Financial management objectives
The objectives of Financial Management revolve around the balance between maintaining the existence of the institution and protecting it from the risk of bankruptcy and liquidation and achieving an appropriate return on investment. Within this general framework, the objectives of the financial management in the institution can be defined as follows:
- Maximizing the present value of the enterprise
- Return on Investment
Each of these objectives will be dealt with in some detail in this topic and the next topics:
Maximizing the present value of the enterprise
Economists see the use of maximizing profitability as a goal to evaluate the operational performance of the institution because maximizing profitability expresses, in their opinion, the extent of the economic efficiency of the institution, so they said that all decisions within the institution must be directed towards achieving the maximum possible profit, by working to increase the productivity of the resources available for investment to the maximum extent Maybe. As for the financiers, they did not accept the idea of profit maximization, which economists talked about as a goal for evaluating the operational performance of the institution because this concept has flaws, including:
- Not taking investment risks into consideration
- His disregard for the time value of money
- Ambiguity in the way it is calculated
The financiers presented the idea of maximizing the value of the firm, to measure its operational performance as an alternative to maximizing profitability for several considerations, including:
Considerations of maximizing the present value
1. The absolute maximum profit does not adequately reflect the optimal use of resources, as financial resources may increase and profits may increase, but at a lesser rate than the increase in resources, which means a low return on investment, and thus the current value of the institution.
2. The goal of achieving the maximum possible profit ignores the risks resulting from investment, because this idea means bias towards the most profitable project regardless of the risk ratio, while investors do not accept projects with high risks, especially if they do not result in high profits parallel to these risks, especially If it is calculated using a discount rate proportional to the expected risk.
3. The absolute profit does not take the time element into consideration. If two projects achieve a profit of ten thousand dinars, one of them achieved in the first year and the second achieved in the second year, then the profit in the absolute sense is equal in both cases, but if the time element is taken into account, they will never be equal unless the interest or discount rate was zero, and such a problem does not arise except when using the idea of present value.
4. Ambiguity in the method of calculating the profit. The amount of private profits in an organization may vary due to the flexibility of the accounting theory, whereby following an acceptable accounting principle (accelerated depreciation, for example) may lead to a profit that differs in its amount from what can be reached using another acceptable accounting principle to the same degree (constant depreciation). This avoids the idea of maximizing value. The present problem is this problem, because it is based on the concept of cash flow, and its outcome is the same, no matter how different the accounting principles used are, unlike the concept of profit.
Factors affecting the present value of the enterprise
1. The present value of the corporation is the present value of the cash dividends expected to be received by shareholders. This value represents the market price of the share multiplied by the number of shares.
2. The present value of the enterprise is affected by the following elements:
3. The expected return on the share, as the increase in the return on the share leads to an automatic increase in its value and the value of the institution.
4. The timing in which the investor gets the returns on his investment.
5. The discount rate in the market, as the higher the discount rate, the lower the current value of the dinar expected to be obtained in the future, and vice versa.
6. The expected risks for the institution, and the high risks are expressed by choosing a high discount rate when finding the present value of the institution, and vice versa.
7. Investors’ expectations regarding the institution’s future and its activity, as this has a direct impact on income and dividends.
How can the present value of the enterprise be maximized?
Maximizing the present value of the institution is the outcome of financial decisions in the areas of investment and financing.
The impact of financial decisions on the value of the institution comes through its impact on the amount of return that it is expected to achieve, and through its impact on the amount of risks that the institution may be exposed to as well.
The following table shows this relationship:
Factors determining the present value of an enterprise
|Expected Return:||Financial Decisions:|
|Enterprise value||Investment decision|
|Degree of Risk||Financing Decisions|
Financial management objectives : return and risk
It should be noted that the relationship between return and risk is a direct relationship, as the expected returns increase as the risks increase. In the case of investment, we find that investing in fixed assets requires a higher return due to the high risks associated with it, unlike the situation in the case of investing in traded assets where the risks are less and the investors are on Willingness to accept a lower return.
In the field of finance, the institution’s increased reliance on loans to finance its investments leads to an increase in the expected return (if the investment returns in the institution exceed the cost of borrowing), but this leads at the same time to an increase in the risks of the institution’s inability to service its debt.
- Financial Management Encyclopedia, MDRS Center, 2022.