The most popular business books seem to be on the “soft” topics. Things like managing people, setting your BHAG/mission/vision/values, creating happy employees; stuff like that. I’m an avid reader of this kind of stuff. But, at a certain point, don’t all of us as business people have get on with it and make money?
Charlie Munger, Vice-Chairman at Berkshire Hathaway, calls this, “Soft skills, hard results.”
In my opinion, there is no panacea in business. But profit comes close. If a business is profitable, there can still be many challenges. But profit will generally help solve those challenges.
Profit takes several forms. There is gross profit which is the difference between revenues and cost of sales. To my way of thinking, this is the quantification of your value proposition. It is what value you provide (what your customers are willing to pay you) compared to your cost of providing your good or service. For most businesses, gross profit, especially as a percentage of sales, is a Key Performance Indicator (KPI).
Profit is also often measured by project, business line, department or location. In any case, this is usually similar to gross margin. Sometimes overhead is allocated to each project, business line department or location but this really confuses the issue since any allocation is going to be somewhat subjective.
Profit by project, business line, department or location, and including any allocated overhead, is before the “corporate” overhead. Just as gross margin is before corporate overhead.
Net profit is important too. It is the proverbial “bottom line.” That is, the net income after everything is considered. Put another way, it is the gross profit less selling, general and administrative expenses. For most businesses, this is another important KPI because this is the most comprehensive view of the organization’s performance.
Sometimes profit doesn’t mean cash flow. For example, if goods or services are sold on account, there can be a significant delay until the account receivable is collected. If you’re a construction contractor there is often a gap between when a progress payment is earned and when the cash is received. But this is a timing issue and usually can be solved by short-term borrowing to bridge the gap.
Why do I think profit is so wonderful? Mostly because it gives one choices. With profit you can lower prices if you need to, pay employees more in compensation or benefits, invest in future growth or invest in innovation. Or any number of other things; all good options. You can also, as the owner, take more out of the business, pay off debt or save for a raining day. Choices are good.
Without profit or with little profit, your choices are constrained. Tight cash flow usually follows poor profitability. The situation is tense and there is little margin for error. Typically, the situation becomes progressively more desperate. Over time, if you can’t make money do you really have a business or do you have a non-profit organization?
Profit is also the reward for entrepreneurial risk. It is a scorecard of success. Profit is good if it is ethically derived from a legitimate business.
Let’s sing the praises of profit.
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