Wealth Maximization Vs Profit Maximization Case Study
The essential difference between the maximization of profits and the maximization of wealth is that the profits focus is on short-term earnings, while the wealth focus is on increasing the overall value of the business entity over time. These differences are substantial, as noted below:
- Planning duration. Under profit maximization, the immediate increase of profits is paramount, so management may elect not to spend on discretionary expenses, such as advertising, research, or maintenance. Under wealth maximization, management always makes the discretionary expenditures.
- Risk management. Under profit maximization, management minimizes expenditures, so it is less likely to pay for hedges that could reduce the organization's risk profile. A wealth-focused company would work on risk mitigation, so its risk of loss is reduced.
- Pricing strategy. When management wants to maximize profits, it prices products as high as possible in order to increase margins. A wealth-oriented company could do the reverse, electing to reduce prices in order to build market share over the long term.
- Capacity planning. A profit-oriented business will spend just enough on its productive capacity to handle the existing sales level and perhaps the short-term sales forecast. A wealth-oriented business will spend more heavily on capacity in order to meet its long-term sales projections.
It should be apparent from the preceding discussion that profit maximization is a strictly short-term approach to managing a business, which could be damaging over the long term. Wealth maximization focuses attention on the long term, requiring a larger investment and lower short-term profits, but with a long-term payoff that increases the value of the business.
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Enterprise Risk Management
Financial Management is concerned with the proper utilization of funds in such a manner that it will increase the value plus earnings of the firm. Wherever funds are involved, financial management is there. There are two paramount objectives of the Financial Management: Profit Maximization and Wealth Maximization. Profit Maximization as its name signifies refers that the profit of the firm should be increased while Wealth Maximization, aims at accelerating the worth of the entity.
Profit maximization is the primary objective of the concern because of profit act as the measure of efficiency. On the other hand, wealth maximization aim at increasing the value of the stakeholders.
There is always a conflict regarding which one is more important between the two. So, in this article, you will find the significant differences between Profit Maximization and Wealth Maximization, in tabular form.
Content: Profit Maximization Vs Wealth Maximization
- Comparison Chart
- Key Differences
|Basis for Comparison||Profit Maximization||Wealth Maximization|
|Concept||The main objective of a concern is to earn a larger amount of profit.||The ultimate goal of the concern is to improve the market value of its shares.|
|Emphasizes on||Achieving short term objectives.||Achieving long term objectives.|
|Consideration of Risks and Uncertainty||No||Yes|
|Advantage||Acts as a yardstick for computing the operational efficiency of the entity.||Gaining a large market share.|
|Recognition of Time Pattern of Returns||No||Yes|
Definition of Profit Maximization
Profit Maximization is the capability of the firm in producing maximum output with the limited input, or it uses minimum input for producing stated output. It is termed as the foremost objective of the company.
It has been traditionally recommended that the apparent motive of any business organisation is to earn a profit, it is essential for the success, survival, and growth of the company. Profit is a long term objective, but it has a short-term perspective i.e. one financial year.
Profit can be calculated by deducting total cost from total revenue. Through profit maximization, a firm can be able to ascertain the input-output levels, which gives the highest amount of profit. Therefore, the finance officer of an organisation should take his decision in the direction of maximizing profit although it is not the only objective of the company.
Definition of Wealth Maximization
Wealth maximizsation is the ability of a company to increase the market value of its common stock over time. The market value of the firm is based on many factors like their goodwill, sales, services, quality of products, etc.
It is the versatile goal of the company and highly recommended criterion for evaluating the performance of a business organisation. This will help the firm to increase their share in the market, attain leadership, maintain consumer satisfaction and many other benefits are also there.
It has been universally accepted that the fundamental goal of the business enterprise is to increase the wealth of its shareholders, as they are the owners of the undertaking, and they buy the shares of the company with the expectation that it will give some return after a period. This states that the financial decisions of the firm should be taken in such a manner that will increase the Net Present Worth of the company’s profit. The value is based on two factors:
- Rate of Earning per share
- Capitalization Rate
Key Differences Between Profit Maximization and Wealth Maximization
The fundamental differences between profit maximization and wealth maximization is explained in points below:
- The process through which the company is capable of increasing earning capacity known as Profit Maximization. On the other hand, the ability of the company in increasing the value of its stock in the market is known as wealth maximization.
- Profit maximization is a short term objective of the firm while the long-term objective is Wealth Maximization.
- Profit Maximization ignores risk and uncertainty. Unlike Wealth Maximization, which considers both.
- Profit Maximization avoids time value of money, but Wealth Maximization recognises it.
- Profit Maximization is necessary for the survival and growth of the enterprise. Conversely, Wealth Maximization accelerates the growth rate of the enterprise and aims at attaining the maximum market share of the economy.
There is always a contradiction between Profit Maximization and Wealth Maximization. We cannot say that which one is better, but we can discuss which is more important for a company. Profit is the basic requirement of any entity. Otherwise, it will lose its capital and cannot be able to survive in the long run. But, as we all know, the risk is always associated with profit or in the simple language profit is directly proportional to risk and the higher the profit, the higher will be the risk involved with it. So, for gaining the larger amount of profit a finance manager has to take such decision which will give a boost to the profitability of the enterprise.
In the short run, the risk factor can be neglected, but in the long-term, the entity cannot ignore the uncertainty. Shareholders are investing their money in the company with the hope of getting good returns and if they see that nothing is done to increase their wealth. They will invest somewhere else. If the finance manager takes reckless decisions regarding risky investments, shareholders will lose their trust in that company and sell out the shares which will adversely effect on the reputation of the company and ultimately the market value of the shares will fall.
Therefore, it can be said that for day to day decision making, Profit Maximization can be taken into consideration as a sole parameter but when it comes to decisions which will directly affect the interest of the shareholders, then Wealth Maximization should be exclusively considered.
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