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Explain the differences between wealth maximization and profit maximization. Explain relation between finance and accounting.

Answer: Wealth maximisation vs. profit maximisation
  • ·         Wealth maximisation is based on cash flow. It is not based on the accounting profit as in the case of profit maximisation.
  • ·          In an organisation, shareholders typically own the company, but the management of the company rests with the board of directors. Directors are elected by shareholders. Company management procures funds for expansion and diversification of capital markets.
  • Through the process of discounting, wealth maximisation takes care of the quality of cash flow. Converting uncertain distant cash flow into comparable values at base period facilitates better comparison of projects. The risks that are associated with cash flow are adequately reflected when present values are taken to arrive at the net present value of any project.
  • ·         When a firm follows wealth maximisation goal, it achieves maximisation of market value of share. A firm can practise wealth maximisation goal only when it produces quality goods at low cost.
  • ·         Another notable feature of the firms that are committed to the maximisation of wealth is that, to achieve this goal they are forced to render efficient service to their customers with courtesy. This enhances consumer welfare and benefit to the society.
  • ·         From the point of evaluation of performance of listed firms, the most remarkable measure is that of performance of the company in the share market. Every corporate action finds its reflection on the market value of shares of the company.
  • ·         Since listing ensures liquidity to the shares held by the investors, shareholders can reap the benefits arising from the performance of company only when they sell their shares.


Relation between Finance and accounting

In the hierarchy of the finance function of an organisation, the controller reports to the CFO. Accounting is one of the functions that a controller discharges. Accounting is a part of Finance. For computation of return on investment, earnings per share and for various ratios of financial analysis, the data base will be accounting information. Without a proper accounting system, an organisation cannot administer the effective function of financial management.

Since financial decisions are futuristic, they are taken and put into effect under conditions of uncertainty. Assuming the condition of uncertainty and incorporating the effect on decision making results in use of various statistical models. In the selection of the statistical models, element of subjectivity creeps in. The relationship between finance and accounting has two dimensions:
(a) They are closely associated to the extent that accounting is an important input in financial decision making
(b) There are definite differences between them

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