The objective of financial management is profit maximisation. It cannot be the sole objective of a company as there is a directs/relationship between risk and profit. If profit maximisation is the only goal, then risk factories ignored.
Sometimes, higher the risk, higher is the possibility of profits. Hence, risk has to be balanced with the objective of profit maximisation. In addition, a firm has to take into account the social considerations, and normal obligations to the interests of workers, consumers, society, government, as well as ethical trade practices. However, as profit maximisation ignores risk and uncertainty and timing of returns, a firm can’t solely depend on the objective.
Hence, the objective of a firm is to maximise its wealth and the value of its shares. According to van Home value is represented by the market price of the company’s common stock. The market price of a firm’s stock takes into account present and prospective future earnings per share (EPS), the timing and risk of these earnings, the dividend policy of the firm and many other factors that bear upon the market price of the stock.
The concept of wealth in the context of wealth maximisation objective refers to the shareholders’ wealth as reflected by the market price of their shares in the share market. Hence, maximisation of wealth means maximisation of the market price of the equity shares of the company.
Profit Maximisation Vs Wealth Maximisation:
Total profits are not as important as earnings per share. Even maximisation of earnings per share is not enough because it does not specify the timing or duration of expected returns. Further, it does not consider the risk of uncertainty of the future earnings. Hence, wealth maximisation is appropriate and it is possible by maximising the market price per share.
According to Prof. Ezra Soloman, wealth maximisation also maximises the achievement of other objectives. Maximisation of wealth of the firm implies maximisation of value of owner’s share capital reflected in the market price of shares. Therefore, the operative objective of financial management implies maximisation of market price of sharesy.
Comparison Between Profit Maximisation and Wealth Maximisation!
The critical notion of profit maximisation is based upon the belief that the business enterprises are rational and economic- minded and they weigh all the alternatives open to them before they allocate the scarce financial resources at their disposal to particular use.
It follows that business companies always attempt to choose the best among all” alternatives, but it is not so as it is assumed. However, the profit maximisation objective has been criticised in recent years.
It relates to the problem of uncertainly and balancing between expected returns and risk. It fails to provide an operationally feasible measure for ranking alternative courses of action in terms of their economic efficiency’.
The social responsibility has prevented enterprises from trying to maximise profits and the pressure from Government and trade unions restricted them from earning the optimal profit. Moreover, there is a divorce between management and ownership in corporate enterprises. In this new business environment, profit maximisation is regarded as unrealistic, difficult, inappropriate and immoral.
An alternative to profit maximisation is the objective of wealth maximisation. Solomon has made a good case of the thesis that wealth maximisation also maximises the achievement of other motives such as maximising sales or size, growth or market share.
He concludes by stating that it is a useful and meaningful objective as basic guideline by which financial decisions should be evaluated. Hence the ultimate goal of every business is to maximise wealth of its shareholders.