Question

An article in the Wall Street Journal discussing the financial results for General Electric Co. (GE) for the first quarter of 2017 reported that, compared with the same quarter in the previous year, the firm's revenue had fallen from \(\$ 27.94\) billion to \(\$ 27.66\) billion, while its profit had increased from \(\$ 228\) million to \(\$ 653\) million. How is it possible for GE's revenue to decrease but its profit to increase? Doesn't GE have to maximize its revenue to maximize its profit? Briefly explain.

Short answer

It is possible for General Electric Co. (GE) to have an increase in profit while experiencing a decrease in revenue because profit is calculated by subtracting costs from revenue. If the costs decrease significantly enough, the overall profit can still increase even with a decrease in revenue. As such, a company does not necessarily need to maximize its revenue to increase its profits. It can also achieve this by significantly reducing its costs.

Step-by-step solution

Understand the meaning of revenue and profit

First, it is important to understand that revenue is the total amount earned by a company from its operations and profit is what remains after all costs and expenses are deducted from the total revenue. Therefore, revenue is the gross earnings of a company while profit is the net earnings after all operating expenses, payments to suppliers, rents, and taxes are subtracted.

Understand the scenario

In the given scenario, GE's revenue decreased but its profit increased, indicating that the company has probably managed to decrease its costs and operating expenses, which has in turn increased the profit.

Answer the second question

It's not strictly necessary that a firm needs to maximize its revenue to maximize profit. If a company can manage to reduce its costs and operating expenses while maintaining or slightly reducing its revenue, it's possible to increase the profit. This is because profit is revenue minus cost. Even if revenue decreases slightly but costs decrease significantly, the profit will increase.

Key concepts

Revenue vs Profit

Understanding the distinction between revenue and profit is crucial when analyzing financial results. Revenue, often referred to as sales or turnover, is the total amount of money generated from the sale of goods or services before any expenses are deducted. On the other hand, profit is the surplus after all operating costs, taxes, and other expenses have been subtracted from revenue.

It is perfectly plausible for a company's revenue to decrease while its profit increases, as seen in the case of General Electric Co. (GE). This apparent contradiction occurs when a company improves efficiency or cuts costs more significantly than the decrease in sales. Revenue is not the sole indicator of a company's financial health; rather, the ability to translate revenue into profit efficiently is usually of greater importance to investors and stakeholders.

Operating Expenses Management

The management of operating expenses is a pivotal area that significantly impacts a company's profit margins. Operating expenses encompass all the costs required for the day-to-day functioning of a business, such as rent, utilities, payroll, and materials. Effective control and reduction of these expenses can lead to a better bottom line, even if revenue is stagnant or decreases slightly.

For GE, the scenario indicates that they have successfully managed their operating expenses. This could involve strategies like negotiating better terms with suppliers, investing in more efficient technology, or restructuring the organization to be leaner. By doing so, GE has increased its net earnings or profit, emphasizing that proactive expense management is as critical as revenue generation.

Cost Reduction Strategies

Cost reduction strategies are crucial for companies like GE to increase profits independently of their revenue streams. These strategies involve analyzing all areas of the business to find and implement ways to save money. This might include the consolidation of services, outsourcing non-core functions, improving supply chain logistics, or adopting new technologies that require less manual intervention and therefore lower labor costs.

By systematically lowering expenses, companies can effectively increase their profit margins. It's important to note, however, that the goal of cost reduction is not just to slash expenses arbitrarily but to do so in a way that preserves or enhances the quality of the company's offerings and its operational effectiveness. Useful strategies often involve a comprehensive review of a company's operations to identify waste and areas for improved efficiency.