Difference between Profit Maximisation and Wealth Maximisation Explained
The only objective of businesses during the previous periods of commercial capitalism was to maximise profits rather than maximising wealth. Hence, it caused resource exploitation without any consideration for adding value. As a result, several businesses that had made enormous profits were unable to maintain their expansion and filed for bankruptcy.
So, if you want to learn in detail about profit maximisation vs wealth maximisation, continue reading!
What is Profit Maximisation?
Profit maximisation in financial management refers to determining the ideal profitable method of producing goods or rendering services. In economics, maximising profits is one of a company's primary goals. In commercial and accounting jargon, profit typically refers to the money that stays after revenue overlaps the cost of production. Here, cost refers to the money spent on production, while revenue refers to the money a business makes from selling its products and services.
Advantages of Profit Maximisation
A few advantages include the following:
- Excellent resource management
- Principal Source of Inspiration
- Best possible social welfare
- Decision-Making Foundations
Disadvantages of Profit Maximisation
Some disadvantages include the following:
- It is unclear
- It disregards time’s worth of money
- It disregards dangers
- Social duty is disregarded
What is Wealth Maximisation?
People and companies both strive for wealth maximisation. In this regard, profit maximisation is the destination of business owners, even though wealth maximisation is the primary aim of a company. In layman’s terms, wealth maximisation attempts to multiply the owner's wealth, whose value is evaluated by the stock price. Hence, as a result, maximising wealth is drastically different from maximising profit.
Advantages of Wealth Maximisation
A few of the merits include the following:
- First off, cash flows rather than earnings are the foundation for wealth maximisation. In contrast to accounting gains, cash flows are precise, eliminating doubt.
- Second, profit maximisation offers a shorter-term perspective compared to wealth maximising. This is because the managers can maximise short-term profits at the expense of the company's long-term viability.
- Third, the time worth of money is considered while maximising wealth. Future fund flows are discounted to represent their present value in the wealth-maximising process at an acceptable discounted rate.
- Fourth, while considering the discounting rate, the wealth-maximisation criterion also considers the risk and uncertainty component. Discounting rates take into account both risk and time. The discounting rate rises when uncertainty increases and vice versa.
Disadvantages of Wealth Maximisation
Besides merits, a few of the demerits are:
- The comparison of value to cost linked with the business concern is considered when maximising wealth. The overall value is derived from all expenses involved in running the firm. It gives the company concern's exact value.
- This idea takes the time and risk of a company's concern into account. This standard guarantees that resources are allocated effectively, and that society's economic interests are protected. However, the wealth maximisation criterion is based on cash flows produced instead of calculating profit.
- Cash inputs and outflows are accurately calculated. In this regard, wealth maximisation can be triggered only with the aid of the business concern's profitable position.
Differences Between Profit Maximisation and Wealth Maximisation
The table below represents some differences between profit and wealth maximisation.
Its primary goal is to generate significant profits.
Its primary goal is to generate the highest market value of common stock.
It prioritises short-term goals.
It prioritises long-term goals.
Value of Time and Money
It disregards the time worth of money.
It values the time worth of money.
Risks and Uncertainty
It disregards uncertainty and risks.
It acknowledges uncertainty and risks.
It disregards the return's timing.
It is aware of the return times.
Profitability is a key factor in managing every firm. However, a business would not prosper over the long term if it just focused on making a profit. As a result, this calls for a company to combine wealth and profit maximisation strategies.
The management of financial resources through various actions is known as profit maximisation. It has a primary goal of raising a company's profits. The goal of wealth maximisation is to allocate financial resources to increase the value of shareholders' shares in a corporation.
Profit Maximisation vs Wealth Maximisation: Which Is Better?
Regardless, here are a few differences between wealth maximisation and profit maximisation.
- Profit maximisation is accomplished by raising the business's earning potential. Contrarily, wealth maximisation refers to using a company's resources to increase stock value for stakeholders and shareholders.
- The overall thing of maximising profits does not include taking on risks and avoiding uncertainties. At the same time, Wealth Maximisation considers and acknowledges the necessity of evaluating all potential risks and uncertainties.
- Any business's long-term objective is wealth maximisation. In comparison, profit maximisation is a short-term objective.
- Maximising profits guarantees the company's growth and longevity. Wealth maximisation, in contrast, concentrates on a company's long-term rate of growth by growing its market share.
- Profit maximisation ignores the temporal worth of money, but wealth maximising takes it into consideration. According to the time value of money theory, a specific quantity of funds is worth more than it should be in future. This statement is true because the only way to build money is through investments. Therefore, when an investment is put off, an opportunity is missed.
- Profit maximisation is the primary objective of businesses, and they place a strong emphasis on increasing productivity while minimising costs. While organisations whose primary goal is wealth maximisation actively concentrate on raising and strengthening the stock price of the company in order to increase shareholder value.
- A corporation prefers to maximise profits when profit maximisation is involved. It only makes money from the profits generated by the difference between total revenue and cost plus taxes for the current fiscal year. As shareholders are the true owners of the business, a corporation with a wealth maximisation mission seeks to raise the value of their money. It accomplishes this by placing its funds at risk in the market in exchange for higher returns but unpredictable dangers.
- Profit maximisation has the advantage of limiting the company's growth to the current fiscal year. But wealth maximisation has the advantage of extending that year's growth with a significant market share and higher share price. This eventually benefits all of the company's stakeholders.
Hence, profit maximisation is a wholly short-term strategy for business management, which might be detrimental in the long run. However, wealth maximisation places more emphasis on the long term. It also raises the worth of the company and ultimately yields superior results. Hence, in profit maximisation vs wealth maximisation, the latter wins in the long run.