Traditional Financial Management

Financial management is a part of enterprise management, which is the management of the acquisition and effective use of funds. The objectives of financial management depend on the general objectives of the enterprise and are governed by the characteristics of financial management itself.

The financial objectives of enterprises have the following three main points of view:

1. Profit maximization

This point of view: profit represents the new wealth created by the enterprise, the more profit means that the enterprise's wealth increases the more, the closer the enterprise's goal.

The defects of this view are: (1) it does not take into account the time of profit. For example, this year's profit of 1 million dollars and next year's profit of 1 million dollars, which one is more in line with the goal of the enterprise? Without considering the time value of money, it is difficult to make a correct judgment. (2) Failure to consider the relationship between the profit made and the amount of capital invested. For example, the same profit of 1 million yuan, an enterprise invested capital of 5 million yuan, another enterprise invested 6 million yuan, which is more in line with the objectives of the enterprise? It is difficult to make a correct judgment without relating it to the amount of capital invested. (3) Failure to consider the relationship between profit and risk. For example, the same investment of 5 million yuan, this year's profit of 1 million yuan, an enterprise profit has been fully converted into cash, another enterprise profit is all accounts receivable, and may be bad debt losses, which one is more in line with the objectives of the enterprise? Without considering the size of the risk, it is difficult to make a correct judgment.

2. Earnings per share maximization

This point of view: the profits of the enterprise and the capital invested by shareholders should be linked to the examination of earnings per share (or net interest rate on equity capital) to summarize the financial objectives of the enterprise, in order to avoid the shortcomings of the "profit-maximizing objective".

This viewpoint still has the following defects: (1) It still does not take into account the timing of the acquisition of earnings per share. (2) It still does not take into account the risky nature of EPS.

3. Shareholder Wealth Maximization

This view holds that shareholder wealth maximization or enterprise value maximization is the goal of financial management. This is also the view adopted in this book.

The purpose of shareholders in founding a business is to increase their wealth, and if the business fails to create value for the shareholders, they will not fund the business. Without equity capital, the business would cease to exist. Therefore, the business has to create value for the shareholders.

Shareholder wealth can be measured by the market value of shareholders' equity. The increase in shareholder wealth can be measured by the difference between the market value of shareholders' equity and the capital invested by shareholders, which is called the "market value added of equity". The market value added of equity is the value that a business creates for its shareholders.

Sometimes the financial objective is stated as maximizing the share price. A rise in the share price can reflect an increase in shareholder wealth, and a fall in the share price can reflect a decrease in shareholder wealth, given that the capital invested by the shareholders remains constant. The rise and fall of the share price represents the objective evaluation of the value of the company's equity by the investing public. It is expressed in terms of price per share, which reflects the relationship between capital and profitability; it is affected by the expected earnings per share, which reflects the size of the earnings per share and the time to obtain it; it is affected by the size of the enterprise's risk, which can reflect the risk of the earnings per share. It is worth noting that the transaction between the enterprise and the shareholders also affects the share price, but does not affect the shareholders' wealth. For example, the share price falls when dividends are distributed and rises when shares are repurchased. Therefore, assuming that the capital invested by shareholders remains constant, maximizing the share price has the same significance as increasing shareholder wealth.

Sometimes the financial objective is also stated as maximizing enterprise value. An increase in enterprise value is caused by an increase in the value of equity and an increase in the value of debt. Changes in the value of debt are caused by changes in interest rates, which are not controllable by the firm. Assuming that interest rates remain constant, increasing enterprise value has the same significance as increasing equity value. Assuming that the capital invested by shareholders and the interest rate remain constant, maximizing enterprise value has the same meaning as increasing shareholder wealth.

One of the disagreements about financial objectives is how to view the requirements of other stakeholders, including creditors, customers, employees, and government. One view is that a firm should have multiple objectives, each satisfying the requirements of different stakeholders.

Theoretically, any discipline needs a unifying goal around which to develop its theories and models. Any decision that meets the goal is considered a good decision, and one that does not is a poor decision. A unique objective provides a unified basis for decision making in business finance and maintains the internal consistency of decisions. If multiple objectives are used, it is difficult to guide the choice of decisions and to ensure that decisions are not in conflict.

Advocating the maximization of shareholders' wealth is not to disregard the interests of other stakeholders. The corporate laws of all countries provide that shareholders' equity is residual equity, and that shareholders' interests are satisfied only after other interests have been met. Firms must pay taxes, pay their employees, and provide their customers with products and services they are satisfied with before they can earn after-tax income. The demands of other stakeholders are met before the shareholders and therefore must be limited. If the demands of other stakeholders were not limited, there would be no "surplus" for shareholders. Unless the shareholders are convinced that the investment will yield a satisfactory return, they will not contribute and the demands of other stakeholders will not be realized. It is undeniable that there are both * * * common interests and conflicts of interest between shareholders and other management interests. Shareholders may harm other stakeholders for their own interests, and other stakeholders may also harm shareholders' interests. Therefore, it is necessary to regulate the relationship between them through legislation to protect the interests of both parties. Enterprises operating in compliance with the law can be said to have basically met the requirements of other stakeholders, on the basis of which the pursuit of maximizing their own interests will also be beneficial to society. Of course, the law alone is not enough, but also need the constraints of moral norms as well as enhance the sense of corporate social responsibility.