Profit Management.pptx for mcom students
- 1. “CONCEPT OF PROFIT MANAGEMENT”
- 2. INDEX PROFIT MANAGEMENT • MEANING OF PROFIT & PROFIT MANAGEMENT • DISTINCTIVE FEATURES OF PROFIT AS A FACTOR REWARD • TYPES OF PROFIT • FUNCTIONS OF PROFIT • THEORIES OF PROFIT a) WALKER’S RENT THEORY OF PROFIT b) CLARK’S DYNAMIC THEORY c) HAWLEY’S RISK THEORY d) KNIGHT’S UNCERTAINTY BEARING THEORY e) SCHUMPETER’S INNOVATION THEORY • CONCLUSION
- 3. PROFIT MANAGEMENT MEANING OF PROFIT ‘Profit means a positive gain generated from business operations after subtracting all expenses or costs from total sales.’ MEANING OF PROFIT MANAGEMENT ‘It is the proper planning, forecasting, controlling, risk & uncertainty analysis and measurement of profits to achieve the profit maximisation goal of an organisation by maximizing revenue and minimizing expenses.’
- 4. DISTINCTIVE FEATURES OF PROFIT AS A FACTOR REWARD: TYPES OF PROFITS TYPES OF PROFIT GROSS PROFIT NET PROFIT ACCOUNTING PROFIT SUPERNORMAL PROFIT NORMAL PROFIT ECONOMIC PROFIT Not a fixed remuneration Residual surplus Uncertain May even be negative Greater fluctuations than returns
- 5. Gross profit is the profit a business makes after subtracting all the costs that are related to manufacturing and selling its products or services. GROSS PROFIT: TOTAL SALES – COST OF GOODS SOLD Normal profit occurs when economic profit is zero or alternatively when the total implicit and explicit costs equal the total amount of money the company generated within a specified period. NORMAL PROFIT= TOTAL REVENUE – (TOTAL EXPLICIT COST + TOTAL IMPLICIT COST)= 0 Net profit is the amount of money a business earns after deducting all indirect expenses and tax from the gross income for a given accounting period. NET PROFIT: GROSS PROFIT+ INDIRECT INCOME – INDIRECT EXPENSES - TAX Super normal profit is also known as abnormal profit, it is when a firms total sales revenue exceed the total costs of production i.e. they are earning a profit above and beyond the level of normal profit. SUPER-NORMAL PROFIT= TOTAL REVENUE – TOTAL COST GROSS PROFIT NET PROFIT NORMAL PROFIT SUPER-NORMAL PROFIT
- 6. PROFIT ACCOUNTING PROFIT ECONOMIC PROFIT Economic profit is defined as the profit arrived at after deducting both explicit and imputed cost, i.e., the cost that would have been incurred in the absence of the employment of self owned factors. It is the reward received by an entrepreneur for his risking taking, uncertainty bearing and innovative activities. It is also known as pure profits. ECONOMIC PROFIT= TOTAL REVENUE – (TOTAL EXPLICIT COST + TOTAL IMPLICIT COST Opportunity/ imputed cost: rental income on self-owned land & building employed in the business. An accountant looks at profit as a surplus of revenues over costs, as recorded in the books of accounts. Accounting profit is defined as the revenue realised in a given period after providing for expenses incurred during the production of a commodity. It is also known as residual profit Accounting Profit = Total Revenue – Explicit Costs
- 7. According to Peter Drucker, there are 3 main purposes of profit, they are: FUNCTIONS OF PROFIT 1. TOOL FOR MEASURING PERFORMANCE: Profits generated by an organisation helps in estimating the effectiveness of its business efforts. High profits Efficient management of business Low profits In-efficient management of business 2. SOURCE OF COVERING COSTS: An organisation needs to earn sufficient profit to cover its various costs of the business. 3. AID TO ENSURE FUTURE CAPITAL: Profits retained assures the availability of capital in future for investment, innovation, expansion and growth.
- 8. OTHER PURPOSES: 4. REWARD FOR SHAREHOLDERS: 5. AID FOR ECONOMIES: If organisations generate high profits, they would be able to cope with adverse economic situation, such as recession and inflation. This results in stability of economies even in adverse situation. 6. TOOL TO STIMULATE GOVERNMENT FINANCES: If the profits generated by organisation are high, they are liable for paying high taxes. This helps government to earn high revenue and spend for social welfare. High profits High dividend Attract more investors
- 9. THEORIES OF PROFIT WALKER’S RENT THEORY OF PROFIT CLARK’S DYNAMIC THEORY HAWLEY’S RISK THEORY KNIGHT’S UNCERTAINTY BEARING THEORY SCHUMPETER’S INNOVATION THEORY
- 10. WALKER’S RENT THEORY OF PROFIT According to Prof F.A. Walker, “as rent is the difference between least and most fertile land similarly, profit is the difference between earnings of the least and most efficient entrepreneurs.” He advocated that profit is the rent of exceptional abilities that an entrepreneur possesses over others. It is the difference between the earnings of the least and most efficient entrepreneurs. An entrepreneur with least efficiency generally strives to cover only the cost of production whereas an efficient entrepreneur is rewarded with profit for his/her differential ability. Prof. FRANCIS AMASA WALKER AMERICAN ECONOMIST
- 11. ASSUMPTIONS WHILE FORMULATING THE THEORY: • Perfect competition in which all organizations are supposed to have equal managerial ability. • No pure profits. All organizations earn only normal profit. CRITICISM: • Provides only a measure of profit. The theory does not focus on the nature of profit. • Assumes that profits arise because of the superior or exceptional ability of the entrepreneur, which is not always true. Profit can also be the result of the monopolistic position of the entrepreneur.
- 12. CLARK’S DYNAMIC THEORY According Clark’s Dynamic theory, profit does not arise in a static economy, but arise in a dynamic economy. According to Clark, the role of entrepreneurs in a dynamic environment is to take advantage of changes that help in promoting businesses, expanding sales and reducing costs. The entrepreneurs, who successfully take advantage of changing conditions in a dynamic economy, make pure profits Static economy SAME • Size of population • The amount of capital • Nature of human wants • Methods of production • No risk & uncertainty • Normal profits earned Dynamic economy CHANGES FROM TIME TO TIME • Increase in population • Increase in capital • Manipulation of consumer wants • Advancement in production techniques • Changes in form of business organisation • Pure profits earned JOHN BATES CLARK AMERICAN ECONOMIST
- 13. HAWLEY’S RISK THEORY According to Hawley, “profit is the reward of risk taking in a business. During the conduct of any business activity, all other factors of production i.e. land, labour, capital have guaranteed incomes from the entrepreneur. They are least concerned whether the entrepreneur makes the profit or undergoes losses.” Hawley refers profit as reward for taking risk. The greater the risk, the higher is the expected profit. Risks in businesses are inevitable and cannot be predicted and hence an entrepreneur is rewarded for undertaking risks. CRITICISM: • Profits arise not because risks are borne, but because the superior entrepreneurs are able to reduce them. The profits arise only because of better management and supervision by entrepreneurs. • Profits are never in the proportion to the risk undertaken. Profits may be more in enterprises with low risks and less in enterprises with high risks. Given by Frederick Barnard Hawley in 1893
- 14. KNIGHT’S UNCERTAINTY BEARING THEORY According to Knight, profit is a reward for the uncertainty bearing and not the risk bearing. According to Knight, “risks are foreseen in nature and can be insured.” Risk taking is not a function of an entrepreneur, but of insurance organizations. RISK • Those risks whose probability of occurrence can be easily estimated i.e., certain & can be anticipated. • Calculable risks can be insured. • Example: Risks due to fire and theft • Those risks that cannot be accurately calculated and insured i.e., uncertain. • Example: Covid 19, shifts in demand of a product CALCULABLE RISK NON-CALCULABLE RISK Prof. FRANK H KNIGHT AMERICAN ECONOMIST
- 15. CRITICISM: • Assumes that profit is the result of uncertainty bearing ability of an entrepreneur, which does not always hold true. The profit can also be the reward for other aspects, such as strong co-ordination and market share. • Fails to show any relevance with the real world.
- 16. SCHUMPETER’S INNOVATION THEORY According to Schumpeter, profits are the reward for innovation. Profit is the cause and effect of innovation. CRITICISM: • Ignores uncertainty as a source of profit. • Denies the role of risk in profit. INNOVATION TAKE PLACE IN TWO WAYS Reducing the cost of production, improving quality and earning high profit. Stimulating the demand by enhancing the existing capacity or finding new markets. INNOVATION: Introduction of a new product, new technology, new method of production, new sources of raw materials, new policy or measure. JOSEPH SCHUMPETER POLITICAL ECONOMIST
- 17. Profit is the primary objective of all business organisations. The expectation of earning higher profits of business organisations induces them to invest money in new ventures. This results in large employment opportunities in the economy which further raises the level of income. Consequently, there is a rise in the demand for the goods and services in the economy. In this way, profit generated by business organisations play a significant role in the economy. CONCLUSIO N