The short-term objective of Financial Management is to procure financial resources at an affordable cost thereby increasing the return to the shareholders in the form of Earnings Per Share (EPS). EPS comprises two elements namely Dividend per share (DPS) and Retained Earnings per share (REPS or Reserves per share). This objective is often times referred to as “profit maximization”. This is known as the short-term objective as it is done on a continuous, year-to-year basis. One or more of the following measures can achieve this:
- Monitoring of costs on a continuous basis through budgets
- Suitable cost reduction techniques wherever the costs are high
- Minimization of cost of borrowed capital from outside through financial discipline
Control over liquidity available in the organization so as to minimize the cost of carrying too much cash etc…
The long-term objective of financial management is to increase the wealth of the shareholders. The term “wealth” refers to various business assets of the enterprise that are free of debt. This means that this wealth belongs to the equity shareholders. It is often reflected in the “book value” of the share as reflected in the balance sheet.
The formula for book value is:
Equity share capital + Reserves and Surplus
Number of equity shares issued
This can be explained through an example.
Equity share capital = Rs. 100 lacs (paid up capital)
Reserves and surplus = Rs. 200 lacs
Number of shares = 10 lacs with the Face Value being Rs.10/-
Then the book value of the share would be = Rs. 100 lacs + Rs. 200 lacs = Rs. 30/-.
10 lacs shares
This means that at the starting point the book value was Rs.10/- and this has gone up to Rs. 30/- due to the prudent policy of the management of retaining profits within the organization. Thus the short-term objective also is a contributory factor to realizing the long-term objective of wealth maximization.
Some of the measures through which we achieve the long-term objective are:
Strategic financial management decisions relating to expansion, takeover of another business, financial re-restructuring through financial re-engineering (example – swap a costly loan for a cheaper loan provided the credibility of the firm is quite high), joint venture etc. Thus while profitability reflects the operating efficiency wealth maximization reflects the managerial/entrepreneurial efficiency.
To sum up, both short-term objective and long-term objective need to be put in place for sustained growth of a business enterprise. To an extent at least, the long-term objective is dependent upon the short-term objective of profit maximization.