Long-term objective of Financial Management

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The long-term objective of financial management is to increase the wealth of the shareholders. The term “wealth” refers to various business assets of the enterprise that are free of debt. This means that this wealth belongs to the equity shareholders. It is often reflected in the “book value” of the share as reflected in the balance sheet.

The formula for book value is:

Equity share capital + Reserves and Surplus

    Number of equity shares issued

This can be explained through an example.

Example:

Equity share capital = Rs. 100 lacs (paid up capital)

Reserves and surplus = Rs. 200 lacs

Number of shares = 10 lacs with the Face Value being Rs.10/-

Then the book value of the share would be = Rs. 100 lacs + Rs. 200 lacs   = Rs. 30/-.             

10 lacs shares

This means that at the starting point the book value was Rs.10/- and this has gone up to Rs. 30/- due to the prudent policy of the management of retaining profits within the organisation. Thus the short-term objective also is a contributory factor to realising the long-term objective of wealth maximisation.

Some of the measures through which we achieve the long-term objective are:

Strategic financial management decisions relating to expansion, take over of another business, financial re-restructuring through financial re-engineering (example – swap a costly loan for a cheaper loan provided the credibility of the firm is quite high), joint venture etc. Thus while profitability reflects the operating efficiency wealth maximisation reflects the managerial/entrepreneurial efficiency.

To sum up, both short-term objective and long-term objective need to be put in place for sustained growth of a business enterprise. To an extent at least, the long-term objective is dependent upon the short-term objective of profit maximisation.

 

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