Are profits real?
We now live in a world where a corporation will report profits most years for a 10 year period, and then suddenly announce that, without massive subsidies from the government, it must declare bankruptcy.
One definition that I’ve heard used for “profits” is that it is “surplus cash, left over after all costs and investments of a business have been taken care of, unneeded by the enterprise and therefore free to be given back to the shareholders/owners.” That is, this is wealth that can safely be extracted from the enterprise and given to the owners. This definition is close to the one that Peter Drucker uses in his 1985 book, Innovation and Entrepreneurship.
But how can any business ever know if a given a dollar is unneeded? What if a great crisis lurks in the future? What if the money that a business gives back to shareholders this year turns out to be exactly the money that the business needs to survive the terrible financial crisis that just happens to break out next year? The overwhelming majority of all businesses that have ever been created have disappeared. How many businesses are there still surviving from the 1700s? If a business had the goal of surviving for as long as possible, surely, it would never declare a profit, never give any money back to shareholders. It would hoard every penny, and save it up for future disasters.
The question “How much profit does this company have?” reminds me of some aspects of the question “How long is the coast of Britain?” Obviously you can come up with some methodology which, if applied consistently, will give you an estimate of the length of the British coast. A different methodology will give you a different answer. Neither answer is more true than the other. There is no true answer, there is only the answer that a given methodology offers. And the same applies when you go seeking the profits of a firm. You can use GAAP to estimate the profits of a firm. (Though, of course, GAAP is easy to game, as any of thousands of recent news articles will remind us.) You can use some other methodology, and it will give a different estimate of the profits of some particular firm. But it won’t give the truth.
If there is a truth to be discovered here, it would be that, over the very long term, there are no profits. There is no true surplus that a company can freely part with. There is no money that a firm won’t at least potentially need when the next crisis strikes.
But why would investors want to start a company if they can never get any of their money back? After all, most would argue that the purpose of a company is to generate profits. Most of the time, most people would argue that longevity should not be a goal for a business, but rather, longevity should simply be a side effect of being profitable. However, during the current crisis, both politicians and a large part of the public seem to feel that longevity is more important than profitability. How else to explain the billions of subsidies being given to auto makers who have been unable to turn reliable profits for years?
As a practical matter, we might agree that there has to be some agreed upon methodology that gives an estimate of how much surplus wealth can reasonably be extracted from a business and given back to the shareholders. But it should be remembered that every dollar that is taken out of the firm, even in the most profitable years, is moving that company one small step closer to its death.