The term ‘profit maximization’ implies generation of largest amount of profits over the time period being analysed, secondary to Prof. Peter Drucker, business profits play a functional role in three different ways.
term ‘profit maximization’ implies generation of largest amount of profits over
the time period being analysed, secondary to Prof. Peter Drucker, business
profits play a functional role in three different ways. In the words of Peter
1. Profits indicate the effectiveness of business profits
2. They provide the premium to cover costs of staying in business and
3. They ensure supply of future capital.
Profits are source of funds from
which organizations are able to defray certain expenses like replacement,
obsolescence, marketing etc.
Maximization of profits for a
long term is desirable and appreciable. The tendency to maximize profits in the
short run may invite innumerable problems to the organization concerned. In
fact, maximization of profits in the short run may give an impression of being
exploitative. The extent of uncertainty in business increases the appreciation
of proprietor / partner / company and hence many prefer short-run
profit maximisation to long –run profit maximisaiton.
The underlying basic of profit
maximization is efficiency. It is assumed that profit maximization causes the
efficient allocation of resources under the competitive impact conditions and
profit is regarded as the most appropriate measure of a firm’s performance.
Arguments in favour of profit maximization
Arguments in favour of profit maximization as the objective of business are enumerated below:
1. Profits are the major source of finance for the growth and development of its business.
2. Profitability serves as a barometer for measuring efficiency and economic prosperity of a business entity.
3. Profits are required to promote socio-economic welfare.
levelled against profit maximization
However, profit maximization objective has been criticized on innumerable grounds. Under the changed economic and corporate environment, profit-maximisation is regarded as unrealistic, difficult, unappropriate and socially not much liked goal for business organizations. Profit maximization as an objective of financial management has been considered inadequate and rejected because of the following drawbacks.
1. There are several goals towards which a business firm / organization should direct themselves profit – maximization is one of the goals of the organization and not the only goal.
2. Maintenance of firm’s share in the market, development and growth of the firm, expansion and diversification are other goals of business concern.
3. Rendering social responsibility
4. Enhancing the shareholders’ wealth maximization.
As Solomon opines, profit maximisation has been rejected as an operational criterion for maximising the owner’s economic welfare as it cannot help us in ranking alternative courses of action in terms of their economic efficiency. This is because—(i) it is vague; (ii) it ignores the timing of returns; (iii) it ignores risk.
Profit maximisation is considered as an important goal in financial decision-making in an organisation. It ensures that firm utilizes its available resources most efficiently under conditions of competitive markets. Profit maximisation as corporate goal is criticised by scholars mainly on following grounds:
1. It is vague conceptually.
2. It ignores timing of returns.
3. It ignores the risk factor.
4. It may tempt to make such decisions which may in the long run prove disastrous.
5. Its emphasis is generally on short run projects.
6. It may cause decreasing share prices.
7. The profit is only one of the many objectives and variables that a firm considers.
Tags : Financial Management - Finance – An Introduction
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