Loss of profi

In the business world, the term “Loss of Profit” is generally associated with the insurance business and relates to a transaction where loss of profit arising from a shutdown of operations due to a perceived calamity is insured by businesses. Notwithstanding that calculating loss of profit in any case tethers subjectivity; all calamities cannot be anticipated, especially bungling idiots.

For those unfamiliar with the context, the Great Man Theory, courtesy Wikipedia, is a 19th-century idea according to which history can be largely explained by the impact of “great men”, or heroes. Later, Ian Morris brilliantly pointed out that the other side of the great-man coin is the bungling-idiot theory of history. While the tendency to characterise personalities under either framework is generally limited to world leadership, it can as easily be applicable to profit-makers.

Curiously, while world history is unforgiving to bungling leaders, business archives are all about great CEOs and great decisions with exceptions limited to great blunders or greater frauds. The trend is similar in public finance, while the world, justifiably, recognises and credits the Mexican Finance Minister for his decision to hedge Mexico’s oil prices in 2009, resulting in huge gains for his country, one cannot recall any incident when a national finance manager was chastened for performance. Perhaps the world of business and finance is populated with great men only, barring a few tricksters, which crop up now and then, the exceptions to the rule!

Logically, that would be impossible. “I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will,” Warren Buffet. Penetrating insight, however in recent times such wonderful businesses are rare, if not extinct and depending upon circumstances anyone of the aforementioned dynamic duo can have a defining impact on profit. The information age has significantly heightened business risk and challenges especially due to rapidly evolving markets. Even wonderful businesses like oil, for instance, require great men to optimise gains and to guard against risks such at the Dutch oil curse at the national level and falling reserves at the corporation level.

To further elaborate, countries blessed with oil need to plan for life after oil runs out or the eventuality of technological advances commercialising a cheaper source of energy. Profits from selling oil are uncontrollable, unpredictable and are a sole byproduct of international supply and demand scenario; hence credit for performance does not accrue to any individual. Au contraire, such effortless cash flows foster an environment where manufacture and industry invariably are ignored. Controllable actions which optimise such profits and at the same time invest them in developing other profitable sectors having a futuristic outlook are the hallmark of great men.

With this background, the term “loss of profit” is elaborated as the profit which should have been earned under a given circumstance and was lost due to unwise controllable actions or inaction. While white-collar incentives and performance bonuses are the norm in the corporate world, disincentives are conspicuous by their absence. Hardly has there been a case when management responsible for a failed corporation faced personal bankruptcy. Shortly before the 2008 subprime crisis, financial sector profits and consequently management bonuses were booming for about a decade, in most cases while the institutions were subsequently liquidated or needed to be saved by the government, there are no instances of management payback? Accordingly, even where there are profits, performance needs to be judged on controllable actions or inaction and uncontrollable occurrences; rather than evaluating results as a percentage of historical data only.

The biggest pitfall of a monopoly is this particular loss of profit primarily because the ability to increase price of scarce resource camouflages inefficiencies thereby promoting a false sense of reality. Since this series of profits recognises that monopolies are natural and that national assets should be managed in a protectionist regime for enhancing valuations and earning profits, the risk of window dressing of profits becomes current and real.

Fundamentally, profit not earned needs to be targeted; simultaneously losses might not signify loss of profit, confused? To clarify, most State Owned Enterprises are burdened with excessive human resources who may even include political appointees. In such a scenario, judging managerial performance purely on the bottom line will be inappropriate. One option might be to subtract uncontrollable surplus staff costs before evaluating managerial performance.

While it is easy to criticise state-owned enterprises for poor performance, there is a need to apprise critics, of profit lost due to interference by vested interests. Continuing on the same tangent, the debate on why public sector enterprises become profitable shortly after privatisation also needs a detailed analysis beyond bottom line results.

But who will bell the cat? Independence is the primordial ingredient for any evaluation of profit, even before capacity and knowledge. The necessity therefore to strengthen an independent and competent monitoring function especially in relation to operations of national assets can hardly be underscored. A proactive approach is the need of the hour; profits once lost may never be recovered. At the end of the day any simplistic analysis of growth in revenues or other similar key indicators, especially on borrowed money, might even have a negative connotation for the future! Serendipitously, the Mercantilists were right; trade surpluses are the primary directive for therein lays the primary ingredients for a nation’s loss of profit.

(The writer is a chartered accountant based in Islamabad)