Is Profit Maximization An Appropriate Goal For Financial Managers?

According to conventional theory of the firm, profit maximization is considered to be the principal objective of the firm because price and output decision associated with a firm is usually based on the profit maximization criteria. Profit maximization refers to maximizing dollar income of the firm.

According to this goal, the actions that increase profits should be undertaken and those that decrease profits are to be avoided. Those who are in favor of profit maximization argue that profit is a test of economic efficiency; it leads to effective utilization of scaring economic resources in every business firm, and it leads to total economic welfare since it increases the economic efficiency of every individual firm.

Therefore, profit maximization is considered to be a basic criterion for financial decision-making. However, this goal is not appropriate on the following grounds;

It is ambiguous

Profit is a vague term. it conveys a different meaning to different people. For example, the term profit may mean long-term profit or short-term profit, profit after tax or profit before tax, gross profit or net profit, earning per share, return on equity etc. So if profit maximization is taken as a goal of the firm, there will be confusing in decision-making.

Merely issuing shares and using the proceeds in the treasury bill can maximize the amount of profit. However, this would result in a decrease in earnings per share (EPS). This goal is not clear whether the financial manager should take such to step to maximize the profit.

It ignores time value of money concepts

Benefits received in earlier periods are valuable than those received in the later period. But, profit maximization goal ignores this fundamental truth the benefits received earlier are more valuable than those that receive later because the earlier benefits can be reinvested to earn a return.

Thus, earlier the better principal match to the real world situation. But the profit maximizing goal ignores the fundamental truth, earlier the better.

It ignores the quality of benefits

Quality of benefit refers to the degree of certainty with which the future benefits can be expected from the financial course of action. The quality of expected benefits is said to be lower if they are more uncertain or fluctuating. Profit maximization considers only the size of the total benefits. not it’s quality.

So, it selects a project with large benefit without considering their degree of certainty and exposes the firm to high-risks. So, the profit maximization cannot be taken is an appropriate decision criterion.

Unsuitable in modern business environment

Profit maximization objective was developed in the 19th century when the majority of business was sell financing. The modern business is characterized by separate ownership and management. The owners and managers have their own rights and responsibilities. The owners or investors, therefore, cannot impose profit maximization goal in a firm.

Maximizing profits goal is considered outdated, unethical, unrealistic, difficult and unsuitable in the present context. It increases conflict of interest among a number of shareholders such as customers, employees, government, society etc. it might lead to inequality of income and wealth. So it is doubtful that it leads to optimum social welfare as advocated.

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