BUSINESS FINANCE AND FINANCIAL ENVIRONMENT FOR BUSINESS
Business Finance is the act or process of accumulation and utilisation of funds in order to accomplish a firm's ultimate goal of maximisation of owners’ wealth.
Ultimate Goal of a Firm
Maximisation of the wealth of the owners or the shareholders of a firm is considered as the ultimate goal of financial management. The price of the stock in the securities market represents a shareholder's current wealth position for investing in to a particular company’s financial assets.
Why Wealth and not Profit Maximisation should be the Goal of a Firm
Because accounting profit can be manipulated in different ways. Adoption of different inventory valuation practice can result in different amount of profit. Credit sale in huge amount disregarding the credit worthiness of the customer can result in big volume of accounting profit for some time. But ultimately this will result in bankruptcy. A firm can also make huge profit by issuing large number of new shares and using the proceeds buying treasury bonds or other risk free investments. Thus maximisation of profit can not be goal of a firm. The alternative objective can be maximisation of EPS. But the concept of EPS has the following limitations:
The maximisation of EPS as a goal does not consider time value of money. The nominal value of a stream of EPS will be growing in future. But the real value or present value of that high nominal future EPS can be less than the current EPS. That is value of EPS in future can not be understood from current EPS.
The concept of EPS maximisation does not consider the riskiness of a project. The future EPS stream can be very much volatile in nature; accordingly the risk adjusted cost of capital will be much higher for the firm. There by the discounted value of EPS may tell us a different story than a simple concept of EPS. As such EPS maximisation also can not be considered as a goal of a firm.
The concept of EPS maximisation does not consider dividend policy of the firm. The dividend policy of the firm tells us how much profit will be retained by the firm for reinvestment as a source of internally generated capital. The growth of future EPS depends significantly upon retention of profit and its proper reinvestment.
Therefore neither total profit maximisation nor the maximisation of EPS can bring about maximum welfare to the shareholders. On the other hand the concept of wealth maximisation can overcome the limitations of profit maximisation. Because wealth of a shareholder is represented by the market price of an investor's stock in the firm. The price of the stock is dependent on present income as well as the present value of future income of the firm. The present value of income of the firm is determined through discounting the future income flow using the risk-adjusted cost of capital of the firm. The dividend policy of the firm does also influence the value of the firm's stock. The distribution of current earnings between dividend and investment influence future cash flow of the firm. Thus the concept of wealth maximisation ultimately maximises the investors’ welfare in the form of maximising the share price of the firm. That is, the more effective investment decisions the firm take up and the more appropriate financing decision the management takes up, the future cash flow will be higher and the cost of capital will be lower. Accordingly, the present value of future cash flow of all the projects of the firm will be higher. The stock market will reflect this situation through enhancing the stock price of the firm. Thus the wealth position of the stock holders will be maximized.
Functions of Finance Manager
The Finance managers have two types of functional responsibility. These are i) Specific Finance Functions and ii) Routine (Daily Finance Functions). i) The specific functions include two functional areas...
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