“There is no such thing. There are only costs.”

There’s a particular pressure that comes with a business hitting its stride. The growth is real, the market is responding, and the advice arrives from every direction at once: raise, expand, hire ahead of demand, move fast. 

The founder, who has usually earned this moment the hard way, has every reason to want to run at it. And the number they reach for to confirm it’s working, the one everyone trusts to say the growth is real and affordable, is profit.

I would argue that profit is the one number least able to tell them that. It will confirm the business is bigger. It will say almost nothing about whether the business can afford the future it’s racing toward. 

For that argument I go back, as I often do, to Peter Drucker.

Drucker’s claim

Many years ago, so long ago that I can’t even remember which decade it was (I’ll guess the very beginning of the 1990s), I came across a reference to an essay by Drucker, the fabled professor of management theory and practice. Drucker is one of those Yoda-like figures everyone in business is fond of quoting but few, outside of dedicated devotees, have actually read. I can distinctly recall being intrigued by his premise that there is, except in unusual circumstances, no such thing as profit.

The essay ran in the Wall Street Journal in February 1972, one of two he published there between 1972 and 1976. They’re written with a clarity I could spend the rest of my life following down exploratory rabbit holes and still not exhaust. They remain as relevant now as when he wrote them, nearly half a century ago.

Drucker’s foundational point is that the residual surplus at the bottom of a profit and loss statement, the thing everyone calls profit, is an illusion. 

It’s an arbitrary number that ignores several real costs a business carries, for the sole purpose of producing a taxable surplus. Ignore interest, rent, or depreciation and you’d rightly call the resulting number meaningless. Drucker’s argument is that we do exactly this to profit, and call it accounting.

Drucker names three such costs. 

The three costs profit doesn’t account for

Drucker names three such costs, each a real charge against the business that the profit figure neglects to record.

  1. The cost of the capital itself. Every dollar of equity funding a business carries a real cost: the return that capital could have earned somewhere else. Drucker’s observation was that very few businesses actually earn enough to clear that hurdle, and it holds whether capital is cheap or expensive. Failing to clear it is as real a shortfall as failing to cover wages or raw materials, and nothing on the P&L will flag it for you.
  2. An insurance premium against an uncertain future. Products age, processes get overtaken, markets and buying habits shift, and whole industries get reordered by new technology (a shift that is very much underway with AI today). A healthy business owes a reserve against all of it, the same way it already insures against fire. Most still don’t. They cover the risks that have a name and leave the larger one — that the world simply moves on without them — uninsured.
  3. Tomorrow’s jobs. The capital a business keeps today is what funds its next stage, and the people who will depend on that stage existing. Drucker’s point was that the investment needed to support each job keeps rising, and rises fastest in the capital-heavy industries where the future is most expensive to build: energy, healthcare, infrastructure, food. Spend today’s surplus proving this year’s growth and there may be nothing left to fund what comes next.

These costs are, in Drucker’s words, “fully as much ‘economic reality’ as wages and payments for supplies. They belong on a company’s financial statements just as plainly as the others do.

A few conclusions of my own

Most businesses do not earn enough to finance the risks and requirements of their own futures. Given that fact, it’s hardly surprising that the average lifespan of a modern business keeps shrinking, or that roughly 75% of the companies currently in the S&P 500 will not exist in their current form by the end of the decade. 

Calculating profit properly is the difference between a business built to survive its next stage and one that only appears built for it.

The clearest failure of this thinking shows up in financialization. Replacing equity with debt through share buybacks. Executive compensation tied to per-share metrics that have little to do with the underlying health of the business. Cash diverted away from research, development, expansion of capacity, renewal of plant and equipment, and other future-proofing investment, toward financial engineering instead. By Drucker’s math, that diversion is a business spending, today, the capital it will need for the stage it hasn’t reached yet.

There’s a real distinction between good profit and bad profit, and it’s one I come back to often. Charles Koch’s version is the cleanest I’ve found: “Good profit comes from Principled Entrepreneurship — creating superior value for our customers whilst consuming fewer resources and always acting lawfully and with integrity. Good profit comes from making a contribution to society — not from corporate welfare or other ways of taking advantage of people.”

The questions profit won’t answer

Which returns me to the founder at the top, the one being told to chase growth as aggressively as possible. 

Drucker’s three costs are, read plainly, three questions the owner is rarely asked to answer. 

  • Is the capital funding this growth earning back more than it could earn elsewhere, or only earning applause? 
  • Has anything been set aside against the risk that this expansion changes what the business is exposed to? 
  • Is there enough left, after the growth is paid for, to fund the stage that comes after this one?

 A business can be growing by every visible measure and be failing all three, and its profit will not breathe a word of it. That is the danger of trusting the number.

The best way I know to combat any of this is education, comprehension, and context. It’s why I care so much about teaching owners the language of their own business, and about pressing them to look past the classic constraints of accounting and GAAP when they judge how the company is really doing. The aim is a plain one: to help good owners aim high for good profit in companies they mean to keep. If you’re ready to start the conversation, I’m ready to talk.

A previous version of this was originally published in Pitchfork Papers.