Since surviving is the main goal of small businesses, they are more inclined towards profit maximisation by reducing costs

Any organisation is an ongoing concern and has to make decisions, either big or small, daily. These decisions converge towards its overall goal. So, what should be the overarching goal of a firm from the point of view of financial management? Financial managementis a critical branch of economics that makes profit maximization the main goal of any firm.

Profit, as an accounting term, is the excess of income generated by sales over the expenses incurred from the overall operation of a business. Any business is said to be in a loss if the expenses are consistently more than the income. And it is said to be profitable if the income is more than the expenses. Therefore, in the context of economics, the goal of a firm should be to maximize profits, or to say in simple terms, to realize a large amount of profit.

Profit maximization can be achieved in two ways: enhance revenue and minimize costs. Therefore, to maximize profits, many firms minimize their costs and boost their revenue. The problem, however, with such a goal is that it is short-term in nature and banks on extreme measures to reduce costs, like cutting down and paring advertisement budgets, employee training, development expenses, research and development expenditure, customer care budget, employee salary, or bonuses.

In some cases, firms, in an attempt to maximize profit, may also neglect the safety, welfare, benefits of the environment, and their different stakeholders. These knee-jerk reactions are short-term in nature and can be efficient for the near future but in the longrun, these measures slow down the sales, which in turn diminishes the profits and dwindles the overall value of the firm. Therefore, the objective of profit maximization has a myopic outlook towards the long-term growth of the firm.

Over the years, when financial management became independent from economics and became a branch on its own, the objective of the firm witnessed a steady shift from profit maximization to shareholders' wealth maximization. This is a comprehensive approach focusing on the long-term growth, profitability, and the value of the firm. This goal focuses on wider objectives and includes the welfare of employees, communities, and society at large. It is a fact that wealth or value is a long-term concept and for the firms, it is reflected in the market price of its shares that in turn depends on the success and expectations of the future success of a firm. Firms with higher performance receive a higher valuation from investors which is reflected in the increase in the share prices as compared to the initial listed value. Therefore, the value of a firm is a dynamic function of the overall performance of the firm and the rationality of the firm's investment, financing, and dividend decisions.

In a way, shareholders' wealth maximization is also associated with intangible assets like goodwill, branding, good customer relations, a significant and loyal customer base, committed employees, and intellectual property rights. This concept also overarches and includes community and social welfare. Therefore, firms are moving away from the goal of profit maximization that has a short-term approach, ignores any risk or uncertainty,and overlooks the timing of returns. In comparison, a long-term vision acknowledges risks and uncertainty and considers the overall shareholders' wealth and not just profits.

This concept of shareholders' wealth maximization is mainly applicable to large firms where there are a large number of shareholders, including promoters, financial institutions like banks and mutual funds, foreign investors, and retail investors. The managers' actions should enhancethe value of the firm to benefit all shareholders. But does this concept apply to small businesses, where the owners are the managers and there are no diverse set of shareholders, excepts family members or partners?

The situation for small businesses is also different as they are not listed on the stock markets.In the absence of external shareholders, the objective of profit maximization appears to be the correct approach. For small businesses, the availability of funding or capital is difficult, which is not a constraint for many large firms and they can invest in other stakeholders and efficient business processes. This improves the overall value of the firm and increases the wealth of the shareholders. Since surviving is the main goal of small businesses, they are more inclined towards profit maximization by reducing costs or enhancing revenue. As and when these small businesses start to grow and achieve a sizable expansion, the concept of shareholders' wealth maximization should be the way to go forward.

(The writer is Associate Professor at Amity University, Noida. The views expressed are personal.)