CHAPTER 11

GOALS AND
FUNCTIONS OF
FINANCE

Management: Principles, Processes & Practices

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 Learning Objectives
 The goals of a business entity
 The meaning and implications of profit
maximization
 The role and function of finance and
financial managers
 Value creation for shareholders
 Economic value added (EVA)
 Corporate social responsibility and
business

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 Goal of the Company – Value
Creation for Shareholders
The fundamental
Goal of the company purpose for the
existence of a
business entity is
Value creation for shareholders:
to create value for
By maximizing shareholders’ wealth by availing the shareholders -
profitable business opportunities.
Although there are
many stakeholders
in a business
Requires effective and Market value of stock of
efficient: the company entity, its key
Investment decisions stakeholders are
Financing decisions Enhanced dividends
Dividend decisions the owners of the
company

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 Profit Maximization & EPS
Profit maximization as well as maximization of EPS
are not reasonable measures of a company’s
success as these fail to consider the following:
 Timings of returns.

 Availability of cash flows to stakeholders (stockholders’

inflows not only depend upon dividends arising from
accounting profits but also on a large share of inflows
dependent upon the market price of the stock)

 Uncertainty and risk (profits or EPS does not take care

of future risk associated with investment as also
expected future flows)

Management: Principles, Processes & Practices

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 Maximizationof Shareholders
Wealth
Financial mangers should focus on Key factors that
influence the share price of the company.

 Maximization of profits and EPS are important, it

is necessary to maximize the shareholders’
wealth by the maximization of market price per
share.
 Measurement of the stockholders’ wealth by the
share price of the stock is dependent upon the
timing of returns, magnitude of returns, and
other associated risks.

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 Economic Value Added (EVA)
Economic Value Added (EVA) is concept used to
find out whether an existing or a proposed
investment opportunity would positively
contribute to the shareholders’ wealth.

EVA = Net operating profit after taxes (NOPAT) −

(Capital × Cost of capital)

Investment opportunities having positive EVAs

increase shareholders’ wealth, while those with
negative EVAs reduce it

Management: Principles, Processes & Practices

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 Social Responsibility
 A good company not only has the maximization of
the shareholders’ wealth as its corporate goal, but
also adheres to its social responsibility of by
taking care of interest of it all stakeholder.

 Responsible governing is part of a good corporate

culture and is part and parcel of its ultimate goal
of maximizing the shareholders’ wealth.

 A good business believes that corporate existence

depends upon social responsibility.

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 Role of Finance and Financial
Managers
 Till the 1950s, the main role of financial managers
continued to be fund-raising and management of the
company’s cost across various activities.
 It was in the 1950s that the concept of present value
led to a change in the role and responsibilities of
financial managers. Which included capital investment
projects as also implications of time value of money to
the financial decisions.
 1990s, transformed the role of financial managers
which included making financial decisions regarding
acquisition, financing, and effective management of
acquired assets to achieve overall goals pertaining to
stockholders and stakeholders. Vital decisions pertain
to—investment decisions, financing decisions, and
dividend/share repurchase decisions.

Management: Principles, Processes & Practices

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 Financial Decisions
 optimization of financing mix or capital structure.
 to generate profit changing the mix of money raised
from time to time, retirement of high-cost debt by
substituting it with low-cost debt, changing the
short-term and long-term mix of funds deployed in
the business, etc.
 to decide as to what proportion of the surplus
should be used for repurchasing dividends/shares
and what proportion should be redeployed within
the business.
 To build good investor relations, so that company
has their support whenever needed.

Management: Principles, Processes & Practices

© Oxford University Press 2008 All rights reserved