Explained: The differences between profit maximisation and wealth maximisation
Prior to the advent of commercial capitalism, corporations had just one goal: to maximise profits at the expense of wealth. As a result, it led to resource extraction without regard for adding value. Numerous companies that had achieved tremendous profits as a result were unable to sustain their expansion and filed for bankruptcy.
Therefore, keep reading if you want to discover more about the differences between maximising profit and maximising wealth.
How does profit maximisation work?
In financial management, profit maximisation refers to choosing the most profitable way to produce things or provide services. In economics, one of a company’s main objectives is to maximise profits. Profit is often used to refer to the money left over when revenue exceeds cost of production in financial and business jargon. Here, revenue denotes the money a business makes from selling its goods and services, whereas cost denotes the money used in manufacturing.
Profit maximisation benefits
Among the benefits are the following:
outstanding resource management Principal Inspiration
Optimal Decision-Making Foundations for Social Welfare
Problems with Profit Maximisation
Among their drawbacks are the following:
It’s not clear
It disregards the value of time.
It ignores threats
Social responsibility is ignored
What does maximising wealth mean?
Both individuals and businesses aim to maximise their wealth. Although wealth maximisation is a company’s main goal, business owners’ ultimate goal in this case is profit maximisation. In plain English, wealth maximisation aims to increase the owner’s wealth, the worth of which is determined by the stock price. Maximising wealth differs greatly from maximising profit as a result.
Benefits of Wealth Optimisation
The following are a few of the benefits:
First instance, maximising wealth is based on cash flows rather than profits. Cash flows are exact, as opposed to accounting profits, which removes uncertainty.
Second, compared to wealth maximisation, profit maximisation offers a shorter-term view. The reason for this is that managers have the capacity to maximise short-term earnings at the price of the business’s long-term viability.
Third, when maximising wealth, the time value of money is taken into account. In the wealth maximisation process, future fund flows are discounted to represent their present worth at a reasonable discounted rate.
Fourth, the wealth maximisation criterion takes uncertainty and risk into account in addition to the discounting rate. Discounting rates consider both time and risk. When uncertainty rises, the discounting rate also rises, and vice versa.
Problems with Wealth Maximisation
Along with the merits, some of the demerits include:
When maximising wealth, the value to cost ratio related to the business concern is taken into account. All costs associated with maintaining the business are included to calculate the overall worth. It provides the exact value of the business concern.
This concept considers the duration and danger of a company’s concern. This criteria ensures that resources are used wisely and that the economic interests of society are safeguarded. Instead of determining profit, the wealth maximisation criterion is focused on the cash flows generated.
Calculations of cash inflows and outflows are precise. In this regard, the profitable position of the business concern is the only way to start wealth maximisation.
Profit maximisation and wealth maximisation have different goals.
Primary Objective: To make substantial profits is the organization’s main objective.
Goal Periods: Short-term objectives are given priority.
Value of Time and Money: It ignores the value of time in relation to money.
Risks and Uncertainty: It ignores risks and uncertainty.
Timing of Return: The timing of the return is disregarded.
To maximise wealth
The company’s main objective is to increase the market value of its common shares.
Goal Periods: Long-term objectives are given priority.
It rates the time and monetary values of both.
Risks and Uncertainty: It recognises risks and uncertainty.
Timing for Returns: It is aware of the times for returns.
Which is preferable: Profit or Wealth Maximisation?
By increasing the business’s earning potential, profit is maximised. Contrarily, wealth maximisation means maximising the value of a company’s stock for shareholders and stakeholders.
Taking on risks and avoiding uncertainty are not part of the ultimate goal of maximising profits. The need to assess all potential risks and uncertainties is also taken into account by Wealth Maximisation.
The long-term goal of any firm is to maximise wealth. Profit maximisation, by contrast, is a short-term goal.
Profit maximisation ensures the company’s development and survival. Contrarily, wealth maximisation focuses on a company’s long-term growth rate via increasing its market share.
Wealth maximisation takes into account the temporary value of money, whereas profit maximisation ignores it. The time value of money hypothesis states that a certain amount of money is worth more now than it should be in the future. This statement is accurate because investments are the only method to accumulate wealth.
So, when an investment is postponed, a chance is lost.
Businesses’ main goal is to maximise profits, and they strongly emphasise raising productivity while lowering costs. However, firms whose main objective is wealth maximisation actively focus on boosting and solidifying the company’s stock price in order to increase shareholder value.
In cases when profit maximisation is involved, a corporation prefers to maximise profits. It only generates a profit if the total income for the current fiscal year is more than the cost plus taxes. A company with a wealth maximisation mission tries to increase the value of shareholders’ investments because they are the genuine owners of the company. By putting its money at risk in the market in exchange for larger rewards but unpredictably high risks, it achieves this.
The benefit of profit maximisation is that it keeps business expansion within the current fiscal year. The advantage of wealth maximisation, however, is that it can prolong that year’s growth thanks to a sizable market share and greater share price. In the end, this is advantageous to all parties involved in the business.