Profit and profitability

Profit

Profit can be measured for each transaction separately or for all transactions within a given period of time, most typically a financial year.

For the purposes of taxation returns and company reports, it is necessary in order to be able to satisfy statutory demands. In such cases, the periods are naturally, financial years. There are also good reasons for measuring profit over periods shorter than years, such as for the purpose of monitoring trends in profitability and for similar internal management activities.

The measurement of profit over a period can be made in two quite different ways. In the first, the profit is measured as the increase in the value of the business over the period, ie the difference between the value at the beginning and the value at the end. In business management and accounting, the second method is more favoured (and practically universal). That is where profit is measured as the difference between the total inflow and the total outflow in the period, taking into account all transactions, all sales, all injections of cash, all expenses and all parts of uncompleted transactions which attract partial payment. (In such calculations, there are three options for determining which amounts to use for 'inflow'. In the accrual method, the value of work performed is used. In the earnings method, the value of work chargeable is used. In the case method, the value of payments actually received is used. In progressive work, such an architectural project, these three do not usually have the same value until the end of the project, which would often extend over more than one reporting period).

It is stated above that a business and its owner or owners are separate entities. Every business is owned by somebody, other than the business itself. A business can own other businesses and be owned by other businesses, but it cannot be its own owner. The reason for making that distinction is to acknowledge that profits always belong to the owners in the first place and never belong to a business unless the owners hand back the profits or part of the profits to the business that created the profits.

There are three potential destinations for all profit: into the personal assets of the owners (in the form of dividends or drawings), or into the financial assets of the business, or shared with non-owners such as employees, all at the owner's discretion. In the second case, the earnings that the owners allow the business to retain, together with capital contributed by the owners, make up the value of proprietorship or owner's equity. The retained earnings and the contributed capital, together with any borrowed finance, make up the total cash inflow to the business assets.

This means that profit has the capacity to increase the owner's equity, or the proprietorship, in a business because it can increase the value of the owner's financial rights and interests in the business. Whether it does so in a particular case depends on what the owner does with the profit that the business has created. That is always a decision of the owner, not of the business.

In the converse situation, a loss decreases the owner's equity, but whether temporarily or permanently depends on the circumstances at the time of the loss.

The view of profit as an increase in the owner's equity suggests that a business owner can manipulate the transactions of the business in whatever way will maximise the increase in equity and/or maximise the part of the profit which is not added to the equity but is spent in some other way or just put into the owner's pocket. That is perfectly true and legitimate, but it does sometimes give rise to the uninformed opinion that profit and greed are somehow related in business.

The human nature factor and the very large number of businesses in our community, together provide the inevitability of unethical conduct in business control and profit manipulation, where the motive is avarice and cupidity, but that fact should not discolour the perfectly ethical pursuit of profit for perfectly ethical reasons – the norm for most businesses and in the eyes of the law makers.

Back to top

Objectives in profit-making

In addition to the objective of increasing owner's equity in a business, there are three other equally proper objectives of profit-making.

Firstly, and closely related to the increase in owner's equity, is the reward for risk-taking. The degree of risk involved in putting one's money into a business operation by contributing capital is obviously variable, depending on many factors. The relationship between profit level and the risk is similarly very variable, but it would be unusual if there were no risk or very little risk. The risk, of course, is the risk of losing one's money and, in the extreme, other possessions as well. It is a risk not shared and sometimes not even understood by other members of the community who do not contribute to the capital of a business.

Secondly, profit allows a 'kitty' to be built up over a period of time as a reserve to pay for increased expenses not easily forecast, such as might be needed at a time of sudden inflation or for necessary but unforeseen, and therefore unbudgeted, business expansion and potentially to reinvest into pro bono and worthy causes.

Thirdly, profit can provide a reserve to bridge periods of economic difficulty, when normal cash flow is slowed down and support is needed to bolster the recessional and, by itself, inadequate income in order to maintain the business intact for as long as possible. It should be noted that if a trust operates the practice, it may be necessary to 'empty the barrel' each year, which can erode the real value of working capital.

Back to top

The profit process

The process of earning profit-enabling income, as distinct from income as an employee, may be broken down into the following stages of business activity (separate from the architectural activity in this particular context).

1. Acquiring resources sufficient to allow the services being offered to be provided – at the very least, a room and a piece of paper would be needed.
2. Obtaining a client who gives an instruction to perform a particular service for a fee.
3. Performing the service for which payment will be given.
4. Asking for payment.
5. Collecting the payment.

Some architectural practitioners are better skilled in some of those activities than in others, eg better in performing the service than in asking for payment. In terms of profit planning and achievement, the last stage is critical – collecting the payment – but it is a fact that many businesses, not only architects, experience many problems because of failure to collect payments due to them when the payments are due.

The earning of profit-enabling income clearly requires a considerable degree of discipline on the part of the income earner, quite unlike the employees of that person, if the profit result is to be meaningful.

Back to top

No profit: no business?

It is a fact of business life (but one not readily acknowledged) that a business does not need either profit or profitability in order to stay in business. Lack of profit does not spell the end of a business. An unprofitable business may last for years if it has planned for downturns and cut outgoing expenditure.

Businesses collapse because they cannot pay their debts at the time the debts are due to be paid. The reason is lack of liquidity, not lack of profit. If its owners have planned for their own salaries, notional or true, then they could be much better off at the end of their ownership than their colleagues who have not. Further, even if a business cannot make enough profit to pay its owners anything at all, it can continue in existence for as long as it can pay its debts. (If that situation arises, there is always hope for recovery from hard times).

Lack of profit, unlike lack of liquidity, does not mean the end.

Back to top

Conclusion

The fact that a professional practice necessarily has goals different from those of the conventional commercial business enterprise does not mean that a professional practice cannot also be a commercial enterprise or business operation. Privately owned professional practices are nearly always commercial businesses. There is no conflict at all between 'professional' and 'commercial' in this sense. In most cases, the professional practice must be commercially operated if it is to continue to give services to clients.

There is nothing new in this view. What has brought it into more public perception is a combination of commercial, statutory and technological necessities that in recent years have provided both restraints and freedoms. Some professions have been slower to react than others. Architecture, in particular, with its high proportion of creative and artistic minds, has not been noted for its speed to adapt to commercial considerations such as costing, budgeting, advertising and profit planning.

Profit may not be essential in the pursuit of artistic goals such as in architecture, but the avoidance of loss should be regarded as absolutely essential. The best way to avoid loss is to plan for profit. The best way to do that is to start with a proper understanding of the concept of profit and tracking this data regularly.

Back to top