Profit Management

Nature of Profit

Profit is a residual sum.

Profit is the sum over and above the ordinary costs of business including contractual outlays.

No body contracts to pay this residual sum.

Profits are contingent upon successful management of risk.

Business is faced with number of uncertainties.

Uncertainties in Business

Technical (physical process of production)

Cost uncertainties (change in the prices of Raw materials, wages, rent etc.)

Demand (change in consumer preferences and innovations)

Market (future price and volume of sales)

Profits vary

From Industry to industry,

Businessman to businessman,

By level of business activity.

Profit theories

1. Profit is the reward for risk taking and uncertainty bearing:

According to Prof.Knight risks are of two types:

Insurable andNon insurable risks

Insurable risks:a) Risk of loss of property due natural

disastersb) Risks of dishonesty Non insurable risks: Competition Technical Business cycle Government action

2. Profit as a consequence of market imperfection and Monopoly

Profit is the result of contrived scarcity It can exist only in imperfect market

where o/p is restricted and consumers are deprived of opportunities of alternative sources of supply

3. Profit as a reward for successful Innovation(Schumpter)

Innovation refers to any purposeful change in production methods or consumer tastes

Invention is the creation of something new whereas

Innovation is the application of an invention to business use.

Many inventions never become innovations.

The innovator is one who turns a new idea or invention into a commercial proposition

Thus innovator reaps the profits of innovation

Then comes a period of adjustment when new competitors come in and innovational profits die out.

Functions of profit

Provides incentive to produce what consumers want, when and where they want it at the lowest feasible cost.

Measure of performance

Premium to cover costs of staying in business

Ensures supply of future capital

Accounting profit and Economic profit