Understanding profit

- Making money, being profitable, that's the goal of every business, but it's not very easy. No matter how big or small, companies of every size often struggle to make a profit. For example, did you know that Amazon.com did not have one profitable year in the first 20 years of its existence? I'm serious. How can that be? How can a company not make a profit and still be in business? Well, before we try and answer that question, you need to first understand the basics of profit.

Profit is the amount of money left over after a company pays all of its bills. Profit is calculated using this simple formula. Revenue minus cost equals profit. Looks simple, but, in fact, it isn't. That simple formula has so many layers. Let's first concentrate on revenue. Revenue is the amount of money a company collects from its customers. Think of a professional sports team. Look at some of the different ways they can collect money.

As you can see, this sports team has multiple revenue streams. With so many ways of generating revenue, you might think, "How is it possible "they might not make a profit?" Well, for that, we have to look at the other element of profit, cost. Cost is the sum of all the expenses for a company. We need subtract all of the costs from the revenue. Let's take a look at a short list of some of the costs paid by a professional sports team.

The list goes on and on. It's a very challenging balancing act. Every company in every industry is trying their best to tip that scale in the revenue direction. There are a couple of ways to do this. Increasing sales can be tough. As a result, many companies try and control costs by cutting employee hours and using lower quality materials, but by doing that, you may alienate customers. Down go your revenues. Do you see the challenge? So let's get back to Amazon.

No profits for 20 years. Look, while Amazon may be popular, while they may be innovative risk takers, and while everyone you know may buy a few things from Amazon each month, Amazon struggles every day to be profitable. How is that possible? I mean, it seems like Amazon gets bigger every year. Well, for companies like Amazon that are trying to grow, sometimes being profitable is extra hard. To grow quickly, you need to do things like buy more land, open facilities, invest in more inventory, and hire and train lots of new people.

That's a lot of money out of Amazon's pocket. Their cost to constantly grow are very high, and so even a few months of good sales may not be enough to make a growing company profitable. Amazon is not alone, though. Startup companies often lose money for many years before they start making a profit. Soon you'll start to see every story in the news as a signal of profit. Try it right now. Go to a reputable news site and look at the headlines. War on terrorism.

Does that mean lower sales for airlines? Does it mean increased sales for a military supplier? The price of oil. How does that impact the cost of a trucking company? How does it impact the revenue of an oil company? Child birth rates increase. A new cancer drug is approved. A massive snowstorm is due to hit your part of the country. The government passes a new law. In each case, think about which companies will see changes in revenues and which companies will face changes in their costs.

Making money, being profitable, that's what business try to do. These are the big decisions business executives face on a daily basis.