The essential difference between the maximization of profits and the maximization of wealth is that the profits focus is on short-term earnings, while the wealth focus is on increasing the overall value of the business entity over time. These differences are substantial, as noted below:
- Planning duration. Under profit maximization, the immediate increase of profits is paramount, so management may elect not to spend on discretionary expenses, such as advertising, research, or maintenance. Under wealth maximization, management always makes the discretionary expenditures.
- Risk management. Under profit maximization, management minimizes expenditures, so it is less likely to pay for hedges that could reduce the organization's risk profile. A wealth-focused company would work on risk mitigation, so its risk of loss is reduced.
- Pricing strategy. When management wants to maximize profits, it prices products as high as possible in order to increase margins. A wealth-oriented company could do the reverse, electing to reduce prices in order to build market share over the long term.
- Capacity planning. A profit-oriented business will spend just enough on its productive capacity to handle the existing sales level and perhaps the short-term sales forecast. A wealth-oriented business will spend more heavily on capacity in order to meet its long-term sales projections.
It should be apparent from the preceding discussion that profit maximization is a strictly short-term approach to managing a business, which could be damaging over the long term. Wealth maximization focuses attention on the long term, requiring a larger investment and lower short-term profits, but with a long-term payoff that increases the value of the business.
Cost Management Guidebook
Enterprise Risk Management
Profit maximization vs. wealth maximization
The world has been changing, both slowly as well as dramatically depending on what the change is about. For the economic environment however, the change has been rather dramatic than gradual. From the advent of the Industrial Revolution in the earlier centuries, to the 20th century, the change wasn’t so much felt, since capitalism was just finding its footing. However, from the 20th century onwards, the world has progressively been turning towards capitalism. In some instances, the growth of capitalism has even taken a bloody turn, as was the case in the 60s, when communism was also a force to reckon with. The main point of note in capitalism is that profits should be made in every way possible. In other terms, the essence of a business is to make profits, any other thing on the contrary makes it cease from being useful along these lines. With profits, wealth is created. This brings to the fore, the contentious issue or point of argument, between wealth and profit maximization.
Financial management is critical to the growth and sustenance of all companies, whether private or public. It is what embodies the existence of any commercial organization. In financial management, the fundamental aims are profit maximization and wealth maximization. Achieving profit and wealth maximization requires that a company utilizes its available resources efficiently. Profit maximization involves optimization of a company’s profit strategy to realize maximum possible profit within a given period, mostly short duration while wealth maximization is concerned with enhancing the value of the stock of a company in the targeted market. From this understanding therefore, profit maximization precedes wealth maximization. In other terms, wealth cannot be maximized if the business is lagging behind in profit maximization.
Profit maximization is a short-term strategy. It is a short term strategy because it is usually weighed against certain financial periods, for example annual, semi-annual or quarterly. The main aim of profit maximization is to improve the profit of a company drastically within a certain set period. Maximum profit is always viewed as the measure of the operational efficiency of businesses. Financial managers of a company use all the available company resources to improve on profit. In the growing of the profit, the financial managers do not consider the risks and uncertainties involved.
A company requires a maximum benefit for sustenance and growth. Achieving high profits in a short period may force a company to use all its cash. Use of too much money in a short time may make a company run the risk of bankruptcy. Also, some companies manipulate their financial records to manifest high profits. Manipulation of financial records and bankruptcy can only fail a company.
Wealth maximization as stated earlier is concerned with improving the market value of shares. Wealth maximization is a long-term strategy and requires adequate planning. Unlike profit maximization, wealth maximization takes risks and uncertainties into consideration. Wealth maximization strategy involves majorly improving quality of services and goods offered to the targeted customers. Good quality of goods and services increases customer base resulting in significant market share.
In general, a company requires a substantial profit for its rejuvenation, but the idea of not considering risk can make a company fail without notice. Since wealth maximization results in a big market share, a company can benefit primarily from this market share and eventually realize optimal profits. Therefore, companies should concentrate on wealth maximization rather than profit maximization.