Profit Maximization vs Wealth Maximization

Profit Maximization

Profit Maximization is the capability of the firm in producing maximum output with the limited input, or it uses minimum input for producing stated output. It is termed as the foremost objective of the company.

The process of increasing the profit earning capability of the company is referred to as Profit Maximization. It is mainly a short-term goal and is primarily restricted to the accounting analysis of the financial year. It ignores the risk and avoids the time value of money. It is primarily concerned as to how the company will survive and grow in the existing competitive business environment.

It has been traditionally recommended that the apparent motive of any business organization is to earn a profit, it is essential for the success, survival, and growth of the company. Profit is a long-term objective, but it has a short-term perspective i.e. one financial year.

Profit can be calculated by deducting total cost from total revenue. Through profit maximization, a firm can be able to ascertain the input-output levels, which gives the highest amount of profit. Therefore, the finance officer of an organization should take his decision in the direction of maximizing profit although it is not the only objective of the company.

Wealth Maximization

Wealth maximization is the ability of a company to increase the market value of its common stock over time. The market value of the firm is based on many factors like their goodwill, sales, services, quality of products, etc.

It is the versatile goal of the company and highly recommended criterion for evaluating the performance of a business organization. This will help the firm to increase their share in the market, attain leadership, and maintain consumer satisfaction and many other benefits are also there.

The ability of a company to increase the value of its stock for all the stakeholders is referred to as Wealth Maximization. It is a long-term goal and involves multiple external factors like sales, products, services, market share, etc. It assumes the risk and recognizes the time value of money given the business environment of the operating entity. It is mainly concerned with the long-term growth of the company and hence is concerned more about fetching the maximum chunk of the market share to attain a leadership position.

It has been universally accepted that the fundamental goal of the business enterprise is to increase the wealth of its shareholders, as they are the owners of the undertaking, and they buy the shares of the company with the expectation that it will give some return after a period. This states that the financial decisions of the firm should be taken in such a manner that will increase the Net Present Worth of the company’s profit. The value is based on two factors

(I) Rate of Earning per share

(II) Capitalization Rate

Differences

Risk management. Under profit maximization, management minimizes expenditures, so it is less likely to pay for hedges that could reduce the organization’s risk profile. A wealth-focused company would work on risk mitigation, so its risk of loss is reduced.

Planning duration. Under profit maximization, the immediate increase of profits is paramount, so management may elect not to pay for discretionary expenses, such as advertising, research, and maintenance. Under wealth maximization, management always pays for these discretionary expenditures.

Capacity planning. A profit-oriented business will spend just enough on its productive capacity to handle the existing sales level and perhaps the short-term sales forecast. A wealth-oriented business will spend more heavily on capacity in order to meet its long-term sales projections.

Pricing strategy. When management wants to maximize profits, it prices products as high as possible in order to increase margins. A wealth-oriented company could do the reverse, electing to reduce prices in order to build market share over the long term.