The profit maximization objective of financial management is concerned with maximizing the net monetary income of firms. 

It is the traditional and narrow objective,  which is based on obtaining the maximum return possible in terms of profit.

Profit is calculated as the difference between total revenue and total costs.

The profit-maximizing objective is the dominant objective in economics.  The profit maximization objective emphasizes that firms produce only profitable goods.

If the goods become unprofitable, producers abandon them in favor of more profitable goods.

In essence, the profit maximization objective holds that a firm should only engage in profitable activities and avoid unprofitable activities.

This means that any economic activity undertaken by a profit-maximizing firm must be assessed in terms of the profit that can be made from them.

Advantages of the profit Maximization objective of financial management 

1. Profit-motivated: The profit maximization objective is profit-oriented, as profit-maximizing firms only produce goods that earn profits.

Profit inspires a company to work more and become more efficient.

Indeed, Most businesses would shut down if there are no profits.

2. Leads to efficiency: Profit-oriented company tends to produce more profitable goods and less unprofitable goods.

Profit maximization thus leads to efficiency since more resources are directed toward producing profitable goods and services

3. Necessary for growth and development: A company can only expand production and grow if it has made enough profit.

No company can survive in the long run or expand production if it does not earn adequate profit.

4. Motivates entrepreneurship: The reward of an entrepreneur is profit. 

Therefore, profit maximization encourages entrepreneurship.

5. Measure of financial stability: Profit, to some extent, serves as a measure of financial stability as no firm can survive in the long run without profit.

Limitations or Criticisms Of the Profit Maximization objective of financial management.

1. It is vague: Profit maximization objective fails to exactly define some important terminologies. 

For example, the definition of the term profit is ambiguous.

Does it mean short-term or long-term profit? Does it refer to profit before or after tax? Total profits or profits per share? Does it mean gross profit or net profit?

The ambiguous definition of profit posed a big question: which profit are we maximizing under the profit maximization objective?

2. Ignores the time value of the money concept: Profit maximization objectives do not make a distinction between returns received in different periods.

It treats all earnings equally, not minding the difference in the timing of the income.

The profit maximization objective effectively ignores the time value of money because it treats income received today and income received after a period as the same, which contradicts the time value of money concept.

3. Ignores risk and uncertainty: The profit maximization objective does not consider the risk associated with the prospective earning streams.

It only considers how large earning streams are. It does not consider the level of uncertainty associated with an income stream as the wealth maximization objective does.

4. Ignore stockholders' interest: The profit maximization objective does not take into account the interest of consumers, employees, government, and other major stakeholders of the business.

For example, a profit-maximizing firm, in a bid to earn more profit, usually charge high prices. This is an exploitation of consumers

As another example, we have seen profit-maximizing firms exploit employees by giving them poor conditions.

A firm that ignores the interest of stakeholders is unlikely to last long in business, as stakeholders are critical to a company's long-term growth and development.

Furthermore, a company may have other objectives, such as increasing market share or maintaining stability. The profit maximization objective does not account for any of these other objectives.

5. Not suitable for imperfect competition: In today's world, where imperfect competition is the dominant market structure, profit maximization cannot be a sole objective of a firm

In reality, profit maximization is best suited to a perfectly competitive market.

Help us grow our readership by sharing this post

Related Posts

Post a Comment

Subscribe Our Newsletter