tence, we may say that profit is made possible because risk makes scarce the number of men who have sufficient ability to succeed in spite of the risks involved in business.

Pure Profit in Final Analysis.-At the outset, gross profit was separated into three elements,-interest, wages of management, and pure profit. In light of the foregoing analysis, it is apparent that this third element closely resembles wages of management. It arises from the scarcity of managers who are able to shoulder business risk successfully. It is a payment directly traceable to the scarcity of the better grades of management. It is, therefore, in last analysis a form of wages of management itself. Pure profit, in large part, is not a thing separate and distinct, but has to be classified under wages of management.

But there is another aspect of pure profit which cannot be identified with wages of superior management. This form is traceable only to chance and fortuitous circumstance. Profit often is due simply "to the breaks of the game." The recipients cannot claim superior ability or superior shrewdness. They are downright lucky. In fact, there are times when business men cannot prevent themselves from making profits. During a period of rapid price inflation, for instance, business men of very mediocre ability reap a wonderful harvest of profit. They have benefited from a force which they did not create and which they did not control. They took risks, and the wheel of fortune stopped at the right place. Pure profit in this sense is attributable to pure chance.

This view of pure profit, of course, looks at the matter from the standpoint of the individual business. From such a standpoint, company earnings of 30 or 300 per cent may commonly be gained. Such earnings appear in the everyday reports of any number of corporations. But they are by no means the whole story. Let us assume the viewpoint of all industry over a considerable period of years. When we record all of the losses as well as the gains, when we consider the lean years as well as the fat years, will there be any substantial element of pure profit left? Will not the residual share disappear altogether, or even become a negative quantity, an absolute loss? In the opinion of most of the orthodox economists, the answer to these questions is the dismal one. The opinion has commonly been that in the long run and for industry as a whole, pure profit is net loss. It has been maintained that profit seeking is bound to be a losing adventure. This view, of course, is only an opinion. There are no statistical records which can verify or disprove it.

If the opinion be correct, of course it becomes futile to explain the cause of pure profit. It is an empty task to explain the origin of a thing which later on is said not to exist in the first place. If pure profit does not exist in the long run and for industry as a whole, and there is no such eventual share in distribution, we can ignore the permanent existence of pure profit altogether. Our theory of pure profit can, at best, be a theory of a temporary share in distribution received by the individual business.

Profit theory has long been one of the least satisfactory parts of the orthodox economic analysis. If the foregoing approach to a theory of profits. seems somewhat indefinite and uncertain, it is because this residual share has never been given a perfect logical position in economic theory. To put the case as definitely as possible, we may say that pure. profit may not exist at all in the long run, although facts are wanting for a conclusive answer to this problem. Assuming that it exists temporarily, and moreover only for a certain limited number of individual concerns, it is attributable to two basic causes: first, the scarcity of the ability to shoulder risk successfully; second, the favorable outcome of chance and fortuitous change.

For the purpose of an abstract theory of profit, these various considerations and definitions are necessary. They serve a particular purpose. But the very abstractness and indefiniteness of the reasoning has meant that practical business has been compelled to evolve certain profit terms and concepts of its own. These serve the purpose of actual business reckoning, and are of vital importance in modern business enterprise. They are largely the outgrowth of accounting, and the following analysis explains profit from the standpoint of the modern science of accounting.

Business Profit and Modern Accounting.-The accountant finds that for adequate analysis of business earnings, at least three separate computations are necessary. These are commonly referred to as gross profit, operating profit, and net profit.

Gross profit is the total sales less the cost of goods sold. In calculating the cost of goods sold, the purchase price of merchandise is the chief factor in those lines of business where merchandising is the principal part of the enterprise, whereas the factory cost or direct expenses are often taken as the chief factors where manufacturing is the principal part of the enterprise.

Operating profit is gross profit less the operating expenses of the business. These expenses include such items as labor, rent, and depreciation, but do not include such items as interest, income taxes, or any return on the capital used. Operating profit is particularly valuable as a measure of the efficiency of the executive staff.

Net profit is operating profit less interest, income taxes, and miscellaneous losses not directly chargeable to operating expenses. This final net profit is the amount available for dividends and surplus. It is the net gain of the business from the standpoint of the stockholders or proprietors of the enterprise. The net profit is the real measure of the earning power of the business from the stockholders' point of view.2

2 The accountant's concept of net profit is substantially in agreement with the government's concept of net income for the purpose of applying federal income or excess profits tax. Thus, Regulations 65, Article 21, of the Treasury Department, bearing upon the computation of taxable net income, state: "Although taxable net income is a statutory conception it follows, subject to certain modifications as to

The primary service of these accounting devices is that they measure with reasonable definiteness the quantity of profit in a business enterprise. They are measuring devices, and for that purpose, they are indispensable. They supplement the theoretical concept of the economists with an exact, concrete sum of profit. There is nothing necessarily contradictory between the two ways of viewing profit. For purposes of economic theory, one view of profit may be desirable, whereas for purposes of business calculation, a more precise and commensurable view may be essential. The work of the accountant does not displace the work of the traditional economic analysis. The relation is mutually supplementary, not mutually exclusive."

Since profit in the accounting sense is primarily useful as a measuring device, it is important to know in any given case exactly what is being measured. Profit may be stated as a per cent on net worth or stockholders' investment, or as a per cent on the volume of sales. It may be stated as a lump sum for the business as a whole, or as a lump sum per unit of capital stock or per unit of sales. It may be stated in relation to money values or to physical units. Unless otherwise specified, profit in ordinary business parlance is quoted as a per cent on the stockholders' investment. Thus, if a certain business is said to have earned 10 per cent, it is commonly understood that this means 10 per cent on the capital investment. This method of expressing profit is the dominating one in the stock exchanges and wherever the money values of corporate securities are being calculated. Financiers, investors, specuexemptions and as to deductions for partial losses in some cases, the lines of commercial usage. Subject to these modifications, "statutory net income" is "commercial net income." The statutory computation is substantially as follows:

Gross sales

Other income

Total gross income

Cost of goods

Labor, salaries

Rents

Interest paid

Depreciation, etc.

Taxes paid

Total expenses and deductions

Net profit after taxes

8 It should be noted that the accountant's "net profit" or net income corresponds with the general term "profit" as used in economic theory. Thus, net profit may be dissolved into the three elements of an interest factor, a wages of management factor, and a risk factor. The risk factor, or pure profits, is not synonymous with net profit, as used in accounting. Pure profit of economic theory is simply one element, namely, the risk element, in the net profit of accounting.

4 Profits may be specified as a certain amount per $100 of sales, or as a certain amount per bushel, or ton, or other physical unit. For various purposes, gross profit or operating profit may be the proper amounts to use instead of net profit. Each of these various concepts serves a particular use and purpose in the hands of accountants and business executives.

lators, demand to know the rate of earnings on the capital in the business. Likewise, from the standpoint of the public, when the accusation of profiteering is made, the accusation is aimed at an exorbitant per cent of earnings with reference to the invested capital. When public service commissions are instructed to allow a fair rate of return to public utilities, the determination of fair rate refers to a fair per cent of profit on the invested capital. In all such cases, the thing measured is per cent of profit on the capital put into the business. This form of statement of profit is the one which will be most commonly required in dealing with profit in the present development of economic theory.

Differences in Profits Among Different Concerns.-Any branch of business shows marked differences in the rates of profits earned by different concerns. All degrees of low, high, and medium profits are to be found.

We may classify these differences in three groups. Group one includes the least successful business enterprises. These are the concerns at the no-profit margin. At best, they earn less than a normal interest return on the investment. Many of them barely meet their costs of doing business. Many of them suffer an actual loss. They are as a group on the borderland of failure. Many will be extinguished entirely, whereas others will recoup their losses in later years and climb to a position of substantial profit.

At the opposite extreme, group three includes the exceptionally successful concerns. In each industry are to be found certain companies which earn extraordinary returns. Their super-profits are decidedly in excess of those earned by the rank and file of business concerns.

Group two lies between the extremes-between the no-profit fringe at the bottom and the super-profit fringe at the top. Here are found the bulk of concerns in any given industry. The majority of enterprises are bunched together in this central group. They represent the rank and file of moderately successful concerns.

The No-Profit Group.-The proportion of business found in the noprofit group varies greatly from industry to industry and from year to year. Available statistics of profits would indicate that in years of fair prosperity, from 10 to 20 per cent of the invested capital in the average industry fails to earn a profit. Even in years of great prosperity, upwards of one-tenth of the invested capital shows no profit. In years of depression, upwards of one-quarter to one-half of the invested capital in many industries may fail to show a profit.

Some idea of this variation from industry to industry and from year to year may be obtained from data on corporation net income reported under the federal income tax law. Corporations reporting no taxable income are classified separately from those reporting taxable income. The group reporting no taxable income do not correspond exactly with the no-profit group of business concerns, but they do correspond substantially. The following table indicates the variations and differences which occur in corporations reporting no net income.

• Statistics of Income, United States Bureau of Internal Revenue, 1921, 1922.

The computing of profit and loss in this connection follows the general formula set out in the above footnote to page 203.

Not only are there wide variations between different industries, but also there are wide variations in the average of all industries from year to year. Some notion of these aggregate year to year changes may be gained by studying the volume of business which earned no net income in various years. The following table shows the per cent of the gross business of all corporations which was done by those corporations reporting no taxable net income."

5 Statistics of Income, 1922, p. 143. M. C. Rorty estimates that in a year of fair prosperity, about ten per cent of the total capital earns less than a normal interest rate and so belongs with the no-profit group. See, Some Problems in Current Economics, p. 125. This estimate is chiefly based upon the special study by J. E. Sterrett in the American Economic Review, March, 1916. A slightly smaller fraction in the no-profit group is indicated by David Friday, Profits, Wages, and Prices, pp. 41-44. Studies of costs and prices in several industries by the Federal Trade Commission indicate that from ten to twenty per cent of the output comes from concerns earning no net profit. Likewise, F. W. Taussig found that in price fixing in the war period, from ten to twenty per cent of the output tended to have such high costs of production that no net profit could be earned. See Quarterly Journal of Economics, February, 1919, p. 225.