Objectives of The Business Firm 1
Objectives of The Business Firm 1
INTRODUCTION
Economic theory underscores the fact that each firm in the industry operates
under competitive conditions and hence tries to operate more efficiently to
withstand the competition. The indicator of efficiency is profits. The assumption
here is that each firm has one man as the owner and entrepreneur, and that his
sloe aim is to maximise profits.
In common man’s language, profit means the excess of income over costs. In
economics and managerial economics profits refer to rewards for entrepreneurial
skills . some economists believe that profit is a reward for entrepreneurial skills,
while others regard it as a remuneration for the entrepreneur and not a reward for
his entrepreneurial skills. In this sense, profit is regarded as income accruing to
equity holders, in the same sense as wages accrue to labour ; rent accrues to
owners of rentable assets ; and interest accrues to money lenders.
Profit is always linked with risk and uncertainty. Therefore profits differs. First, it
is the residue of the income after other factors of production--- namely, land
labour and capital --- have been paid for . Therefore profit does not mean fixed
remuneration--- like rent wages and interest. Profits fluctuate, and, therefore,
they are either positive or negative. Profits fluctuate because of the fact that
business involves speculation, risk, and operations under uncertain conditions,
that is under conditions of uncertainty.
Example
The dress making industry is highly volatile because fashions change quite often.
Now, if a businessman brings a new fashion into the market, it may click or it may
not click.
2. Profits also emerge as a result of innovation. Innovation means that one brings
some new product into the market following laboratory and market research.
Example
Before Nescafe was introduced, coffee drinkers depended upon filters., and it
took some time to prepare the decoction Once Nescafe was introduced, coffee
drinkers ceased to depend upon filters, because coffee powder dissolved
instantaneously in water.
3. Profits may also from some advantageous conditions. In the present imperfect
competition, Monopolistic conditions have set in. There is heavy product
differentiation. One particular brand may capture the market and drive out
competitors and substitutes as well. Such a situation arises out of some
advantageous or accidental conditions. Again, a firm may enjoy a monopoly; if
does, it rakes in huge profits.
4. Profits arise out of a sudden windfall. The demand for a particular product, for
example may shoot up sky-high; the businessman makes enormous profits
Profit Measurement: Profits are measured over a period of time --- generally a
year. That is from 1st April to 31st March. Profits are measured by accountant in
accordance with accounting methods. But the economists approach is different
from the accountant. While calculating profits, the accountant deducts the
expenses from the revenue of the company. But when expenses are considered
he takes into account only the explicit costs; that is, actual costs. The economist
on the other hand, does not stop at explicit coasts, he takes into account imputed
costs as well. By imputed costs we mean, the costs that would have been
incurred on any item if it had not been owned by the company.
Example:
A firm may be housed in its own building. Now the economist calculates the rent
of the building at the prevailing market rate and treats that as cost. This is known
as imputed cost.
It is evident, then, that the accountant and the economist differ in their approach
to the measurement of profits. The formula may be written as follows:
Accountant’s Formula
Economist’s Formula
Economic profits are considered to be more realistic from the managerial point of
view because they project a true financial picture of a company.
There is no reason to believe that all businessmen pursue the same objective”
Recent research on this issue reveal that the objectives that the business pursue
are more than one. Some important objectives other than profit maximization are
: (a) maximization of sales revenue, (b) maximization of the firm’s growth rate, (c)
maximization of manager’s utility function, (d) making satisfactory of profit,(e)
long-run survival of the firm and (f) entry prevention and risk avoidance
The factors which explain the pursuance of this goal by managers are the
following:
First, Salary and other earnings of managers are more closely related to sales
revenue than to profits.
Second, Banks and financial corporations look at sales revenue while financing
the corporations.
Fourth, Increasing sales revenue increases the prestige of the managers while
profit goes to the owners.
Finally, Growing sales strengthen competitive spirit of the firm i n the market and
vice versa.
4. Satisfying Behaviour
Apart fro dealing with the uncertain business world , managers will have to satisfy
a variety of groups of people – managerial staff, labour, shareholders, customers,
financiers, input suppliers accountants, lawyers, authorities, etc. All these
groups have their interests in the firms – often conflicting . The managers
responsibility is to “satisfy” them all. This “Satisfying Behaviour” implies satisfying
various interest groups by sacrificing the firms interests or objectives.
In order to reconcile between the conflicting interests and goals, the managers
form an aspirational level of the firm combining the following goals: (a)
Production goal (b) Sales and market share goals (c) Inventory goal and (d)
Profit goal.
Production Goal
The production targets is the outcome orders booked by the marketing department.
The marketing department sends its requisition to the production department indicating
the quantity required and the time period within which the quantity is required. To keep
up both the volume of production and deadline, the production department plans its
production schedule. The problems faced by the production department are
Inventory Goals
Inventory could mean stock of raw materials, stock of spare parts and stock of
finished goods. Inventory is expressed in terms its monetary value ; that is in
terms of costs. The cost of holding stocks include
All these expenses have to be incurred, and these are know as inventory costs.
Therefore the higher the level of stocks to be maintained, the higher the cost of
maintaining them. This is known as cost of holding stocks.
Then there is the cost of what is known as stock-out. If the stock-out situation
happens in the case of raw materials, it could cause a interruption in the flow of
production and thereby reduce the availability of the product to the customers.
This will lead to a loss of goodwill in the market and would lead to a loss of
customers.
So a balance has to be struck between high inventory and the resultant inventory
carrying costs and minimum inventory to avoid stock out situations and the
accompanying loss. These can be done by several inventory control methods
and inventory management.
Sales Goal
The sales department generally keeps a target and every year it tries to achieve
the target. Sometimes, the sales department tries to push the sales beyond the
target and as a consequence the firm tries to increase its output. A stage comes
when the output is optimum and that the profits are at their maximum. If a firm
produces beyond this level, it incurs losses. The first stage, that is, when the
profits increase, with an increase in output, in known as increasing returns. The
level of output at which profits are maximum is known as constant returns.
When the output is increased beyond a certain point, resulting a decline in
profits, the process of decreasing returns sets in. In the language of
Managerial Economics, we say that is the sales department pushes sales
beyond the point of constant returns, diminishing returns sets in. Sales, therefore
should not be pushed beyond the profit maximising point.
Every company constantly strives to increase its market share. Therefore, the
goal of market share is linked with the goals of those persons in a firm who are
interested in increasing the market share, so that their company may occupy a
better position in the market than its competitors.
CONCLUSION
The goals discussed so far --- namely, production goal, inventory goal,
market share goal, and the profit goal are interlinked.
2. The sale department may not be able to market the entire production and
there might be losses.
4. The sales department may boost sales and the market share of the firm
may go up but only in terms of cost of diminishing returns.