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Entrepreneurs and Profits, Return on Sales

high fashion clothing, grocery industry, percent return, uranium, good times

Year after year, U.S. manufacturing firms average profits of about 5 percent of sales. Many business owners with profits at this level or lower like to say that they earn only about what people can earn on the interest from their savings accounts. That sounds low, especially considering that the federal government insures many savings accounts, so that most people with deposits at a bank run no risk of losing their savings if the bank goes out of business. And in fact, given the risks inherent in almost all businesses, few stockholders would be satisfied with a return on their investment that was this low.

Although it is true that on average, U.S. manufacturing firms only make about a 5-percent return on sales, that figure has little to do with the risks these businesses take. To see why, consider a specific example.

Most grocery stores earn a return on sales of only 1 to 2 percent, while some other kinds of firms typically earn more than the 5-percent average profit on sales. But selling more or less does not really increase what the owners of a grocery store (or most other businesses) are risking. Each time a grocery store sells $100 worth of canned spinach, it keeps about one or two dollars as profit, and uses the rest of the money to put more cans of spinach on the shelves for consumers to buy. At the end of the year, the grocery store may have sold thousands of dollars worth of canned spinach, but it never really risked those thousands of dollars. At any given time, it only risked what it spent for the cans that were at the store. When some cans were sold, the store bought new cans to put on the shelves, and it turned over its inventory of canned spinach many times during the year.

But the total value of these sales at the end of the year says little or nothing about the actual level of risk that the grocery store owners accepted at any point during the year. And in fact, the grocery industry is a relatively low-risk business, because people buy food in good times and bad. Providing goods or services where production or consumer demand is more variable—such as exploring for oil and uranium, or making movies and high fashion clothing—is far riskier.

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