Profit/EPS Maximization Decision Criterion
According to this approach, actions that increase profits (total/EPS should be undertaken and those that decrease profits/EPS are to be avoided. In specific operational terms, as applicable to financial management. The profit maximization criterion implies that the investment, financing and dividend policy decisions of a firm should be oriented to the maximization of profits/EPS.
The term profit can be used in two senses a counter-oriented. It refers to the amount and share of national income which is paid to the owners of business that is, those who supply equity capital. As a Ontarian, it is described as profitability. It is an operational and signifies economic efficiency. In other words, profitability refers to a situation where output exceeds input, that is, the value created by the use of resources is more than the total of the Input resources. Used in this sense, profitability maximization would simply that a firm should be guided financial decision making one test asset, and-reject those which are not in the current financial literature, there is a general agreement that profit maximization is used in the second sense.
The rationale behind profitability maximization. as a guide to financial decision making, is simple. Profit is a test of economic efficiency. It provides the yardstick by which economic performance can be judged. Moreover, it leads to efficient allocation of resources, as resources lend 10 be directed to uses which in terms of profitability are the ‘most desirable. Finally, it ensures maximum social welfare. The individual search for maximum profitability provides the famous invisible hand by which total economic welfare is maximized. Financial management is concerned with the efficient use of an important economic resource (input), namely, capital. It is, therefore, argued that profitability maximization should serve as the basic criterion for financial management decisions.
The profit organisational criterion has, however, been questioned and criticized on several grounds. The reasons for the opposition in academic literature fall into two broad groups: (1) those that are based on misapprehensions about the work ability and fairness of the private enterprise itself, and (2) those that arise out of the difficulty of applying this criterion in actual situations. It would be recalled that the term objective, as applied to financial management, refers to an explicit operational guide for the internal investment and financing of a firm and not the overall goal of business operations. We, therefore, focus on the second type of limitations to profit maximization as an objective of financial management? The main technical flaws of this criterion are ambiguity, timing of benefits, and quality of benefits.