The function of profit

The nature of business discussions usually begin and after initial deliberations the concerned are ready to talk of profit and profitability. For profit is not a cause. It is the result of the performance of the business in marketing, innovation and productivity. It is at the same time the test of this performance, the only possible test, as the communists in Russia soon found out when they tried to abolish it in the early twenties. Indeed profit is a beautiful example of what today’s scientists and engineers mean when they talk of the feed-back that underlies all systems of automatic production: the self regulation of a process by its own product.

Decision making by firms is often subject to certain restrictions or constraints, which may be internal or external. The internal constraints refer to the ones imposed by the organization itself. For example, while deciding on what to produce, a firm might not like to explore each and every alternative goods or services it could produce. If the promoter, for example, is a fresh engineer with a little money of his own and is a risk averter, he might consider only a handful of small manufacturing firms to choose just one amongst them. Instead, if the promoter is a vast business enterprise and has the objective of creating employment for unskilled workers, they might decide to establish a large manufacturing unit which can employ unskilled labor.

But profit has a second function, equally important. Economic activity because it is activity, focuses on the future; and the one thing certain about the future is its uncertainty, its risks. It is no accident that the word “risk” itself in the original Arabic meant “earning one’s daily bread”; it is through risk taking that any businessman earns his daily bread. Because activity is economic it always attempts to bring about change. It always saws off the limb on which it sits, always on purpose making existing risks riskier or creating new ones. This future of economic activity is a long one; it may take fifteen or twenty years for basic decisions to become fully effective and for major investments to pay off. “Lengthening the economic detour” has been known for fifty years of necessity for economic advance. Yet while we know nothing about the future, we know that its risks increase in geometric progression, the future ahead we try to predict or fore ordain it.

It is the first duty of the business to survive. The guiding principle of business economics, in other words, is not the maximization of profits; it is the avoidance of loss. Business enterprise must produce the premium to cover the risks inevitably involved in its operation. And there is only one source for this risk premium: profits. Indeed business enterprise must provide not only for its own risks. It must contribute towards covering the losses of those businesses that operate unprofitably. Society has a real interest in active economic metabolism in which some businesses always incur losses and disappear. This is the main safe guard of a free, flexible and “open” economy. The enterprise must also make a contribution to the social cost- the schools, the armaments, etc., of a society; that is it must earn enough to pay taxes. Finally it must produce capital for further expansion. But first and foremost it must have enough profit to cover its own risks.

To summarize whether it is the motive of the businessman to maximize profits is debatable. But it is an absolute necessity for the business enterprise to produce at the very least the profit required to cover it own future risks, the profit required to enable it to stay in business and to maintain intact the wealth producing capacity of its resources. This “required minimum profit” affects business behavior and business decisions both by setting rigid limits to them and by testing their validity. Management in order to manage needs a profit objective at least equal to the required minimum profit and yardsticks to measure its profit performance against this requirement.