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Feb 29

Wealth & Profit

The foundation of financial management involve 5 basic principles of the economics. These principles are the followings:

1) Cash Flow is What Matters

2) Money has a time value

3) Risk requires a reward

4) Market prices are generally right

5) Conflicts of interest cause agency problems

These 5 basic concepts make countries’ or individuals’ financial statements better off.

As a student of finance you have to know foundations of financial movements. First of all you have to know that a firms, which need financial knowledge, basic

goal is to maximize shareholders wealth. For maximizing shareholders wealth we have to adjust security prices etc. If you increase price of a

common stock you also increase or maximize shareholders wealth directly. You may heard “maximizing” word from your economics or math

courses.

We were use this structure mainly for maximizing firms’ PROFIT! But right now you have to forget about it because we are considering just “maximizing

shareholders wealth”.

But why we didn’t choose pofit-maximization?

For the firms well being and with respect to basic principles of the economics we need knowledge of time frame,

reliable calculations of profit, we have to consider risk and timing of cash flows. Instead of considering these concepts profit maximization ignores them and it

can also manipulate the profit. Modern approach about finance is that, to maximizing the wealth. The wealth maximization approach is concerned with the

amount of cash flow generated by a course of action rather than the profit.

Let’s determine benefits of maximizing shareholders wealth. First, current resources used by firms efficiently because of the competition. Whole firms try to

produce more and qualify products, and earn huge profits but basicly for maximizing their wealth, they try to use their inputs efficiently. Second point is that,

they make good corporate decisions for creating wealth for shareholder.