Scope and Objectives of Financial Management
Financial management is examined as the discipline of sourcing funds and deploying them so that the long-run market value of the firm rises while liquidity risk stays tolerable. The syllabus tests whether you can distinguish decision areas, objectives and the constraints imposed by company law, tax and capital markets.
Core framework
- Investment decision: choose assets and projects whose expected return exceeds the risk-adjusted cost of capital.
- Financing decision: set the debt–equity mix and maturity profile to minimise cost without breaching covenants.
- Dividend decision: decide retention versus distribution, recognising signalling and clientele effects.
- Liquidity decision: manage working capital so solvency is not sacrificed for return.
Profit maximisation is a short-run accounting objective; it ignores timing, risk and the equity invested. Wealth maximisation is operationalised as maximising net present value (NPV), which adds the present value of incremental cash flows after all capital charges. Agency costs arise because managers may pursue size or perks; governance, incentives and debt covenants are control devices.
Worked example
A firm can invest ₹10 crore in a project returning ₹2.4 crore annually for six years. At a 12% opportunity cost, the annuity factor is 4.111, so PV is ₹9.866 crore and NPV is −₹0.134 crore. Accounting profit of ₹0.4 crore a year after depreciation looks attractive, but the project destroys value because it fails to earn the required return. The wealth-maximising decision is to reject it unless strategic options not captured in the cash flows justify a premium.
Marks-losing traps
Do not call profit maximisation equivalent to wealth maximisation; do not ignore risk or time value; do not treat financing inflows as project benefits; and do not confuse the objective with a target such as sales growth.