Written by The profit-maximization objective refers to the goal of businesses to maximize their profits or financial gains within a given period.
It is concerned with maximizing the net monetary income of firms.
Profit-maximization objective may also be defined as the traditional and narrow objective based on obtaining the maximum return possible in terms of profit.
Profit is calculated as the difference between total revenue and total costs.
Simply put, it is about maximizing the difference between a firm’s total revenue and its total cost
The profit-maximizing objective is the dominant objective in economics. It believes that firms generally 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 implies 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 since profit-maximizing firms only produce goods that earn profits.
Profit inspires a firm to work more and become more efficient.
Indeed, most firms would shut down if there are no profits.
2. Leads to efficiency: A profit-oriented company tends to allocate its resources efficiently.
Since the objective is to maximize profits, the company will prioritize the production of goods or services that are most profitable.
This focus on profitability encourages the efficient allocation of resources, as more efforts and resources are directed toward producing goods or services that yield higher profits
3. Necessary for growth and development: Profit is vital for a company’s growth and development.
A company can only expand its production capacity, invest in research and development, acquire new technologies, or enter new markets if it has sufficient profits to support these initiatives.
Profit provides the financial resources needed to fund growth opportunities and drive the company’s development over time.
4. Motivates entrepreneurship: Profit maximization serves as a key motivator for entrepreneurs.
Entrepreneurs take on the risks associated with starting and running a business with the expectation of earning profits.
Profit maximization therefore incentivizes and rewards entrepreneurship,
5. Important for financial stability: Profit, to some extent, serves as a measure of financial stability as no firm can survive in the long run without profit.
As a result, maximizing profit is necessary for financial stability.
Limitations or Criticisms Of the Profit Maximization Objective of financial management.
1. It is vague: The profit maximization objective lacks clarity in defining crucial terms related to profit.
The concept of profit itself can have different interpretations.
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 prospective earning streams.
It only considers how large earning streams are. It does not consider the level of uncertainty associated with an earning stream as the wealth maximization objective does.
4. Ignore stockholders’ interest: Profit maximization disregards the interests of consumers, employees, the government, and other major stakeholders of a business.
In pursuit of maximizing profits, we see firms exploit consumers by charging high prices or exploit employees by providing poor working 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 most suitable for a perfectly competitive market, where firms have no control over market prices and must, therefore, focus on maximizing their profits.
Bottom line
So, while profit maximization is the most dominant objective in economics, it has limitations and drawbacks.
It lacks specificity, ignores the time value of money, disregards risk and uncertainty, and overlooks stakeholders’ interests.
It is because of these limitations that is why many firms are now switching to the wealth maximization objective.
