25 November 2022
by Julia Vorontsova
Innovation Park
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There are two primary objectives of every business andcorporation. One bases its decisions entirely on theshareholders' interest, and the other focuses on companyprofits. What are the key differences between wealth maximizationvs. profit maximization?
Does one objective take precedence over the other?
Learn about the definition of wealth maximization and find outwhy most firms consider it their primary goal. Discover what profitmaximization means and if it's an outdated concept in financialmanagement.
Unearth what these strategies aim to achieve and whetherthey're different from each other. First, let's start bydefining wealth maximization.
The Definition of Wealth Maximization
Wealth maximization is the concept of increasing a firm'sworth to increase the value of stockholders' shares.
Wealth maximization is also known as net worthmaximization. A stockholder's wealth increases when acompany's net worth maximizes.
Many businesses consider it superior to profit maximization. Infact, most large management-controlled firms are likely to list shareholder wealth maximization as theirdominant goal.
A corporation focusing on wealth maximization as its primarygoal puts the shareholders' interests at the heart of everydecision. Therefore a firm needs to appoint professionals such asexperienced CFOs, CEOs, and sales directors to manage shares.
This management team considers crucial factors like the timing,risk, and duration of a company's earnings and dividendpolicies. They also examine other factors that may influence oraffect market prices.
A share of stock represents ownership in a corporation orbusiness. The objective of any stockholder or investor is to gain asubstantial return on their capital. Wealth maximization aims toimprove their wealth by increasing the marketing share prices.
Shareholder numbers are rising worldwide, so more businesses arefocusing on wealth maximization. For example, South Korea'slisted corporations saw an almost 50% rise in stockholders between 2016-2020.That's a substantial amount of new investors.
How can you keep your shareholders happy?
Appoint professional managers to make essential operating,investment, and financing decisions to increase the market price ofcommon stock.
Consider the law of supply and demand. If stock supplies arehigher than consumer demand, the market price will fall, and theshareholders will lose money.
If shareholders aren't happy, they might sell their sharesand diversify their investments elsewhere.That's not good news for you.
Wealth maximization's ultimate goal is to keep thestockholders invested in a business by increasing overallvalue.
What are the differences between wealth maximization vs. profitmaximization? Let's quickly define profit maximization beforediscovering the answers.
The Definition of Profit Maximization
Most of you are familiar with the term profit, a monetary rewardor gain when a company successfully organizes productionfactors.
Profit maximization aims to maximize gains over a short durationby using efficient methods to equalize the marginal costs andrevenues.
Enterprises aim to boost their profits by implementingstrategies to increase the difference between their entire revenueand total costs. As a result, firms usually raise profits bydecreasing the production cost of goods.
Businesses also adjust highly influential factors like sellingprices and output levels to reach reward targets. Undoubtedly,profit maximization is necessary for your company'sprogress.
Profit maximization happens when the gap widens between acorporation's marginal costs (MC) and marginal revenue (MR). Ofcourse, the former must be significantly lower than the latter.
Why is it good for your MC to be low? Well, it means yourbusiness is operating with reduced costs at a fixed productionvolume. Therefore, keeping your MC low is essential as it may notbe in your firm's best interest to increase production.
Profit maximization is a subsection of wealth maximizationbecause it's a short-term company benefit. Entrepreneursgenerally calculate it on a monthly, quarterly, or annual basis.It's impossible to find a business today that calculatesprofits over more extended periods.
Some managers tend to fixate on short-term numbers and resultsbecause they portray the company in a positive light. However,it's not beneficial in the long run.
While profit maximization leads to stockholders' valueexamination, it doesn't necessarily generate wealthmaximization.
Now that you know more about the two concepts, how do theycontrast? Let's look at the main differences between wealthmaximization vs. profit maximization.
Wealth Maximization vs. Profit Maximization: The MainDifferences
It's essential to know the contrasts regarding wealthmaximization vs. profit maximization. Let's go through theirmain objectives to determine the fundamental differences.
Wealth maximization objectives:
- Focuses on increasing the value of shares for stockholders
- Considers the time value of money
- Examines uncertainties and risks regarding cash flows
- Are long-term
- Are superior in financial management
- Consider your firm's dividend policy's effect on marketprice shares
- Incorporate the interests of shareholders in decisions
- Are a modern approach to financial management
Profit maximization objectives and comparisons:
- Focus on increasing a company's profits
- Don't consider the time value of money
- Don't examine uncertainties and risks regarding cashflows
- Are short-term
- Are superior in economics
- Don't consider your firm's dividend policy's effecton market price shares
- Neglect the interests of shareholders in decisions
- Are a traditional approach to financial management
Profit maximization also doesn't require promotionalactivity from business managers. In contrast, wealth maximizationemploys product updates, marketing, and research to achieve itsprimary goal.
When the management team wants to increase profits, it pricesservices and products as high as possible to increase margins. Acompany focusing on shareholders' wealth could do the oppositeand reduce prices to build market share over a long duration.
Roll With the 21st Century and Take the Modern Approach
Profit maximization is a traditional approach to financialmanagement and has been around since the early 19th century. Butwhen it comes to wealth maximization vs. profit maximization, whichis best for business?
Both concepts have similarities and notable differences, butwealth maximization is far superior to profit maximization.
Wealth maximization is a modern and better approach forcorporations to set as their dominant goal. It covers a largerarea, including your business's financial and operational riskfactors.
Remember, you need the right people for the job to ensure thelong-running success of your company. Hire experiencedprofessionals to maintain sustainability while increasing yourwealth to keep those stockholders happy.
Want to learn more about maximizing your shareholder'swealth? Why not book a paid consultation with Innovative Park?Contact us if you're ready to enter the modern world offinancial management.
Sources: Researchgate.net, Statista
The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circ*mstances.
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