In contrast, stockholder wealth maximization is a long-term goal, since stockholders are interested in future as well as present profits. For example, suppose our forecasting system always gave us a forecast that was on average ten units below the actual demand for that period. While related, they are not the same thing. To increase sales and maximize profit in a retail store, you must stock up on inventory and invest in marketing to get customers in the door. A company requires a maximum benefit for sustenance and growth.
It focuses on the present values of inflows and outflows. As we know, profit is a relative term, it can be a figure in some currency, a percentage etc. However, from the 20th century onwards, the world has progressively been turning towards capitalism. Wealth maximization also considers risk of a business while profit maximization ignores it. In some cases demand forecasts are not merely inaccurate, but they also exhibit bias.
It considers the time value of money. So, to measure the same, value of business is a function of two factors. Financial management is critical to the growth and sustenance of all companies, whether private or public. The main aim of profit maximization is to improve the profit of a company drastically within a certain set period. Under wealth maximization, management always pays for the discretionary.
On the other hand, consider General Motors. It does not focus on creating wealth. Thus, the proper goal of financial management is wealth maximisation. It can be accomplished by taking new deductions, credits or exemptions if the business qualifies for them. It can also be basically referred to as the interpretation of profit in it absolute manner within a short period of time.
S It emphasizes long term S It considers time value of money. Aside from the financial issue of losing customers when your substandard products don't meet their needs, you'll also end up taking less pride in your offerings and compromising your values if you've built your business on quality and integrity. This in turn attracts other firms to produce such goods and services. Wealth Maximization is based on the cash flows into the organization. It is what embodies the existence of any commercial organization. Because shareholders own the firm, they are entitled to the profits of the firm.
It has been universally accepted that the fundamental goal of the business enterprise is to increase the wealth of its shareholders, as they are the owners of the undertaking, and they buy the shares of the company with the expectation that it will give some return after a period. The bottom line was to minimize the expenditure and maximize revenues to boost profit. Focuses on increasing the profit of the company in the short term. The wealth maximization objective when used as decisional criterion serves as a very useful guideline in taking investment decisions. S It ignores risk and uncertainty. It is mainly concerned with the long-term growth of the company and hence is concerned more about fetching the maximum chunk of the market share to attain a leadership position.
This gives a longer term horizon for assessment, making way for sustainable performance by businesses. Consider the 2008 Great Recession and one of its main causes - the subprime mortgage crisis. Of course you can put the extra money you earn towards doing good, such as donating to charity or investing in clean technologies. Those investment portfolios were filled with toxic assets, which eventually compromised the operations of many financial institutions and caused the failure of several big banks. 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. The world wealth refers to the net present worth of the firm.
On the other hand, we create the errors that we observe because we create the forecasts; better forecasts will have smaller errors. Shareholders Wealth Maximization It refers to maximization of the net present value of a course of action for increasing shareholders wealth. One of the most important attributes of the wealth creation is that it is dependent on cash flows and not the profit. The Market Value of shares is the parameter to judge the firms performance. These are and capitalization rate. It represents present value of the benefits minus the cost of the investment.
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. In wealth maximization, the future cash flows are discounted at an appropriate discounted rate to represent their present value. On the other hand, goods and services not in demand fetches low price which forces producers to stop producing such goods and services and go for goods and services in demand. Further, it does not consider the risk of uncertainty of the future earnings. Profit maximization is a short term objective of the firm while the long-term objective is Wealth Maximization. Moreover, the return profit vague and has not been explained clearly what it means. So, we can say that profit maximization is a subset of wealth and being a subset, it will facilitate wealth creation.