Profit Maximization vs Wealth maximization
Published by admin on November 8th, 2007 | Tagged Business, Corporate Social Responsibilities, Management
The traditional approach of financial management was all about profit maximization.The main objective of companies was to make profits.
The traditional approach of financial management had many limitations:
1.Business may have several other objectives other than profit maximization.Companies may have goals like: a larger market share, high sales,greater stability and so on.The traditional approach did not take into account so many of these other aspects.
2.Profit Maximization has to defined after taking into account many things like:
a.Short term,mid term,and long term profits
b.Profits over period of time
The traditional approach ignored these important points.
3.Social Responsibility is one of the most important objectives of many firms.Big corporates make an effort towards giving back something to the society.The big companies use a certain amount of the profits for social causes.It seems that the traditional approach did not consider this point.
Modern Approach is about the idea of wealth maximization.This involves increasing the Earning per share of the shareholders and to maximize the net present worth.
Wealth is equal to the the difference between gross present worth of some decision or course of action and the investment required to achieve the expected benefits.
Gross present worth involves the capitalised value of the expected benefits.This value is discounted a some rate,this rate depends on the certainty or uncertainty factor of the expected benefits.
The Wealth Maximization approach is concerned with the amount of cash flow generated by a course of action rather than the profits.
Any course of action that has net present worth above zero or in other words,creates wealth should be selected.