Every business organisation’s aim is to make profit and more profit. Does it end there? What should be the real motive behind running an organization?
Profit maximization alone does not help the organization to firmly plant its feet in the business environment, as the success of an organization in the long run is decided by many critical factors like, market share, value of the company shares, market stand, image etc.
So, shall we say, let wealth maximization be the goal of any organization, which focuses on increasing the “earnings per share” of the share holders.
Profit Maximization in Financial Management
Profit maximization does not take into consideration, the interest of share holders or stake holders, who ought to be the ultimate beneficiaries.
Concentrating on short term profits confines a firm and limits its scope and growth whereas; value creation is something that the management should aim for, as it helps to increase the “net worth” of a company.
Mere price versus output calculations make firms to operate in a profitable manner, but it should never be the only objective of a firm, as it has the moral and social responsibility to patronize its shareholders by increasing the net worth of the company.
While maximizing profit, a firm either produces maximum output for a given amount of input, or uses minimum input for producing a given output. Thus the underlying logic for profit maximization is efficiency.
Under perfect competitive market conditions, profit serves as a perfect measure for the performance of a firm. If profit is the motive of a firm, it fails to consider the time value of money which is an important criterion that decides the success of a firm, and also it values benefits received today and after a period as the same. Moreover the uncertainty factor is there to be considered too.
Firms always prefer to have smaller but surer profits rather than larger benefits but less certain.
When we talk about profits, the next indispensable factor will be the taxes that demand a portion of your profit. Maximizing profits after the payment of taxes facilitates the firm to increase the net profit ratio to serve the best interests of the owners. But, this also fails to maximize the economic welfare of the owners, as it does not take into account, the timing and uncertainty of the benefits.
Wealth maximization is the ideal alternative that is consistent with the survival goal and also with the personal objectives of managers such as recognition, power, status and personal wealth.
Mangers while deciding on investment options, seek to achieve a right balance between risk and return. If the firm borrows heavily to finance its operations, care should be taken to ensure that, the rate of return on investment should be sufficient enough to support the payment of interests on borrowings and also to repay the principal.
If the firm is not able to “service the debt” there is a danger of the firm becoming bankrupt or insolvent. The firm’s investment and financing decisions are unavoidable and continuous. In order to make rational decisions, the firm must have a goal, which is nothing but the “shareholder’s wealth maximization” which is theoretically logical and operationally feasible.
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