Firms just like individuals operate with specific goals. Without goals the firm will not be able to achieve much. These goals include;
(a) Financial goals
(b) Non-financial goals
- FINANCIAL GOALS
a) Profit maximization goal
Profit can generally be defined as the difference between sales and expenses. In order for a firm to increase its profitability it might either:-
- Increase its sales holding expenses constant. This may entail increasing the selling price per unit.
- Reduce its expenses holding sales constant. This may entail reducing the expenses per unit but maintaining the selling price.
However, these two strategies may not be sustainable in the long-run because increasing selling price means overcharging the customers while reducing expenses may involve under paying the workers.
Disadvantages of profit maximization goal
- The short term goal is inconsistent with the going concern concept of the firm
- Its ambiguous in the sense that it is not clear which profit should be maximized i.e. is it profit before tax, profit after tax, retained earnings or operating profit (profit before interest and tax)
- It ignores the concept of time value of money. This means that the goal does not distinguish between money received at different times.
Consider two projects A and B which promise the following cash flows:-
Year Project A Project B
1 0 10,000
2 0 10,000
3 30,000 10,000
The goal will assume that the projects have the same value. This of course is not true. Since cash received in earlier years from project B could be re-invested to generate more cash flows for project B.
- The profit maximization goal is normally associated with sole proprietorship which may not be applicable in the modern corporate set-up of joint ownership.
- It ignores other stakeholders who are entrusted with the firm. For example employees and customers.
The benefits received by the shareholders will be in two forms, namely dividends received each year and capital gains or losses. When these two are added up together and expressed in present value terms, they give the theoretical value of a share. This goal will involve investing in projects which will yield positive net present values. Any course of action which yields a positive net present value will maximize wealth and vice versa.
Advantages of wealth maximization goal
- It takes into account the concept of time value of money. This is done by calculating the present value of all the expected future benefits.
- It considers the risks and uncertainties associated with a given cash flow by discounting the cash flows.
- It’s a long term goal which is consistent with the going concern concept of the firm.
- Ignores the welfare of other interested parties in the firm.
- It is a subjective goal since it uses future cash flows which are uncertain.
- NON-FINANCIAL GOALS
These goals conflict with the financial goals since they limit the ability of the company to achieve its financial goals. However, the goals are still pursued by the company because the company has to interact with other parties in its environment. They are actually the social responsibilities of the firm and include the following:
- Welfare to employee’s e.g. fair remuneration, promotion, good retirement benefits and a conducive working environment.
- Welfare to the government e.g. prompt payment of taxes and following the rules and regulations set-up by the government.
- Welfare to the community at large e.g. pollution controls, employment of its members, taking part in community development programs and adhering to business ethics.