Profit Maximization and Wealth maximization

Profit Maximization and Wealth maximization are the different concepts of economics. The main objective of a business is to maximize the owner’s economic welfare. There are two main objectives of financial management:

profit maximization

Profit Maximization

Profit maximization refers to the maximization of rupee income of the firm. Under profit maximization objective, business firms attempt to adopt those investment projects, Which yields larger profits, and drop all other profitable activities. In maximizing profits, input-output relationship is crucial, either input is minimized to achieve a given amount of profit or the output is maximized with a given amount of input. Thus, this objective of the firm enhances productivity and improves the efficiency of the firm.

Profit maximization is the traditional and narrow approach, which aims at maximizing the profit of the concern. It is also called as cashing per share maximization.

Limitations of Profit Maximization

1. Quality of Benefits: Profit maximization approach ignores the quality aspects of benefits associated with a financial course of action. The quality means the degree of certainty with benefits are expected.

2. Ambiguity-Vague: The term ‘profit’ is vague and has different interpretations. It means different things to different people. It can be pre-tax or pro-tax profit. It is not clear whether it is short-term profit or long-term profit. Does it means operating profit or profit available for shareholders? The order equivalent term, often used, is ‘return’. Return can be total capital employed or total asset or shareholders equity and so on.

3. Timing and value of money-ignored: The concept of profit maximization does not help in making a choice between projects,giving different benefits, spread over a period of time. It ignores the difference in time in respect of benefits arising from the similar amount of investment. The fact that a rupee received today is more valuable than the rupee received later is ignored in this concept.

4. Social welfare may be ignored: Due to profit maximization objective, business may produce goods and services, which may not be necessary and beneficial to the society. So, it is ,indeed,doubtful how far the profit maximization objective serves or promotes social welfare, let alone optimizes social welfare.

5. Ignores financial and dividend aspects: The profit maximization concept concentrates on profitability aspect alone and impact of financing and dividend decisions on the market value of shares are, totally, ignored.

Wealth Maximization

“The gross present worth of a course of action is equal to the capitalized value of the flow of future expected benefits, discounted at a rate which reflects the uncertainty or certainty. Wealth or net present worth is the difference between gross present worth and the amount of capital investment required to achieve the benefits”.

The wealth maximization is also universally accepted criterion for financial decision making. The value of an asset should be viewed in terms of benefits it can produce over the cost of capital investment.

This also is known as net present worth maximization approach, it takes into consideration the time value of money. Its operational features satisfy all the three requirements of a suitable operational objective of financial courses of action i.e. quality of benefits,timing of benefits and exactness.

Limitations of Wealth Maximization

  1. The objective of wealth maximization is not, necessarily,socially desirable.
  2. There is some controversy whether the objective of maximization of wealth is of the firm or stockholders. If wealth of firm were maximized, it would be benefiting the interests of debenture holders and preference shareholders too.