Financial management is a vital part of both personal and corporate finance. It involves planning, arranging, and regulating financial resources to reach certain goals and objectives. The basic purpose of financial management is to optimise financial resources and processes to meet corporate goals and generate shareholder value. However, the particular aims of financial management may differ based on the organisation’s size, industry, and goals.
This blog will explore the different goals in detail, including profit maximisation and wealth maximisation in financial management.
Primary Goals of Financial Management
1. Maximising Profits in Financial Management
The most important goal of financial management is profit maximisation. It refers to the objective of a business to maximise its profits by making decisions that increase its earnings per share (EPS) and overall profitability. Here are some key points about profit maximisation:
- Measuring tool: Profit earning capability measures a firm’s efficiency. It helps analyse the success and performance of the company.
- Diverse perspectives: The notion of profit might have diverse connotations for individuals. It can relate to long-term or short-term profit, total profit made, per share, profit before or after tax, etc.
- Time value of money: The profit maximisation aim does not account for the time value of money, meaning it overlooks the timing and amount of profits. It considers all profits identically, without considering the value of money over time.
- Impact on decision-making: Profit maximisation is crucial in directing investment and financing decisions. All choices linked to new initiatives, asset acquisition, capital raising, etc., are reviewed based on their influence on earnings and profitability.
- Social and economic welfare: When a firm produces a profit, its correct utilisation and distribution of resources result in payments for capital, fixed assets, labour, and organisation. This, in turn, adds to economic and social well-being.
2. Maximising Wealth in Financial Management
Wealth maximisation is a financial management strategy that aims to increase a business’s value by increasing the value of its shares held by shareholders. This approach requires a company’s management team to consistently seek the highest returns on invested funds while mitigating risk. Wealth maximisation is superior to profit maximisation as it considers a broader arena.
Changes in the price of a company’s shares are the most direct proof of wealth maximisation. For example, if a company invests in something valuable like new property, people who invest in the company might think it’s a good idea because it could make more money in the future. Similar reactions may emerge if a company continues to announce growth in cash flow or profitability.
Wealth maximisation offers both advantages and disadvantages. Before investing in any firm, every investor should consider this element. However, wealth maximisation can lead to immoral practices such as labour exploitation, pollution of the environment, and disregard for social duties.
3. Liquidity Maintenance
Liquidity maintenance in financial management refers to efficiently managing a company’s cash and financial resources to ensure it has enough liquidity to satisfy its financial commitments when they are due. It encompasses methods and activities to improve, maximise, and preserve a company’s liquidity. Here are some key points:
- Visibility and control: Effective liquidity management offers full visibility and control over a company’s cash and financial resources. This can be done through centralised procedures and technologies that give real-time information on the company’s liquidity condition.
- Complexity: Managing liquidity may be particularly complicated for organisations operating in numerous countries and currencies and holding accounts with different financial institutions. Effective bank liquidity management requires getting complete insight into the company’s liquidity through centralised operations.
- Risk management: Liquidity management also involves controlling the risk associated with liquidity. This involves analysing and reducing liquidity risk exposure, ensuring the firm has adequate cash and collateral to meet its obligations without suffering major losses.
- Financial performance: Effective liquidity management immediately affects a company’s working capital and financial performance. It helps firms set aside cash for payments, avoid going into debt or selling assets under unfavourable terms, and develop a sound financial foundation.
- Tactics and techniques: Liquidity management tactics involve proactive budgeting, efficient invoicing, effective collections management, and maximising working capital. Organisations may implement different liquidity management techniques based on their financial maturity and specialised demands.
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4. Estimating Financial Needs Correctly
Proper estimation of financial requirements involves determining the amount of money needed to start or run a business and ensuring that enough funds are available at the right time. Here are some steps:
- Determining the revenue: To determine the possible revenue for the first several months, use information about the industry.
- Establish a budget: Design a preliminary budget for the first year based on the bank’s loan line and retained profits.
- Calculate the cost: Calculate the cost of producing the good or service, considering labour, supplies, and administrative costs.
- Consider contingencies: Consider unforeseen expenses, market fluctuations, and other occurrences that might impact the firm’s financial needs.
5. Appropriate Mobilisation
Proper mobilisation in financial management involves efficiently allocating resources to all departments to increase efficiency. It aims to maximise profits in the short and long run. Effective liquidity management ensures cash availability. Financial control sets KPIs and helps businesses meet objectives. Tracking and analysing mobilisation costs helps project managers identify inaccurate estimates and adjust for future projects.
6. Appropriate Use of Financial Resources
Here are some key points on how one can effectively use financial resources:
- Fund allocation: Properly distribute funds to different parts of the company based on their value and potential for sustainability and profitability.
- Financial planning: Develop a thorough financial plan that describes the organisation’s financial goals, strategies, and resource allocation.
- Financial control: Implement effective financial control procedures to monitor and manage the consumption of funds.
- Risk management: Assess and manage financial risks to reduce possible losses and optimise rewards.
- Investment decisions: Make educated investment decisions by doing detailed financial research and considering prospective rewards and hazards.
- Monitoring and evaluation: Continuously monitor and assess the consumption of financial resources to find areas for improvement and make required modifications.
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7. Enhanced Efficiency
The goal of financial management is to improve corporate efficiency by simplifying operations, lowering expenses, and optimising resource allocation. It entails measuring efficiency with indicators like return on investment, gross profit margin, and operating expense ratio.
Maximising time, effort, and resources, lowering costs, and increasing return on investment are all aspects of business efficiency. Controlling and monitoring financial resources to fulfil corporate goals is part of effective financial management planning.
8. Fulfilling Financial Commitments with Creditors
Financial management is essential for firms to meet their responsibilities to creditors, such as loan repayment and contractual agreements. It includes budgeting, distributing funds, maintaining investor relationships, and implementing successful management concepts such as rigorous lending standards, conservative regulations, and risk assessment. This assures the financial stability and profitability of a corporation.
9. Building Reserves
Financial management includes setting aside funds to cover unforeseen bills, economic downturns, or investment possibilities. Setting up reserves helps stabilise a nonprofit’s finances by acting as a buffer against unforeseen events and high costs.
For finance managers in accounting, accounts receivable, and accounts payable teams, effective financial management planning entails establishing, controlling, and monitoring financial resources to fulfil corporate goals such as profitability, costs, cash flow, and credit.
10. Lowers the Cost of Capital
Financial management uses cost-effective financing options, optimised capital structures, and debt management to try and minimise a company’s cost of capital. The minimum rate of return a business must achieve before creating value is known as the cost of capital. The optimum capital structure is the best possible balance of debt and equity financing since it maximises market value while lowering capital expenses.
The trade-off theory states managers should aim for a stock and debt ratio that minimises the firm’s weighted average cost. Planning for effective financial management helps create long-term strategies, guides investment choices, and gives data on funding, liquidity, profitability, and cash runway.
11. Minimising Operating Risk
Financial management seeks to decrease operational risks through risk management measures such as diversifying investments, hedging against losses, controlling cash flow, managing debt, and preparing contingency plans.
These tactics assist investors in spreading their assets over multiple risk levels, mitigating possible losses, and maximising returns on investment while minimising loss exposure.
12. Balancing Structure
Maintaining a balanced financial structure through managing debt and equity, guaranteeing liquidity, and optimising the capital structure to meet a business’s goals is what financial management entails.
The aim is to discover the ideal capital structure that results in the lowest weighted average cost of capital and the greatest possible firm value. Companies with stable cash flows may bear higher debt loads, whereas companies with erratic cash flows have less debt and greater equity.
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13. Creating Financial Scenarios
Financial management creates financial scenarios and forecasts to analyse economic situations and make sound judgements. Scenario analysis assists corporate executives in forecasting future events and profitability. It comprises four major components— planning, budgeting, forecasting, and risk management.
Financial performance assesses a company’s capacity to utilise assets and create income, whereas risk management incorporates risk-mitigation tactics such as portfolio diversification, asset allocation, and position size. This procedure is critical for people and corporations considering large investments.
14. Determine Your Success
Financial management includes establishing financial measurements and performance indicators to assess a company’s success and profitability. These measures, including sales growth, profits per share, customer loyalty, and product quality, are critical for determining a company’s financial health and profitability.
Understanding and monitoring these indicators enables firms to discover areas for development and make data-driven decisions that will lead to growth and success.
15. Marketing Activity Optimisation
Financial management optimises marketing efforts by allocating resources, assessing ROI, and aligning tactics with financial goals. Businesses must define their goals, set KPIs, and regularly assess and analyse their efforts. Effective marketing tactics develop a strong market presence, connect with target consumers, and maximise reach. Aligning marketing analytics with financial objectives boosts ROI.
16. Survival of a Business
Financial management is critical for a company’s existence and sustainability. Planning, control, decision-making, and analysis are all aspects of strategic financial management. A solid strategic plan incorporates measurements and financial goals to generate profit and ensure a reasonable return on investment. Successful plans offer clearing direction, explaining policies, managing expenditures, and tracking results.
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What Makes These the Basic Objectives of Financial Management?
The points mentioned above are the core aims of financial management since they all attempt to improve the company’s financial performance, ensure long-term growth, and maximise value for shareholders and other stakeholders while complying with ethical and regulatory requirements.
By applying financial management practices, businesses can improve their financial efficiency, increase profitability, and ensure their long-term existence. The strategies should be adjusted to each company’s individual demands and goals. Regular examination and adjustment of financial plans are also essential for long-term success.
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What is the concept of wealth maximisation in financial management?
The notion of wealth maximisation in financial management is the idea of raising the value of a corporation to raise the value of the shares owned by its investors. It includes continuously striving for the maximum potential returns on cash invested in the firm while limiting any related risk of loss.
What are some strategies or approaches used to maximise profits in financial management?
Some strategies or approaches of profit maximisation in financial management include focusing on customer retention, increasing revenue, decreasing expenses, conducting market research, analysing financial statements, and facilitating team contributions.
Can you discuss wealth maximisation's role as a financial management goal?
Wealth maximisation is a financial management goal that involves increasing the value of a business to increase the value of the shares held by its stockholders.
How does the primary goal of financial management impact decision-making within an organisation?
The primary goal of financial management is to optimise financial resources and techniques to achieve corporate goals and create shareholder value. This influences organisational decision-making by prioritising financial efficiency and value generation.