In a capitalist society profits play a crucial role in creating incentives for business owners and entrepreneurs. The reward of profit encourages innovation, costs cutting and improvements in business operations in addition to meeting the needs and wants of the community effectively.
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What is profit in business
Profit is the surplus obtained after all the necessary costs of a business have been covered. It can be seen as a monetary reward to shareholders, partners or owners of an organisation. If an industry is profitable new firms will be encouraged to enter it and if it is not, companies will close down. The role of profit in business is described as follows.
Reward to the Entrepreneur
The role of profit in businesses of any nature is to compensate the entrepreneur for taking the risk in starting and running a business. A labourer is rewarded with wages, skilled workers such as accountants and engineers offer their services in exchange for salaries and an entrepreneur is rewarded with profit. After paying off salaries, wages and other expenses an entrepreneur is rewarded with the surplus. Without profit no one would be in business unless the organisation is a non-profit firm. However, most business owners are in business to generate a surplus above costs.
Efficiency and Effectiveness
The second role of profit in business is to improve efficiency and effectiveness. In order to maximise profits, businesses need to run their operations effectively and efficiently. This means finding ways to cut down unnecessary expenditure and setting up processes in ways that minimise time and improve production. This will result in low cost absorption and increase profits as seen in competitive markets where, a firm with the least costs maximises on profit. Hence, profit acts as a regulator of efficiency in businesses.
In a competitive market the role of profit in business is to allocate resources in such a way that they produce what the market wants and needs. A high demand for a specific product is reflected by a high price. Products or services that can be sold at high prices indicate what consumers need or want hence, a business that produces such will enjoy higher profits. Products that sell at lower prices also show what the market does not desire. Resources can then be allocated towards the production of goods that can be sold at high prices so that the entrepreneur can make more profit. Thus, the need for high profit encourages entrepreneurs to allocate resources efficiently. Also, high prices indicate a shortage of certain products in a market and low prices reflect a surplus in that product. Profits cannot be made by producing goods that are in large supply so entrepreneurs will allocate resources towards the production of goods that are in short supply.
Source Of Capital
Another role of profit in business is that it can be reinvested. A business can continue to expand its operations and grow through ploughing back the profits in the business. This will also increase the value of the business and attract more investors. Opportunities of expansion and growth can be easily exploited if profits are retained.
An incentive for Innovation
Profits are a key element of innovation in an ever-changing economy. This is because new processes and products are brought about by entrepreneurs seeking profit. The need for profit encourages innovators to come up with several creative ways to solve people’s problems. This is an important role of profit in business. Without the incentive of profits no one would seek new and creative ways of meeting people’s needs and wants. The Industrial revolutions, from the first to the fourth, are the result of innovation brought about by the need to make profits as much as they have solved the various problems in society. If there was no profit, there wouldn’t be innovation.
Source of Government Revenue
A reasonable amount of government revenue is obtained from corporate taxes. This revenue obtained from taxes can be used to finance government expenditures that benefit the rest of the society. Thus, the role of profit in business is to serve society. Also, profit making firms can easily sponsor other social programmes such as sports, schools and help the vulnerable groups in society. This way profit can be seen as a measure of how a firm is serving society.
A measure of Performance
Another important role of profit in business is its use in measuring a company’s performance. In order to determine if a firm is doing well profit is used. Abnormal profits indicate that the company is doing well and that the opportunity for growth are high in that industry. Also, abnormal profits show that there is not much competition in the industry a firm may be operating in. A firm making reasonable profits may be operating relatively well and a firm making little to no profits may need to improve on operations, cut down on costs or deal with whatever problem hindering it to perform optimally. Another role of profit in business is that profits act as an index for the overall economic performance of a society. When a large number of companies earn reasonable profits in any country it shows that the country is progressing and if not, it indicates that the country’s economy is not developing.
Investment in Research and Development
High profits allow a firm to invest in research and development. As a result, technology can be improved. This is an important role of profit in business. If firms do not invest in research and development, they will stagnate and lose their competitiveness. This will have a detrimental effect on a society as jobs will be lost. Research and development allows companies to become efficient, become innovative and allocate resources appropriately.
The role of profit in business cannot be underestimated, however the pursuit of profits can be detrimental to a country. Issues such as environmental degradation resulting from mining, manufacturing and processing companies should not be ignored. As much as business ventures create employment, profit maximisation creates income inequality. Also, the desire to make quick profits can encourage reckless behaviour. It is important therefore, for firms to pursue growth and social objectives together with profit.