To what extent is profit a good indicator of the success of an organisation?
What incentives drive people to spend their time, energies and engaged into businesses? When many people in businesses and firms are approached and asked by this question, their reply is simply and straightforward: to make money. In other words: to make a profit. It maybe true for some organizations. As we all have known, there are various organisations operating everyday, they give profound implications for the way we make sense of our lives and of the changing world we live in. But what are involved in organizations?
Different objective aims distinguish them between non-profit and for-profit. Organisations Non-profit For-profit Public sector private sector Charities; Hospitals Sole traders; partnerships; Churches etc. Private limited companies; Public limited companies Category of organisations From the diagram shown above, a large percentage of the organizations are for-profit ones. Which factors should we take into account when measure a performance of a for-profit organization? Is it justified to say that the only measurement of a successful organisation is profit?
How important is profit relate to an organisation? Profit is probably the initial motive that most people choose to take risks other than pursue another ease career. It is the driving force in most businesses (except charities). 1 There would not be many individuals to commit their time and personal resources to business activities without profit. In economists’ point of view, profit is the difference between the revenue the firm gains from selling its output minus the costs of producing that output. 2 It is a surplus of making up activities.
Especially in public limited companies, maximising profit is probably their most important objective, entrepreneurs use it in two ways: one is to reinvest into businesses, the other is pay to shareholders in the form of dividends. 3 Only if the sale’s revenue exceeds by as much as possible the costs of goods, they can make a good profit. The more profit a company gains, the more capital can be reinvested, then by consequences, the larger scale and more output they can receive, and the more share capital are attracted into the business. Those aspects have all helped to develop a successful organisation.
Without profit, they either cannot have a good reputation, therefore would not be able to borrow more loan for further development. Worse, the business closed down. Indeed, what most for-profit companies seek to are growth and maximise profits. Mr. J. A. Schumpeter pointed out that ‘For the capitalist system, it must be added that without profit there would be no accumulation of wealth. ‘4 In the free-market economy, according to the law of ‘self-interest’, both suppliers and consumers are directed by profit, where their interest lies.
At each of the end of the finance year, the amount of profit will be seen as one initial indication of the performance that the business has made during that year. 5 For instance, firm A in the market was considered more successful than its rivals, it revealed this firm probably used more efficient methods to gain more profit, thus other firms are likely to emulate firm A by copying their methods. Therefore, to some extent, profit can be seen as a good indicator of a prosperous organisation. The amount of profit decides who is in a predominance position in the market.
Organisations cannot survive without profit and profit-making organisations create wealth in the economy. In many respects, it is may indeed be true to say that profit plays a dominant role in the vital area of most of the for-profit organisations and indicates how success they are. However, skeptics wonder does the factors have been considered thoroughly? What are the arguments against it? At first glance, is profit the difference between the cost of providing goods or services and the revenue derived from their sales?
Further analysis reveals drawbacks to this way of thinking. Due to there are various types of cost which can be allowed for, profit is also classified by several different types: gross profit, operating profit, pre-tax profits and profit after tax. In accountancy, it is wrong to judge an organisation is a successful one by only looking at its gross profit. Instead, to make an accurate estimation of organisations’ statements, we always look at the operating profit figure which is defined as the gross profit minus the organisation’s expenses and overheads.
6 It is possible for a firm to have an increased gross profit but a decreasing trend in net profit. Overdue their overheads or expenses can be one of the causes. In this case, it is optimistically assuming the firm. A second point to bear in mind is that when analysing accounts, long-term profit is a very important element to examine the performance of an organisation. Profit quality in this case can predict organisation’s potentials of further development. A one-off profit will either gives a profit or a loss to the organization, and not be likely to continue into future.
Because of the unsettled character, it is said a low quality profit. Hence, this kind of profit cannot show a good performance of an organisation. ‘Long term profitability is better than isolated one off occurrences of high profit. ‘7 Moreover, a balance sheet, which helps to make an appropriate judgement of the value of an organization, involves many facets. The most relevant aspects are depreciate and the value of stock. The bigger misevaluation of those two factors, the bigger error could happen on profit calculation.
In spite of profit, however, there are many other factors which can influence the performance of an organisation. One of the important things is the objective of an organisation. Different organisations have different aims, such as a private limited company, maximise their profit to grow further may not occupy the dominant role, maintaining their own business can satisfied them a lot. But a public company on the other hand seeks to maximising shareholders’ wealth. In this case, it’s more important for them to make profits to show how well they can performance.
Secondly, in a short-term run, businesses should concentrate more on cash flow, which at the beginning seems more important than to make a profit. There was a British industrial firm called TI Group, it was succeeded in the 1990s, but unfortunately, rapidly growth called for more cash investment than it was willing to provide, a French company then took the advantages, bought 50% stake of TI Group. 8 Because a liquidity crisis will cause problems in the sort-term run and so give a badly implication to the firm. Yet unprofitable activities cannot last in the long run.
Apart from those for-profit organisations; profit cannot be an indicator in non-for-profit organisations, as the measurement is not according to how much profit they gain through business activities, but due to their various functions and the different services they provide. Such as charities, public goods service, education, churches and so on. To sum up, clearly, every aspects contributions to the success of an organisation-but in what proportions? This, of course, is the heart of the debate. Profit indeed occupies a large proportion of the total ‘ingredients’ of making a successful organisation.
If you cannot make profit, you cannot exist; if you cannot make profit, you cannot develop; if you cannot make profit, you cannot survive… (Even charities want profit to maintain their daily needs). Therefore, profit is said to be a good indicator of the success of an organisation. But on the other hand, profit is not absolutely perfect. Not only because profit itself plays a limited role, but also when we analysis organisations’ performance, a suitable circumstance should be chosen and taken into account, as it is said: one key only matches one locker. Profit, to some extent is a good indicator when it is defined in a suitable, properly way.
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