Financial goals

Financial goals can be discussed by classifying them into two objectives i.e. Profit Maximization Objective and Wealth Maximization Objective.

The firm always sets the two important objectives for its growth. They are as follows:

1. Profit Maximization Objective
2. Wealth Maximization Objective

1. Profit Maximization Objective

We know, in the conventional theory of the firms, the objective is to maximize profit. Maximization of profit means the maximization of the rupee income of the firm. Under profit maximization, firms only accept or tend to attempt those investment projects which yield larger profits and drop all other unprofitable activities in business.

Profit maximization depends on the following grounds:

• In a competitive market, only those firms survive which are able to make a profit. Hence, they always try to make it as large as possible. All other objectives are subjected to this primary objective.
• Profit maximization assumption is a time-honored objective of the firm and evidence against this objective is not conclusive or ambiguous. 
• Almost not perfect, but it is the most efficient and reliable measure of the efficiency of the firm.
• This objective has been found extremely accurate in predicting certain aspects of a firm's behavior and trends as such the behavior of most firms are directed with the objective of profit maximization.

Drawbacks of Profit maximization Objectives are listed below:

• It ignores the timing of returns. It equates a rupee earned in the present with a rupee earned in the future. In fact,  Rs.1000 earned in the present time is more valuable than the Rs.1000 earned in the future because the present money can be reinvested to gain more returns.
• It ignores the risk associated with the stream of cash flow of the project. For example, two projects may generate the same profits at the end of the project, but there can be a project with a wide range of profits annually and another with uniform profits annually. The project with a wide range of profits annually is riskier. This fact is ignored by this objective and it only focuses on the gained profit. So, it is not the most reliable objective of the firm.
• The term "profit" is so vague as it may be manipulated from a different perspective. Since the creditor's profit may seem related to the earnings before interest and tax (EBIT), in case of shareholders may look for the earnings after tax or profits per share. 
• It has greater relevance to the short run. In the long run, a firm cannot survive with this objective.
• Also, if a firm keeps profit maximization as an objective, it may commit unfair practices to maximize profit.

2. Wealth Maximization Objective

According to this objective, the firm's manager take decisions that maximize the shareholder's wealth. In other words, it is fully dedicated to making its shareholders rich.

Shareholder's wealth is maximized when a decision of firm generates net present value. Net present value refers to the difference between the present value of the benefits of a project and the present value of its costs.

A project that has a positive net present value creates wealth for shareholders and a project with a negative net present value creates a loss for shareholders' wealth. So, a firm's manager should only accept projects with a net present value and drop the project with a negative net present value. 

It is considered a superior decision criterion because of the following features described below.

Features of Wealth Maximization Objective are listed below:

• Recognizes the time value of money
• Considers risk
• Efficient allocation of resources
• The separation between ownership and management
• Residual owners
• Emphasis on cash flow

Recognizes the time value of money:

Time value of money is an important factor of financial decision making. According to the wealth maximization object, all cash flows generated over the life of the project are discounted back to the present value using the required rate of return as the discount rate and the decision is based on the present value of future returns. 

Considers risk:

This objective also considers the risk associated with the streams of future cash flows. The risk is taken care of by using the appropriate required rate of return to discount the future streams of cash flows. The higher the risk, the higher will be the required rate of return. 

Efficient allocation of resources:

Shareholder's wealth maximization provides the guidelines for the firm's decisions making and also promotes an efficient allocation of resources in the economic system. resources are generally allocated taking into consideration of the expected return and risk associated with the course of action. 

The firm makes financing decisions considering the riskiness of the income stream or the market price of the share maximization as it only increases the capital, so it only raises capital when necessary and investment ensures the use of the capital.

The separation between ownership and management:

Shareholder provides funds for the operation of a business firm and they appoint a team of management to run the firm. Therefore, it is essentially not good to play an unfair game with the money of shareholders rather than to promote their welfare. Shareholders' wealth maximization is reflected only in terms of the high market price of the shares.

Residual owners:

Shareholders are the last to share in the earnings and assets of the company. Therefore, if the shareholder wealth is maximized, then all others with the prior claims than shareholders could be satisfied.

Emphasis on cash flow:

The wealth maximization goal uses cash flows rather than accounting profit as the basic input for decision-making. The use of cash flows is more unambiguous because it uniformly means profit after tax plus non-cash outlays to all.