Q&A - What is profit and why is it important?

Profit is a very important concept for any business – particularly a start-up. Profit is the financial return or reward that firms or entrepreneurs aim to achieve to reflect the risk that they take.

Given that most firms and entrepreneurs invest in order to make a return, the profit earned by a business can be used to measure the success of that investment.

Profit is also an important signal to other providers of finance to a business. Banks, suppliers and other lenders are more likely to provide finance to a business that can demonstrate that it makes a profit (or is very likely to do so in the near future) and that it can pay debts as they fall due.

Profit is also an important source of finance for a business. Profits earned which are kept in the business (i.e. not distributed to the owners via dividends or other payments) are known as retained profits.

Retained profits are an important source of finance for any business, but especially start-up or small businesses. The moment a product is sold for more than it cost to produce, then a profit is earned which can be reinvested.

Profit can be measured and calculated. So here is the formula:

PROFIT = TOTAL SALES less TOTAL COSTS

Here is an example which illustrates the formula in action: