Profit Maximization vs Wealth Maximization Essay Essay
Profit maximization and wealth maximization are two distinctive objectives when it comes to financial management. However, there are several arguments against and favor of these objectives.
There are different opinions about the two objectives and while some people advocate that goal of the financial management should be profit maximization, many people are of the opinion that the goal of the financial management should be maximization of wealth management.
The limitations of profit maximization objectives are as detailed below:
- It relates to the problem of uncertainty as the future profits cannot be well known to express now. Thus it is not possible to maximize what cannot be known.
- Most decisions involve a balancing between expected return and risk. The investment projects having higher expected yields are associated with a greater risk and also requires a higher capitalization rate. The combinations of expected returns with risk variants and related capitalization rate are ignored in the concept of profit maximization.
- The decision maker may not have enough confidence in the estimates of prospective earnings and he does not attempt further to maximize.
- The objective of profit maximization is too narrow because it fails to take into consideration the interests of government workers and other persons in the enterprise.
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As a solution to the limitations of profit maximization, according to Prof. Solomon it is useful to distinguish between the profits and profitability. The maximization of profits by accruing maximum wealth to shareholders is clearly an unreal motive. On the other hand, profit maximizing results in using of all resources to generate economic values than the joint values of inputs is a useful goal.
The goal of the profitability achieves in terms of greater output than input involves a different set of considerations. Further the proper goal of financial management is wealth maximization. When it comes to the operations of the firm in regard to wealth maximization, the other motives of the firm namely; maximization of sales or size, maximizing growth or market share do not necessarily conflict. Thus Prof Solomon concludes that maximization of wealth provides a useful and meaningful objective as the basic guidelines for evaluating the financial decisions.
The developers of financial management and its various planning and control tools over the past twenty years have equipped well the financial manager than any other officer to provide adequate information to the chief corporate executive. In addition to raising funds, the financial management is directly concerned with production, marketing and other functions within an enterprise whenever decisions are made about the purchase of assets.
In the modern enterprise the basic finance functions are to decide about the expenditure decisions (investment decisions) and to determine the demand for capital for these expenditures. In other words, the financial manager is concerned with the efficient allocation of funds. Thus the role of finance manager shifts from the traditional role of raising of funds to the new role of efficient and effective use of funds.