Financial Goal – Profit Maximization vs Wealth Maximization Explained

FINANCIAL GOAL - PROFIT VS WEALTH 

Every firm has a predefined goal or an objective. Therefore, the most important goal of a financial manager is to increase the owner’s economic welfare. Here economics welfare may refer to maximization of profit or maximization of shareholders wealth. Therefore, Shareholders wealth maximization (SWM) plays a very crucial role as far as financial goals of a firm are concerned.

 

Profit is the remuneration paid to the entrepreneur after deduction of all expenses. Maximization of profit can be defined as maximizing the income of the firm and minimizing the expenditure. The main responsibility of a firm is to carry out business by manufacturing goods and services and selling them in the open market. The mechanism of demand and supply in an open market determine the price of a commodity or a service. A firm can only make profit if it produces a good or delivers a service at a lower cost than what is prevailing in the market. The margin between these two prices would only increase if the firm strives to produce these goods more efficiently and at a lower price without compromising on the quality.

The demand and supply mechanism plays a very important role in determining the price of a commodity. A commodity which has a greater demand commands a higher price and hence may result in greater profits. Competition among other suppliers also effect profits. Manufacturers tend to move towards production of those goods which guarantee higher profits. Hence there comes a time when equilibrium is reached and profits are saturated.

According to Adam Smith - business man in order to fulfil their profit motive in turn benefits the society as well. It is seen that when a firm tends to increase profit it eventually makes use of its resources in a more effective manner. Profit is regarded as a parameter to measure firm’s productivity and efficiency. Firms which tend to earn continuous profit eventually improvise their products according to the demand of the consumers. Bulk production due to massive demand leads to economies of scale which eventually reduces the cost of production. Lower cost of production directly impacts the profit margins. There are two ways to increase the profit margin due to lower cost. Firstly, a firm can produce at lower sot but continue to sell at the original price, thereby increasing the revenue. Secondly a firm can reduce the final price offered to the consumer and increase its market thereby superseding its competitors.

Both ways the firm will benefit. The second way would increase its sale and market share while the first way only tends to increase its revenue. Profit is an important component of any business. Without profit earning capability it is very difficult to survive in the market. If a firm continues to earn large number of profits, then only it can manage to serve the society in the long run. Therefore, profit earning capacity by a firm and public motive in some way goes hand in hand. This eventually also leads to the growth of an economy and increase in National Income due to increasing purchasing power of the consumer.

PROFIT MAXIMIZATION CRITICISMS

Many economists have argued that profit maximization has brought about many disparities among consumers and manufacturers. In case of perfect competition, it may appear as a legitimate and a reward for efforts but in case of imperfect competition a firm’s prime objective should not be profit maximization.

In olden times when there was not too much of competition selling and manufacturing goods were primarily for mutual benefit. Manufacturers didn’t produce to earn profits rather produced for mutual benefit and social welfare. The aim of the single producer was to retain his position in the market and sustain growth, thereby earning some profit which would help him in maintaining his position. On the other hand, in today’s time the production system is dominant by two tier system of ownership and management. Ownership aims at maximizing profit and management aims at managing the system of production thereby indirectly increasing the income of the business.

These services are used by customers who in turn are forced to pay a higher price due to formation of cartels and monopoly. Not only have the customers suffered but also the employees. Employees are forced to work more than their capacity. they are made to pay in extra hours so that production can increase.

Many times, manufacturers tend to produce goods which are of no use to the society and create an artificial demand for the product by rigorous marketing and advertising. They tend to make the product so tempting by packaging and labelling that it’s difficult for the consumer to resist. These happen mainly with products which aim to target kids and teenagers. Ad commercials and print ads tend to provide with wrong information to artificially hike the expectation of the product.

In case of oligopoly where the nature of the product is more or less same exploit the customer to the max. Since they form cartels and manipulate prices by giving very less flexibility to the consumer to negotiate or choose from the products available. In such a scenario it is the consumer who becomes prey of these activities. Profit maximization motive is continuously aiming at increasing the firm’s revenue and is concentrating less on the social welfare.

Government plays a very important role in curbing this practice of charging extraordinarily high prices at the cost of service or product. In fact, a market which experiences a high degree of competition is likely to exploit the customer in the name of profit maximization, and on the other hand where the production of a particular product or service is limited there is a possibility to charge higher prices is greater. There are few things which need a greater clarification as far as maximization of profit is concerned.

Profit maximization objective is a little vague in terms of returns achieved by a firm in different time period. The time value of money is often ignored when measuring profit.

It leads to uncertainty of returns. Two firms which use same technology and same factors of production may eventually earn different returns. It is due to the profit margin. It may not be legitimate if seen from a different stand point.

3 MODERN FINANCIAL MANAGEMENT TECHNIQUES THAT WILL CHANGE YOUR BUSINESS

Whether you’re a business or an individual, you have to find a way to manage your finances now and in the future. The cost of everything continues to increase and there’s no sign that this trend of price increases will stop anytime soon. As a result, all entities have to develop a financial management system to ensure their stability for many years to come.

This system has to provide the businesses in question with enough flexibility for them to continue to grow and pay for their necessary expenses. It also has to be stringent enough to allow for money to be put away in the event of future catastrophes.

In the case of a business, all expenses have to be prioritized in the interest of spending money on the right things.

When it comes time for cost cutting measures to be implemented, they have to be come with consequences in mind. Everything that’s done to cut costs has an end result once it becomes a common procedure.

You have to ponder whether you’re cutting enough or you’re cutting too much. Work has to be done to ensure that cutting individuals from the workforce is the last possible resort. Odds are there are expenses that can be sliced without having to touch the workforce.

Individuals in the private sector have to manage their finances in the interest of being able to acquire credit.

A person’s credit score can affect every possible aspect of their life. The biggest issue currently impacting the financial future of most people is the regular use of high interest credit cards.

Most retail establishments try to push their credit card on their customers on a regular basis. These cards should only be used for small purchases that can be paid shortly after they have been completed.

Financial management is a challenge in a world where spending is seen as the key to getting ahead.

You have to exercise the utmost level of restraint if you want solvency to be in your future. Once you have established an effective budget, your worries about finances will become a thing of the past.