“Profit” is Not a Dirty WordPosted on December 17th, 2018
Outsourced Accounting Department, Inc.
In the news recently, General Motors announced the closing of several plants causing an uproar in Washington, especially after the government bailed them out only a few years ago (which in truth was to rescue the economy, not just “GM”). So what’s the problem? Is GM just being greedy, or unappreciative, or what?
At the risk of over-simplifying the matter, a while back I worked for a company as its Vice President of Finance. Due to the loss of a major contract the company had been counting on, the owner of the company was forced to cut expenses, which included among other things, temporarily halting some employee benefits such as matching contributions on the company’s 401(k) plan. Shortly after these measures were announced, a disgruntled employee left a note on the bulletin board accusing the owner of being “greedy.” When the owner saw this note, he called me into his office to show it to me, and he was visibly heartbroken.
The truth of the matter was, despite the company’s losses and tight cash flow, and because of the owner’s compassion for his employees, he was avoiding making any staff reductions, even though reductions were warranted under the circumstances. Instead, he invested more and more of his personal funds into the business to fund its operating losses and keep the company afloat, while continuing to attempt to “grow the business” to restore profitability – until, that is, the bank stepped in and put a stop on everything because the company continued to show operating losses. Ultimately, he was forced to sell the company in a distressed sale. So a lot of those employees eventually lost their jobs anyway, and the owner ended up having to pay back a large amount of the company’s debt personally.
As I have talked about in several articles, profit is not just a “number,” it’s a critical component of cash flow, and without it, the business will eventually die. To illustrate, the below Profit & Loss, Cash Flow Statement, and Asset-Based Credit Facility – Borrowing Availability, reflects the dramatic impact that operating losses have on cash flow:
Note the large “over-advance” on the line of credit. This reflects the funding requirement from external sources caused by the operating losses. The reality however, is that a bank isn’t going to knowingly fund these losses, as profit is (ultimately) what repays debt in the first place. So in lender jargon, there is no “source of repayment.” Nor will most investors be interested who are also looking to the company’s earnings for a return on their investment.
The point is, when a business is losing money, those funds have to come from somewhere. Those losses represent being drained out of the company to pay suppliers, loan payments, and yes, payroll! When the funds eventually dry up, the business either dies, or makes the expense adjustments necessary for survival. Or, in the case of what large companies like General Motors did a few years ago, allow the government (you and I) to fund their losses. But sooner or later, even tax money can run out (whole different topic).
The moral of the story is, if a business cannot be made to operate profitably, someone is going to end up “holding the bag.” The only question then is, WHO? The bank? As indicated above, not if they can help it, banks are risk averse by design; taxpayers? possibly, whether they like it or not (if the company is big enough to have an economic impact); or, the owner / shareholders – most likely, as they have the most at risk. But (most) business owners and shareholders don’t invest their money into businesses just to lose it, and they are not going to keep pouring money into a losing proposition. They are interested in a return on their investment (“ROI”), or in other words – “Profit,” the motive that led to the creation of those jobs in the first place, .