There are two primary objectives of every business and corporation. One bases its decisions entirely on the shareholders' interest, and the other focuses on company profits. What are the key differences between wealth maximization vs. profit maximization?
Does one objective take precedence over the other?
Learn about the definition of wealth maximization and find out why most firms consider it their primary goal. Discover what profit maximization means and if it's an outdated concept in financial management.
Unearth what these strategies aim to achieve and whether they're different from each other. First, let's start by defining wealth maximization.
The Definition of Wealth Maximization
Wealth maximization is the concept of increasing a firm's worth to increase the value of stockholders' shares.
Wealth maximization is also known as net worth maximization. A stockholder's wealth increases when a company's net worth maximizes.
Many businesses consider it superior to profit maximization. In fact, most large management-controlled firms are likely to list shareholder wealth maximization as their dominant goal.
A corporation focusing on wealth maximization as its primary goal puts the shareholders' interests at the heart of every decision. Therefore a firm needs to appoint professionals such as experienced 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 dividend policies. They also examine other factors that may influence or affect market prices.
A share of stock represents ownership in a corporation or business. The objective of any stockholder or investor is to gain a substantial return on their capital. Wealth maximization aims to improve their wealth by increasing the marketing share prices.
Shareholder numbers are rising worldwide, so more businesses are focusing on wealth maximization. For example, South Korea's listed 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 of common stock.
Consider the law of supply and demand. If stock supplies are higher than consumer demand, the market price will fall, and the shareholders will lose money.
If shareholders aren't happy, they might sell their shares and diversify their investments elsewhere. That's not good news for you.
Wealth maximization's ultimate goal is to keep the stockholders invested in a business by increasing overall value.
What are the differences between wealth maximization vs. profit maximization? Let's quickly define profit maximization before discovering the answers.
The Definition of Profit Maximization
Most of you are familiar with the term profit, a monetary reward or gain when a company successfully organizes production factors.
Profit maximization aims to maximize gains over a short duration by using efficient methods to equalize the marginal costs and revenues.
Enterprises aim to boost their profits by implementing strategies to increase the difference between their entire revenue and total costs. As a result, firms usually raise profits by decreasing the production cost of goods.
Businesses also adjust highly influential factors like selling prices and output levels to reach reward targets. Undoubtedly, profit maximization is necessary for your company's progress.
Profit maximization happens when the gap widens between a corporation's marginal costs (MC) and marginal revenue (MR). Of course, the former must be significantly lower than the latter.
Why is it good for your MC to be low? Well, it means your business is operating with reduced costs at a fixed production volume. Therefore, keeping your MC low is essential as it may not be in your firm's best interest to increase production.
Profit maximization is a subsection of wealth maximization because it's a short-term company benefit. Entrepreneurs generally calculate it on a monthly, quarterly, or annual basis. It's impossible to find a business today that calculates profits over more extended periods.
Some managers tend to fixate on short-term numbers and results because they portray the company in a positive light. However, it's not beneficial in the long run.
While profit maximization leads to stockholders' value examination, it doesn't necessarily generate wealth maximization.
Now that you know more about the two concepts, how do they contrast? Let's look at the main differences between wealth maximization vs. profit maximization.
Wealth Maximization vs. Profit Maximization: The Main Differences
It's essential to know the contrasts regarding wealth maximization vs. profit maximization. Let's go through their main 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 market price 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 cash flows
- Are short-term
- Are superior in economics
- Don't consider your firm's dividend policy's effect on market price shares
- Neglect the interests of shareholders in decisions
- Are a traditional approach to financial management
Profit maximization also doesn't require promotional activity from business managers. In contrast, wealth maximization employs product updates, marketing, and research to achieve its primary goal.
When the management team wants to increase profits, it prices services and products as high as possible to increase margins. A company focusing on shareholders' wealth could do the opposite and 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 financial management and has been around since the early 19th century. But when it comes to wealth maximization vs. profit maximization, which is best for business?
Both concepts have similarities and notable differences, but wealth maximization is far superior to profit maximization.
Wealth maximization is a modern and better approach for corporations to set as their dominant goal. It covers a larger area, including your business's financial and operational risk factors.
Remember, you need the right people for the job to ensure the long-running success of your company. Hire experienced professionals to maintain sustainability while increasing your wealth to keep those stockholders happy.
Want to learn more about maximizing your shareholder's wealth? Why not book a paid consultation with Innovative Park? Contact us if you're ready to enter the modern world of financial management.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.