Profit maximization is a traditional approach which is claimed to be the main goal of any kind of business, small or big. Profit equals to revenues substracted by expenses. It is needed for business survival; pay rents, employees salary, capital, research and development. If a business doesn’t yield any profit, it can be said that they’re on danger in term of survival because profit is the main objective.
Wealth maximization is the new approach and claimed to be superior to profit maximization. Wealth maximization means increasing shareholder’s wealth. The term wealth here is the market price of capital invested by shareholders. When the net worth of a business increased the wealth of shareholder are also increased. Unlike profit maximization, wealth maximization serves shareholder’s objective; get good return and safety of their capital. If profit maximization is an objective of a business, wealth maximization is the tools to maintain the objectives. Wealth equals to present value of cash flows substracted by cost.
Since wealth maximization is based on cash flow, it can avoids any ambiguity in accounting the profit. While profit maximization is based on profit, it is kind of hazy. There are many kind of profit It can be gross profit, net profit, before the tax profit, etc. Wealth maximization also considers risk of a business while profit maximization ignores it. Profit maximization presents a shorter term view as compared to wealth maximization. Short term profit maximization can be achieved by the managers at the cost of long term sustainability of the business. Wealth maximization considers the time value of money. A dollar today and a dollar one year latter do not have the same value. In wealth maximization, the future cash flows are discounted at an appropriate discounted rate to represent their present value. [continues]
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