Organizational objectives are used by financial managers as decision criteria in financial management. This implies that what is relevant is not the overall object of the company, but an operationally useful criterion by which to judge a specific set of decisions
Companies have numerous objectives, but none of them can be achieved without causing conflicts in the face of achieving other objectives.
These conflicts generally arise due to the different purposes of the groups that, in one way or another, intervene in the company, which include shareholders, directors, employees, unions, clients, suppliers and credit institutions.
The company can define its objectives from different points of view as in:
- Maximizing sales or market share. Providing quality products and services. In the long term the company has responsibility for the welfare of society. The company must be managed in accordance with the interests of the shareholders.
You can also see the meeting of some or all of the factors described above, but what is important is how the financial management of the company influences these organizational objectives.
Decisions in Financial Management
The decisions made by those responsible for the financial area must be based on policies related to investment, financing and a consistent dividend policy.
Financial management
Financial management is related to decision-making regarding the size and composition of assets, the level and structure of financing, and dividend policy.
In order to make the right decisions, a clear understanding of the objectives to be achieved is necessary, because the objective provides a framework for optimal financial decision-making. To this end, there are two broad approaches:
1. The maximization of benefits as a decision criterion
The rationale behind profit maximization as a guide to financial decision making is simple. The benefit is a test of economic efficiency. It provides a benchmark against which to judge economic performance and also leads to an efficient allocation of resources, when they tend to be directed to uses that are the most desirable in terms of profitability.
Financial management is directed towards the efficient use of an important economic resource: capital. For this reason, it is argued that the maximization of profitability should serve as a basic criterion for financial management decisions.
However, the profit maximization criterion has been questioned and criticized based on the difficulty of its application in real-world situations. The main reasons for this criticism are the following:
Fundamental ambiguity
A practical difficulty with the profit maximization criterion is that the term profit is a vague and ambiguous concept, that is, it does not have a precise connotation. It is susceptible to different interpretations for different people.
Scholars of the subject argue that the benefit can be short term or long term; it can be total profit or profit ratio; before or after taxes; it can be in relation to the capital used, total assets or capital of the shareholders, etc. If profit maximization is the goal, the question arises which of those profit variants should a company try to maximize. Obviously, an imprecise expression such as profit cannot form the basis of operational financial management.
From the formation of the company as a social entity, it is convenient to distinguish between the objectives of the company considered from the perspective of financial management and from the angle of economic theory.
Periodicity of benefits
A more important technical objection to profit maximization, as a guide to financial decision-making, is that it ignores the differences in benefits received in different periods derived from investment proposals or courses of action. That is, the decision is made on the total benefits received, regardless of when they are received.
Quality of benefits
Probably the most important technical limitation of profit maximization, as an operational objective, is that it ignores the quality of benefits aspect associated with a financial course of action.
The term quality refers to the degree of certainty with which benefits can be expected. As a general rule, the truer the expectation of benefits, the higher the quality of the benefits. Conversely, the lower the quality of the benefits, as they will involve risks for investors.
The uncertainty problem makes profit maximization inappropriate, as an operational criterion for financial management, since only the size of the benefits is considered and the uncertainty level of the future benefits is not weighted.
Disadvantages compared to organizational objectives
The profit maximization criterion is inappropriate and inappropriate as an operational objective of a company's investment, financing and dividend decisions. It is not only vague and ambiguous, but also ignores two important dimensions of financial analysis: risk and the time value of money. Consequently, an appropriate operational criterion for financial decision making should: a) be precise and exact; b) consider the dimensions of quantity and quality of benefits, and c) recognize the time value of money.
The alternative to profit maximization is wealth maximization, which meets all three of the above conditions.
2. The maximization of wealth as a decision criterion
The value of an asset should be seen in terms of the benefit it can produce, it must be judged in terms of the value of the benefits it produces less the cost of carrying it out, which is why when evaluating a financial action in the company, accurately estimate the benefits associated with it.
The wealth maximization criterion is based on the concept of the cash flows generated by the decision rather than the accounting profit, which is the basis for measuring profit in the case of the profit maximization criterion.
Cash flow is a precise concept with a defined connotation in contrast to accounting profit, it could be said that on some occasions it is conceptually vague and susceptible to various interpretations regarding the measurement of accounting benefits. This is the first operational feature of the wealth maximization criterion.
The consideration of the dimensions of quantity and quality of benefits is the second important element in the criterion of wealth maximization, at the same time that it incorporates the time value of money.
The value of a cash flow stream with the criterion of wealth maximization, is calculated by discounting each of its elements at a ratio that reflects time and risk. In applying the wealth maximization criterion, this should be seen in terms of maximizing value for shareholders, this shows that financial management must focus its efforts primarily on creating value for owners.
For the aforementioned reasons, " wealth maximization is superior to profit maximization as an operational objective ", consequently, for financial managers it is a decision criterion to apply the concept of wealth maximization in terms of the value it It gives its work, since in reality in financial management what is relevant is not the overall objective of the company, but the criteria it has to decide at the right time on the appropriate financial operations.
