cash per share maximization. It helps in achieving the objects to maximize the business operation for profit maximization. ❖ The ultimate objective of any business is to earn a huge amount of return in terms of profit. Thus, this objective of financial management considers all the possible ways to increase the profitability of the business concern. ❖ Profit earning capacity is kind of a parameter for measuring the efficiency of a particular business. Thus, it shows the entire position of business along with the measures to improve and increase profitability. ❖ Profit Maximization is an objective that helps in reducing risk.

Arguments in the favor of Profit Maximization: 1. When earning the profit is the only motive of doing the business, the objectives to achieve those targets should be considered feasible; therefore, profit maximization should be the obvious objectives. 2. Profit earning capacity is the barometer for measuring efficiency and economic prosperity of business concern, thus this objective is justified based on rationality. 3. Economic and business situations don’t go the same all the time. There are at times adverse business conditions like recession, depression, severe competition, etc. During these situations earned profit works as a savior. Thus, a business should earn more and more profit at the time of a favorable situation. A business entity will be able to survive under unfavorable situations only if it has certain funds in the form of past accumulated earnings that it can rely upon. 4. The main source of income and funds for the business is the amount of profit earned. Thus, a business should aim to maximize its profit for enabling its growth and development.

5. The fulfillment of social goals is also achieved by earning the expected amount of profit. A business concern by pursuing the objects of maximizing the profit also maximizes socio-economic welfare.

Arguments in the Criticism of Profit Maximization: 1. A firm pursuing its objective of profit maximization usually starts exploiting its workers as well as its customers. 2. To earn maximum profits business usually engaged in immoral and number of corrupt practices such as unfair trade practices, corrupt practices, etc. 3. It affects the ideal social system by leading to colossal inequalities amongst stakeholders such as customers, suppliers and public shareholders, etc. and lowers the human values. 4. In today’s era of imperfect competition, profit maximization cannot be the legitimate objective. Thus, it is more suitable in the conditions of perfect competition. Drawbacks: Irrespective of profit maximization being the best objective as it maximizes the owner’s economic welfare, this objective is being rejected from practice due to the following drawbacks: ❖ Ambiguity: This objective is ambiguous as profit means different things for different people. Should it mean long term profit or short-term profit? Or we shall consider total profit earned or only earnings per share are sufficient. Profit before tax is considered or the one after tax. ❖ Ignores the time value of money: Profit Maximization objective does not consider the time value of money and ignores the magnitude and timings of earnings. It treats all earnings similar irrespective of the fact that those income has occurred in different periods. It ignores the fact that cash received today has more value than the same cash received in previous years.

❖ Ignores risk factor: W  hile considering the objective of profit maximization, it does not consider the fact of risk involved in the prospective earning streams. Like some projects are riskier than the other. Two firms can have the same expected earnings per share but in case of earning a stream of anyone is riskier than the market value of its share would be comparatively less. ❖ Dividend Policy: The effect of dividend policy on its market value of the share is also not considered in the objective of profit maximization. If the object of the firm is to increase earnings per share then an enterprise may not be considered paying a dividend because it can be satisfied by retaining all the profit in the business or investing it in the market.

WEALTH MAXIMISATION Wealth Maximization Objective is also known as “Value Maximization” or “Net Present Worth Maximization.” This objective is considered appropriate for decision making. Wealth means wealth of shareholders. Wealth of shareholders is determined by market value of shares.

Wealth also signifies Net Present Value(NPV) which is the difference between present value of cash inflows and present value of cash outflows. In this way, wealth maximization objectives considers time value of money and assign different values to cash inflows occurring at different point of time. So, according to wealth maximization objective, investments should be made in such a way that it maximizes Net Present Value.

Arguments in favor of Wealth Maximization objective: 1.

It is superior: This objective is superior to profit maximization as its main aim is to maximise shareholder’s wealth.

2. It is precise and unambiguous: It is based on the concept of cash flows rather than profit. The concept of profit in the profit maximization objective is vague and ambiguous. 3. Considers time value of money: Wealth maximization objective takes into account the time value of money as it considers timing of cash inflows. The cash flows occurring at different period of time are discounted with appropriate discount rate. 4. Considers risk: This objective also considers future risk associated with occurrence of cash flows. This is done with the help of discounting rate. Higher the discount rate, higher the risk and vice-versa. 5. Ensures efficient allocation of resources: Resources are allocated wisely to increase shareholder’s wealth. 6. Ensures economic interest of society: When wealth of shareholder is maximized, it ultimately upholds economic interest of society. Unfavorable arguments for Wealth Maximization objective 1. Creates owner-management problem: The concept of wealth maximization creates an owner-management problem as owners want to maximize their profits and management want to maximize shareholder’s wealth. 2. Ignores other stakeholders: This objective has been criticized on the ground that it is inclined towards wealth maximization of shareholders only and ignores other stakeholders such as creditors, suppliers, employees etc. 3. Criteria of market value is not fair: The criteria of wealth maximization is based on market value of shares which is not a correct measure. Because value of shares could increase or decrease due to other economic factors which are beyond the control of the firm. 4. It is just another form of profit maximization: Ultimate aim is to earn maximum profits. Without earning profits wealth cannot be maximized. 5. Management alone enjoy certain benefits. 6. It is not suitable for present-day businesses.

CONCLUSION: Effective procurement and efficient use of finance lead to proper utilization of the finance by the business concern. It is the essential part of the financial manager. Hence, the financial manager must determine the basic objectives of the financial management.But Wealth and profit maximisation are the ultimate objectives that are to be achieved by every organisation. Achievement of wealth maximization also maximizes the achievement of the other objectives It is a true indicator of the company's progress and the shareholder’s wealth. However, “profit maximization can be part of a wealth maximization strategy. Quite often the two objectives can be pursued simultaneously but the maximization of profits should never be permitted to overshadow the broader objectives of wealth maximization....