The Amount and Distribution of Profits
We come now to that phase of the subject which transcends all others in importance, the question to which all that we have said hitherto has been but an introduction; namely, the relation of profits to the common welfare. This is a large question -- complicated, many-sided, farreaching. To some reformers the question seems an easy one to answer; but it is far from easy. It cannot be disposed of summarily; and it can never be answered by the counting of votes. It has to do with facts rather than with opinions; it calls for measurement rather than for argument.
Ordinarily, we do not have heated controversies concerning the area of a farm; we survey it. We do not argue about the weight of a load of hay; we weigh it. Economic questions, as well, we should strive to answer in the only way that such questions can be answered finally, by means of accurate accounting and statistical analysis. Business men, it is true, cannot wait for final answers. They must act; otherwise most of us would starve. And every day they must take the risk of acting on imperfect knowledge, sometimes on mere guesses and hunches. Their constant aim, however, should be to decrease risks by increasing the range and reliability of economic measurements.
The relation of profits to the welfare of mankind, though a many-sided problem, is on all sides quantitative. The moment we examine any aspect dispassionately, we come to the question, how much? Even the effect of the profit motive on general welfare, though it seems to defy measurement, is none the less a quantitative problem.
More obviously are questions of material income quantitative. If we want to know about the material fortunes of wage-earners under a profit economy, we must measure the changes in real wages with the best scales we can devise; for no man's opinion on this subject is of much interest to anybody but himself. So with all the other problems that center about profits. What proportion of profits is distributed as dividends? What proportion of national savings is made by business concerns out of profits? To what extent does the withholding of profits as surplus or as working capital cause a deficiency of consumers' purchasing power? To what extent does the expansion of capital facilities out of profits result in overproduction? What is the relation of fluctuations in the rate of profit to fluctuations in employment? All these questions clearly call for statistical answers. First of all, then, we need a basis of fact.
The Available Statistics are Inadequate
Unfortunately, in spite of the notable progress of the last decade in the scientific study of social phenomena, especially in the perfecting of index numbers, the available statistics concerning profits still fall far short of meeting our needs. Indeed, in the whole domain of economics, there are few topics that lend themselves so readily to statistical analysis, concerning which we know so little. Our ignorance may be ascribed partly to the fact that enterprisers, struggling for survival in the midst of keen competition, have considered it good business policy to have very little to say about their profits; partly to confusion in the use of terms; partly to accounting methods which have given business men themselves no reliable measure of their profits.
What are the profits of a given concern for the year just closed? They depend in part on what is regarded as capital, what is charged to operating expenses, in what way the expenses are pro-rated over a series of years, what value is placed on inventories, and how much is charged to depreciation. Such questions offer large scope for the exercise of judgment. Whether the annual report shows a substantial profit or a large deficit often depends on how these questions are answered.
Furthermore, as a base upon which to compute the rate of profit of a company, total investment, including surplus, should be used; but what is surplus? Sometimes it is nothing more than a bookkeeping transaction. Sometimes it stands for fictitious sums which have never been used in the business; sometimes for money that has been lost; sometimes for overvalued machinery or inventories. Whether the amount set down as surplus in the report of a particular company represents money that has been earned and put back into the business, or inflated capital values, or good-will, or something else, it is often impossible to tell.
To illustrate the difficulty of finding the rate of profit from official statements, we may compare the balance sheet of the Willys-Overland Company at the end of 1923 with the balance sheet at the end of 1922:
1923 1922
Common Stock................................ $10,798,805 $53,993,850
Profit and Loss Surplus..................... 13,002,418 def. 43,231,300
The change from a deficit of over 43 million dollars to a surplus of over 13 million was achieved in part by means of bookkeeping entries which involved writing down the value of the common stock from $25 to $5. This is an unusual example. For an ordinary example let us take an automobile company which has spent $200,000 on dies and presses for new models. The money is gone. How should it be charged? That depends in part on how many years the new dies and presses are to be used, and that is a question which nobody can answer in advance. Something, however, must be done with that item of $200,000, and book profits for the year will depend in part on what is done with it. Or, take the case of a Southern lumber company which has invested 20 million dollars during the past four years in acquiring timber land and in preparing for operations in the Northwest. Is the interest on this investment to be charged to the operating expenses of the Southern mills and thus deducted from the profits of those mills? Or is the interest to be treated as an operating expense of the Western mills and pro-rated over twenty years? Again, are the operating losses of the new mills in the first year to be treated as expenses or as capital investment? Evidently book profits depend partly on facts and partly on the interpretation of facts.
We shall do well, therefore, to use all our statistics in this field with care. We must bear in mind that they do not always cover exactly what they seem to cover or measure the data with the precision they suggest. We must make due allowance for the fact that such terms as 'capital,' 'net income,' 'book profit,' 'surplus,' and 'depreciation' have different meanings in different corporation reports, with the result that statistics often lump together items that are not strictly comparable. We must take account of bookkeeping methods that sometimes credit profits to periods in which they are not earned, and sometimes show large paper profits, based on estimates of inventory values, which never become money profits. And we must not overlook the fact that at times some business concerns have strong motives for making their profits appear larger than they are, and others for making them appear smaller than they are. Finally, we must be wary about drawing generalizations from reports which cover selected concerns, unless we can be reasonably sure that the basis of selection does not invalidate the data for the purpose at hand.
For certain purposes some of the statistics we are about to present do not show clearly enough what they cover; some are not sufficiently accurate; some are not sufficiently comprehensive. For our purposes, however, we believe that these statistics are adequate. In drawing conclusions from them, we shall endeavor to keep their shortcomings in mind.
These Statistics do Reveal Important Facts
The available statistics, though far from satisfactory, are much more extensive and reliable than they were before the income and excess profits taxes brought about greater uniformity and accuracy in accounting methods and greater publicity. These are valuable by-products of the new laws. Data for the years before the World War, unfortunately, are relatively scarce; but for recent years there is a wealth of material in corporation balance sheets and Government reports that are now a matter of public record. These by-products of the income taxes have not yet been fully utilized, perhaps because long tables of statistics in official reports are forbidding.
If we take pains to analyze these statistics, they will tell us, accurately enough for our purposes, much that we need to know about the extent of profits and losses as a whole; variations in the rate of profits; the changing ratio of profits and other sources of income; the proportion of individual incomes derived from dividends; the variations, from place to place and from time to time, in the profits of certain industries; the variations in the profits of different concerns in the same industry, and of the same concern in different periods; the contrast between the fortunes of some industries and the misfortunes of others; the relative success of small concerns and large concerns; fluctuations from time to time in the number of business failures, and in the amounts which successful enterprises set aside as corporate surplus.
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