The essential difference between the maximization of profits and the maximization of wealth is that the profits focus is on short-term earnings, while the wealth focus is on increasing the overall value of the business entity over time. These differences are substantial, as noted below:
Planning duration. Under profit maximization, the immediate increase in profits is paramount, so management may elect not to pay for discretionary expenses, such as advertising, research, and maintenance. Under wealth maximization, management always pays for the discretionary expenditures. Risk management. Under profit maximization, management minimizes expenditures, so it is less likely to pay for hedges that could reduce the organization’s risk profile. A wealth-focused company would work on risk mitigation, so its risk of loss is reduced.
Pricing strategy. When management wants to maximize profits, it prices products as high as possible in order to increase margins. A wealth-oriented company could do the reverse, electing to reduce prices in order to build market share over the long term.
Capacity planning. A profit-oriented business will spend just enough on its productive capacity to handle the existing sales level and perhaps the short-term sales forecast. A wealth-oriented business will spend more heavily on capacity in order to meet its long-term sales projections.
It should be apparent from the preceding discussion that profit maximization is a strictly short-term approach to managing a business, which could be damaging over the long term. Wealth maximization focuses attention on the long term, requiring a larger investment and lower short-term profits, but with a long-term payoff that increases the value of the business.
Profit maximization is often seen as a more short-term approach. Businesses who use this financial management system focus on how the business can increase profits and reduce both losses and risk. Here are some of the common features of profit maximization in financial management:
Measured by money made over shorter periods of time
Helps organizations understand their operational efficiencies
Primarily focused on how to increase earnings – companies may choose to not spend money on certain expenditures such as marketing, advertising, research, or sometimes even hiring to maximize profits
Companies who engage in profit maximization may choose to increase prices to gain as much per transaction as possible
Wealth maximization is considered a more modern, long-term approach that is focused on creating value over time and using acceptable risk to make wealth-creating investments and increase the cash flow of a business.