A buddy at work didn’t understand why corporations needed to try to make, what he called “huge profits“, so I thought I’d share my thoughts on the topic.
Have you ever been to a soccer (or basketball or football) game where the opposing team looked like they were standing still, and the game was a huge mismatch?
Well, that is exactly what would happen if the companies don’t try to make a healthy profit. Nobody invests in the company, and there is no motivation for the company employees to try. In fact, company can have a better product and still fail to an inferior product from a competing company because of the lack of profits! The failure of a superior product to an inferior one is why profits and the abilities of the management team (CEO, etc) to achieve them are so important.
Why wouldn’t the company employees try, you might be wondering?
Well if your company isn’t profitable, your company isn’t going to give bonuses and may not even give raises (this is obvious given the past few years). We go to work to feed our families and make money so we can use the cash to buy stuff to make our lives better. Without the hope of future raises and bonus, we start to look for other places to get ahead in life! (Note, this doesn’t apply directly to government workers, but indirectly it does. If companies and their employees don’t make money, governments don’t get taxes, and eventually government workers are affected too).
I think my friend didn’t really understand what happens to the profits after they are declared. First, the profits that the companies make don’t just disappear… They are distributed as dividends to the shareholders, used to buyback outstanding company shares or saved and used for future company growth.
Even if the money is just held in cash, that money still belong to the shareholders of the company! Occasionally, you’ll see a company like Microsoft give a huge cash dividend. This is because they have enough money in retained earnings to cover their future needs, so the excess is given back to the risk takers (stock owners like us) that invested money in the stock. Actually dividends are a good wealth distributor and benefit all of us in one way or another, vs private companies like Fidelity. Private companies don’t even have to report their profits publically!
So given the choice been a company that is very profitable and one that doesn’t really care about money and isn’t expected nor even tries to earn a profit, I’m going to pick the one to invest in that cares about a profit! And I’m betting so would you if you want to be a successful investor!
I’m writing this article today, because sometimes we don’t see all the pieces of a business process. Just because those pieces are not in the media or communicated out doesn’t mean that they aren’t critical for a given company, and in the end society as a whole! So yes profits are necessary…
What is your take on company profits? Do you understand why the are necessary?
MR
I recently heard on the news that American companies are holding unto something like $2 billion dollars in cash. During a normal economy they would, as you pointed out, reinvest it in the business, make capital purchases, give out dividens, etc, but, since they’re scared about the future, they’re just holding onto it. As we can see, it’s not doing much for our economy right now!
That because of the policies of the government. Where at one minutes they help businesses (bailout), then they punish them the next, via a lawsuit, and other contradictory policies…
The government has no direction that currently makes sense, they need to focus.
Businesses are made up of people like us, and if you don’t help people with rules that make sense, then people shut down. This is exactly what is happening!
Money sitting on the sidelines isn’t making profit, this is not what the company executives want to do, I’m positive! But if nothing makes sense, companies made up of people like us pull out their investment and wait for the storm to pass.
The government need to wake up and realize this. The white house in particular is a huge part of the problem. I’m ready for the elections!
I will tell just this: when we did not hit any profits in 2008 and 2009, we had HUGE lay offs. It was horrible. So my take on this is simple now – I’d rather companies make profits, reinvest it, and keep their people.
Oy, what a nice surprise… Welcome back!
Yeah, I can’t figure out why people want to hurt companies… Companies are made up of people like them, so when the government and others try to hurt companies, they have to lay off people (or work close their doors). All the people that they hire now don’t have a job.
I think people are not thinking beyond greed and envy. It’s like sitting on a tree branch, and at the same time sawing the branch to cut it off, but you are sawing between your body and the tree… you’re going to fall eventually…
I actually feel bad for those seniors in retirement that were depending on the dividends provided by banks like J.P Morgan.
Oh, and great to see you back! I still think of that great article on China you did a while back. I literally felt like I was there through your words! 🙂
Without the profit motive, there’s not much incentive to grow. Companies that make HUGE profits usually invest them in other companies. Sometimes acquisitions don’t work out, but for the most, I think it’s a positive to the economy.
Yeah, I think my buddy (who is very smart) just wasn’t business oriented and didn’t realize the benefits of company profits. The money isn’t sitting under the mattress of the CEO and executive board… That money is doing exactly what you said, investing it back into other businesses…
Corporations are bligated to earn profits for their shareholders. Even if you were a private company, you should earn a profit. That is why you are in business.
Very true… My buddy was acting surprised when I told him that’s why they exist! Surprisingly, he himself surely wouldn’t work for free, but he expects everybody else to… what a laugh…
Of course a corporation aim to make a lot of profit. That’s the whole system right? If their aim is not to make profit, then they probably fits better as a non-profit entity.
exactly, but what non-profit can compete with aggressive businesses overseas? Interestingly, non-profit CEO make pretty good money too…
Of course, it makes sense why companies would want and need to make a profit. That’s how you stay in business. I think there’s a difference though between being making good decisions that lead to profits, and huge profits at any cost. I do not believe that always doing what’s most profitable without considering the long term & other impacts is what’s best for the shareholders.
Hopefully, most large public companies are smart enough not to go after profits without considering the consequences of making harmful decisions. Actually I think most realize that have higher visibility and are scrutinized more so than smaller companies.
It’s the small to medium companies that are private that have the make profits no matter what mentality (at less some of them). They are the ones you have to worry about!
Profits are essential to well-run businesses. I am not sure how well-versed in how companies work your friend is, but I think you make some very interesting points. As you indicate, the profits shouldn’t just disappear. Some profits are reinvested for growth (acquiring, hiring, etc), some go to dividends, some go to develop new products. They (profits) are essential.
I’ve come to realize that just because a person is intelligent, doesn’t mean that they aren’t naive in matters that they don’t have expertise or at least some background in. I’ve found that they (like my buddy) just blindly follow whatever is regurgitated out by then TV shows.
This is a bad way to learn and form an opinion on a matter. And I have to admit that in the past I’ve done the same (shame on me). But now I’m awake and aware! I now do the research myself and try to take in all angles and decide for myself. It took me a while to get to this point though…
It is a process to not accept things at face value, but it is also worthwhile. All too often people can be eloquently wrong or at least relentlessly biased!
good points..but still don’t understand why this isn’t a common sense to everyone. I don’t understand why your friend asked such question.
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To put it bluntly it sounds like your friend is completely disconnected from real life…the sort of guy who would ask why the Credit card company is allowed to charge interest on money borrowed.
Notwithstanding a public corporation’s sole mandate is to make money…period.
Interesting post/comments. I would like to just stick up a little for your friend who asked the question. In itself it is quite “obvious” why a company would want to make profits. I am self employed and as such, I have to earn more than I spend (resulting in profit) if I am to survive.
However what is not so obvious (and perhaps THIS is what your friend was getting at?) that once a company has made it’s profit, paid its wages/overheads/dividends etc, AND kept enough back for reinvestment/growth, what is the purpose of any surplus? When we hear about BIG businesses making literally billions of dollars/pounds/euros in profits, what happens to all that money? Why do these companies need to make SO MUCH profit? Is it simply greed? Saving billions for a rainy day? Every year they seem to pile billions of profit ontop of billions of profit – surely they are not reinvesting all of that? If this were the case then surely there would be little/no unemployment?
Recently we heard Apple is sat on something like $5 billion it doesn’t know what to do with and yet the people who actually make the phones in China are on dismal wages in working conditions us “westerners” would consider brutal. I don’t understand why Apple wont just increase its payments to its contractors. (Sorry, call me an old leftie! ;))
It is THIS that I don’t understand. It seems to be the persuit of profit at all and any cost.