Every firm has a predefined goal or an objective. Therefore the most important goal of a financial manager is to increase the ownerâ€™s economic welfare. Here economics welfare may refer to maximization of profit or maximization of shareholders wealth. Therefore Shareholders wealth maximization (SWM) plays a very crucial role as far as financial goals of a firm are concerned.
Profit is the remuneration paid to the entrepreneur after deduction of all expenses. Maximization of profit can be defined as maximizing the income of the firm and minimizing the expenditure. The main responsibility of a firm is to carry out business by manufacturing goods and services and selling them in the open market. The mechanism of demand and supply in an open market determine the price of a commodity or a service. A firm can only make profit if it produces a good or delivers a service at a lower cost than what is prevailing in the market. The margin between these two prices would only increase if the firm strives to produce these goods more efficiently and at a lower price without compromising on the quality.
The demand and supply mechanism plays a very important role in determining the price of a commodity. A commodity which has a greater demand commands a higher price and hence may result in greater profits. Competition among other suppliers also effect profits. Manufacturers tends to move towards production of those goods which guarantee higher profits. Hence there comes a time when equilibrium is reached and profits are saturated.
According to Adam Smith - business man in order to fulfill their profit motive in turn benefits the society as well. It is seen that when a firm tends to increase profit it eventually makes use of its resources in a more effective manner. Profit is regarded as a parameter to measure firmâ€™s productivity and efficiency. Firms which tend to earn continuous profit eventually improvise their products according to the demand of the consumers. Bulk production due to massive demand leads to economies of scale which eventually reduces the cost of production. Lower cost of production directly impacts the profit margins. There are two ways to increase the profit margin due to lower cost. Firstly a firm can produce at lower sot but continue to sell at the original price, thereby increasing the revenue. Secondly a firm can reduce the final price offered to the consumer and increase its market thereby superseding its competitors.
Both ways the firm will benefit. The second way would increase its sale and market share while the first way only tend to increase its revenue. Profit is an important component of any business. Without profit earning capability it is very difficult to survive in the market. If a firm continues to earn large amount of profits then only it can manage to serve the society in the long run. Therefore profit earning capacity by a firm and public motive in some way goes hand in hand. This eventually also leads to the growth of an economy and increase in National Income due to increasing purchasing power of the consumer.