There are four main objectives of a business firm. The objectives are Profit Maximization Objective, Wealth Maximization Objective, Value Maximization Objective, and Other Maximization Objectives.
- Profit Maximization Objective:
Profit as an objective has emerged from economic theory. According to traditional economic theory, a small firm owner managed and will compete with a large number of similar firms.
Under below circumstances, profit is the sensible objective because:
- Firm’s profit will become the income of the owner. Maximization of profit ensures the self-interests of the owner or manager, who decide and carry out the actions of the firm.
- The competitive force imposed profit maximization upon the firm to remain in business. The behavioral assumption of profit maximization has served economic theory well. As profit is the difference between revenue and costs, once the revenue and costs are identified the assumption of profit maximization enables predictions to be readily available for any environmental change.
Moreover, if we know about the identifiable profits, the techniques of classical optimization can be used for decision-making. However, in recent years, doubts were expressed about the profit maximization model accuracy as a description of current business behavior. The actual objective of the firm is something very near to profit. Often the objective is linked to security, survival or the maintenance of liquid assets.
Each of these objectives is interrelated to profit, in that the maximization of profit may make sure that the attainment of those objectives as well. Firm’s behavior can then be modelled as if the firm was maximizing the profit. Previously, many used to argue that the objective of a company is to earn a profit; hence the objective of financial management is also maximization of profits.
- Wealth Maximization Objective:
The Wealth maximization is a process which increases the current business net value or shareholder capital gains, with the objective of bringing in the maximum possible return. The net present value of the business is obtained by taking the difference between the present value of its benefits and a present value of its costs. A financial action which has a positive net present value generates wealth so it is desirable.
A financial action which results in a negative net present value shouldn’t be accepted. When we have a number of desirable mutually exclusive projects, the one with the higher net present value should be selected. The maximization of wealth is possible if our decisions for the firm lead to profit which exceeds costs. A company establishes its overall goals, for long-range planning and management controls.
Since owners of the company are its shareholders, the main financial objective of corporate finance is generally stated to be the maximization of shareholders wealth. As shareholders receive their wealth in the form of dividends and capital gains, shareholders’ wealth will be increased by increasing the value of dividends and capital gains which shareholders receive over a period of time.
The shareholder wealth maximization objective states that management should try to increase the present value of the expected future returns to the owners of the firm. Present value is the value today of some future payment or stream of cash flows, evaluated at an appropriate discount rate.
The discount rate accounts the returns which are available from different investment opportunities during a specific future time period. The wealth maximization objective considers the time and risk of expected benefits. The difficulty here is selecting an appropriate rate for discounting future cash flow.
If high risk is associated with receiving future economic benefit, the higher discount rate is adopted which lowers the value of the investor’s wealth. Since an organization is a consortium of group’s viz., managers,owners, suppliers, employees, customers, government etc., wealth maximization is not just for shareholders but for all the stakeholders in the organization.
- Value Maximization Objective:
The objective of a firm is to maximize the present wealth of the owners i.e., equity shareholders in an organization. An organization’s equity shares are traded in the stock markets, the wealth of the equity shareholders appears in the market value of the equity shares.
Firm’s Cash flow and Value Maximization
The prime objective for the company is to maximize the market value of equity shares of the company. The market price of a share is considered as one of the performance indexes of the company. It also takes into account the risk associated with the business, present and prospective future earnings per share, level of gearing, dividend and retention policies of the firm etc.
We can maximize shareholder’s wealth only by maximizing the market value of the share. Presently, the term ‘wealth maximization’ in financial management is redefined as ‘value maximization’. The objective of maximizing economic welfare of shareholders is achieved by maximizing their wealth. The maximization of the utility value of shareholders can be achieved through maximization of their economic welfare.
For a company which is doing business, the wealth generated is affected in the market value of its shares. Therefore, the financial decisions which create wealth are affected in the market price of the company’s shares. Hence the primary goal of financial management is to maximize the value of the firm.
- Other Maximization Objectives:
i. Sales Maximization Objective:
The interests of the company are best served by the maximization of sales revenue, which also improves growth, market share, and status.The size of the firm, prestige, and aspirations are more closely recognized with sales revenue rather than profit.
ii. Growth Maximization Objective:
Owners of the firm (shareholders) will seek the objectives which will give them satisfaction with market values such as sales, profit, and market share. On the other hand, managers are concerned with salary, job security, prestige, and status. These various kinds of objectives are reconciled by focusing on the growth of the firm, which brings higher salaries and status for managers and profits and market share for the owners of the firm.
iii. Maximization of ROI:
The strategic objective of a business is to earn a return on capital invested. If in case, the return in the long-run is not satisfactory, then the deficit should be corrected or make changes in the activity by choosing a more favorable alternative. Measuring the historical performance of investment made demands a comparison of the profit earned with capital employed.
The rate of return on investment is calculated by dividing net profit by the capital employed to achieve that profit. ROI analysis serves as a strong motivation for optimal utilization of the assets of the company. This encourages managers to get and retain assets which provide a satisfactory ROI and to dispose of assets that provide an unacceptable return. While selecting from alternatives of long-term investment proposals, ROI is a suitable measure for assessment of profitability.
iv. Social Objectives:
The business enterprise is an integral part of a prospering country. In return for the privileges and rights granted to it by the state or central governments, the business firm should be responsible for social objectives.
v. Group of Objectives:
According to Cyert and March, an organization is not a unified structure; it is a consortium of individuals, each having varying interests and objectives. They have five goals, which are listed below:
- Production Goal
- Inventory Goal
- Sales Goal
- Market Share Goal
- Profit Goal
Sufficient profit must be earned to finance capital investments and to divide as capital gains to shareholders. The profits are not merely goals; they are the very good reasons for the existence of the business enterprise. The assumption of profit maximization has huge benefits for enabling decisions which can be modelled. But at the same time, we can’t ignore non-profit maximizing theories.