Profit maximization is the capability of a business or company to earn the maximum profit with low cost which is considered as the chief target of any business and also one of the objectives of financial management. According to financial management, profit maximization is the approach or process which increases the profit or Earnings per Share (EPS) of the business. More specifically, profit maximization to optimum levels is the focal point of investment or financing decisions.
“Profit maximization may be the ‘end’ but the means to achieve this end, is what matters, and that distinguishes a company in the corporate world and the market.” – Henrietta Newton Martin
Benefits of Profit Maximization:
Profit maximization has the following benefits:
- Economic Existence:
The foundation of the profit maximization theory is profit and profit is a must for the economic existence of any company or business.
- Performance Standard:
Profit determines the standard of performance of any business or company. When a business is unable to make profits it fails to fulfill its chief target and causes a risk to its existence.
- Economic and Social Well-being:
Profit maximization theory indirectly plays a role in economic and social well-being. When a business makes a profit, it utilizes and allocates resources properly which in turn results in the payments for capital, fixed assets, labor and organization. In this way, economic and social welfare is performed.
Drawbacks of Profit Maximization:
- The Vagueness of the Profit Concept:
The concept of profit is indefinite because different people may have a different idea about profit, such as profit can be EPS, gross profit, net profit, profit before interest and tax, profit ratio, etc. Particularly, no definite profit-maximizing rule or method exists in reality.
- Does Not Consider Time Value of Money:
The profit maximization theory only states that higher the profit better the performance of the business. The theory only considers profit without considering the time value of money. The concept of the time value of money tells that a certain unit of money today will not be equal to the same unit of money a year later.
- Does Not Consider the Risk:
Any business decision only considering profit maximization model ignores the involved risk factor which may be harmful to the existence of the business in the long-run. Because if the business is incapable of handling the higher risk, it’s survival will be in question.
- Does Not Consider the Quality:
Intangible benefits e.g. image, technological advancements, quality, etc. are not considered in the profit maximization approach which is considered as one of the biggest drawbacks. These intangible assets have a mentionable role in creating value for the business which cannot be ignored. Profit maximization theory is based on a traditional viewpoint but the modern business and financial concept value wealth maximization much more than profit maximization.
How to Achieve Profit Maximization:
The following two steps can be applied to achieve profit maximization.
- Increasing Sales-revenue:
Sales-revenue can be increased in the following profit-maximizing ways.
- Increasing sales quality by applying better marketing strategies, quality improvement, a thorough market study to assess that from which segment more money is coming to the business and concentrate in making more sales from those products or services. You can also borrow the best marketing strategy from your competitors, or similar businesses.
- Insisting existing customers to buy extra services or products.
- Diversification by selling a wider variety of products or services.
- Revising pricing of products or services to achieve increased sales-revenue. You can charge a higher price for your product or service if its better in quality. Temporarily you can lose a few clients but according to researchers, people prefer a quality product or services even by paying a little high.
- Motivating employees can also increase sales-revenue because satisfied employees will perform better and help to produce better products and services which will help the company to earn a profit. Better performance appraisal techniques such as announcing employee of the month, promotion, increment, etc. or going out for picnic, lunch, arranging cultural programs, etc. can motivate employees.
- Educating all customers both existing and potential for your product or service by tv or radio or newspaper advertisements, digital marketing or email-marketing or social-media marketing, publishing and distributing leaflets, posters, banners, etc.
Cost-cutting can be done in the following profit-maximizing manners.
- Analysis of the full expenditure of money to different sectors.
- Negotiate with suppliers for cheaper prices especially when buying in large quantities.
- Manufacturing process should be more efficient to reduce wastage. Technologies which saves time and expands production should be applied.
- Looking for a new cost-effective energy supplier because a large amount of money is spent on the energy sector.
- Outsourcing: A business cannot do all the tasks by itself or a small business cannot hire a talented people on a full-time basis at a higher Outsourcing can save a lot of money here. Full-time employees will be engaged in revenue-generating projects and simple tasks can be done by outsourcing or through freelancers.
Business people can maximize profit by following the above steps keeping time value of money, the risk and quality factor in consideration.