Profit is often perceived
as a dirty word in business.
The connotations of the term profit
are often of selfishness, greed,
capitalism, and finite thinking.
Simply put profit gets a bad rap.
The most successful entrepreneurs
preach that all businesses
should be driven by purpose not profit.
To make the world a better place,
to improve the lives of others.
Humans need a narrative to
tell themselves a story,
to inspire them, to leap
out of bed every morning.
A company should thus be mission
led, guided with purpose,
meaning and aspiration.
It shouldn't be about
making stacks of money.
Not exactly inspiring, would you agree?
Whilst I agree with this rhetoric
following this advice
literally can be dire.
The reality is that without profit,
your business is a charity.
To create an enterprise,
an organisation that
outlives its founders,
you need capital.
Relying on venture
capital and bank financing
is not a longterm business strategy.
The only way to be self sufficient
is to generate your own capital,
capital in the form of profit.
The next type of profit
that all business owners
should be measuring is
known as net profit.
Net profit is a type of profit
that I'm sure all of
you are familiar with.
It's calculate as your revenue,
less your total expenses.
It's generally expressed as a percentage
by taking your net profit
divided by revenue.
Now, funny enough,
there's actually a
variation of net profit,
you should also be paying
attention to, it's known as EBIT.
EBIT stands for Earnings
Before Interest and Tax.
And is the same as net profit,
except as the name suggests
doesn't include your interest
or income tax expenses.
So why do we do this?
So when you want to understand
the financial performance of a business,
you want to look at the operating profit.
That is the performance of
the underlying operations
of your business.
The problem with net profit
is that it doesn't
actually give you clarity
over the actual financial
performance of your business,
because it can be often skewed
by taxes and interest expenses.
Let's compare these two companies
to demonstrate my point.
Let's say, as you can see here,
the two companies have exactly
the same operating profit,
but their net profit is different.
So why is that?
Well, you can see that company
A has interest expenses
because it has taken on debt from a bank.
Company B on the other hand
has taken funding from a VC,
hence there's no interest.
Problem is if you looked at net profit,
you would say that company B
is actually a better performing
company than company A.
That's actually wrong.
Fundamentally,
these two companies have the
same financial performance.
What differs is how the
businesses is funded.
Investors like Warren Buffet,
therefore look at EBIT
instead of net profit,
to understand the financial
performance of a company,
because he's more interested
in the performance of a
business, not how it was funded.
So, next time you refer to profit,
make sure you know which
one you're talking about.
Are you talking about net profit or EBIT.
