From the course: Finance Strategies for Business Leaders

Growth vs. earnings

From the course: Finance Strategies for Business Leaders

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Growth vs. earnings

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- One CEO I know likes to say about startups that, "You have got to have profits, "you got to have growth, but you can't have neither." Of course, for most companies in the world, you should ideally have both growth and profits. Growth is an increase in revenue, whereas profits, or earnings, is equal to the revenues minus the costs. There's a trade-off between growth and profits, and it's one of the most important trade-offs in all of corporate finance. The basic question is, how much money do you want to take out now versus leave in the business to help it grow? Some companies, especially startups and other high-growth organizations, will take the money they make and reinvest it in the business to help the business grow. This means that the owners, who may be individuals or shareholders, will need to get by without taking a profit. Now in theory, the more you invest, the more you should grow, but that doesn't always happen. When it does, it's good and investors are usually quite happy. But, keep in mind, the goal of having a business at some point is to take profits. This means that even if a company's leaders decide not to take out profits for many, many years, they're doing so in the belief that the growth they achieve now will turn into even greater profits in the future than the profits they otherwise could have today. That approach worked well for Amazon, Google, and Uber, but it didn't work for every company. And some companies will give up profits in order to achieve growth that may not happen. And if companies fail to achieve growth and give up profits, they'll go out of business pretty quickly. At a strategic level, this is like the marshmallow test, where you offer a child one marshmallow now, but if they wait five minutes you'll give them two marshmallows. Some kids will take the one marshmallow now, others will wait. For business leaders, the decision to take profits now or wait for bigger profits in the future will really depend on the priorities of the owners and the investors and what they think about waiting for more financial marshmallows.

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