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Profit Maximi ation vs. Wealth Maximi ation

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Profit Maximization vs.

Wealth Maximization

Profit Maximi ation vs. Wealth Maximi ation

Sunday, 13 December 2009 06:40 Sanjay Borad Corporate Finance - Finance / Finance

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The financial management has come a long way by shifting its focus from traditional approach to modern approach. The modern approach focuses on wealth maximization rather than profit maximization. This gives a longer term horizon for assessment, making way for sustainable performance by businesses. A myopic person or business is mostly concerned about short term benefits. A short term horizon can fulfill objective of earning profit but may not help in creating wealth. It is because wealth creation needs a longer term horizon Therefore, financial management emphasizes on wealth maximization rather than profit maximization. For a business, it is not necessary that profit should be the only objective; it may concentrate on various other aspects like increasing sales, capturing more market share etc, which will take care of profitability. So, we can say that profit maximization is a subset of wealth and being a subset, it will facilitate wealth creation. Giving priority to value

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Profit Maximi ation vs. Wealth Maximi ation

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to modern approach of financial management that focuses on wealth maximization. This leads to better and true evaluation of business. For e.g., under wealth maximization, more importance is given to cash flows rather than profitability. As it is said that profit is a relative term, it can be a figure in some currency, it can be in percentage etc. For e.g. a profit of say $10,000 cannot be judged as good or bad for a business, till it is compared with investment, sales etc. Similarly, duration of earning the profit is also important i.e. whether it is earned in short term or long term. In wealth maximization, major emphasizes is on cash flows rather than profit. So, to evaluate various alternatives for decision making, cash flows are taken under consideration. For e.g. to measure the worth of a project, criteria like: present value of its cash inflow present value of cash outflows (net present value) is taken. This approach considers cash flows rather than profits into consideration and also use discounting technique to find out worth of a project. Thus, maximization of wealth approach believes that money has time value. An obvious question that arises now is that how can we measure wealth. Well, a basic principle is that ultimately wealth maximization should be discovered in increased net worth or value of business. So, to measure the same, value of business is said to be a function of two factors - earnings per share and capitalization rate. And it can be measured by adopting following relation: Value of business = EPS / Capitalization rate

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Profit Maximization vs. Wealth Maximization Types of Lease Working Capital Management At times, wealth maximization may create conflict, known as agency problem. This describes conflict between the owners and managers of firm. As, managers are the agents appointed by owners, a strategic investor or the owner of the firm would be majorly concerned about the longer term performance of
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Profit Maximi ation vs. Wealth Maximi ation

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 on stake. Hence, a manager should align his/her objective to broad objective of organization and achieve a tradeoff between risk and return while making decision; keeping in mind the ultimate goal of financial management i.e. to maximize the wealth of its current shareholders. Comments (29) priya rautela Add New Search
| 115.241.157.xxx | 2010-09-21 22:14:35

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MOST COMMENTED
2012-03-31 09:21:22 ...

- profit maximisation vrs wealth maximization content was outstanding.i really like it...it is usefull for all the students of mangment........... [b] [color=red[b]]THANKS[/color[/b]][/b]
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3

i have get some idea so nice

2012-03-25 21:41:32 ...

profit maximization ignores the risk.....

2012-03-21 17:39:13 ...

monica - profit and risk

| 121.241.189.xxx | 2010-10-11 04:51:01

is it TRUE that profit maximization should be the main goal of the corporation as it takes into consideration of the timing of profits and the riskness of different operating plans or is it FALSE?
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2

useful to introduce the topic of capital budgeting... thnx..

2012-03-17 09:48:28 ...

xyz - ......

| 117.229.37.xxx | 2012-01-17 14:38:33

false.. profit maximization ignores risk in achieving higher profit and ignores the timing of cost and return
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2 3

2012-03-17 09:47:42 ...

Arti Sharma

| 121.241.189.xxx | 2010-11-26 07:52:43

Mehta - Profit maximization vs wealth maximization [i]Its really wonderful and easy to understand. Thanx[/i]
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4 3

THE CONCEPT AND I CLEARED ALL THE DOUBTS GOOD WORK.......

leesiewchin

| 203.82.94.xxx | 2010-12-15 18:57:39

- Thanks for the clarification

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