Profit maximization goal of financial management
The maximization of the firm’s net income is called profit maximization. It is mainly a short-term goal and mainly is restricted to the accounting analysis of the financial year. The main objective of concern is to earn a larger amount of profit.
Profit maximization: Profit = Total revenue – Total expense.
Profit can be calculated by deducting the total cost from total revenue.
It is defined as the management of financial resources aimed at increasing the profit of the company. According to this approach action that increases profit should be undertaken and those that decrease profits are to be avoided. It focuses on increasing the profit of the company in the short term. It ignores the risk and avoids the time value of money. In specific operational terms as applicable to financial management, the profit maximization criterion implies that the investment financing and dividend policy decisions of a firm should be oriented to the maximization of profits. Profit Maximization is necessary for the survival and growth of the enterprise. It is mainly concerned as to how the company will survive and grow in the existing competitive business environment. It helps in achieving efficiency in the company’s day-to-day operations to make the business profitable.
Rational of profit maximization:
(i) Profit is the yardstick of measure efficiency.
(ii) Proper utilization of the resource.
(iii) Social welfare.
Benefits of Profit Maximization:
- Economic Existence: The foundation of the profit maximization theory is profit and profit is a must for the economic existence of any company or business.
- Performance Standard: Profit determines the standard of performance of any business or company. When a business is unable to make profits it fails to fulfill its chief target and causes a risk to its existence.
- Economic and Social Well-being: When a business makes a profit, it utilizes and allocates resources properly which in turn results in the payments for capital, fixed assets, labor and organization.
Drawbacks of Profit Maximization:
- The Vagueness of the Profit Concept: The concept of profit is indefinite because different people may have a different idea about profit, such as profit can be EPS, gross profit, net profit, profit before interest and tax, profit ratio, etc.
- Does Not Consider Time Value of Money: The concept of the time value of money tells that a certain unit of money today will not be equal to the same unit of money a year later.
- Does Not Consider the Risk: Any business decision only considering the profit maximization model ignores the involved risk factor which may be harmful to the existence of the business in the long-run.