The Purpose of Profit

Profit is the ultimate test of business performance.

Profit serves three purposes. One it measures the net effectiveness and soundness of a business’s efforts. Another is the “risk premium” that covers the costs of staying in business – replacement, obsolescence, market risk, and uncertainty. Seen from this point of view, there is no such thing as “profit”; there are only “costs of being in business” and “costs of staying in business.” And the task of a business is to provide adequately for these “costs of staying in business” by earning an adequate profit. Finally, profit ensures the supply of future capital for innovation and expansion, either directly, by providing the means of self-financing out of retained earnings, or indirectly, through providing sufficient inducement for new outside capital in form in which it is best suited for the enterprise’s objectives.

ACTION POINT: Decide to pull the plug on an unprofitable business if it is not covering the cost required to stay in business or providing enough capital for future growth.

The Practice of Management