Profit is used to measure a business's success. It is the yardstick entrepreneurs use to know if they are doing well. An entity not making a profit implies that its capital or equity is being utilized for business survival. And if eroded, it may result in business failures.
What should you know?
Startups that bootstrap rely on the profit or earnings they make yearly. However, when losses are incurred by a startup in its early stage, it will require more equity and/or debt capital. More so, where a startup has enough cash flows and still makes losses, it may survive the period of losses.
Earnings rather than cash are the primary measurement for a company's growth. Dividends are paid out of profit and some businesses are valued based on their earnings per share. So, more earnings mean better value.
While startups are not expected to profit in their first few years, they need enough capital to stay afloat and run the business effectively. Failure to have sufficient cash flow results in the entity not meeting customers' needs on the due date.
In addition, profit is not the net present value (NPV) of an investment. When a company plans on capital expenditure, it usually measures the NPV of the investment. This is different from earnings. Although, a positive NPV may translate to profit, if other expenses are minimised. Below we discussed the ten importance of profit to a business.
1. Business Growth
The profit or income earned in a business can be ploughed back and used for growth and expansion. This is referred to as bootstrapping. For large companies, part of the profit is held for business growth, and the remainder is shared with shareholders as dividends.
2. Source of finance
Retained earnings are an internal source of funds to an entity. Retained earnings are the accumulated profits a company has earned over the years. It increases the business capital, thereby providing a useful source of finance.
3. Improve operational effectiveness
The excess income can serve as working capital. This is used to ensure daily business operational needs are met. Also, in the period of high sales volume, the available excess income can be utilized to ensure operational effectiveness.
4. Decision making
Segmented profit can help senior managers decide which segment is doing well. Therefore, departments and subsidiaries that are not profitable are discarded. We can say that profitability can ease managers' decision-making.
5. Improve borrowing capability
Lenders, banks, and debt holders are willing to lend to entities with profits. Before companies request loans from banks, the bank asks for their financial statements. These financials help the bank in deciding the amount of loan they are willing to offer the company. If a company earns more profit, it can borrow more loans from the bank.
6. Business survival
Just as in business growth, a company that is incurring losses for several years can only recover from such losses when it starts earning a profit. As it does, it increases the shareholders' fund and ensures the business's future survival.
7. Attract investment
Investors are willing to invest in companies that are making profits. The reason is that these companies have a better future and the reward for their investment is assured. Value investors are interested in companies that have sound profitability. Why, value investors are interested in dividend payout which is usually from profit.
8. Support communities
It is not possible for a loss-making company to be interested in supporting the communities where it carries out business activities. However, profit-making entities try to support their communities through good roads, streetlights, employment, climate improvement, green products, and more.
9. Pay taxes
A company that doesn't earn excess income cannot pay good taxes to the government. After computing taxable profit or loss, a company will pay a minimum of 25 percent in taxes.
10. Effective financial management
Earlier, we said that retained earnings are an internal source of finance. Therefore, the finance manager is responsible for the effective and efficient usage. There should be a financial plan on how the retained earnings will be used and a financial control vehicle to safeguard the fund.
Post a Comment