Concerning profit and its consequences

January 2014

Concerning profit and its consequences for the way we conduct economic life, we all need to stop, think and start again. Today people make a big distinction between ‘normal’ enterprise and ‘social’ enterprise, the somewhat tactless implication being that normal enterprise is not only not social;; it is anti-social. 

Taking the high ground in this way does not serve the wider aim of a non-bifurcated image of society and economic life. Indeed, it maintains the classic divide under which modern life has long been conducted. Between left and right, capitalism and communism, ‘the West’ and Islam – even orthodox and heterodox economics.

Not only is this divisive;; it is imprecise and contradictory. It leaves so-called ‘social enterprises’ trying to match themselves and their performance to ‘anti-social enterprise’. And all the while seeking for government help in the form of preferred treatment and finance, as if state-funding of enterprise were an economically healthy thing to do. It is certainly not associative.

To be associative, there would need to be associations or their proto-versions – which might be banks, were these reduced to bookkeeping and financial advisory institutions. As they are, today’s banks are instead of associations insofar as they depend on money as a thing in itself and on the need to preserve capital, whereas associations – because by definition they do not regard money as a thing in itself – deliberately aim at systematic consumption of excess capital. 

We are tying ourselves up in knots, a process that will see two predictable outcomes: an increase in state-dependent business in ‘inefficient’ sections, while errant corporatism will proceed apace, claiming that the downside of capitalism is outside its jurisdiction, that being the prerogative of ‘social enterprise’.

Profit as a social metric

If one looks at profit from an accounting point of view, however, none of this bifurcation is necessary because the accounting treatment of profit tells a different story. In any set of accounts one’s income demonstrates that people value what one offers (and that they profit from buying from you as opposed to anyone else). One’s expenses are expected (by the logic of accounting) to be less than one’s income, but one’s expenses are income to others because in turn one value what they offer. One also profits by making the purchase. To make a profit on operating is a social metric: it demonstrates that what one offered was socially valid (in the minds of the buyer, moreover, not the vendor;; the consumer, not the producer).

This excess of income over expenses is profit in accounting terms. It is expected of all accounts, in particular of both parties to a trade, and regardless of the type of entity. People argue over to whom it belongs, but in accounting there is nothing to discuss: the profit (or loss) is added to (or subtracted from) the ‘own capital’ account of the trading entity, which is not a synonym for those who have invested in it. To them it has a liability, but investors do not own what they invest in. They may have a call on the ‘residual value’ of a business, but the business is in reality ‘owned’ by the person running it. This remains the prerogative of the entrepreneur. One may change the entrepreneur or director using one’s power as majority shareholder, but nothing is thereby changed: it is still the prerogative of the entrepreneur to decide cash distribution.

In essence, then, profit belongs to the entity in which it occurs;; that is to say, it belongs to neither the workers nor the capitalists. The accounting question is: What use is made of profits, which can also be seen as ‘internally generated’ capital? Whether they are held as reserves for future liabilities, remitted to shareholders as dividends, or invested in the rest of the economy, via the markets or the banking system, here again capital does not belong to either capitalist or worker. ‘Own capital’ means what it says: the capital belongs to the entity. The shareholders, those with ‘equity’, are simply creditors. Unlike trade creditors who are owed the value of their unpaid invoices, or banks who are paid what they have lent plus interest, shareholders are owed whatever is left over once assets have been cashed in and non-equity liabilities paid out. As any liquidation shows, they are\ due whatever is left over but they cannot decide what this amount is.

In this sense, the counterpart of capital is not those who have lent to an entity or those who work in it, but the capacities of the entrepreneur – the person using the capital and, ideally, making it good (increasing its amount and its value).

Enjoy one another’s profitability

On this basis, provided it has not externalised to the public balance sheet such costs as underpaid remuneration and environmental impacts, every true enterprise is both profitable and social. The words should be synonyms. The question then becomes: Cane one have excess profits, excess capital? Not in principle. If profits are not needed as internally generated capital, they flow away – to finance other activities (either within the same entity or in others via the banking system), or as refunds of capital. Above all, they can be the funding so essential to new initiatives. 

Not only is the social/anti-social divide in the field of enterprise anomalous, therefore, but so, too, is the idea of separate for-profit and not-for-profit worlds. All true enterprise should be profitable, that is social. And all true enterprise should maintain the capital necessary to its activities, neither more nor less. This would result in a flow or circulation of capital, not in its preservation.

For some, even so, there would be excess capital, which should then be given to those who cannot attract capital or generate it internally. But in an associative economy such enterprises would no longer be there! It is only an aberration of our thinking and our tax system that organises the world to make money on one side, then give it away on the other.

In a world where bifurcation no longer operated, excess profit could not and would not arise. It would, as it were, be pre-distributed. Each enterprise would look to its own balance sheet to see that it was (a) optimally capitalised, and (b) profitable (in the sense described here). We would enjoy one another’s profitability.