Meaning of profit
Profit is defined as the reward for taking the risk and doing investments in the business. It is the surplus amount that a business earns overall its costs and expenses. It is simply the difference between the total sales of the business and its total cost. Profit is the motivating factor for every business to continue its operations.
Earning profit is the ultimate aim for every business as it affects its growth and survival in the market. If a business is not able to generate profit then it will ultimately discontinue its operations. Profit is termed as the basis for measuring business efficiency and success. The businesses earning large profits are termed as the most efficient and successful in the market.
Every business aims to earn more and more profit by increasing its sales and minimising its cost. Good profit earning business has a better image in the market and can easily attract funds from investors, banks, shareholder.
There are basically three types of profits which are analysed for measuring the success of every business- Gross profit, Net profit and operating profit. Gross profit is the profit earned after deducting direct expenses from the Net sales of business. Operating profit is the profit earned after deducting indirect expenses from the Gross profit of the business, whereas Net profit refers to profit arrived after deducting all expenses like taxes and interest from operating profit of the business. The role and importance of profit for every business can be well understood from the following points given below.
Role of profit in business
Essential for Survival
Profit is essential for every business for its survival and growth. Businesses exist and carry on its operations with a view to earning the profit. If a business is not earning sufficient margin over its cost by selling its products then it will lead to losses for the business, ultimately forcing it to discontinue its operations. Therefore, profit is the ultimate aim for which business exists and is important for its survival.
Reward for Shareholder
Shareholders get a reward in the form of dividend for investing their money. These dividends to shareholders are paid out of profit earned by the companies. Higher profit will lead to the declaration of a higher dividend to shareholders by the company. Whereas if a company is not earning enough profit or generating losses then it will be not declared any dividend for its shareholders.
Helps in Hiring Better Employees
Better employees help the business in maximizing their productivity and overall efficiency. High skilled employees expect higher return in the form of remuneration from its employers. If a business is able to generate higher and sufficient profit then it can easily hire and pay these high skilled employees. On the other hand, if the business is not earning enough funds it will definitely hire cheap and low skilled employees.
Affects Business Market Value
Profit has a direct influence on the market value of the business. Stock prices of profit earning companies automatically goes up due to their profit-earning capacity. Everyone is willing to invest in the stock of high profit-generating companies with a view to earn large dividends. This increases the overall market value of the business and sets a positive image in front of all.
Affects the Ability to Borrow
Business generating adequate profit have a better ability to borrow funds. They can easily borrow funds anytime in market from different lenders available. Profit of the company determines its ability to pay back the borrowed sum of money. Lenders look at profit of business to analyse their payback ability. They won’t lend any amount to non-generating business.
Measures Management Effectiveness
Profit helps in measuring the efficiency and effectiveness of management in business. Amount of profit earned by business clearly depicts the efficiency of its management team. If a management is working effectively then the overall cost of businesses will be minimised increasing its productivity and return. Whereas, if management is inefficient in managing the business affairs then it will have adverse effect on its productivity and cost of operation.
Profit generating business have a better and positive image in the market. Every investor looks at the profit earning ability of business while doing any investment or lending money. High profit means that a business will be able to provide better returns over its investments to its investors. This attracts a large no. of investors who are always willing to invest their money in these profit-generating companies.