Wealth Maximisation – A Modern Approach for Businesses

You may find businesses talking about wealth maximisation rather than profit maximisation. Why is it so popular to businesses nowadays?

What is wealth maximisation?
Wealth maximisation focuses on the cash flow amount that can be generated by a course of action. The goal of wealth maximization for businesses is to maximize shareholders’ wealth or the company share’s market value or earnings per share (EPS).

Why wealth maximisation is more important?
Wealth maximization goal has discounted stream of future benefits exceeding costs for any financial actions to create more wealth. As a result, wealth maximisation counts the time value of money which considers a long term approach.

Agency problem – Owners vs Managers

Agency problem is the conflict between shareholders and managers due to the difference of interests. Unless the managers own the company’s stock, they will not gain benefits from the wealth maximisation goal.

Earnings per share (EPS) – How to increase?
Earnings per share are a good way for you to compare companies before you make any investment.

Here is how it is calculated:
EPS = Net Earnings / Outstanding Shares

EPS is the most important indicator to determine a share price which suggests a company’s profitability. To increase earnings per share, a company needs to decrease the number of shares to increase earnings for their shareholders. The company can buy back their shares to reduce the share number in the market. Moreover, they need to try to increase their revenues or cut down their expenses.