These are two terms that have caused some trouble for students in the past, and it’s most probably because they are so closely related. How do we distinguish between them? What do they mean exactly, and when should you use them?
- Profit is what is left after subtracting total costs from total sales (revenue). Profit = Total Sales – Total Costs
- Profit maximisation is where the greatest positive difference between total revenue and total costs is achieved
Ultimately, profit is the return for the risk that business owners take for investing in the business. Remember opportunity cost? Business owners also had to deal with opportunity cost when they initially invested in the firm. Instead of starting up a business or purchasing shares in a company, the owners (or entrepreneurs) could have rather invested their finance elsewhere. They might have saved the money in an interest-bearing account, purchased shares in a different firm or started their own business.
Profit maximisation is a business objective. Just like survival, increasing market share and growth, profit maximisation is an objective that a business hopes to achieve, and makes certain decision in order to reach this outcome.
For most businesses, profit is seen as necessary for the long-term survival of the firm. The profit motive rewards the taking of risks and hard work; it gives business owners an ultimate outcome. For the sole trader, profit will always be in mind: it’s his or her “salary” earned from the business’s activity.
Profit maximisation is not always necessary or even vital for long-term success. Of course, in the competitive, globalised business world of today, ‘the bottom line’ is always of concern. But it’s not always the main aim or objective. In some cases and different contexts, the objective of survival is more important (such as during an economic recession where consumer spending is reduced). Alternatively, a business may value the objective of increasing market share more highly; gaining a greater proportion of the total market might be seen as an important step in attaining loyalty (profit maximisation could be sought thereafter).
QUESTION: In your own words, explain one situation where profit maximisation might not be the most important objective for a business.