Financial management is the management of the company’s finances. It is a management function connected to securing funding and monitoring cash to achieve the enterprise’s objective.
The primary goal of financial management is most associated with increasing the firm’s market value and the market value of its existing stock.
It centers on foreseeing, organizing, directing, controlling, and coordinating the financial activities involved with obtaining and using funds to fulfill the organization’s goals.
What are these goals now? There are two goals for financial management.
Profit and wealth maximization are the two main objectives.
The main difference between profit maximization and wealth maximization is that the former focuses on managing a corporation in a short-term manner.
On the other hand, wealth maximization aims to raise the entity’s entire value over time.
Let’s first understand the definition of profit maximization and wealth maximization:
Table of Contents
What is Profit Maximization?
Profit maximization refers to how a company determines the input, output, and price level.
These three produce the largest profit in particular for all decisions the finance management makes on investment financing and dividend policy.
Since all these policies aim to maximize profits, it is determined whether or not they do so when considering other alternatives.
Making financial decisions is governed by the principle of profitability maximization. It offers a standard against which the company’s economic performance can be evaluated.
The term “profit” is unclear, which implies that various individuals will understand it differently. It might refer to short-term profit, gross profit, net profit, or rate of profit before tax or after tax.
Since it is common knowledge that proposals with higher-than-average risk often result in higher-than-average earnings. The finance manager can ignore the risk factor if profit maximization is the company’s only goal.
Advantages of Profit Maximization
Profit is the foundation of the profit maximization concept and is necessary for any firm or company to survive economically.
Indirectly, the profit maximization theory affects social and economic welfare.
When a company is profitable, it uses its resources wisely, producing capital, fixed assets, labor, and payments for the company.
What is Wealth Maximization?
The opposite of profit-maximization is wealth maximization, but before we begin, it is important to understand what wealth means.
Simply put, wealth is the total value of all the assets that an individual, business, or nation owns.
Therefore, the total number of equity shares and the market price per share can be multiplied to get the company’s wealth.
It can also be determined by summing the total market value of all the company’s tangible and intangible assets.
Wealth for a company is equivalent to the value of its equity.
Its value or wealth is determined by changes in the market price of its stock shares.
It is based on the firm’s overall performance and the validity of its investment finance and dividend decisions.
To improve the market value of its shares, a company engages in a process known as wealth maximization.
This process usually increases the company’s share price, which ultimately raises its market capitalization.
Advantages of Wealth Maximization
The value of the stock directly relates to the growth in shareholder wealth and wealth generation.
The larger the wealth creation, the greater the market value of equity shares which ultimately adds to the shareholders’ wealth.
Cash flow and timing of cash flow are considered while maximizing wealth.
The term “cash flow” refers to the money available for use.
Whereas “cash flow timing” relates to the idea that money received today will be worth more than money received tomorrow or in a year.
Further, wealth maximization always considers the risk factor while making decisions for the future because the future is unpredictable.
Employee pay increases with increased wealth when the company’s financial status improves.
Since the firm’s wealth is a component of society’s wealth, increasing the firm’s wealth has a positive impact on society’s overall development.
Wealth Maximization Account
A Wealth maximization account is a specially designed dividend-paying whole life insurance policy that uses a salaried additions rider to increase cash value while also providing tax benefits quickly.
Compared to a standard whole life insurance policy, it offers a better rate of return and expands more quickly.
Differentiate Between Profit Maximization and Wealth Maximization
The differences between profit maximization and wealth maximization are given below:
1. Goal
The main difference between profit maximization and wealth maximization is that profit maximization is an economic concept in which the company aims to maximize its profit.
The basic goal of the company in profit maximization is to generate more profit.
On the other hand, Wealth maximization is an economic concept that states that a company should maximize the value of its owners’ wealth.
2. Time Period
Another difference between profit maximization and wealth maximization is that wealth maximization is a long-term goal for the company.
As opposed to profit maximization, which is a one-time or short-term goal.
This shows that while maximizing profit is a short-term goal, maximizing wealth is long-term since shareholders care about the company’s present and future profits.
3. Risk And Uncertainty
Risk and uncertainty are another reason wealth maximization is preferred over profit maximization because it takes risk and uncertainty into account.
In profit maximization, the higher the risk, the greater the reward, so decisions are made without taking the risk factor into account.
However, in the case of wealth maximization, all decisions are made after determining the overall risk to guarantee transparency in transactions.
Maximizing wealth is essential for long-term business success. The part of the firm that changes the most is profits.
What are the Differences Between Profit Maximization and Wealth Maximization?
Highlighting the main differences between profit maximization and wealth maximization in the following table:
| Profit Maximization | Wealth Maximization |
|---|---|
| Increased sales and organizational profit are the foundation for profit maximization. | The idea of maximizing wealth is based on an organization’s cash flows. |
| The basis for profit maximization is short-term objectives. | The basis for profit maximization is long-term objectives. |
| Profit maximization neglects the risk component. | Wealth maximization takes risk into account |
| It disregards the concept of the time value of money. | It takes into account the idea of the time value of money. |
Conclusion
Profit maximization and wealth maximization are inherently oppositional, and it is difficult to determine which is better because profit maximization is viewed as a separate limitation.
However, when a conflict directly affects stockholder interests, wealth maximization should be considered carefully.
The difference between profit maximization and wealth maximization is that wealth maximization involves all factors contributing to generating a profit, including shareholders’ interests and corporate risk.
Whereas profit maximizing involves only those that contribute to producing a profit.
Learn more: What is the Difference Between Entrepreneur and Entrepreneurship?
