Financial Management: Goals, Nature, Scope and Functions

Goals of Financial Management:

Goals of financial management should be so articulated as to help achieve the objective of

wealth maximization and maximisation of profit pool. Financial goals may be stated as
maximizing short-term profits and minimizing risks.

These goals imply that finance manager should take financial decisions in such a way as to
ensure high level of profits. He should seek courses of action that avoid unnecessary risks and
anticipate problem areas and ways of overcoming difficulties.

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In the pursuit of the above goals, finance manager should recognize the inter-relationship
between profit and risk. In fact, value of a firm is influenced jointly by return and risk. In real
world, the relationship between the two is inverse. Investments promising high profits will be
more riskier than their counterparts.

It is therefore, the prime responsibility of the finance manager to strike judicious balance
between return and risk in order to maximize value of the firm. To assure maximum profits to the
firm, a finance manager must monitor the cash inflows and outflows of the business and thereby
ensure effective utilization of resources.

He should also endeavour to build in sufficient flexibility in the financial operations of the
enterprise so as to deal with uncertainty. He has to gain flexibility by identifying strategic
alternatives both in regard to investment outlets and acquisition of funds.

Another major financial goal of a firm is imparting sufficient liquidity and profitability of the
enterprise. Thus, a finance manager while managing funds has to ensure that the firm has
adequate liquid resources on hand to satisfy its obligations at all times and in addition it has a
certain level above its expected needs to act as a reserve to meet emergencies.

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But if the enterprise carries large amount of funds in cash, it loses opportunity cost of the funds
and, therefore, goal of high level of profit suffers.

An enterprises to improve his return must ensure optimum utilization of resources. Thus, finance
manager is in dilemma. The dilemma is: high profitability means low liquidity and vice-versa.
He must, therefore, strike satisfactory trade-off between profitability and liquidity.
Management Vs. Owners:

The management of an enterprise is supposed to pursue the objective set for the firm. Although
they may not act in the best interests of the owners and pursue its goal to fulfil their ambitions of
perpetuating their control over the enterprise, the possibility of pursuing its personal goal
exclusively is remote and limited because of the constant evaluation of the managerial
performance in the light of the overall goal.

The management acting against this goal will not be allowed to continue. Furthermore, in a
competitive world, a company must undertake actions which are reasonably consistent with
wealth maximisation objectives.

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However, on certain occasions the interest of the management may clash with that of the owners.
Thus, an entrenched management plays the role of a ‘satisfier’ rather than of a ‘maximiser’. The
term satisfier here means a person willing to settle for something less. An entrenched
management desirous of perpetuating its existence for years to come may like to play safe and
seek an acceptable level of growth rather than take the risk to maximise the wealth of
stockholders.

It is, however, cumbersome task to determine when a particular management is playing the role
of a satisfier and when it is acting as maximiser. For instance, when a risky venture is rejected
because its potential benefits fall short of its potential costs, how it can be ascertained that
decision to reject the venture was motivated by satisficing factor.

In sum, it can be observed that the management may have other goals but the goal of
‘maximising owners’ interest is the dominant goal which the management has to pursue because
more and more firms now-a-days are tying their compensation to the firm’s performance. Even
the existence of the management is linked to the maximisation goal.

Nature of Financial Management:

Financial management is an integral part of overall management and not a staff function. It is not
only confined to fund raising operations but extends beyond it to cover utilization of funds and
monitoring its uses. These functions influence the operations of other crucial functional areas of
the firm such as production, marketing and personnel. In view of this, overall survival of the firm
is influenced by its financial operations.

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The heart of the financial management lies in decision making in the areas of investment, finance
and dividend. In investment decision, a finance manager has to decide about total amount of
assets to be held in the enterprise and kinds of the assets—the proportion of fixed assets and
current assets.
The basic problems facing a finance manager concerning investment are:

(I) How should the firm invest?

(II) In which specific projects should the firm invest?

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In financing decision, finance manager has to decide as to how much funds the firm should raise
to fund its operations and in what form-debt, equity shares, preference shares and other sources.
While deciding about the debt-equity mix, finance manager’s endeavour should be to evolve
such a pattern as may be helpful in maximizing earnings per share and also market value of the
firm.

A finance manager while making dividend decision decides as to how the firm’s income should
be allocated between dividend and retention. He has to formulate such a dividend policy as may
provide sufficient funds to finance the firm’s growth requirements and at the same time ensure
reasonable dividends to the stockholders.

The above decisions are intimately related. Thus, the proportion in which fixed assets and current
assets are mixed determines the risk complexion of the firm. Costs of various methods of
financing are affected by this risk. Likewise, dividend decisions influence financing decisions
and are themselves influenced by investment decisions.

Since finance functions are intimately connected with other business functions, finance manager
should call upon the advice of other functional executives of the firm while making decisions
particularly in regard to investment.

Decisions in regard to kinds of fixed assets to be acquired for the firm, level of inventories to be
kept in hand, type of customers to be granted credit facilities, terms of credit, etc., should be
made after consulting production and marketing executives. However, determination of dividend
policies is almost exclusive finance function and finance manager need not consult other
functional managers.

Finally, imperativeness of the continuous review of the financial decisions explains generic
nature of the financial management. As a matter of fact, financial decision making is a
continuous dynamic process that constantly interacts with various environmental forces and
adapts and adjusts its financial objectives and strategies accordingly.

An astute finance manager is always alive to changes in internal as well as external environment
and bring about necessary adjustments in objectives, strategies, operating policies and
procedures with a view to seizing potential opportunities and minimizing impending threats.

A onetime financial plan not subjected to periodic review and modification in the light of
changed conditions will be a fiasco because conditions change to such an extent that the plan is
no longer relevant and acts as a hindrance.
Scope of Financial Management:

In order to understand more clearly the meaning of financial management it is worthwhile to

highlight the scope and functions of financial management. At the outset it may be pointed out
that financial management is concerned with finances of 60th profit seeking 60th organisations
and non-profit seeking.

Finance as such is but one facet of broader economic activity of mobilising savings and directing
them in investments. Finance includes both public and private finance. Public finance is the
study of principles and practices relating to acquisition of funds for meeting the requirements of
government bodies and administration of these funds by the government.

Contrary to this, private finance concerns with procuring money for private organisation and
management of the money by individuals, voluntary associations and corporations. Private
finance, therefore, comprises personal finance, business finance and the finance of non-profit
organisations.

Personal finance seeks to analyse the principles and practices of managing one’s own daily
affairs. Study of practices, procedures and problems concerning the financial management of
profit making organisation in the field of industry, trade and commerce and service and mining is
covered in financial management.

The finance of non-profit organisation deals with the practices, procedures and problems
involved in the financial management of educational, charitable and religious and the like
organisations.

Financial management can further be split into three categories:

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1. Finances of sole trading organisations,

2. Partnership firms and

3. Corporate organisations.

In the study of financial management emphasis is given to financial problems and practices of
incorporated enterprises because business activities are predominantly carried on by company
form of organisation. That is why subject of finance management is also studied as corporation
financial management.

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It should be remembered that the same principles of finance apply to large and small and
proprietary and non-proprietary organisations nevertheless there are sufficient differences of a
specific operating nature justifying separate consideration of each of these organisations.
The field of corporation finance encompasses the study of financial operations of business
enterprise right from its very inception to its growth and expansion and in some cases to its
winding up also. However, special attention is devoted to the analysis of the problems and
practices involved in raising and utilisation of funds.

It should be noted that problems of purchase, production and marketing are outside the purview
of business finance although their problems are so intimately linked to problems of finance that
in actual practice it is difficult to segregate them.

Functions of Financial Management:

As hinted in the preceding paragraphs, views of traditional and modern scholars regarding
finance function differ markedly. It would, therefore, be germane to give a brief idea about their
views.

(i) Traditional Concept of Finance Function:

Traditional writers contended that primary responsibility of a finance manager is to raise

necessary funds to meet operating requirements of a business. He has to take decisions with
respect to the choice of optimum source from which the funds would have to be secured, timing
of the borrowing or scale of stock and cost and other terms and conditions of acquiring these
funds.

Planning quantum and pattern of fund requirements and allocation of funds as among different
assets, said traditional scholars, is the concern of non-financial managers.

Traditional approach to finance function has been bitterly criticized by modern scholars on
various cogent grounds. One such ground is that the traditional approach is too narrow. It viewed
finance as a staff specialty.

According to them, it would be mistaken to argue that responsibility of a finance manager is

limited to acquisition of sufficient funds for the enterprise and he has little concern as to how
such funds would be allocated.

Another criticism of traditional approach is that it overemphasized episodic and non-recurring

problems like, incorporation, consolidation, reorganization, recapitalisation and liquidation and
gave little attention to day-to-day financial problems of on-going concerns.

Another shortcoming of the traditional approach is that it gave concentrated attention to

problems of corporation finance while problems of unincorporated organisations like sole trading
concerns and partnership firms were altogether ignored.

Finally, modern authorities charged that the traditional approach laid relatively more Stress Oil
problems of long- term financing as if business enterprises did not have to encounter any
financial trouble in the short run. As a matter of fact, problem of working capital management is
very critical problem which has to be dealt with efficiently by a finance manager if an enterprise
has to reach the objective of wealth maximisation.

(ii) Modern Concept of Finance Function:

Modern Scholars view finance as an integral part of the overall management rather than as a staff
specialty concerned with fund raising operations. Accordingly, finance manager is assigned
wider responsibilities. According to them, it is not sufficient for a finance manager to see that
firm has sufficient funds to carry out its plans but at the same time he has to ensure wise
application of funds in the productive process.

Thus, to carry out his responsibilities effectively it is the bounden responsibility of a finance
manager to make a rational matching of the benefits of potential uses against the costs of
alternate potential sources so as to help the management to accomplish its broad goal.

Finance manager is, therefore, concerned with all financial activities of planning, raising,
allocating, and controlling and not with just any one of them. Aside from this, he has to handle
such financial problems as are encountered by a company at the time of incorporation,
liquidation, consolidation, reorganization and the like situations that occur infrequently.

Thus, finance functions, according to modern experts, can be categorized into two broad
groups:

Recurring finance function and Non-recurring finance function.

Cardinal Principles of Financial Management:

In his endeavour to maximize corporate value of the enterprise a finance manager must
keep in view the following basic considerations:

(i) Strategic Principle:

According to this principle, financial objectives and decisions should be tethered to the overall
corporate objectives and strategies. As a matter of fact, financial decisions have to reinforce the
execution of strategic decisions.

The strategic principle also demands that a finance manager while deciding any matter pertaining
to finance should interface with external environmental forces such as fiscal and industrial
policies of the government, economic and industrial trends and state of money and capital
markets and assess long-term implications of the decision being taken.
(ii) Optimalisation Principle:

Maximum utilisation of funds is pre-requisite to the success of an enterprise. Wasteful utilisation

of funds is as dangerous as inadequacy of funds. Financial decisions should, therefore, insist on
intensive use of available capital.

For that matter, finance manager must aim at maintaining proper balance between fixed and
working capital. He should never think in terms of employing the surplus of either to offset the
shortage of the other as it may land the enterprise in grave financial crisis.

Risk-Return Principle:

This principle of financial management is concerned with maintaining proper balance between
risk and return objectives that will maximize the wealth of the enterprise. The basic strategic
decision of an organization is to choose industry in which to operate the product-market mix of
the enterprise.

Given this strategy, return and risk are the functions of decision relating to size of the firm, kinds
of assets to be acquired, types of funds to be employed, extent of funds to be kept in liquid form
etc..

These decisions are important to an organization. However, they are in conflict with each other.
An increase in the cash position, for instance, reduces risk of illiquidity. However, since cash is
not a productive asset holding larger amount of assets in cash tends to reduce profitability.
Likewise, recourse to additional debt raises the rate of return on the shareholders’ funds but at
the same time the firm is exposed to higher risk.

In his bid to maximize value of the enterprise a finance manager has to strike golden trade-off
between conflicting goals of risk and return. He should avoid taking unnecessary high risks for
the sake of higher return.

He should closely monitor funds flowing in and out of the enterprise with a view to ensuring that
funds are optimally utilised. But at the same time the enterprise is exposed to more risk. Risk and
return move in the same direction. Higher the return, higher the risk and the vice-versa is evident
from the following figure.
Risk-return relationship ingrained in financial decisions affects market value of the shares of the
enterprise and so also its overall value, Figure 1. exhibits relationship between the three critical
financial decision areas.

(iii) Marginal Principle:

According to this principle, an enterprise should operate up to the point where its marginal
revenue is just equal to its marginal cost. When this is applied to investment decisions,
shareholders’ wealth is maximized. A firm should acquire assets if the marginal revenue
obtained there from exceeds the marginal cost.

Finance manager should reject investment proposal where marginal cost exceeds the marginal.
Marginal revenue in case of investment is taken to be the rate of return on investment while
marginal cost is the firm’s cost of capital incremental.

A simplified version of this principle is exhibited in Figure 1.4. In this figure, the horizontal axis
measures rupees of investment during a year, while the vertical axis shows both the percentage
cost of capital and the rate of return on projects. Projects are denoted by boxes. Figure 1.4
illustrates that firm should invest in projects A, B, and C because their returns exceed the firm’s
cost of capital. Other projects will be rejected.

(iv) Suitability Principle:

Principle of suitability should be followed while deciding about sources of funding needs of the
enterprise. Thus, according to this principle, each asset should be offset with a financing
instrument of the same approximate maturity.

Thus, short-term financial needs should be financed by short-term sources such as short-term
borrowings and long-term needs should be funded by long-term sources as shares and
debentures.

(v) Flexibility Principle:

According to flexibility principle, financial plan of the enterprise should be capable of being
adjusted when so desired. Sometimes it becomes necessary to adjust the plan in the light of
environmental developments leading to changes in the scope of operations of the enterprise. The
plan should be easily adjustable to these changes.

Flexibility principle should also be followed while deciding sources of funds so that the firm has
not only several alternatives before it for assembling required funds but also its position is
strengthened while negotiating with the supplier of funds.
(vi) Timing Principle:

Timing should be a crucial consideration in financial decisions. Investment and financing

decisions should be taken at a time that enables the organization to seize market opportunities
and minimize cost of raising funds. Important point, which is to be kept in mind while deciding
to raise funds from the market, is to make the public offering of such securities as are greatly in
demand.

(vii) Ploughing Back Principle:

According to this principle, a firm should focus more on internal funds for its needs for
expansion, modernization and replacement. This is the fact that reliance on internal resources is
not only cheaper in comparison to other sources but it also strengthens the financial position of
the organization to absorb boldly the shocks of business vicissitudes and resist adverse
conditions.

A strong and stable organization will obviously enlist the support of investors as well as creditors
that will enable the firm to procure funds from external sources at reasonable rate conveniently.
With past accumulated funds the management can relieve the company of the rigours of debt
burden. Thus, ploughing back offers the best means of the organizational future growth.

The stockholders’ equity position is also strengthened. The stockholders can take advantage of
the price rise by disposing of entirely or a part of the shares in the stock market. Furthermore,
they will be getting fairly large amount of dividends regularly in future when the company’s
earnings improve considerable.

In view of the above, finance manager, while deciding about allocation of income between
dividend and retention should, dispassionately take into consideration, among other factors, the
organization’s investment opportunities and stockholders’ preferences.

Organisational Framework for Financial Management:

Functions of financial management, as stated above, are, by and large, the same in almost all
types of business concerns. However, organisation of these functions is not standardized one. It
varies from enterprise to enterprise depending essentially on the characteristics of the firm, size,
nature, convention, etc.

Thus, in smaller companies where operations are relatively simple and less complicated and little
delegation of management functions exists, no separate executive is appointed to handle finance
functions.

In fact, it is the proprietor who handles all these activities himself. He prepares cash budget for
his firm to assess the requirements and arranges finance to meet these requirements. He himself
looks after receipts and disbursement work, extends credit, collects accounts receivable, manages
cash accounts and arranges additional funds.
In such concerns, finance function is not properly defined and finance function is combined with
production and marketing functions. Financial planning is hardly given important place.
Proprietors have seldom any training in such activities.

With growth in the size of the organisation degree of specialisation of finance function increases.
In medium sized undertakings financial activities are handled by senior management executive
who is designated as treasurer, finance director, finance controller, vice-president in charge of
finance.

He is generally given the charge of credit and collection departments and accounting department,
investment department and auditing department. He is also responsible for preparing annual
financial reports. He reports directly to the president and Board of Directors. His voice in
decision making depends in pan on his ability and whether or not his firm is one that is closely
held.

In large concerns finance manager is top management executive who participates in various
decision making functions, for example, those involving dividend policy, the acquisition of other
firms, the refinancing of maturing debt, introducing a major new product, discarding an old one,
adding a plant or changing locations, floating a bond or a stock issue, entering into sale and lease
back arrangements, strategic alliances, etc.

In most of cases a finance manager holds the rank of vice-president reporting directly to the
president and Board of Directors. Place of finance in management hierarchy in a large enterprise
has been diagrammatically portrayed in figure 1.5.

It appears that a large organisation has finance committee consisting of some members of the
Board and a finance manager. The committee makes recommendations for the final approval of
the Board.

In larger concerns, for handling financial matters Controller and Treasurer are appointed.
Finance controller is responsible for financial planning and control, preparation of annual
financial reports and for carrying on capital expenditure activities whereas treasurer’s
responsibility is limited to raising resources for business purposes, management of working
capital and security investment and tax and insurance affairs.

8 Functions of a Financial Manager (Management)

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Some of the major functions of a financial manager are as follows: 1. Estimating the Amount of
Capital Required 2. Determining Capital Structure 3. Choice of Sources of Funds 4. Procurement
of Funds 5. Utilisation of Funds 6. Disposal of Profits or Surplus 7. Management of Cash 8.
Financial Control.

Financial Manager is the executive who manages the financial matters of a business.

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 The functions of Financial Manager are discussed below:

1. Estimating the Amount of Capital Required:

This is the foremost function of the financial manager. Business firms require capital for:

(i) purchase of fixed assets,

(ii) meeting working capital requirements, and

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(iii) modernisation and expansion of business.

The financial manager makes estimates of funds required for both short-term and long-term.

2. Determining Capital Structure:

Once the requirement of capital funds has been determined, a decision regarding the kind and
proportion of various sources of funds has to be taken. For this, financial manager has to
determine the proper mix of equity and debt and short-term and long-term debt ratio. This is
done to achieve minimum cost of capital and maximise shareholders wealth.

3. Choice of Sources of Funds:

Before the actual procurement of funds, the finance manager has to decide the sources from
which the funds are to be raised. The management can raise finance from various sources like
equity shareholders, preference shareholders, debenture- holders, banks and other financial
institutions, public deposits, etc.

4. Procurement of Funds:

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The financial manager takes steps to procure the funds required for the business. It might require
negotiation with creditors and financial institutions, issue of prospectus, etc. The procurement of
funds is dependent not only upon cost of raising funds but also on other factors like general
market conditions, choice of investors, government policy, etc.

5. Utilisation of Funds:

The funds procured by the financial manager are to be prudently invested in various assets so as
to maximise the return on investment: While taking investment decisions, management should be
guided by three important principles, viz., safety, profitability, and liquidity.

6. Disposal of Profits or Surplus:

The financial manager has to decide how much to retain for ploughing back and how much to
distribute as dividend to shareholders out of the profits of the company. The factors which
influence these decisions include the trend of earnings of the company, the trend of the market
price of its shares, the requirements of funds for self- financing the future programmes and so on.
7. Management of Cash:

Management of cash and other current assets is an important task of financial manager. It
involves forecasting the cash inflows and outflows to ensure that there is neither shortage nor
surplus of cash with the firm. Sufficient funds must be available for purchase of materials,
payment of wages and meeting day-to-day expenses.

8. Financial Control:

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Evaluation of financial performance is also an important function of financial manager. The

overall measure of evaluation is Return on Investment (ROI). The other techniques of financial
control and evaluation include budgetary control, cost control, internal audit, break-even analysis
and ratio analysis. The financial manager must lay emphasis on financial planning as well.

Resources: smritti chand

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Functions of Management
– Planning, Organizing,
Staffing and More
Management is an aspect of the business that doesn’t have the same specific duties some of the
other parts of the business have. While an accountant will always know quite clearly the
expertise and responsibilities he or she has, a manager needs to have a much broader set of skills,
with the tasks ranging depending on the business. Yet, management like all the other parts of the
business have certain functions to guide the operations. Sites: https://www.cleverism.com/functions-
of-management-planning-organizing-staffing
© Shutterstock.com | rassco

In this guide, we’ll talk about these functions, first by looking at the definition of management
and then moving on to present popular theories regarding the functions of management. You’ll
also be able to read about the five functions core functions – planning, organizing, staffing,
directing and controlling – and why they are important and how you can achieve them with your
management.

DEFINING MANAGEMENT
To understand the functions of management, you must first examine what management is about.
How do you define management?

Management is a process with a social element. It requires the efficient use of resources
combined with the guidance of people in order to reach a specific organizational objective. It
involves responsibility to achieve the objectives and to fulfill specific organizational purposes
through economical and effective planning and regulation. It’s about taking charge and ensuring
focus is placed on the things and aspects of the business that help achieve the vision and the
goals.

Three key characteristics define the process of management.

 First, management is a process of continuing and related activities. Each of the

functions is related to each other and the functions complement each other. It is hard to
consider the functions in isolation, as management requires each activity to complement
 one another. When you as a manager engage in one function, you in effect also start the
process of another function.
 The second core characteristic of management is about it involving and concentrating
on organizational goals. Management is largely focused on achieving the key mission of
the organization, its vision. Whilst there are detailed objectives it might focus on,
management is mainly interested in identifying the wider organizational goals and using
the different functions in order to achieve the objectives. Each function takes the
organization closer to achieving its vision.
 Finally, management achieves the organizational goals by working with people and
organization resources. You might use different financial resources or physical
equipment as part of the process, while also directing and guiding the staff towards the
objectives. The manager is in charge of supporting the people and connecting the right
person with the right resources.

In essence, management is about a dynamic process, with a number of elements and activities as
part of the process. The dynamic and social element of management mean the functions of
management are separate from operational functions. Whilst operational functions refer to
activities and processes such as marketing, finances and purchases, the management functions
differ depending on the organizational level at which they take place.

The functions remain the same, yet are essentially different depending on the organizational
hierarchy. A manager at the senior level will be involved in different activities than the manager
at the junior level. The core concepts might be the same, but they are dynamic in manifestation.
On the other hand, operational function of marketing will change according to the organization,
the person in charge and the operational goals. For management functions, the objective of the
specific activity remains largely the same, even though the manifestation might be different
depending on the specific situation.

Management functions are the same, but the management processes people use can differ. A
management style or process can depend on the organization, the manager in question, and even
the objectives. You’re likely to change management style if you are directing a single person or
being in control of a team. You can find out more about management styles from the
introductory clip below:

THE FAMOUS THEORIES ON THE FUNCTIONS OF

MANAGEMENT
Since management involves solving the problems within an organization in order to reach the
desired objectives, the focus is on understanding the functions that make up the process. As
experts began studying and theorizing the essence of management, different ideas and concepts
regarding the functions were born.

Although the theories about the functions of management lead to rather similar results, it can be
helpful to study the differences as well as the historical journey to our current understanding of
the functions. Here are a few of the most influential theories and theorists, who’ve outlined their
ideas about the functions of management.

Henri Fayol

Henri Fayol was the first to attempt classifying managerial activities into specific functions. The
French engineer established the first principles of the classical management theory at the start of
the last century. Fayol is considered the founding father of concepts such the line and staff
organization. When Fayol developed his strategies and ideas, managers in organizations didn’t
have any kind of formal training and therefore Fayol’s ideas were ground-breaking.

As well as setting out 14 general principles of management, Fayol also defined the five core
functions of management, which are still used and which form the basis of much of the later
theories. To Fayol, manages is a process, which includes forecasting, planning, organizing,
commanding and controlling. These are the foundation of setting the relationship between the
subordinates and the superior and the five core functions help the management to solve problems
in the relationship or within the organization in a creative manner.

George R. Terry

After Fayol, many theorists have looked at the functions and crafter their own ideas, deviating
only slightly from Fayol’s core functions. George R. Terry wrote a book Principles of
Management in 1968 and outlined his view on the principles. Terry believed there to be four core
functions, each function posing and responding to a specific question the management must
solve. The question, the fundamental function and the resulting action are outlined in the below
graph:

The Question The Function The Result

Objectives, policies, procedures
What is the need? Planning
and methods
Work division, work
Where should actions take place
Organizing assignment, and authority
and who should do what work?
utilization
Why and how should group Leadership, communication,
Actuating
members perform their tasks? development, and incentives
Are the actions being performed Reports, comparisons, costs and
Controlling
according to plan? budgets

Harold Koontz and Cyril O’Donnell

In 1976, Harold Koontz and Cyril O’Donnell published an essay Management: A Systems and
Contingency Analysis of Managerial Functions. They felt the previous studies have been
effective in describing the functions, but believed the division should be more detailed. Koontz
and O’Donnell believed there to be five key functions of management:

 Planning
  Organizing
 Staffing
 Directing/Leading
 Controlling

These five functions of management have become perhaps the most cited and they are explained
further in the following section. Overall, the quick outlook would hopefully have highlighted the
alignment of the functions of management in different management theories.

THE FIVE FUNCTIONS OF MANAGEMENT

While there are slight variations in how the functions are named and the different management
theories might combine or divide certain functions into smaller chunks, the consensus points to
five core functions. What do these functions entail, why are they important and how to utilize
them?

Planning

The first managerial function involves planning. The function is about creating a detailed plan
towards achieving a specific organizational objective. When you are planning, you are
identifying the tasks, which are required to achieve the desired goals, outlining how the tasks
should be performed, and identifying when and by whom they must be performed. The focus of
planning is about achieving the objectives and it does require knowledge of the organization’s
objectives and vision. You will need to look both at the short- and long-term success of the
organization as part of the plan.

An example of planning would be a situation where you have an objective, such as increasing the
sales by 20% in the following month. You will need to look at the different ways you and the
team could achieve this goal. This might include things like creating a new advertisement
campaign, reducing prices or speaking to customers about their shopping plans. Your role is to
pick the processes that you find the most appropriate and to organize them into a logical pattern.
You must also identify the timeline for these processes.

As you might realize, planning is on on-going function. Management will regularly have to plan
the future tasks and adjust the plans based on the organizational situation and the achievement of
previous goals. Furthermore, it requires the whole organization to work together as the different
departments or team plans need to link to each other and align with the organizational objective.
Henri Fayol called the function the most difficult to achieve! You need a lot of knowledge and
flexibility in order to plan activities effectively.

Why is planning essential?

Why is planning important? Planning provides the organization a better sense of what it wants to
achieve and how it can achieve this. You essentially have more focus when you plan for things.
Think what would happen if you went into a big job interview without any planning.
You might be OK, but you wouldn’t be able to focus on the details and it might take time for you
conduct your answers. But if you plan for the interview, you now exactly the points you want to
make, you have enough knowledge to respond to specific questions about the company and so
on.

In effect, planning ensures the proper utilization of the available resources and the ability to
understand how these should be used in order to achieve the goal. In the example of the
interview, the planning helps you take advantage of information on company websites, research
interview questions and to then use this information to outline example answers.

A key part of planning is also the vital role it plays in reducing risks. When management plans
for the tasks ahead, they are looking at the situation and detailing the possible pitfalls ahead. As
with your interview, the risk of not knowing anything about the company or giving an incoherent
answer is higher than if you had planned your answers a little.

How to plan?

Planning is an intellectual activity that doesn’t always require a lot of visible labor and effort, as
much of it is about thinking creatively about the issues at hand. When you need to come engage
in planning, you should focus on the following steps:

 Gain knowledge of the issues – You need to understand the organizational objectives,
the different components they involve, and the available resources you and the team
have. You also need to be knowledgeable of the topic at hand. In terms of increasing
sales, you need to have an understanding of how the sales industry works and what
different methods can effectively boost company sales.
 Look into the future – The function is about understanding the short- and long-term
objectives the organization wants to achieve. You need to consider not just these different
elements, but also be able to make predictions about the future conditions for achieving
these. Perhaps you have noticed changes in customer behavior due to the downturn in the
economy. When you are planning, you need to take into account these little nuances.
 Determine the objectives – Once you are aware of the organizational objective, the
resources available, and the future outlook to achieving the objectives, you need to
identify the specific processes and detailed goals that are required to achieve the bigger
goal. You might want to create a marketing campaign to increase sales, which requires
the team to conduct market research and to come up with ideas. The more detailed
objectives and processes you can set, the better the plan is.
 Create flexible structures – However, your planning needs to be flexible and take into
account things don’t always go according to plan. Your management plan must take into
account the other departments and their specific organizational goals. Perhaps the
financial team has to cut down costs for the sales team and you need to be aware of the
impact this would have on your new marketing campaign.

Organizing
The next function of management follows planning and it is about organizing. It’s about using
the plan to bring together the physical, financial and other available resources and use them to
achieve the organizational goal. If your task were to increase sales, you would look at the plan
and determine how to divide the resources you have in order to put your plan in place.

The marketing campaign would be handed out the Becky and you would provide them with the
financial resources available and needed to give birth to the campaign. You would also need to
ensure the team has access to the customer files in order to utilize vital information. You’d then
direct Danny and his team to calculate the possible reductions you can make, help them have the
resources to determine which products are best to discount and so on.

You’d use the above plan and information about the resources you have or which you need, and
arrange the resources to the right tasks. As the example shows, this can be about arranging the
finances, ensuring the right equipment is used and appointing the personnel to the specific tasks.

Your objective as the manager is to provide your team or department the resources it needs to
turn the plan into reality. The organizing function is about the overall structure of the specific
managerial level. You are creating the foundations to everyday operations by organizing the
resources. This function is closely linked to the hierarchy of management.

Depending on your management level, you will have different responsibilities and resources to
organize. The top-level managers need to organize the teams below them, while the lower-level
managers will be partly taking orders for effective organizing from the managers above.
Organizing is a vital part of ensuring the company can function effectively and it concerns the
day-to-day activities.

Why is organizing essential?

While it might be difficult to work without a plan, it can be impossible for an organization to
function without organizing. The function is vital because it ensures there is structure to the
operations. You are aware of the resources and you ensure they are used in a manner that best
helps the company to achieve its targets.

In terms of finances, organizing can guarantee you don’t waste money on functions that don’t
provide the right results. If you don’t organize the right persons to do the right jobs, you might
damage productivity. If you know Sarah is talented in accounting, you don’t want to put her in
charge of marketing. By organizing the resources, you ensure operational efficiency and
structure. The company’s day doesn’t start in chaos, with people trying to figure out what they
are supposed to do. Organizing puts the plan in action.

Without organizing, resources wouldn’t necessarily work towards the operational goals. While
you might have the team still doing tasks, the tasks might not be the correct ones for the
situation. Consider you are a manager of a team in a café. When you organize the team to
perform the tasks required to boost coffee sales, you have each person working towards the goal.
Jerry might be greeting customers and telling them about the new coffee flavour, while Dina and
Jack are working to make the sale and the coffee as quickly as possible.
If you hadn’t organized them, you might end up with a situation where Jerry is wiping the floors
(although they are clean) and Dina is working alone at the counter.

How to organize?

When done efficiently, organizing tends to follow the pattern and steps outlined below:

 Identify activities and classify them – The step is straightforward enough because you
already have a plan. Your objective is to identify the different roles, processes, and
activities required to achieve the objectives. These would be the roles for the team
members, the different tasks each role would need to perform and the specific processes
the tasks would include.
 Assign the duties and resources–Once you’ve identified the above, you would begin
organizing the resources. You would assign the specific tasks for the persons you feel are
the most qualified and provide the resources to the processes, which most need them.
 Delegate authority and create responsibilities–Managers shouldn’t behave like
dictators. Although the power is concentrated to your as the manager, it doesn’t mean you
should have all the authority. In order the get the marketing campaign working properly,
you might want to ensure the person in charge of the team has the authority to make
decisions. You need devolution of responsibility, as it can ensure the plan works
efficiently.
 Co-ordinate authority and responsibilities–As well as delegating authority, you also
need to co-ordinate it to match the overall functionality of the organization and the
structure of the objectives. For example, you might want two people to share the
responsibility of organizing the price reductions, with each having the ability to respond
to supplier queries. Furthermore, if you have other managers above you, it’s important to
co-ordinate the authority to ensure the functionality doesn’t suffer as a result of different
plans.

Staffing

The staffing function is an increasingly important function of management, although it is

sometimes left out when the core functions are discussed. It can be seen closely related to
organizing, with both focused on ensuring the resources are directed to the right processes and
tasks. For staffing, the focus is on people and their labor in relation to the organizational
objectives.

The function aims to ensure the organization always has the right people in the right positions
and the organizational structure isn’t hindered by lack or excess of personnel. You would
essentially be looking at the tasks ahead of you and determining who should do what and if you
have the right manpower to achieve the objectives you want.

In terms of hitting your sales targets, you would need to analyze if the current staff is capable of
performing the tasks and whether you have enough employees to ensure the integrity of the
organization. You might find the marketing team to be too small and consider hiring a temporary
or even full-time worker.
The reason staffing is included as a separate function and why it’s a crucial part of management
is due to the changing nature of the workforce and the organization. Today’s companies are
much more complex in terms of where and when they operate – companies aren’t confined
between national boundaries anymore. Technology has also had a huge impact on company
structures, requiring new positions and destroying others.

Whereas your car sales company might have mainly relied on face-to-face sales in the past, today
you might also do business online, which would mean you need people for IT-specific roles and
perhaps fewer salespersons. Management has also become more focused on the human
behavioral aspect of leadership. Finding the right company fit, ensuring employees are satisfied,
and guaranteeing emotional wellbeing as well as physical work safety have emphasized the
importance of staffing as a function.

Why is staffing essential?

As the above showed, staffing’s importance as a core function of management has increased in
the past few decades. But having the right amount of staff and the right people doing the required
roles isn’t just crucial because of changing technology of enhanced focus on complex human
behavior. Staffing is essential to guarantee the operational functionality of the organization.

If you don’t have the right amount of people working in your organization, you make achieving
organizational goals harder. You might either be in a situation where you can’t increase the sales,
as you don’t have the manpower to respond to company queries. On the other hand, you might
be wasting resources by having too many employees with not enough tasks to perform. The
numbers do matter.

Staffing also guarantees the staff you have is qualified to perform the tasks and that they are
adequately supported in those roles. This will further deepen the organizational efficiency, since
people are motivated and qualified to work towards the common objective. You can’t hire a
plumber if you are hoping to fix the roof. Furthermore, even the most qualified of employees
need the occasional help and support. The staffing function helps create these development
opportunities.

How to staff?

According to Koontz & O’Donell, staffing “involves manning the organisation structure through
proper and effective selection, appraisal and development of personnel to fill the roles designed
on the structure”. It consists of a number of separate functions, which are:

 Manpower planning – You need to stay on top of staffing, as manpower requirements

can change from season to season. Planning would see you make estimations of the
number of employees you need, searching for the right kind of employees, and hiring the
perfect employees to the roles in front of you.
 Recruitment, selection and placement – Another key function is the actual recruitment
process, with its various steps.
  Training and development – Staffing also includes the creation of structures, which
ensure the employees are always on top of the latest skills in the position and the
industry. You should also consider training programs in terms of succession, as you need
to ensure the next generation of managers and leaders is coming through your
organization.
 Remuneration – A big part of the function is the financial aspect. Staff remuneration is
key in terms of attracting the right talent without damaging the organization’s finances. If
you aren’t offering a competitive remuneration package, the applicants will go to your
competitors.
 Performance appraisal – You must also create structures of feedback within the
organization. Feedback can play a crucial role in motivating and developing employees;
with the reward structures ensuring good behavior is supported and noticed.
 Promotions and transfers of roles – Related to the above two points, promotions are
essential for staffing operations. You can reward and motivate the staff by offering
enough opportunities to climb up the career ladder. Creating structures for role transfers
and promotions also ensure the talent and knowledge you’ve attracted doesn’t leave
elsewhere.

Directing

The fourth function is known as directing, sometimes also referred to as the influencing or the
leading function of management. Directing is about the actuation of the methods to work
efficiently to achieve the set organizational objectives. The function goes beyond organizing the
employees to their specific roles and involves ensuring they are able to perform the tasks through
a variety of means. Directing in essence is looking after productivity and ensuring productivity is
going up instead of decreasing.

The function delves deeper inside human interaction, making the manager motivate,
communicate and inspire his or her personnel. At this stage, you are meeting and connecting
with your employees to find out how the tasks are going. You would talk to them about the new
marketing program, get their feedback on the project and spend time inspiring them with new
ideas. The directing function is all about the day-to-day interaction between the management and
the staff.

The function of directing has strong links to things such as leadership. A good manager will be
able to inspire the workforce to work towards the goals not because they have to do it, but
because they are driven to achieve these objectives. The manager’s role is not just about ensuring
the workplace has the right resources and employees know what they are doing; it’s also
important to create an environment of friendship. The manager wants to be someone who can
encourage and motivate the personnel and not fear them into submission. With proper directing,
you are able to set in motion the processes you’ve prepared with the above three functions.

Why is directing essential?

Directing has an important role in an organization as it helps strengthen the operational

capability of the organization. It does so by ensuring the different parts of the organization are
working better. Directing is a bridge between the operational needs and the human requirements
of its employees. You essentially create a link between the necessity of turning in a profit, with
the need of keeping employees motivated and interested. Since directing aims to improve
productivity, you are strengthening how well the organisation succeeds.

Research has pointed out how important human-focused management is in today’s organization.
When objectives are approached from a human perspective that aims to ensure people’s opinions
are listened to, the goals are met faster than in task-oriented environments. The management’s
ability to listen to the workforce, support and inspire them will boost the productivity and
profitability of the organization.

If you listen to your team’s concerns and perhaps provide them inspiration with quotes, films or
the occasional days out of the office, you can refresh their resolve to achieve the goal. If you just
throw a blank paper in front of them and tell them to write a story, they are less likely to remain
interested.

How to direct?

You can direct and lead your team by utilizing four key methods based on the findings of human
behavioral studies. These are:

 Supervision – You need to oversee the work your employees are doing. The method
requires watching and monitoring the performance, but also supporting and guiding the
employees when things are not going as planned. You could use evaluation reports,
examine the quality of work, and be present during certain parts, such as team meetings
or when the person is talking to clients. In terms of support, you want to discuss the work
and how it’s moving along. You also want to provide materials that can help the
employee perform better.
 Communication – Directing is built around effective communication. As a manager, you
need to create an environment that supports different communication methods from
passing information to exchanging opinions. The important thing is to ensure these
different communication channels are not just between manager and subordinate, but also
between employees and different management levels.
 Motivation – As mentioned above, big part of directing is about inspiring and motivating
your employees. You need them to get behind the objectives to ensure there is
enthusiasm to achieve the goals. Motivating as a manager includes positive and negative
feedback, provision of ideas and the opportunities to develop skills further. Directing
might also have an element of monetary or non-monetary incentives, such as the
introduction of bonuses.
 Leadership – Managers must essentially act more like leaders when directing the
workforce. This means that you need to occasionally motivate and inspire by setting an
example, instead of simply telling the subordinates what they need to do. You want to get
hands on with the work and be part of the process of achieving the objectives. Although
managers and leaders tend to differ, leadership skills are something a good manager
should keep in mind.
The function might seem rather complex and getting it right might be harder than any of the
other functions of management. You should watch the video of Jim White, professor emeritus at
North Lake College, explaining directing as a function and giving his take on what he thinks are
the three key elements of directing: leading, motivating and communicating.

Controlling

The final function of management is controlling. The function ensures the other four functions
are followed correctly and the flow of work is moving the organization towards the objectives it
has set itself. As Theo Haimann has put it, controlling is

“the process of checking whether or not proper progress is being made towards the objectives
and goals and acting if necessary, to correct any deviation“.

In our example of having the objective to increase sales in a particular month, controlling would
be the function that measures whether the sales are increasing and helps to correct the situation if
the specified target is not getting closer. As a manager, you would examine the processes you set
forward and take note whether they are enhancing your sales records. The marketing campaign’s
effectiveness would be evaluated and measured. If you find the price reductions being inefficient
during the process, you might consider swapping the products on sale, reduce the reduction, or
abort the discount campaign altogether as inefficient.

Controlling requires you to examine the objectives in a measurable manner. You essentially need
to set standards, which guarantee you know exactly what you want to achieve and what counts as
success or failure. But controlling is also a function that due to the set of standards will ensure
you have the ability to correct behaviors when they deviate from the standards. In essence,
controlling is about quality monitoring. You are looking at the processes and ensuring they
achieve the right things for the organization.

Why is controlling essential?

Controlling’s most important function is the risk-reduction ability. Since you are essentially
monitoring the performance of the team and comparing it against the objectives you’ve set, you
can react to problems more easily. Instead of realizing at the end of the month that you’ve missed
your sales target by a huge margin, you can keep on eye on the situation during the process.

If you notice the marketing campaign, for example, is not producing any new customers or
leading to increased sales, you can re-tweak it to better attract customers. With the re-tweak, you
might be able to change the campaign’s attractiveness and recover the situation. This could end
up guaranteeing you meet the sales target at the end of the month.

Even if you miss the target, you might not miss it by as much and you’ve at least had the chance
of correcting the situation. With controlling, you are reducing the risk of failure and the impact
of failing to meet your objectives. As mentioned, even if you happen to fail, you’re prepared for
it and you can start analyzing the reasons behind it immediately.
In the business world, measuring performance can be the difference between the successful and
the failing companies. Think about a start-up. If the management doesn’t have a set of standards
to measure its performance against, they don’t have any idea what success or failure looks like.
Even when they have a set of objectives and they know whether they met them or not, they don’t
have anymore information to go by.

Let’s say they want to earn $100,000 in the first three months. Without standards and proper
control, after three months all they know is whether they earned it or not. They won’t know the
why. Was the success down to the product? Did the marketing help? How much did their social
media strategy push sales? Was it all about the saving mechanisms they put in place? In the end,
understanding the reasons behind success or failure will help the business perform better.

How to control?

For controlling to be effective, you need to take the four steps of this specific function of
management:

 Establish standards of performance – You first need to establish the standards of

performance you are aiming for. These must be set with the organizational objectives in
mind. You look at the objectives and the plan you have set, creating a set of
measurements that would tell you are on the right path. For example, let’s say you want
the manufacturing team to make 10 more shoes every day to boost productivity. Your
first measurement would be the team creating 10 shoes, but you could include other
factors to the set of standards. You might look to reduce the downtime by ensuring
problems are fixed within 30 minutes and add a new person in the chain to fasten the
process by 10 minutes.
 Measure the actual performance – Once you’ve set the standards and you’ve set the
new processes in motion, you can start monitoring the actual performance. The
monitoring process will depend on your standards and the ease of measurement. Part of
the process can be performance reviews, actual quantifiable data and so on. The key is to
start collecting the information from the start.
 Compare the actual performance with the expected standards – As you receive
performance data, you can start comparing it with the standards you’ve set. The
comparison helps you to identify the problem areas or notice patterns that are actually
working more efficiently.
 Take corrective action – With the data you’ve collected and the information you have
about performance, you can take any necessary corrective action. If the recovery team is
not repairing the machinery quick enough, you can look deeper into it and find ways to
boost the performance. On the other hand, you might notice the team is producing more
shoes than you expected, which could help you revise your objectives.

FINAL THOUGHTS
Henri Fayol developed his ideas regarding the functions of management and his theory has
largely shaped the current understanding of the core elements any management would have to
perform. The functions are key to management in all levels, from the entry positions to higher
roles of management.

Furthermore, each five functions – planning, organizing, staffing, directing and controlling – are
linked to each other. In order to use one function, you typically need to follow with another or
have established one beforehand. While certain theorists and experts might disagree whether
there are three, four, five or six functions, the consensus agrees on the detailed representations of
the above skills, processes and structures.

The question is often more about how broadly you want to define each function. If one of the
functions is missing, management is operating insufficiently and the organizational efficiency
might suffer. A good manager has to be able to keep an eye on all of the five functions, often at
the same time, to guarantee productivity and profitability.

The functions of management are crucial to understand if you want to succeed as a manager.
Knowing the above will guide you as a manager to focus on the right aspects when doing the job
and give you confidence in your ability. It also helps provide more clarity in terms of the skills
and characteristics you need to possess to be a good manager.

By studying the above, you have hopefully identified the areas you need to develop and gain
more knowledge. While your management style might differ from someone else’s style, the
above functions will be necessary in order for you to do a good job as a manager. Since
management is a crucial part of any organization, emphasis and proper understanding of the
above functions will boost the company’s operational efficiency and therefore, its chances of
success.

Key Takeaways

Key Points

 In finance, valuation is the process of estimating what something is worth. Valuation is

used to for a variety of purposes: the purchase or sale of a business, appraisal to resolve
disputes, managerial decisions of how to allocate business resources, and many other
business and legal purposes.
 Valuation often relies on fundamental financial statement analysis using tools such as
discounted cash flow or net present value. As such, an accurate valuation, especially of
privately owned companies, largely depends on the reliability of the firm’s historic financial
information.
  Not only do managers want to keep reliable financial statements so that they can know
the value of their own businesses, but they also want to manage finances well to enhance
the value of their businesses to potential buyers, creditors, or investors.

Key Terms

 valuation: The process of estimating the market value of a financial asset or liability.
 fundamental analysis: An analysis of a business with the goal of financial projections in
terms of income statement, financial statements and health, management and competitive
advantages, and competitors and markets.
 financial statement: A formal record of all relevant financial information of a business,
person, or other entity, presented in a structured and standardized manner to allow easy
understanding.

Introduction

Financial management focuses on the practical significance of financial numbers. It

asks: what do the figures mean? Sound financial management creates value and
organizational agility through the allocation of scarce resources among competing
business opportunities. It is an aid to the implementation and monitoring of business
strategies and helps achieve business objectives. There are several goals of financial
management, one of which is valuation.

Valuation: Valuation is, for some, one of the goals of financial management.
Valuation

In finance, valuation is the process of estimating what something is worth. Valuation

often relies on fundamental analysis (of financial statements) of the project, business, or
firm, using tools such as discounted cash flow or net present value. As such, an
accurate valuation, especially of privately owned companies, largely depends on the
reliability of the firm’s historic financial information. Items that are usually valued are a
financial asset or liability. Valuations can be done on assets (for example, investments
in marketable securities such as stocks, options, business enterprises, or intangible
assets such as patents and trademarks) or on liabilities (e.g., bonds issued by a
company).

Valuation is used to determine the price financial market participants are willing to pay
or receive to buy or sell a business. In addition to estimating the selling price of a
business, the same valuation tools are often used by business appraisers to resolve
disputes related to estate and gift taxation, divorce litigation, allocate business purchase
price among business assets, establishing a formula for estimating the value of
partners’ ownership interest for buy-sell agreements, and many other business and
legal purposes. Therefore, not only do managers want to keep reliable financial
statements so that they can know the value of their own businesses, but they also want
to manage finances well to enhance the value of their businesses to potential buyers,
creditors, or investors.

Maximizing Shareholder and Market Value

A goal of financial management can be to maximize shareholder wealth by paying

dividends and/or causing the market value to increase.

Learning Objectives

Describe the relationship between shareholder value and market value

Key Takeaways

Key Points

 One interpretation of proper financial management is that the agents are oriented toward
the benefit of the principals, shareholders, and in increasing their wealth by paying
dividends and/or causing the stock price or market value to increase.
 The idea of maximizing market value is related to the idea of maximizing shareholder
value, as market value is the price at which an asset would trade in a competitive auction
setting; for example, returning value to the shareholders if they decide to sell shares or if
the firm decides to sell.
  There are many different models of corporate governance around the world. These differ
according to the variety of capitalism in which they are embedded. The Anglo-American
(US and UK) “model” tends to emphasize the interests of shareholders.
 The sole concentration on shareholder value has been criticized, for concern that a
management decision can maximize shareholder value while lowering the welfare of other
stakeholders. Additionally, short-term focus on shareholder value can be detrimental to
long-term shareholder value.

Key Terms

 market value: The total value of the company as traded in the market. Calculated by
multiplying the number of shares outstanding by the price per share.
 principal: One who directs another (the agent) to act on one′s behalf.
 shareholder: One who owns shares of stock.

Introduction

Financial management is concerned with financial matters for the practical significance
of the numbers, asking: what do the figures mean? There are several goals of financial
management, one of which is maximizing shareholder and market value.

Money to Shareholders: Maximizing shareholder and market value is, for some, one of the goals of financial
management.
Maximizing Shareholder Value

The idea of maximizing shareholder value comes from interpretations of the role of
corporate governance. Corporate governance involves regulatory and market
mechanisms and the roles and relationships between a company’s management, its
board, its shareholders, other stakeholders, and the goals by which the corporation is
governed.

In large firms where there is a separation of ownership and management and no

controlling shareholder, the principal–agent issue arises between upper-management
(the “agent”) and shareholders (the “principals”). The danger arises that, rather than
overseeing management on behalf of shareholders, the board of directors may become
insulated from shareholders and beholden to management.

Thus, one interpretation of proper financial management is that the agents are oriented
toward the benefit of the principals – shareholders – in increasing their wealth by paying
dividends and/or causing the stock price or market value to increase.

Maximizing Market Value

The idea of maximizing market value is related to the idea of maximizing shareholder
value, as market value is the price at which an asset would trade in a competitive
auction setting; for example, returning value to the shareholders if they decide to sell
shares or if the firm decides to sell.

There are many different models of corporate governance around the world. These
differ according to the variety of capitalism in which they are embedded. The Anglo-
American (US and UK) “model” tends to emphasize the interests of shareholders.

The sole concentration on shareholder value has been widely criticized, particularly
after the late-2000s financial crisis, where attention has risen to the concern that a
management decision can maximize shareholder value while lowering the welfare of
other stakeholders. Additionally, short-term focus on shareholder value can be
detrimental to long-term shareholder value.

Maximizing Value Without Harming Stakeholders

A goal of financial management can be to maximize value without harming

stakeholders, the diverse set of parties affected by the business.

Learning Objectives

Explain how maximizing value for shareholders can harm the business’s other stakeholders
Key Takeaways

Key Points

 Stakeholders are those who are affected by an organization’s activities. The stakeholders
can be internal or external to the firm and some will be involved directly in economic
transactions with the business, while others will not.
 Owners, employees, customers, suppliers, trade unions, the government, local
communities, and the environment can be considered stakeholders. Because of the
potential breadth of the term, there are different views on whom to include in stakeholder
considerations.
 Debate is ongoing about whether firms should be managed for shareholder value
maximization or also with stakeholders in mind. While the Anglo-American “model” tends
to emphasize shareholders, some European countries formally recognize other
stakeholders in corporate governance decisions.
 Some proponents of stakeholder considerations argue that attention to other stakeholders
is intimitely intertwined with market value and can enhance outcomes for all stakeholders.
Others argue that value should be maximized without harming stakeholders.

Key Terms

 stakeholder: A person or organisation with a legitimate interest in a given situation,

action or enterprise.
 market value: The total value of the company as traded in the market. Calculated by
multiplying the number of shares outstanding by the price per share.

Introduction

Professionals in financial management are concerned with the practical significance of

the numbers that appear in financial documents. Given a set of information about
certain financial behavior, they ask, what do the figures mean? There are several goals
of financial management, one of which is maximizing value without harming
shareholders.

The Stakeholder Concept

The stakeholder concept is associated with the concept of corporate governance.

Corporate governance involves regulatory and market mechanisms and the
relationships that exist between a company’s management, its board, its shareholders,
other stakeholders, and the goals for which the corporation is governed. Stakeholders
are those who are affected by an organization’s activities. The stakeholders can be
internal, like owners or employees. They can also be external, like customers, suppliers,
the government, local communities, and the environment. Some stakeholders are
involved directly in economic transactions with the business. Others are either affected
by, or able to affect, an organization’s actions without directly engaging in an economic
exchange with the business (for example, trade unions, communities, activist groups,
etc). Because of the breadth of the term stakeholder, there are different views as to
whom should be included in stakeholder considerations.

Environment as stakeholder: The environment can be seen as a stakeholder. Maximizing value without
harming stakeholders is, for some, one of the goals of financial management.

Stakeholders vs. Shareholders

In the field of corporate governance and corporate responsibility, a major debate is

currently occurring about whether a firm or company should make decisions chiefly to
maximize value for shareholders, or if a company has obligations to other types of
stakeholders. This increased after the financial crisis of the late 2000s, when concerns
deepened about the potential of companies to lower the welfare of other stakeholders
while maximizing their shareholder value. While the Anglo-American (US and UK)
business “model” tends to emphasize the interests of shareholders over other
implicated parties, some European countries formally recognize other stakeholders in
corporate governance decisions.

Some people who argue that businesses should consider other stakeholders, like the
government or the environment, argue that an attention to these types of stakeholders
is intimately intwined with market value. They also argue that a holistic view can
enhance general outcomes for all the stakeholders that are involved. Still others argue
that stakeholders, even if they are not considered in business decisions, should at the
very least not suffer harm, and that businesses should maximize value only if they can
do so without generating harm.