From an economic or financial standpoint, the purpose of every forprofit business is to produce a profit and a return on investment for its owners or shareholders. That’s why they call it ‘for profit.’ Not every business is started for the sole purpose of profit, nor does any company endure long if their only objective is to maximize profits with blatant disregard for everything else. Most companies have a mission or a vision that looks beyond simply making money, and that seeks to produce a positive contribution to the world in multiple ways such as employment opportunities, charitable contributions, societal advancement, and so on. But if a company can’t produce a profit, they won’t be able to fund these noble causes for long.
When a private company earns a profit, it comes to the owner or owners in one of two forms: equity or cash flow. Equity is the value of, or worth of, a company equal to the sum of all of its assets minus all of its liabilities. So, if you or I started a business, one of the things that we might want as a return on our investment would be a company that would grow in value or equity over time. We might decide to pass the business on to our kids as an inheritance, or perhaps we could sell the company at a profit. We might even choose to sell shares of ownership (stock) to the public to fund growth or to ‘cash ourselves out’ and retire.
When a company does decide to ‘go public’ and issues an Initial Public Offering (IPO), you and I can buy shares of stock and become a part owner of that company. And what do we want as shareholders? We want equity and cash flow! The equity or worth of a share of stock would be the stock price. We buy it at $20 a share and we hope it goes to $30, or even $300, but preferably not $3. Cash flow would be synonymous with dividends (money paid to us as a shareholder when the company earns a profit). Investors who are young enough, or aggressive enough, aren’t worried about dividends. They might simply choose to roll those dividends back in to buy more stock. But some people, especially retirees, do invest in stocks for the purpose of living on the dividends paid to them as shareholders.
A business owner or a business manager faces a host of factors that can have an impact on the equity and cash flow of their business: the general economic climate, consumer confidence, interest rates, the price of oil, government regulation, and on and on. But there is at least one thing that a manager can do to proactively impact equity and cash flow, and that is to earn a profit. So, ‘Why do we earn a profit?’ To generate equity and cash flow. And ‘How does a business produce equity and cash flow?’ By earning a profit. The next logical question is, ‘How do you do that?’