Profit as an indicator of performance.
I’m on a roll – 4 blog posts in a month! Unprecedented times call for unprecedented measures, lol. I wanted to write a short blog post to make one specific point. I’ve already covered issues with the CBILS loan scheme and also discussed more broadly about issues with business loans in the UK.
But this issue deserves some special treatment, because it is an issue based on a fallacy of judgement, which in itself needs to be exposed and reformed.
Every day I’m seeing new stories of business owners and directors being refused loans because X years ago they reported a small annual loss. The banks take this loss a signal of poor financial health. But this is a massive assumption, and for a significant proportion of businesses it is a false assumption. To me it says one of two things:
1) Lenders either don’t know how businesses actually work, or
2) Lenders don’t care, don’t have the expertise to evaluate real financial health and just use profitability because it’s cheap and easy.
Hardly a single business anywhere – from Amazon to Apple to our little tech company – tries to maximize profits. In fact, pretty much every business everywhere tries to minimize profits because that’s smart accounting and means you pay less tax.
When offered a choice between taking your monthly sales earnings and a) reinvesting them in your company and team to grow your business and b) giving a large slice of them away to the tax man, it’s pretty much a no-brainer. It’s A-OK.
The majority businesses who are ‘unprofitable’ don’t record losses because they are failing at business, they record losses because they choose to. They choose to invest in future growth, because that is better for the long-term success of the company than cashing out each year and giving a large chunk of change to HMRC.
By the way, I am not in any way advocating tax avoidance here. I believe paying taxes and being transparent about company finance is an essential civic duty. I think the offshore system is a disgrace and anyone specifically employing tactics to hide their money offshore or in trusts in order to shield it from the tax man are morally bankrupt. But this isn’t about that. This is about basic business and economic priorities. If a business always prioritised profits over growth, they wouldn’t grow. They wouldn’t hire more employees. They wouldn’t make long-term investments in equipment and property. If you scaled that attitude across the entire country, the UK’s business landscape would be bleak. The growth mindset in business is important for the economy at large.
So why then don’t banks understand that?
They used to. The sad truth is that banks have long since lost their way when it comes to being a service to society. It feels like the finance tail has been wagging the business dog for a really long time.
But now, I suspect it’s just not worth their effort when there are far more interesting and exciting ways to make even more money.
A great example of this can be seen playing out in the US stock-markets right now. It seems like for every 5 million Americans being made unemployed by the Covid19 crisis, the S&P500 is going up 3-4 pts. How on Earth can that make sense?
It doesn’t if you think the financial markets are based on actual business performance and trade. They aren’t. Not for a long time. Banks and other financial institutions are looking at the 22m Americans made unemployed IN A MONTH and thinking “great, lower staff costs!”.
So to summarise: profitability is normally (although not always) a terrible indicator of business performance. But banks use it because it’s easy and they don’t care. The words “fuck business” may have once inadvertently slipped from the lips of our now Prime Minister, but in the City of London they are sung from the rooftops.