Profit Maximisation And Wealth Maximization

What is profit maximization?

By profit, we mean the gaining from the business activities for the benefit of the owners of the business.

Profit = Total Revenue – Total Cost

Total Revenue is the total amount the company earns from it’s business activities and total cost is the cost incurred by the business in various production, and other business activities.

Profit is the measure of the activities of the business, cost of staying in the business and and the cost for future business capital supply. Profit can be super normal, normal or negative.

So, what exactly is Profit Maximization?

Profit maximization is the process by which a firm predicts the price and output level that returns the greatest profit. There are several approaches to this

Maximization of profit used to be the main aim of a business and financial management till the concept of wealth maximization came into being. Wealth Maximization is a superior goal compared to profit maximization as it takes broader arena into consideration. Wealth or Value of a business is defined as the market price of the capital invested by shareholders.

Both Profit Maximization and Wealth Maximization have their challenges:

Profit maximization is an obvious goal of management, but it does not necessarily imply that short-term profit increases will produce long-term sustainable gains. For example, a reduction in product quality that lowers production costs will produce a quick increase in profit, but lowered quality standards can also tarnish a company 's reputation and provide the competition with an advantage.

Lowering or eliminating a company 's employee training or research and development budget will lessen operating expenses and also maximize short-term profits. However, the competition may not follow suit and instead produce a much better product or service. The long-term result could be a significant loss of market share for the company that decided to lower its budget to pursue a short-term profit gain.

It ignores risk factors and time value of money. And at times is also stated as

Wealth maximization might create conflict, known as agency issues, which describes conflict between the owners and managers of firm. As, managers are the agents appointed by owners as trustees, a strategic investor or the owner of the firm would be majorly concerned about the longer term performance of the business that can lead to maximization of shareholder’s wealth. Whereas, a manager might focus on taking such decisions that can bring quick result, so that he/she can get credit for good performance. However, in course of fulfilling the same, a manager might opt for risky decisions which can put the owner’s objectives at stake. Therefore, a manager should align his/her objective to broad objective of organization and achieve a tradeoff between risk and return while making a decision; keeping in mind the ultimate goal of financial management i.e. to maximize the wealth of its current