This post is part of Investigating Companies: A Do-It-Yourself Handbook. Read, download or purchase the whole book here.
Put simply, companies grow and make profits by selling goods or services for more than they spend making them.
As a general rule of thumb, the less companies can pay for things like staff, supplies, rent and tax, and the more they can charge customers for the products and services they make, the more profit they will make. See section 2.6 for how to find out how much profit a company is making and how much cash it has.
There are a variety of constraints that may hamper a company’s attempts to make a profit, and it’s good to keep them in mind when trying to work out the pressures on a company. They include:
Competition from other companies;
Increased cost of supplies or raw materials;
Reputation or ‘brand’;
External economic factors such as rising interest rates or inflation, or a general decline in consumer spending;
Regulations and state support, for example through subsidies or tariffs (hence many multinationals having ex-ministers or civil servants on their boards);
Workers demanding and organising for better pay, benefits and working conditions;
Negative public perception of their particular company, its activities or type of business or sector;
Boycotts, protests or other resistance to their activities.
In addition, there are two important qualifications that directors have to keep in mind while trying to increase the company’s profits:
BALANCING LONG-TERM OR SHORT-TERM GAINS
The timeframe in which they’re looking to make a profit matters. If a company increases the prices of its products, it may make it some short-term gains, but it may lose customers in the future, reducing its long-term profits, for example.
Equally, increased investment may hurt profits in the short-term, but bolster them in the long-term.
The terms under which people have invested their money in the company can influence how the directors run the business in this regard.
Shareholders in start-up companies are often tolerant of the losses they make in their early years, as they expect the future rewards to be worth the wait. Investors in bigger, established companies, however, may want a quicker return on their investment.
Some lenders may waive interest payments for a year or postpone repayment of a loan if they think they are better off giving a company a few more years to become more stable.
Others will insist on a full repayment on time, even if it means forcing the company into liquidation.
While doing everything they can to increase the company’s profits, directors also have to make sure it can pay its bills and running expenses. In the jargon, this is called liquidity. A company that doesn’t have enough cash to pay its bills is said to be illiquid.
Not having enough cash is the number one reason why companies become insolvent and go under. See section 2.6 for how to find out how much cash a company has.
PROFITS AND WAGES: If the company you’re working for says it can’t afford to increase your wages, find out how much profit it is making. If you find it is posting consistently good profits – and it has enough cash – you could use this information to back-up demands for a pay rise. Those profits are being made on the back of the staff’s work after all.