Financial management is concerned with the optimal use of capital in such a way as to maximize the company’s value plus profits. There is financial accounting anywhere funds are concerned. There are two main goals of financial management: maximizing profits and maximizing wealth.
- Profit Maximization:
It is the ability of the company to produce full output with minimal input or to use less input for the production of specified output. It is referred to as the company’s primary target.
Traditionally, it has been assumed that the obvious motivation of every business organization is to make a profit, which is vital to the profitability, sustainability, and development of the enterprise. Profit is a long-term goal, but it has a short-term outlook, i.e. one financial year.
Profit can be measured by deducting gross costs from total sales. By maximizing profits, a company will be able to determine the input-output ratio, which provides the maximum amount of profit. The financial officer of an organization should then take his judgment in the direction of optimizing profits, although this is not the sole goal of the corporation.
- Wealth Maximization:
It is the tendency of a business to maximize the market value of its common shares over time. The market valuation of the company is dependent on several aspects such as goodwill, revenue, services, product quality, etc. It is a flexible objective of the enterprise and a highly recommended standard for assessing the success of a corporate organization. This will allow the company to grow its market share, achieve supremacy, retain customer loyalty, and many other advantages.
It has been generally agreed that the fundamental objective of the business venture is to raise the equity of its shareholders, because they are the owners of the undertaking, and to purchase the shares of the undertaking, in the hope that it will offer a return after a period of time. This says that the company’s investment actions should be made in such a way as to maximize the net present value of the company’s profits. The meaning is dependent on the following two factors: The rate of earnings per share and the capitalization rate.
Wealth maximization is superior to profit maximization in the following:
- Wealth maximization is dependent on capital flows, not on earnings. Cash balances are accurate and definite, as opposed to sales and thus eliminate the uncertainty involved with accounting profits.
- Profit maximization is a shorter-term perspective relative to the concept of wealth maximization. Short-term profit maximization can be accomplished by the long-term survival of the company in terms of the sustainability of a corporation.
- The maximization of wealth recognizes the time worth of income that is the time value of money. It is significant, as we all know that the dollar today and the dollar one year later will not have the same value. In order to maximize wealth, the potential cash flow will be counted at an appropriate discounted rate to reflect its current value.
- The criteria for maximizing the wealth are to consider the risk and volatility element when taking into account the discount rate. The discount rate represents time and risk. The higher the volatility, the discount rate is higher, and vice versa.
Therefore the wealth maximization is considered better than profit maximization because, under this philosophy, the primary market concern is to increase the worth or wealth of the shareholder. Wealth Maximization calls a distinction between the worth and the risk involved with the market issue. Net benefit detected from the total expense of the company process. Maximizing wealth takes time and risk into account in the market. Wealth Maximization provides an optimal distribution of resources and ensures the economic interest of society. Wealth maximization is commonly favored because it recognizes (1) long-term wealth, (2) risk or ambiguity. (3) pacing of dividends and (4) return of shareholders.
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