# Objectives of Financial Management
Every financial decision is judged against the firm's objective. Two competing objectives are studied in detail:
1. Profit Maximization
2. Wealth / Value Maximization
## 1. Profit Maximization
Traditionally regarded as the primary goal — every alternative is judged by whether it maximises profit. But profit maximization has serious limitations and should not be the sole objective:
| Limitation | Explanation |
|---|---|
| Vague definition of profit | 'Profit' is unclear — short-term vs. long-term, total profit vs. rate of profit; meaning varies among people. |
| Risk ignorance | Ignores risk. Higher risk often brings higher profit, so chasing profit alone can mean accepting dangerously risky proposals. |
| Time factor of returns | Ignores when returns arrive. High profit after 10 years (Proposal A) may be worse than lower but quicker returns (Proposal B). |
| Narrow perspective | Ignores social obligations, welfare of workers/consumers/society and ethics — harming long-term sustainability. |
## 2. Wealth Maximization / Value Creation
The Wealth Maximization Model focuses on increasing shareholder wealth through a cost–benefit analysis adjusted for timing and risk (i.e. the time value of money):
> Wealth = Present Value of Benefits − Present Value of Costs
To apply it, the finance manager must focus on:
- Cash flow instead of accounting profit,
- Cost–benefit analysis, and
- Application of the time value of money.
The shareholder-value model says the firm should maximise its market value, i.e. increase the NPV of the firm's economic profits.
### Measuring the value/wealth of a firm (Van Horne)
Per Van Horne, the value of a firm is the market price of its common (equity) stock, which reflects all market participants' judgment and considers:
- Current and future earnings per share,
- Timing and risk of earnings,
- Dividend policy, and
- Other factors influencing the stock price.
The market price is a performance indicator of how well management is acting for shareholders.
### Why wealth maximization works
Other possible goals — higher growth, larger market share, product/technology leadership, employee welfare, customer satisfaction, community support — are significant, but wealth maximization remains primary because it is critical to survival and growth. Without it, investors lose confidence, restricting growth and making other goals (like community welfare) harder to achieve.
## Conflicts: Profit vs. Value Maximization
- Management decision-making: Management takes decisions, but its personal goals (e.g. short-term profit) may conflict with the broader goals of stakeholders (shareholders, lenders, etc.).
- Stakeholder influence: Management's survival depends on satisfying employees, creditors, customers and government. Wealth maximization aligns better with stakeholder interests because it grows firm value over time, benefiting all parties.
- Why wealth maximization is the better goal: It accounts for uncertainty and multi-period scenarios, whereas profit maximization is limited by timing and social considerations. In short-term, low-risk situations the two goals may appear similar.
## Comparison Table
| Objective | Advantages | Disadvantages |
|---|---|---|
| Profit Maximization (large amount of profit) | (i) Easy to calculate profit; (ii) Easy to link financial decisions to profit | Short-term focus; (i) ignores risk/uncertainty; (ii) ignores timing of returns; (iii) requires immediate resources |
| Wealth Maximization (highest market value of shares) | (i) Long-term focus; (ii) recognizes risk & uncertainty; (iii) considers timing of returns; (iv) focuses on shareholders' return | (i) No clear link between financial decisions and share price; (ii) may cause management anxiety/frustration |