Concept of profit maximisation and wealth maximisation

1. PROFIT MAXIMISATION
VS
WEALTH MAXIMISATION
Manpreet Kaur
Assit. Professor in Commerce

2. Introduction
◦ Financial management is concerned with procurement and use of funds. Its main aim is to use
business funds in such a way that the firm’s value/Earnings are maximized. There are various
alternatives available for using business funds. Each alternatives has to evaluated in detail. The
pros and cons of various decisions have to looked into before making a final selection. The
decision will have to take into consideration the commercial strategy of the business. Financial
management provides a framework for selecting a proper course of action and deciding a viable
commercial strategy.
◦ The main objective of the business is to maximize the owner’s economic welfare. This objective
can be achieved by :
◦ Profit maximisation and
◦ Wealth Maximisation

3. Profit Maximisation
◦ Profit maximization is the main objective of any economic activity. The
performance of a firm are evaluated in terms of profitability. Every business has
to earn profit to cover its costs and provide funds for future growth. Without
profits, no business can survive. Profit provides a cushion for any random risk
arising at any time.

4. Arguments in favour of Profit maximisation
◦ Profit maximization is the main aim of the business.
◦ It is a barometer of the performance and efficiency of a firm.
◦ Covers the cost of running a business.
◦ Provides funds for future growth.
◦ Without profit, a business cannot survive.
◦ Provides support in emergencies.
◦ Essential for fulfilling social goals.

5. Criticism of Profit maximisation
Firms start exploiting workers and the
consumers
Immoral and leads to number of corrupt
practices.
Lower human values

6. Criticism of Profit maximisation
◦ The profit maximization should be objective in the conditions of perfect competition and in the wake of
imperfect competition today, it cannot be legitimate objective of the business
◦ There is separation of management and ownership
◦ company is financed by shareholders, creditors and sinancial institutions and is controlled by professional
managers.
◦ To reconcile the conflicting interest of the parties profit maximization objective is in adequate.

7. Criticism of Profit maximisation
Drawbacks
of Profit
maximisation
Ambiguity Ignores time
value of money
Ignore Risk
factor
Dividend
policy

8. Wealth maximisation
◦ The objective of wealth maximization is a universally accepted concept in the field of business. The term
wealth means shareholder’s wealth. A shareholder’s current wealth in the firm is the product of the number
of shares owned, multiplied with the current stock price per share. The individual shareholder can use this
wealth to maximize his individual utility. Thus wealth maximization is maximising shareholder’s utility.
◦ Wealth maximization objective helps in increasing the market value of shares. The share’s market price is a
performance index of the progress of a firm. It also indicates the performance of management on behalf of
the shareholder.
◦ Thus a firm should aim at maximizing its current stock prices.
Maximum utility Refers to
Maximum shareholder’s
wealth
Refers to
Maximum current
stock price per share

9. Implication of wealth maximisation
◦ It serves the interest of suppliers of loaned capital, employees, management and society.
◦ Besides shareholder there are:
◦ Wealth maximization objective not only serves shareholder’s interest by increasing the value of
holding but ensure security to lenders
Short term
suppliers of
funds
Long term
suppliers of
funds
Interested in
liquidity
position
Priority over
shareholder

10. Arguments in favour of wealth maximisation
◦ It overcomes the limitations of the policy of profit maximization.
◦ It serves the interest of suppliers, financers, employees, management, consumers and society.
◦ The concept of wealth maximization is based on the concept of cash flows. Cash flows are not based on any
subjective interpretation.
◦ Wealth maximization considers the time value of money. Time value of money translates cash flow occurring
at different periods.
◦ The goal of wealth maximization leads towards maximizing stockholders utility r value maximization of
equity shareholders through increase in stock price per share.

11. Criticism of wealth Maximisation
◦ It is a prescriptive idea. The objective is not descriptive of what the firm actually do.
◦ Not necessarily socially desirable.
◦ There is some controversy as to whether the objective is to maximize the stockholders wealth or the wealth
of the firm which includes other financial claimholders such as debenture holders, preferred shareholders etc.
◦ It face difficulty when ownership and management are separated as is the case in most of the large corporate
form of organisations. When managers act as agents of the real owners, there is a possibility for a conflict of
interest between shareholders and the managerial interests. The manager may act in such a manner which
maximizes the managerial utility but not the wealth of stockholders or the firm.

12. Profit Maximisation v/s Wealth Maximisation

13. Conclusion
◦ Profit maximization is a strictly short-term approach to managing a business,
which could be damaging over the long term. Wealth maximization focuses
attention on the long term, requiring a larger investment and lower short-term
profits, but with a long-term payoff that increases the value of the business.
◦ Wealth maximization is the most appropriate objective of a firm and the side cost
in the form of conflicts between the stockholders and debenture holders, firms
and society and stockholders and managers can be minimized.

14. Agency Problems
◦ At times, wealth maximization may create conflict, known as agency problem. This describes conflict
between the owners and managers of firm. Owners appoints managers as their agents to act on behalf of
them. 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.
◦ Hence, a manager should align his/her objective to broad objective of organization and achieve a trade-off
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 shareholders.

15. THANK YOU