Profit and Loss

Most folks believe that business is all about profit. It’s true that profit is necessary to keep a business going, but it is not sufficient.

A business exists to serve its customers. That’s its primary purpose. Without customers, it wouldn’t exist.

If a business serves its customers well, it results in profit. The key word here is result: profit is not the goal of the business, it is merely the result of the business. In this context, profit represents the contribution that the business has made to the greater good of society.

(Let’s assume there is no fraud, no theft, and no violence. That assumption rules out profits made through the violence of intellectual property.)

Now what is the purpose of this profit? Profit is necessary to continue serving existing customers, but it is also useful for expanding the business in order to serve more people.

Existing customers found value in what the business had to offer, so it is likely that new customers would also benefit from those offerings, too. Profit is necessary to bring those benefits to a greater number of people.

But profit has a twin sister, which we call loss. Profit and loss are two sides of the same coin; you cannot have one without the other.

So that brings us to a second important function of profit: A business must make profits so that it can incur losses, which invariably it must accept.

I cannot stress how important it is for businesses to take losses on behalf of their customers. A business must lose from time to time in order for its customers to live their lives with a modicum of stability.

We live in a world of eternal change — a world of great risk. As individuals, we simply cannot bear all of the dangers which could potentially befall us.

So we entrust much of these risks to the businesses which serve us. When bad things happen, it is the business which takes the hit.

These loss-making activities include such things as assuming the burden of debts, writing off defective merchandise, or operating with a negative cash flow for periods of time. In the worst of cases, the business makes the ultimate sacrifice and declares bankruptcy.

All of these losses are necessary to protect the customer so that he or she can live a life with less worry and anxiety. The business assumes the risk of loss in bad times and, in exchange, the business is allowed to make profit in good times. That’s the contract between business and client.

Loss is not only important for protecting customers, it is also critical for the entrepreneur, since it is the primary means for the entrepreneur to learn and get better. Loss informs, much in the way that life teaches us through hard and bitter experience. Loss tells the entrepreneur what he or she must do (or not do) to survive and thrive in the future.

And this is the great tragedy of the financial crisis. By bailing out the banks and car manufacturers, the US government robbed these businesses of the opportunity to learn, improve and innovate.

Everybody wants to profit; nobody wants to lose. But you cannot have profit without loss, and you need loss today in order to learn the lessons necessary to change and adapt. Loss shows the path to future profitability.

All businesses, large and small, must be allowed to make mistakes and learn. There is no such thing as “too big to learn.” Thus, there is no such thing as “too big to fail.”

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