Finance Principle

The main goal of a finance manager is maximizing of wealth rather than maximizing profit--measuring wealth or value is by cash flows and not accounting profits. This goal must be constantly in mind when making investments, financing these investments, and funding the company’s day-to-day operations. The total value of the firm can be increased by pushing up the price or market value of the existing shareholders’ ordinary shares. Investors react to poor investment decisions or poor financing decisions by causing the total value of the firm’s shares to fall, and they react to good decisions by investing more to increase the market price of these shares. The market price of the firm’s share at prima facie is an indication that a company is operating well and as a result it attracts more investments that increases its total value. The finance manager should also take into account the complexities and complications of the real world; below are some difficulties that may affect in the achievement of this goal. 1. Time value of money - a dollar received today is worth more than a dollar received a year from now on. This concept may affect the decision of a finance manager in making investment today or in the future to get better returns. 2. Curse of competitive markets- in the real world it is really hard to find investments that are exceptionally beneficial. If an industry is generating large profits, new entrants are usually attracted. Additional competitions in the same industry will results of profits to decrease. Conversely, if an industry is generating low profits, some competitors will drop out from the market, reducing the competition and in return, prices will tend to increase. There can be 2 common ways in reducing competition in the market (1) is cost leadership (producing the product in least cost possible) and (2)differentiation (if products are differentiated, consumer choice will no longer be dependent on price alone). 3. Agency