What is the Windfall Profit?
A windfall profit can be described as a sudden income or profit of abundant nature which is quite sudden and/or not expected at all and this can happen due to the person winning a handsome lottery compensation or inheritance of wealth which was not expected or demand-supply problems where certain goods/services/commodities are in large demand but there is a limited amount of supply and thus companies increasing the prices to a large extent.
Windfall profit is the abnormal or unexpected huge profits which individuals or companies make based on certain unforeseen scenarios. This can be like when prices of commodity as simple as potato go high due to supply-demand problem, a trader who has previously hoarded quintals of potato in his/her warehouse can sell the stock at an abnormally high rate and make unexpected gains out of it.
How Does it Work?
- Windfall profit or gain is generally transitory in nature. It mainly occurs when someone has received unexpected huge bounty out of certain scenarios. A person may causally book a lottery ticket with the least hope of winning it by investing a dollar or two in it but if he is fortunate and the ticket he booked gains the lottery prize he is allotted with millions of dollars as the prize money.
- This brings about windfall to his earnings and the gain he makes is called windgall profit. There are several countries that have also defined a fixed law along with the taxation policies to tax this unexpected profit. For example in India, if someone wins a lottery amount he/she has to straightaway give close to 35% of the winning amount to the Indian government. Windfall is also relative to the party involved. If a company or individual is handling millions and get another million of the dollar that is not considered to be windfall whereas if a person or company is handling thousands of dollars and manages to get some additional millions, this can be considered a windfall.
- For a business, the management of a company may decide to increase its dividend or give a special one-time dividend which also leads to windfall for the existing shareholders. At times the management also uses to utilize these for future expansions, business growth and reduction of the debt.
Causes of Windfall Profit
#1 – Individual Winning Lottery
A person may causally book a lottery ticket with the least hope of winning it by investing a dollar but if he is fortunate and the ticket he booked gains the lottery prize he is allotted with millions of dollars as the prize money.
#2 – Supply Demand Problem
A commodity or good may be in high demand but due to certain unforeseen circumstances, the supply might be affected. In such cases, one who provides the limited supply abnormally increases the price of the goods or services and make a huge amount of money in the process.
#3 – Change in Prices
Companies that operate in a monopoly market may tend to change the price of their offerings and this might lead to this profit because in a monopolistic market the customers have no other option other than buying from the same company.
#4 – Decisions by Management
Management of a company may decide to increase its dividend or give a special one-time dividend which also leads to windfall profits for the existing shareholders.
Let’s discuss the following examples.
On an individual front, an example for windfall profit can be a case where a person may causally book a lottery ticket with the least hope of winning it by investing a dollar but if he is fortunate and the ticket he booked gains the lottery prize he is allotted with millions of dollars as the prize money. Another example that can be traded has hoarded huge stocks of a commodity for example onion and there is a sudden demand-supply gap in onion in marker. In such cases, the trader can make a huge amount of profit by selling his stock in the market at an abnormally high price.
On the business front, an example of this profit can be a case where the management of the business has decided to give a one-time dividend to its shareholders out of the year of profit plow back. Thus it brings about a sudden windfall for the shareholders of the company. Also, another example can be a case where a company is a monopoly in the market for an essential commodity like oil. Now if it increases the price of oil in the market customers are bound to buy at the higher rates and thus this leads to a windfall for the oil company.
Windfall Profits vs Windfall Gains
Windfall profits are more related to business when the entity operating is not an individual but a company or business firm. Companies when they make abnormally high profits out of unexpected scenarios, we term them as windfall profits. For example, oil companies operating in a monopoly market and increasing the price of oil and making extraordinary profits.
Windfall gains, on the other hand, are more related to an individual or person where one makes huge gains out of unexpected events. For example, a person investing a meager sum in a lottery ticket and winning the first prize amassing a huge wealth or like a person inheriting an extraordinary sum of property from his/her ancestors at a single point of time.
In the US windfall profits are not taxed at present though there are efforts going on to bring back the policy of taxing such unexpected gain or profits which was a common practice earlier. When it comes to a single person or an individual, this profit may be amassing a huge sum of wealth out of some unexpected event and the sum is generally beyond what he/she would have expected. On the other hand, when companies earn such profits they are generally passed over to others or shareholders in the mode of regular dividend or one-time special dividend pay-out. Some companies at times plow back this abnormal profit earned to invest in profitable ventures or use it for further business expansion or to cut down its debt obligation.
This has been a guide to what is windfall profit and its meaning. Here we discuss how windfall profit works along with causes, examples, and differences. You may learn more about financing from the following articles –