Profit isn’t the difference between revenue and costs. It’s not a line item on an income statement that is black or red.
Profit is the capture of excess productivity in value creation.
There’s a functional difference between the ideas.
The first is a measurement which can be gamed. The second speaks to the underlying forces that drive a business.
Which is Profitable?
You could run a profitable product business where you pay yourself a substandard salary and occupy an additional role that most businesses would hire someone else for. Your income statement tells you that you’re making $10,000 every year in profit.
Or you could own a small consulting business that breaks even because you pay yourself a handsome salary. You work a week every month and spend the rest of the time traveling and surfing.
Veteran entrepreneurs see immediately that in the product business you’re losing money and in the consulting business you’re highly profitable.
In the product business, if you’re paying yourself ¾ market value at $60,000 as a manager and you’re also doing the sales and marketing which comparable businesses would hire at least halftime for at $40,000, then you’re actually running at -$50,000 a year ($20,000 that you should be paying yourself + $40,000 in sales and marketing – your $10,000 “profit”.)
In the consulting business, if you’re earning a market salary working one week a month then you’re 4x more profitable than consultants working full time and 6x more profitable than consultants working 60 hour weeks.
Multidimensional Costs and Gains
As important, the accounting definition only calculates tangible costs and representations of value.
Value is traditionally measured by the tangible form of money, but it is subjective and multidimensional with most forms being intangible.
In the first scenario, you’re burning the candle at both ends, draining your time, energy, and attention juggling tasks. In addition are opportunity costs that are never realized because you’re busier than a one legged man in an alligator pit. All of which is damaging your relationships and sense of well being.
There is no line item on an income statement for these forms of value.
And there’s no line item for the value in the consulting business of only working part time and spending most of your life pursuing the activities you enjoy.
And less you think that we’re focusing on small potatoes: this definition scales for corporate empires. Just at larger sizes the intangible value is more typically tied to strategic goals like gaining a foothold in a market, enhancing a brand, blocking out competitors, etc.
Putting Profit to Work
The definition of profit as the capture of excess productivity in value creation is pragmatic.
It gives us three levers to manipulate:
- A business must produce value. Produce. As in productivity.
See: The Profit Window
- A business must create an excess to be profitable.
See: Optimizing for Profit
- A business must also capture that excess of value in some form.
To maximize profit, answer these questions:
For #1: How can you be more productive in creating value?
For #2: How can you engineer things to create an excess or surplus of value?
For #3: What is the difference between what you value and what your customers value and how can you exploit that gap?
Art Credit: Salvator Rosa, Allegory of Fortune