1.0 INTRODUCTION A profit-oriented
business can only be successful only when it uses a goal-oriented financial
structure. The financial manager performs certain task that helps achieve the
goals of the finance department. The goals in turn help the firm achieve its
overall operating objectives. In line with this reality, the starting point for
developing a goal-oriented financial structure is defining workable goals for
the firm as a whole. Although they may be stated in general terms, properly
defined and well-understood goals serve as the key to moving a firm to a
desired position. Since private business is profit-oriented Organizations,
their objectives, which are frequently expressed in terms of money, are maximization
of profit and maximization of wealth. In this note, therefore, goals of
profit-oriented business and the main goals of profit-oriented businesses are
considered.
2.0 OBJECTIVES
By the end of this note, you should be able to:
·
explain what profit-oriented businesses are
·
discuss profit maximization of businesses
·
explain the wealth maximization of businesses.
3.0 MAIN CONTENT
3.1 Profit-Oriented
Businesses
Profit refers to an
excess of receipts over expenses of a business for a trading period. This
includes credit transactions and asset revaluations as well as cash
transactions and changes in holdings of real assets. Profit for a period is
equal to dividends and profit taxes plus the excess of net assets at the end of
the period over net assets at its start. A business refers to all forms of
industrial and commercial profit-seeking activity.
In light of the above, a profit-oriented business refers to all
forms of activities both industrial and commercial, directed towards making profit.
So long as a business is concerned, its profits are a matter of judgment rather
than objective fact. Only when a business has been finally wound up and its
assets converted into cash can profit be objectively measured. Until then,
judgment is required as to the valuation of physical and financial assets,
particularly if they are not traded on liquid markets, and as to the quality of
debts due from credit customers.
3.2 Goals of Profit-Oriented Business
As discussed earlier, a profit-oriented business can be successful
only when its owner employs a goal-oriented financial structure for the running
of the business. The starting point for developing a goal oriented financial
structure is defining workable goals. Therefore, for profit-oriented Organizations,
their goals are often expressed in monetary terms. The primary goals of
profit-oriented Organizations are maximization of profit and maximization of wealth.
3.2.1 Maximization of
Profit
Profit maximization stands
as the first frequently stated goal of the firm. Many businesspersons believe
that as long as they are earning high profit level, they have achieved this
goal. Profit maximization can be described
as a rational goal of a business, which focuses the firm’s effort towards
making money. Despite being widely professed, the concept of profit maximization
has several weaknesses.
Profit maximization is
vague and ignores timing. The problem here is the definition of the term
“profits”. If a firm continues to operate a piece of machinery without proper
maintenance, it may be able to lower this year’s operating cost thereby
improving short-run (current) profit. This firm will however, pay for the
short-run saving in future years when the machine finally breaks down and is
not capable of operating because of prior neglect.
Apparently, maximizing profits does not mean neglecting the
long-term expenditure in favor of short-term considerations. In addition, money
received today has a higher value than money received next year, a
profit-oriented organization must consider the timing of cash flows and profits
(this is the timing aspect). Profit maximization
also overlooks quality aspects of future
activities. Businesses do not carry out their activities solely for the highest
possible profit.
Some businesses have placed a higher value on the growth of sales
and are willing to accept lower profits in order to gain the stability provided
by large volume of sales. Others recognize that diversification of their
activities into different products or a market strengthens the firm even though
it may result in short-term decline. Others engage in social responsibility
thereby reducing their profit or undermining the goal of profit maximization .
3.2.2 Maximization of
Wealth
The second goal of profit-oriented business is to maximize the
value of the firm over the long run. This may also be stated as the maximization
of wealth while wealth is defined as the
net present worth of the firm. Rather than focusing directly on profit, this
goal emphasizes the impact of profits on the current market value of the firm’s
securities, notably its common stock.
Logically, there is a correlation between the present worth of a
firm and its value over the long run. If the firm will be highly valuable in
the forceable future, it has a high current value. The result would be true for
a firm with prior prospects for instance, if an investor is considering
purchasing a firm, desires a return of 15 per cent on money invested and the
firm expects a net income after tax of N150,000.00 per year for many years, the
firm would have a present worth of N1 million.
Maximization of wealth
implies other factors in addition to profits. Long run value is affected by the
firm’s growth, the amount of risk acceptable to investors, the market price of
the stock and the cash dividends paid.
A firm maximizing wealth must do the following:
1. Avoid high risk: If a firm is taking a long-term perspective on its business
operations, it must avoid unnecessary or high level of risk; profits with
relatively high level of risk are not accepted. Accepting these projects over
the long run means that a single major failure may jeopardize the firm’s
continuous operation
.
2. Pay dividends: Dividends are payments from the firms to shareholders. They must
be consistent with both the firms and shareholders’ needs. At the early stages
of growth, need for expansion is inevitable hence, dividends may be small. As
the firm reaches maturity and needs less cash to finance expansion, it will be
able to finance expansion; it will be able to pay out a larger share of profits
as dividends. By doing so, the firm attracts investors seeking cash income,
which maintain the market value of the stock, and keeps up the present stock.
3. Seek Growth: As a firm increases sales and develops new markets for products,
it protects itself against a business set back that might drive it from the
market place. A large stable and diversified volume of sales provides a cushion
for the firm against economic recessions, changes in consumer preferences or other
reductions in the demand for the firm’s products. For this reason, firms
adopting wealth maximization approach
are continually seeking growth in sales earnings.
4. Maintain Market Price of Stock: The value of a firm’s
common stock in the market place is a matter of primary concern to its management.
(Pursuing goal of the common stock, this in effect is being maximized.) A
company’s management can take a number of positive steps to maintain the market
price of the stock at reasonable levels. By seeking sound investments, the firm
will appear to have made a wise investment choice over the long term. These and
other actions can help draw attention to the firm and keep the present worth of
its stock at high levels.
4.0 CONCLUSION
From the above discussion, we observed that a firm that wants to
be successful needs to put in place a goal-oriented financial structure. Under
this, it should define, explicitly, workable goals that are well understood. By
defining these goals, the firm will be in a better position to execute its
goals to sustain itself not only in the short run but also in the long term.
5.0 SUMMARY
This note examined what profit-oriented or businesses are. In
addition, it stressed the need to put in place a goal-oriented financial
structure for success. Furthermore, the note identified profit maximization and wealth maximization as the frequently stated goals: the wealth maximization
is superior to wealth profit maximization
. It also encompasses the latter.
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