Should Your Business Produce a Profit?

There continues to be an ongoing argument regarding ProfitLossthe profit motive of capitalism. Those against profit argue that owners, significant company executives and shareholders are motivated by greed at the expense of employees in order to line the pockets of a few.  Is this true, an exaggeration or an attempt by special interests (idealogs), to target and demean those who have overcome significant obstacles and risks to build profit producing businesses that are the cornerstone of the strongest economy in the world?

Key Questions:

  • Should your business produce a profit?
  • Should an owner or significant executive be motivated by the need and desire to produce a profit?

Profit Definition
A business is dependent upon making a profit if it is to succeed and grow.  Profit can be defined as that which remains after paying the cost of sales and production from the revenue produced during the same period. Profit by this definition would be where revenue would exceed expenses, “which creates” a surplus or profit.

Getting a Loan in place of Profit
If business did not cover the cost to sell and produce a product or service, it would need to find a benefactor to loan the business money to pay what the business could not pay for. The business would then have an additional liability during the next period – to pay off the loan used to pay for what it could not cover by the previous period operation.  In this scenario, who would rush forward to loan money to this business?

Ability to Invest in New Opportunities
If expenses are just covered but produces, very little profit, then the business is limited in what opportunities it can pursue that require additional investment, such as opening another location, starting another line of business or hiring additional employees.  Investment money is needed, in order to implement these strategies.

If the business is producing and accruing profits, then it is creating reserves to afford the new direction of the business until the strategy begins to contribute “profit.”

Creditors/Customers
Often overlooked when a business grows or goes through an economic down turn, are the interests of creditors and customers.  Products and services that the business purchases from a supplier involve a payment period that may be anywhere from C.O.D., 30 to 60 days.  When a supplier extends the business 30 to 60 day payment terms, they are giving the business a loan. Before these terms are offered, the supplier may ask the company for financial data to demonstrate that the company has sufficient business viability to pay off its obligations.

Customers may ask for an even longer payment period exceeding 60 days because they may be waiting for their customers to pay, which then allows them to pay the suppliers they do business with.  A customer wanting to pay beyond 60 days may ask for financial data that will reveal that doing business with the supplier will not result in a financial hardship for the supplier. This could jeopardize the ability of the customer to order products over time and avoid a costly resourcing process and, in some cases, an expensive and extensive certification process (particularly true in aerospace), for the product they are buying.

Attracting External Investment
If reserves have not been produced from previous period profits and the owner or management team feels strongly about pursuing a new direction, then they would need to seek external investment.  External investment can come from a bank loan or attracting new investors to the business.  In both cases, the bank or investor would look at the ability of the business to produce a return on the investment.

A bank would want to assess the credibility of the company to produce surplus (profit) that can pay off the loan (including interest which the bank needs to support its profit objectives) within the terms of the loan agreement.

An investor would be interested in how their investment would grow in value, which would normally be the participation in the distribution of profit (or a percentage of profit) to investors.

Business Cycles and Profit
Business cycles are often hard to predict. Profit during up business cycles (if accrued) can be used to off set “losses” during, the down cycles.  Profit contributes to the working capital of the business.  Seasonality or difficulty forecasting customer demand can result in a month of negative profit (loss), which can be offset, by profit accrued by earlier periods instead of rapidly downsizing the operation or cutting expenses (i.e. salaries).

During longer negative cycles company leadership may elect to retain key employees instead of laying them off due to their value to the business.  Profit accrued in earlier periods is then used to cover their expenses (paychecks and benefits) until the extent of the down turn is determined or until business conditions improve.

Small Business Profit
For many small businesses, profit represents income to the owner, which fluctuates with the success of the business.  While employees may have a guaranteed income during economic down turns, it is not uncommon to find the owner absorbing major changes in their income while protecting the payroll for their employees and providing working capital for the company.

Those critical of profit centric business ostracize small business owners for “doing well”, demeaning their values and motives as examples of greed. These critics do not take into consideration what the owner has experienced during weak business cycles or the risk they have taken starting and running a business that poses significant risk to their personal assets in the event of business failure or legal issues

Summary
Can you now answer the key questions at the beginning of this article? Yes, as a business owner or member of a leadership team, the business should have a strong profit motive.  The leadership team and organization should have a strong profit motive to achieve this objective.

Successful businesses will manage the “profitability” of the business wisely:

  • Investing in new business strategies that produce profits.
  • Provide a market competitive distribution of profits to investors and employees.
  • Direct portions of the profit to the community in which it resides or “serves.”
  • Retain profit as a hedge against business down cycles.

Will there always be examples where owners and corporate leadership misuse profits? Yes, but they will represent a very small percentage of all companies that manage profit responsibly.  Not all businesses master the “profit” objective and ultimately run out of cash and fail.

Profit is good and should be embraced by not only the owner but the entire organization as well.  A healthy profit motive is good for owners, leadership, employees and customers.

Your business should produce a profit!

Comments

  1. Very helpful information. Thanks for sharing.

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  2. Thank you for your comment kumar!

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