Profit is the net difference between revenue and costs. The main way that firms use profit is to:
Dividends
For public limited companies, shares are listed on the stock market. Investors will buy shares in part to gain annual dividend payments. If profit and dividends fall, then investors may sell their shares, making firm more vulnerable to take over. Increasing dividends is a way to make shares more attractive. If firms increase profit, they are likely to increase dividends. For limited companies, the shareholders are only a small number, but it is a way to gain more income from their business.
Research and development
Firms may wish to use profits to invest in developing new technologies which will enable the firm to increase productivity, efficiency and enable it to remain competitive over the long-term. For example, a car firm may invest in new equipment which enables it to automate the investment process. Without the investment in new technologies, firms may find they become uncompetitive and go out of business.
Develop new markets
Fast-changing technology can quickly transform industries. For example, in the mid-1990s, record companies were very profitable, with firms able to charge high prices for an album. The profit margin on CDs was quite high. However, within a few years, new sources of digital music had transformed the industry and many record shops went out of business and record labels found it harder to make profit. Therefore, firms need to be evaluating the industry and whether there is a threat to the current profit stream. If this is the case, they should try to diversify into new markets which offer a chance to benefit from the new technology. For example, traditional retailers who invested heavily in an online presence were successful in maintaining profitability over time.
Acquisition
Firms who are very profitable are in a position of being able to buy up other companies, who are potential competitors. This means that rather than trying to compete with other firms, they can benefit from their innovation and bring the best new products and trends into the firm. For example, Google has made several important acquisitions
However, acquisition can be a risky business. Firms can become over-stretched and find they don’t have the expertise to manage new types of firms. For example in 2001, America Online (AOL) acquired Time Warner in a mega merger worth $165bn. The hope was that it would combine new tech (AOL) with old tech (Time Warner) but the new megalith firm couldn’t find synergies between the very different types of business and culture
Firms like Apple which are very profitable may struggle to even use their profit to the full. Rather than keep investing, they may just accumulate cash reserves until they can decide how to use it.
According to Moody – a rating agency, US non-financial companies held a total of $1.7tn held on their balance sheets.
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Categories economicsReally a good article…it’s make to think more about to investment in equity share before analysing company financial statement….
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