Finance & Accounting

Financial Management for Profit Maximization

Any kind of business needs funds to operate and to meet its day to day requirements in the economic world. Whether the business concern is small or big, irrespective of its size & capital, it needs funds to meet its working capital requirement. Finance is known to be the lifeblood of a business organization. In today’s era, all the activities of a business are concerned with economic activities and in simple language; it is concerned with the profit maximization. The entire business activities are linked to profit-making.

In simple terms, financial management is referred to as an application of general managerial principles in the areas of financial decision making. Thus, the whole concept of financial management is concerned with the “Effective Management of Fund start from the procurement of fund until the effective utilization of the same”.A business concern needs finance to meet the following requirements:

• Factors of production
• Rent to be given to landlords
• Wages to be given to labor
• Interest on capital
• Profit distributed as a dividend to shareholders^[1], etc.

Financial Management is all about managing economic resources such as capital funds. It’s the effective role of the financial manager to procure the funds from the effective sources and to put it to the proper utilization of funds procured.

What are the main Objectives of Financial Management?

Objectives of the Financial Management are broadly categorized into following below mentioned:

• Profit Maximization

The main aim of any form of business is to earn a profit. All the business entity operates to earn the maximum amount of return in terms of profits. Profit earning capacity is a measuring technique to evaluate the efficiency of the concerned business. Profit Maximization is the traditional and narrow approach that aims to maximize the profit for an organization.

• Wealth Maximization

Wealth maximization is also called as value maximization or net present worth maximization. This objective of Financial Management is universally acceptable in all forms of business concern. It’s one of the modern approaches that involve the latest innovations and improvement in the fields of business operations. The term wealth means shareholders’ wealth or the wealth of the persons involved the business concern.

Features of Profit Maximization

Profit Maximization consists of the following features:

• Profit Maximization is also known as cash per share maximization. It helps in achieving the objects to maximize the business operation for profit maximization.
• The ultimate objective of any business is to earn a huge amount of return in terms of profit. Thus, this objective of financial management considers all the possible ways to increase the profitability of the business concern.
• Profit earning capacity is kind of a parameter for measuring the efficiency of a particular business. Thus, it shows the entire position of business along with the measures to improve and increase profitability.
• Profit Maximization is an objective that helps in reducing risk.

Also, Read: Strategic Financial Resources Management.

Arguments in the favor of Profit Maximization

1. When earning the profit is the only motive of doing the business, the objectives to achieve those targets should be considered feasible; therefore, profit maximization should be the obvious objectives.
2. Profit earning capacity is the barometer for measuring efficiency and economic prosperity of business concern, thus this objective is justified based on rationality.
3. Economic and business situations don’t go the same all the time. There are at times adverse business conditions like recession, depression, severe competition, etc. During these situations earned profit works as a savior. Thus, a business should earn more and more profit at the time of a favorable situation. A business entity will be able to survive under unfavorable situations only if it has certain funds in the form of past accumulated earnings that it can rely upon.
4. The main source of income and funds for the business is the amount of profit earned. Thus, a business should aim to maximize its profit for enabling its growth and development.
5. The fulfillment of social goals is also achieved by earning the expected amount of profit. A business concern by pursuing the objects of maximizing the profit also maximizes socio-economic welfare.

Arguments in the Criticism of Profit Maximization

1. A firm pursuing its objective of profit maximization usually starts exploiting its workers as well as its customers.
2. To earn maximum profits business usually engaged in immoral and number of corrupt practices such as unfair trade practices, corrupt practices, etc.
3. It affects the ideal social system by leading to colossal inequalities amongst stakeholders such as customers, suppliers and public shareholders, etc. and lowers the human values.
4. In today’s era of imperfect competition, profit maximization cannot be the legitimate objective. Thus, it is more suitable in the conditions of perfect competition.

Drawbacks

Irrespective of profit maximization being the best objective as it maximizes the owner’s economic welfare, this objective is being rejected from practice due to the following drawbacks:

• Ambiguity:

This objective is ambiguous as profit means different things for different people. Should it mean long term profit or short-term profit? Or we shall consider total profit earned or only earnings per share are sufficient. Profit before tax is considered or the one after tax.

• Ignores the time value of money

Profit Maximization objective does not consider the time value of money and ignores the magnitude and timings of earnings. It treats all earnings similar irrespective of the fact that those income has occurred in different periods. It ignores the fact that cash received today has more value than the same cash received in previous years.

• Ignores risk factor

While considering the objective of profit maximization, it does not consider the fact of risk involved in the prospective earning streams. Like some projects are riskier than the other. Two firms can have the same expected earnings per share but in case of earning a stream of anyone is riskier than the market value of its share would be comparatively less.

• Dividend Policy

The effect of dividend policy on its market value of the share is also not considered in the objective of profit maximization. If the object of the firm is to increase earnings per share then an enterprise may not be considered paying a dividend because it can be satisfied by retaining all the profit in the business or investing it in the market.

FAQs

• What is the difference between Profit Maximization and Wealth Maximization?

The objective of profit maximization aims to incur a high amount of profit rather wealth maximization aims to achieve the highest market value for common stock.

• What are the goals of Financial Management?

Following are the objectives of financial management:

1. Maintaining Compliances
2. Maximizing profits
3. Monitoring Liquidity
4. Boosting market share

• Explain Profit Maximization in a perfectly competitive market

A Perfectly competitive market needs to make only decisions about the number of goods to be produced. The perfectly competitive firm puts the price for its product as determined by the product’s market demand and supply, therefore it doesn’t choose the price it charges. On the other hand, a perfectly competitive firm can choose to sell any quantity of output at the same price. This emphasizes that the firm faces a perfectly elastic demand curve for its product which means buyers are willing to buy any number of products from the firm at the market price. When the perfectly competitive firm decides about the quantity of the goods to be produced, then this quantity along with the prices prevailing in the market for output and inputs will determine the firm’s total revenue, total costs, and level of profits.

Our Recommendation: Financial Risk management as Strategic Tool.