Concept of Profit and Wealth maximization - Net exam preparation

Concept of Profit and Wealth maximization 

The aim of any business is to maximize profitability and minimize losses. In order to meet financial goals, organizations require a financial management plan. There are two forms of financial management; the traditional profit maximization approach and the more modern wealth maximization approach. The financial management goal chosen will depend on the objectives of the firm and its shareholders and the time horizon (long term or short term) in which profits are required. The article provides a clear explanation on these distinct forms of financial management and explains the factors that make them different from one another.

Profit Maximization:

The objective of financial management is profit maximisation.  If profit maximisation is the only goal, then risk factories ignored.Sometimes, higher the risk, higher is the possibility of profits. Hence, risk has to be balanced with the objective of profit maximisation.However, as profit maximisation ignores risk and uncertainty and timing of returns, a firm can’t solely depend on the objective .profit maximization presents a shorter term view as compared to wealth maximization. Short term profit maximization can be achieved by the managers at the cost of long term sustainability of the business.

Wealth Maximisation:

The objective of a firm is to maximise its wealth and the value of its shareThe concept of wealth in the context of wealth maximisation objective refers to the shareholders’ wealth as reflected by the market price of their shares in the share market. Hence, maximisation of wealth means maximisation of the market price of the equity shares of the company.Wealth of a shareholder maximize when the net worth of a company maximizes. The objective of any shareholder or investor would be good return on their capital and safety of their capital. Both these objectives are well served by wealth maximization as a decision criterion to business.
The wealth maximization is based on cash flows and not profits. 

 In the light of modern and improved approach of wealth maximization, a new initiative called “Economic Value Added (EVA)” is implemented and presented in the annual reports of the companies. Positive and higher EVA would increase the wealth of the shareholders and thereby create value.