1.

Profit Maximization

Profit maximization is a stated goal of financial management. Profit is the excess of revenue over
expenses. Profit maximization is therefore maximizing revenue given the expenses, or minimizing
expenses given the revenue or a simultaneous maximization of revenue and minimization of expenses.
Revenue maximization is possible through pricing and scale strategies. By increasing the selling price one
may achieve revenue maximization, assuming demand does not fall by a commensurate scale. By
increasing quantity sold by exploiting the price-elasticity of the demand factor, revenue can be
maximized. Expenses minimization depends on variability of costs with volume, cost consciousness and
market conditions for inputs. So, a mix of factors is called for profit maximization.

This objective of financial management is a favored one for the following reasons:

Profit is a measure of success in business. Higher the profit greater is the degree of success.

Profit is a measure of performance. Performance efficiency is indicated by the quantum of profit.

Profit making is essential for the growth and survival of any undertaking. Only profit making business
can think of tomorrow and beyond. It can only think of renewal and replacement of its equipment and
can go for modernization and diversification. Profit is an engine doing away the odds threatening the
survival of the business.

Profit making is the basic purpose of business. It is accepted by society. A losing concern is a social
burden. The sick business undertakings cause a heavy burden to all concerned, we know. So, profit
criterion brings to the light operational inefficiency. You cannot conceal your inefficiency, if profit is
made the criterion of efficiency.

Profit making is not a sin. Profit motive is a socially desirable goal, as long as your means are good.

However, profit maximization is not very much favored. Certain limitations are pointed out. First,
concept of profit is vague. There are several concepts of profit like gross profit, profit before tax, profit
after tax, net profit, divisible profit and so on. So the reference to the profit has to be clear. Second,
profit maximization in the long-run or in the short-run is to be stated clearly. Long-run or in the short-
run profit orientations differ in the nature, emphasis and strategies. Third, profit maximization does not
consider the scale factors. Size of business and level of profit have to be related. Otherwise no sensible
interpretation of performance or efficiency is possible. Fourth, profit has to be related to the time
factor. Inflation eats up money value. A rupee today is worthier today than tomorrow and day after.
Time value of money is not considered in profit maximization.

2. Profitability Maximization
Profit as an absolute figure conveys less and conceals more. Profit must be related to either sales,
capacity utilization, production or capital invested. Profit when expressed in relation to the above size or
scale factors it acquires greater meaning. When so expressed, the relative profit is known as
profitability. Profit per rupee sales, profit per unit production, profit per rupee investment, etc., are
more specific. Hence, the superiority of this goal to the profit maximization goal.

Further profit per rupee investment or return on investment, (ROI) is a comprehensive measure. ROI =
Return or Profit / Average Capital invested.

Profit divided by sales measures the profit per rupee of sales and sales divided by investment measures
the number of times the capital is turned over. The former is an index of profit earning capacity and the
latter is an index of activeness of the business. Maximization of profitability (ROI) is possible through
either the former or the latter or both.

The favorable scores of this objective are the same as those of the profit maximization objective. The
unfavorable scores of this objective again are the same as those of the profit maximization objective
except one aspect. Profit maximization goal does not relate profit to any base. But profitability
maximization relates profit to sales and/or investment. Hence it is a relative measure. So it is better than
profit maximization goal on this score. But as other limitations continue, this objective too gets only a
‘qualified’ report as to its desirability.

3. EPS Maximization

Maximization Earnings Per Share (EPS) involves maximizing earnings after tax given the number of
outstanding equity shares. This goal is similar to profitability maximization in respect of merits and
demands. It is very specific both as to the type of profit and the base to which it is compared. One
disadvantage is that EPS maximization may lead to value depletion too, because effect of dividend policy
on value is totally discarded.

4. Liquidity Maximization

Liquidity refers to the ability of a business to honor its short-term liabilities as and when these become
due. This ability depends on the ratio of current assets to current liabilities, the maturity patterns of
currents assets and ‘the current liabilities, the composition of current assets, the quality of non-cash
current assets; the relations with the short-term creditors; the relations with bankers and the like. A
higher current ratio, a perfect match between the maturity of current assets and current liabilities, a
well balanced composition of current assets, healthy and ‘moving‘ current assets, i.e., those that can be
converted into liquid assets with much ease and no loss, understanding creditors and ready to help
bankers would help maintaining a high-liquidity level for a business. All these are not easy to obtain and
these involve costs and risks.

How far is it a good goal? It is a good goal, though not a wholesome one. Every business has to generate
sufficient liquidity to meet its day-to-day obligations. Last, the business would suffer. A liquidity rich
business can exploit some rare opportunities like buying inventory in large quantity when price is lower,
lend to the call money borrowers when the interest rate is high, retire short-term-creditors taking
advantage of cash discounts and so on. So many benefits accrue. But, high liquidity might result in idle
cash resources and this should be avoided. Yes, excess liquidity and profitability move in the opposite
directions, they are conflicting goals and have to be balanced.