Profit Analysis: Profitability Is Not Synonymous To Efficiency

Photo by rawpixel on Unsplash
Photo by rawpixel on Unsplash

Profit is an excess revenue over associated expenses for an activity over a period of time. Terms with similar meanings include ‘earnings’, ‘income’, and ‘margin’.

Lord Keynes remarked that ‘Profit is the engine that drives the business enterprise. Every business should earn sufficient profits to survive and grow over a long period of time. It is the index to the economic progress, improved national income and rising standard of living. No doubt, profit is the legitimate object, but it should not be over emphasized.

Management should try to maximize its profit keeping in mind the welfare of the society. Thus, profit is not just the reward to owners but it is also related with the interest of other segments of the society.

According to Harward and Upton, “profitability is the ability of a given investment to earn a return from its use. This shows how efficiently the management can make profit by using all the resources available in the market.

Profitability is not synonymous to Efficiency. Profitability is an index of efficiency; and is regarded as a measure efficiency and management guide to greater efficiency.

Although, profitability is an important yardstick for measuring the efficiency, the extent of profitability cannot be taken as a final proof of efficiency. Sometimes unsatisfactory profits can mark inefficiency and conversely, a proper degree of efficiency can be accompanied by an absence of profit.

The net profit figure simply reveals a satisfactory balance between the values received and values given.

Sometimes, the terms ‘profit’ and ‘profitability’ are used interchangeably. But in real series, there is a difference between the two. Profit is an absolute term, whereas, the profitability is a relative concept. However, they are closely related and mutually interdependent, having distinctive roles in business.

Profit refers to the total income earned by the enterprise during the specified period of time, while profitability refers to the operating efficiency of the enterprise. It is the ability of the enterprise to make profit on sales. It is the ability of enterprise to get sufficient return on the capital and employees used in the business.

As Weston and Brigham rightly note, “to the financial management profit is the test of efficiency and a measure of control, to the owners a measure of the worth of their investment, to the creditors the margin of safety, to the government a measure of taxable capacity and a basis of legislative action and to the country profit is an index of economic progress, national income generated and the rise in the standard of living”, while profitability is an outcome of profit. In other words, no profit drives towards profitability.

However I would personally define profitability as the primary goal of all business ventures. Without profitability the business will not survive in the long run. So measuring current and past profitability and projecting future profitability is very important.

Profitability is measured with income and expenses.