Let me ask you one question in three different ways:
I. What business are the following companies in?
Chances are your answer will be, Tata Motors is into manufacturing automobiles, Infosys provides consulting and services in the field of Information Technology and Hilton is in the business of managing hotels and resorts.
The truth is that all the three names mentioned above are actually in the same business, and that is the business of making profit.
Tata Motors does it through producing and selling automobiles, Infosys through IT products and Hilton by providing hospitality services.
One should never forget that a business is set up with the sole objective of making profit.
II. In a Profit and Loss Statement the topmost figure is Sales and the figure at the bottom is Profit (which could either be a positive or a negative figure). The former, in financial jargon, is called the top-line and the latter the bottom-line.
A question I love to ask is “What is business all about? Are we here to generate top-lines or are we here to generate bottom-lines?”
Always remember, a business is set up to generate positive bottom-lines.
People handling the sales function within an organisation often get offended at this statement. They, of course, feel better when told that there cannot be a bottom-line without a top-line, and therefore the top-line is very important too. But when I emphasise on the bottom-line, what I mean is – we are not here to generate just about any kind of sales. The sales that we bring, the terms on which we sell, the period of credit offered to the customers, all have to be such as to eventually generate a healthy profit. Top-line is a means towards achieving an end; and the end is to have a decent, a healthy profit.
III. A lesson most entrepreneurs learn very early after setting up their venture is that there is no connection between the profit that their business generates and the bank balance it possesses.
Or, maybe I’m wrong.
Perhaps, there is a relationship.
Profit and bank balance have an inverse relationship (or so it often seems to the entrepreneur). Higher the profit, lower the bank balance.
The question that arises is, are we in business to make profit or to make money?
We are in business to make profit.
(Even though the primary objective of a business is to make profit, there is no pleasure in making profit if at the end of the month there is no money to pay salaries. And therefore managing cash flow is equally important).
By now it will be evident to the reader with the meanest intelligence that I am saying, “I don’t care how impressive your vision and your mission statements are; if you are not making profit, you are a failure”.
How much profit is enough?
If profit is so important, then the question that begs an answer is – how much profit should a business earn?
This is a very relevant and important question. There are many organisations that make profit, and therefore have a sense of satisfaction, that everything is fine. They feel that if the test of success in business is that the bottom-line should reflect a positive number, they must be on the right track.
But the profit earned by them may actually be way below what is desired.
Most people understand that profit is the difference between incomes and expenses.
An organisation makes a profit when the revenue that it generates covers the expenses and leaves behind a surplus. Therefore the revenue should exceed the cost of production, the cost of administration, the cost of selling, and even the cost of borrowed capital.
But what they miss out on is that it should also cover (or exceed), the cost of owners’ capital. This is the grey area.
Unfortunately, there is a widespread perception that owners’ money is free. The truth is that, not only is owners’ capital not free, but it is, in fact, the costliest of all sources of funds.
Never forget – a business is run with the sole objective of making profit for the owner. The owner could be a single individual or they could be millions of shareholders. If a business does not make profit that equals or exceeds the owners’ expectations, it is merely being run to generate employment in the country, to provide livelihood to vendors and to help banks make money.
The real test of success of any business, in my opinion, is to have outperformed the owners’ expectations. Then and only then will it be a sustainable model. Else it is a matter of time that it will need to be shut down.