Any business firm would have certain objectives which it aims at achieving. The major goals of a firm are:
Shareholders' wealth maximization
(a) Profit maximization
Traditionally, this was considered to be the major goal of the firm. Profit maximization refers to achieving the highest possible profits during the year. This could be achieved by either increasing sales revenue or by reducing expenses. Note that:
Profit = Revenue – Expenses
The sales revenue can be increased by either increasing the sales volume or the selling price. It should be noted however, that maximizing sales revenue may at the same time result to increasing the firm's expenses.
The pricing mechanism will however, help the firm to determine which goods and services to provide so as to maximize profits of the firm.
The profit maximization goal has been criticized because of the following:
(a) It ignores time value of money
(b) It ignores risk and uncertainties
(c) it is vague
(d) it ignores other participants in the firm rather than the shareholders
(b) Shareholders' wealth maximization
Shareholders' wealth maximization refers to maximization of the net present value of every decision made in the firm. Net present value is equal to the difference between the present value of benefits received from a decision and the present value of the cost of the decision. (Note this will be discussed further in Lesson 2).
A financial action with a positive net present value will maximize the wealth of the shareholders, while a decision with a negative net present value will reduce the wealth of the shareholders. Under this goal, a firm will only take those decisions that result in a positive net present value.
Shareholder wealth maximization helps to solve the problems with profit maximization. This is because, the goal:
i. considers time value of money by discounting the expected future cashflows to the present.
ii. it recognises risk by using a discount rate (which is a measure of risk) to discount the cashflows to the present.
(c) Social responsibility
The firm must decide whether to operate strictly in their shareholders' best interests or be responsible to their employers, their customers, and the community in which they operate. The firm may be involved in activities which do not directly benefit the shareholders, but which will improve the business environment. This has a long term advantage to the firm and therefore in the long term the shareholders wealth may be maximized.
(d) Business Ethics
Related to the issue of social responsibility is the question of business ethics. Ethics are defined as the "standards of conduct or moral behaviour". It can be thought of as the company's attitude toward its stakeholders, that is, its employees, customers, suppliers, community in general, creditors, and shareholders. High standards of ethical behaviour demand that a firm treat each of these constituents in a fair and honest manner. A firm's commitment to business ethics can be measured by the tendency of the firm and its employees to adhere to laws and regulations relating to:
i. Product safety and quality
ii. Fair employment practices
iii. Fair marketing and selling practices
iv. The use of confidential information for personal gain
Illegal political involvement
bribery or illegal payments to obtain business
This is a major objective of small companies which may even invest in projects with negative NPV so as to increase their size and enjoy economies of scale in the future.