I am always amazed that so many individuals condemn profits as evil or at least bad. The idea of making a profit has acquired a bad name and this is due to a gross misunderstanding of what exactly is a profit. One of the reasons profits have acquired a bad reputation is that we may associate their size with over reaching for money. Another is that somehow anyone who makes a profit on some enterprise must be motivated strictly by the money that is made. Well, what does it profit a man to make a profit and lose his soul? With that in mind let us examine this idea of profit.
Properly understood, a profit is an accounting entry. That is, after subtracting the cost of labor, material, and routine operating expense such as electricity, water, and so on, we are less with a surplus of income. Now our operating expenses may include payments for such services as advertising, selling, transportation of the product, monthly payments to service loans and provide payments to sinking funds (the funds that repay the original loan, debt, or note), property taxes, business expenses (the license, the annual fees, etc), and so forth. There can be a number of fixed expenses when operation a business. If one buys medical insurance for one’s employees one must pay the premiums whether the employees are working or not. Things such as payment for vacations, telephone service, internet access, and the like continue whether one has income or not. Just existing as a business is an expensive proposition. The various local, state, and federal government forms must be filled out and sent in as failure to do so can result in fines.
So we see that being in business is more than selling a few goods or services and reaping a lot of money. Corporations and companies such as sole proprietorship or partnerships require money to stay alive. And they often invest funds for improvements to the business. A business that that wishes to keep its debt load low will fund improvements out of its retained earnings. Retained earnings is a way of saying that whatever profits one makes, a portion or all of it is kept for the purpose of investing it in the business. That investment may be training of employees or the building of more facilities or the purchase and installation of more equipment. Sometimes earnings are retained simply to keep cash or its equivalent on hand, much as a savings account works for us. Emergencies arise and one needs funds to deal with them. Prudent financial planning requires such actions. And if one has sold shares of stock in the public market one must remember that each share of stock has a right to participate in a share of the profits of that corporation. The shareholders may vote to refrain from withdrawing that share, the reason may be a wish to grow the business so as to eventually receive a larger share. And such dividends usually raise the price of the shares of stock so that the investor may receive a greater price for each share of stock that the investor owns and wishes to sell.
Sometimes profit is confused with margin. Apple used to make a margin on its iPhone of fifty percent or more. That margin has dropped. Margin is the difference between the price received for a product or service and the cost to provide it. This is before tax and operating expenses. Apple has traditionally make a very large margin on its products. But once products become commodities, the margins drop and become somewhat slim. We see that at the grocery store where the average margin of all goods sold in the store is about five percent and the average earnings are no more that two or three percent. when it comes to profits, the grocery chains are barely profitable. Apple, on the other hand is extremely profitable. On a more local level, the plumber has high fixed costs in terms of equipment needed, insurance, and advertising. But because a plumber needs a master plumber license to undertake a great number of different kinds of work (replacing the water supply line from the water meter to the house, installing natural gas lines for appliances, and etc) and such a license requires a great many hours and years of training and certification, the earnings are large and the profit accordingly so. Many times a city or country planning department will not issue a permit for plumbing work unless it is to be done by a licensed plumber.
We can see that profit has a place in the scheme of things. Profit is the cost of doing business in the future. After all, in your own life would you purposely undertake to work for less that it may take you pay the daily living expenses? sometimes you have no choice. But usually we like to make a wage that pays our bills and a little bit more. We want to save for our retirement and that means contributions to a 401K plan. This is what our ‘profit’ does for us. Of course we could continually overspend our means, pile up debt to the point where we can no longer service let alone pay off that debt. But with a little financial planning we can live well within our means and invest that profit we earn into savings or other forms of investment. Profit is not a bad thing, a dirty word. It is good and we need profitable individuals, families, and companies so that our economic world does not collapse. Profit is a good thing.