In economics, profit maximization is the short run or long run process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to this problem. The total revenue–total cost perspective relies on the fact that profit equals revenue minus cost and focuses on maximizing this difference, and the marginal revenue–marginal cost perspective.
Problems with the 'maximization of profits'
objective: Firstly, there are quantitative difficulties
associated with profit. Maximization of profits as a financial objective
requires the profit to be defined and measured accurately, and that all the
factors contributing to it are known and can be taken into account. It is very
doubtful that this requirement can be met on a regular basis. E.g- If 5
auditors go into the same company; it is very likely that each will come out
with a completely different profit figure.
A second problem concerns the timescale over
which the profit should be maximized.
Should profit be maximized in the short term or
the long term?? Given that profit considers one year at a time, the focus is
likely to be on short-term profit maximization at the expense of long-term investment, putting the long term survival of
the company into doubt.
There are many examples of companies going into
liquidation shortly after declaring high profits. Check out - Polly Peck
Plc's dramatic failure in 1990!
The third problem is that profit does not take
account of or make any allowance for risk! It would be inappropriate to
concentrate efforts on maximizing accounting profit when this objective does not
consider one of the key determinants of
shareholder wealth.
So the 'maximization of profit' is not a
suitable core objective for a company. That is not to say that a company does
not need to pay attention to its profit figures, since falling profits of
profit warnings are taken by the financial
markets as a
sign of financial weakness.
Instead these sorts of profit
targets/objectives should can serve a useful purpose in helping a company to
achieve short-term or operational objectives within its overall strategic plan.