What is the basic goal of a business firm? - QS Study
QS Study

From Finance’s stand-point there are two main goals:

  • Profit Maximization
  • Shareholders’ Wealth Maximization

PROFIT MAXIMIZATION:

Simply a single-period or a short-term goal to be achieved within one-year Management mainly focus on efficient utilization of capital resources to maximize profits WITHOUT considering the consequences of its actions towards the company’s future performance.

Disadvantages of Profit Maximization Goal:

  • It is only a SHORT TERM concept
  • It does NOT consider the timing of returns
  • It IGNORES risk

SHAREHOLDERS’ WEALTH MAXIMIZATION:

Shareholders’ wealth is regarding the maximizing of the total market /market price of the existing shareholders’ common stock

It can be achieved by considering many factors whether short or long term pertaining to decisions/actions made affecting the present and future earnings per share, timing of returns, dividend policy and other factors that can affect the market price of the company stock

Unlike profit maximization, it has the following advantages:

It applies to the principle of time value of money wherein a dollar received today is worth more hand it is to be received say 1 year later. By considering the time value of money, this will lead to an overall increase in the company’s earning To achieve shareholder’s wealth maximization, management needs to consider the uncertainty or risk factor. It accepts a certain degree of risk when it is compensated with the same level of return. Increase in shareholders’ wealth will directly lead to increase in cash flows. It is not concern only with accounting earnings/profits but CASH FLOWS. To achieve shareholders’ wealth maximization, the firm has to achieve all the short-term target like sales/earnings growth and dividend payout targets. Only when these short-term targets being achieved, the firm will then be attractive to the potential investors which might raise the stock price.