There are several effects that stem from the practice and activities of profit maximization in financial management. For example, Corporation X is a manufacturing company facing financial difficulty due to low sales. As a result, the company decides to sell one of its factories that is performing poorly. This decision has several effects:
For starters, the sale of this asset provides the company with much-needed capital that can be used to improve operations, invest in new projects, or pay off debts. In addition, the sale reduces expenses since the factory is no longer operational and the workers from that factory are no longer needed. The company can then focus resources and profits on its core businesses. Furthermore, the sale of this asset can free up corporate funds for other uses and help the company meet its strategic objectives.
Another example of the effects of profit maximization in financial management is when a company decides to acquire a new business. This can provide the company with additional revenue streams, increased market share, and cost-saving opportunities. The acquisition also reduces the risk of failure since the new business brings a proven track record and reliable operations. Furthermore, the organization can expand into new markets or countries with the added resources and capabilities of the acquired business.
Profit maximization in financial management can have a positive impact on an organization and its long-term success. Companies that plan strategically can capitalize on opportunities to reduce costs, increase profits, and diversify their operations. As a result, they can maximize shareholder value while minimizing risk.
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Financial management is the process of strategic capital management with the aim of achieving organizational goals. Capital refers to financial resources such as cash, equity, debt, and other investments. Typically, the primary goal of financial management is profit maximization. Profit maximization is the process of assessing and utilizing available resources to their fullest potential to maximize profits. This has the greatest benefit for company shareholders hoping for the highest possible return on their investment. Senior executives, such as Chief Financial Officers (CFOs), are usually responsible for financial management. They may be in charge of a variety of financial management activities, including the estimation of capital requirements, preparation of budgets, monitoring of cash flow, and setting prices. Additional activities may include maintaining an efficient capital structure, optimizing cash flow, and investing in technology.
While short-term goals may not always increase profits, the typical end goal for any strategic decision within financial management is to maximize profits, reduce risk, and ensure the organization's sustainability. Profit maximization in financial management can have several positive effects, including the provision of additional capital, improved operations, and cost-saving opportunities. For example, a manufacturing company may experience increased profitability by shutting down a poorly performing factory due to reduced expenses and the provision of increased capital. It is important to remember that profit maximization is not always the only aim, as it may conflict with other goals such as sustainability and growth. As such, financial management is an ongoing process that requires strategic planning and effective decision-making.
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Video Transcript
Managing Money
Cash is king.
This phrase is popular in business circles because it's true. A company that is cash-poor is in serious trouble if it wants to remain in business. And some businesses have plenty of capital, or cash, but don't know how to effectively and efficiently use it to their advantage. All businesses, whether cash-rich or cash-poor, must accumulate and dispense capital to remain in business. If they fail to make wise decisions concerning the capital that they spend, it could have serious implications for their future.
Financial management refers to how a company manages its capital (money) in order to fulfill the goals of the company. Senior executives in a company are responsible for this function and are held responsible by shareholders and other investors as they manage the company's capital.
The scope of financial management can be summarized through three points. Each one plays an important part for senior executives as they manage the financial health of their company. These include:
- Estimation of capital requirements (how much money the company needs in the long run)
- Determination of capital structure (how the company's going to get the money it needs)
- Investment strategies that the company can use to make money through investments
Goals of Financial Management
The main goals of the business are always the senior executive's primary target for financial management. Although the business may have concrete goals that are part of a business plan, there are also other goals, sometimes unspoken, that senior executives may focus on as they manage the company's capital. One of these unspoken goals is profit maximization.
Profit maximization is the proverbial golden goose egg to shareholders and other investors. It means that the company is running operations and managing capital to ensure that the maximum amount of profit is made by the company. Senior executives feel pressure to ensure that shareholder value is constantly maximized and the victim in the end is the customer. Customers are shortchanged by companies as they cut corners regarding quality of products or services. This might save the company money now but will rear its ugly head down the road. In addition, employee health and safety may be compromised to save money. Other times, employees lose their jobs in the effort to reduce capital costs, which ultimately is all about maximizing profit. This chart illustrates a few of these concepts:
| Operational Change | Effect to Shareholders | Effect to Employees | Effect to Customers |
|---|---|---|---|
| Use cheaper parts during manufacturing | Helps | Hurts | Both |
| Increase manufacturing speed | Helps | Hurts | Both |
| Increase sale price of goods | Helps | Helps | Hurts |
| Sell factory to another company who will close it down | Helps | Hurts | Both |
| Move jobs to foreign country | Helps | Hurts | Both |
As you can see from the chart, the effects of profit maximization can help or hurt different groups of people. Sometimes it can both help and hurt these same groups. For example, if a company increases manufacturing speed, it will help the shareholder because the increased speed will produce more products that the company can sell, increasing sales and thus, profit. But, it will hurt employees because the increase in speed will negatively affect their health and may compromise safety, and it can both help or hurt customers. It will help them by making more of the products available for purchase; it will hurt them because injuries at the factory, reducing quality in order to increase speed, or regulatory and litigious results can slow down production and decrease the availability of products for purchase.
Effects of Profit Maximization
Let's take a look at how profit maximization can affect different groups of people as a company seeks the goal of increased capital.
As an example, ABC Inc. is a publicly-traded company that sells hunting, fishing, and camping supplies. It has many retail stores throughout the country and sell products online at its website. The corporate headquarters is in a small town in state A. It employs over 6,000 people between corporate, retail locations, and warehouse locations. It also employs people at its call centers.
XYZ Inc., on the other hand, is a hedge fund that is controlled by an activist CEO. It just bought 11% of ABC's stock, becoming the majority stock holder of ABC Inc. In XYZ's regulatory filings with the Securities & Exchange Commission (SEC), an independent agency of the US government whose mission is to protect investors by enforcing federal securities laws, facilitate capital formation, and maintain orderly and efficient markets, it reports a plan on moving the corporate headquarters location to a major metropolis, selling assets, and downsizing in order to increase share price.
Who will this benefit, and who will it hurt? Here are possible benefits or losses for the different groups involved:
XYZ Inc.
- The share price increased 20% the first day after the announcement to the media of the stock purchase
- Increased share value due to purchase of stock
- Moving headquarters to a major metropolis allows for easier access to high quality employees, cheaper supplies and products, and easier access to capital
- Selling productive assets will raise significant capital through the sale and reduce expenses associated with the asset
- Downsizing will eliminate useless employment positions in ABC Inc. and reduce other employee-related expenses
Employees of ABC Inc.
- Possibility of reduced pay and benefits
- Possibility of layoffs
- Possibility of employees who weren't laid off having to move to keep their jobs
Customers of ABC Inc.
- Increased perceived value of ABC Inc. after the stock purchase by XYZ Inc.
- Cheaper products
- Better accessibility to products
Lesson Summary
Financial management is the way that companies manage their capital (money) as they fulfill the goals of the company. Senior executives use a variety of methods to help them manage capital effectively, including estimation of capital requirements, determination of capital structure, and investment strategies. One goal that companies focus on much of the time is profit maximization. This can benefit multiple groups of people related to the company, but it can also hurt other groups. For example, employee safety, product quality, or job security may suffer.
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