Back to: Financial Management
Hello, everyone!
I hope you’re all doing well today. Last week, we introduced the concept of financial management, its nature, and its scope.
Today, we will dive deeper into its core objectives, particularly understanding the difference between profit maximisation and wealth maximisation, which are two important philosophies in finance.
Lesson Objectives:
By the end of this lesson, students should be able to:
Explain the major objectives of financial management.
Differentiate between profit maximisation and wealth maximisation.
Discuss the advantages and limitations of each objective.
Understand why wealth maximisation is more widely accepted in modern finance.
Objectives of Financial Management: Profit vs Wealth Maximisation
The primary goal of financial management is to manage the organisation’s finances in such a way that it creates value for stakeholders. Traditionally, there were two main objectives:
Profit Maximisation
Wealth Maximisation
Let’s take a closer look at each.
Profit Maximisation
This refers to the objective of increasing the financial gains (or profit) of the business. It focuses on short-term earnings, particularly the bottom line (net income).
Merits:
Easy to measure.
Directly linked to the primary goal of any business: to earn a profit.
Encourages efficiency and cost control.
Limitations:
Ignores long-term sustainability.
Overlooks risk and uncertainty.
Ignores timing of returns (e.g., early cash flows are more valuable).
Doesn’t consider the interests of stakeholders beyond shareholders.
Wealth Maximisation
Wealth maximisation is a broader and more modern approach. It refers to increasing the value of the shareholders’ wealth, reflected in the market value of the company’s shares. It is also known as the net present value (NPV) maximisation approach.
Merits:
Considers risk and time value of money.
Focuses on long-term value.
Takes into account the interests of shareholders and other stakeholders.
Aligns with sustainable business practices.
Limitations:
May be difficult to measure precisely.
Market prices of shares can be affected by external factors beyond management’s control.
Which Objective is Preferred?
In modern finance, wealth maximisation is generally considered a more comprehensive and realistic objective. It captures the essence of value creation in both short-term operations and long-term strategy.
Summary:
Today, we’ve examined the two core objectives of financial management: profit maximisation, which focuses on short-term gains, and wealth maximisation, which emphasises long-term value.
Understanding this difference is crucial as it forms the foundation of financial decision-making in modern business.
Evaluation (Assessment Questions):
- Define profit maximisation and list two advantages.
- Define wealth maximisation and explain one reason it is preferred in modern financial management.
- Compare and contrast profit and wealth maximisation.
- In your opinion, which objective is more relevant for a Nigerian business and why?
- How does the time value of money influence wealth maximisation?
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