| It might seem obvious, but in managing a | | | | Profit and Loss, it might seem like a |
| business, it is important to understand how | | | | no-brainer to define just exactly what profit |
| the business makes a profit. A company needs | | | | and loss are. But of course these have |
| a good business model and a good profit | | | | definitions like everything else. Profit can |
| model. A business sells products or services | | | | be called different things, for a start. It |
| and earns a certain amount of margin on each | | | | is sometimes called net income or net |
| unit sold. The number of units sold is the | | | | earnings. Businesses that sell products and |
| sales volume during the reporting period. The | | | | services generate profit from the sales of |
| business subtracts the amount of fixed | | | | those products or services and from |
| expenses for the period, which gives them the | | | | controlling the attendant costs of running |
| operating profit before interest and income | | | | the business. Profit can also be referred to |
| tax. | | | | as Return on Investment, or ROI. While some |
| | | | definitions limit ROI to profit on |
| It is important not to confuse profit with | | | | investments in such securities as stocks or |
| cash flow. Profit equals sales revenue minus | | | | bonds, many companies use this term to refer |
| expenses. A business manager should not | | | | to short-term and long-term business results. |
| assume that sales revenue equals cash inflow | | | | Profit is also sometimes called taxable |
| and that expenses equal cash outflows. In | | | | income. |
| recording sales revenue, cash or another | | | | |
| asset is increased. The asset accounts | | | | It is the job of the accounting and finance |
| receivable is increased in recording revenue | | | | professionals to assess the profits and |
| for sales made on credit. Many expenses are | | | | losses of a company. They have to know what |
| recorded by decreasing an asset other than | | | | created both and what the results of both |
| cash. For example, cost of goods sold is | | | | sides of the business equation are. They |
| recorded with a decrease to the inventory | | | | determine what the net worth of a company is. |
| asset and depreciation expense is recorded | | | | Net worth is the resulting dollar amount from |
| with a decrease to the book value of fixed | | | | deducting a company's liabilities from its |
| assets. Also, some expenses are recorded with | | | | assets. In a privately held company, this is |
| an increase in the accounts payable liability | | | | also called owner's equity, since anything |
| or an increase in the accrued expenses | | | | that is left over after all the bills are |
| payable liability. | | | | paid, to put it simply, belongs to the |
| | | | owners. In a publicly held company, this |
| Remember that some budgeting is better than | | | | profit is returned to the shareholders in the |
| none. Budgeting provides important | | | | form of dividends. In other words, all |
| advantages, like understanding the profit | | | | liabilities have the first claim on any money |
| dynamics and the financial structure of the | | | | the company makes. Anything that is left over |
| business. It also helps for planning for | | | | is profit. It is not derived from one element |
| changes in the upcoming reporting period. | | | | or another. Net worth is determined after all |
| Budgeting forces a business manager to focus | | | | the liabilities are deducted from all the |
| on the factors that need to be improved to | | | | assets, including cash and property. |
| increase profit. A well-designed management | | | | |
| profit and loss report provides the essential | | | | Showing a profit, or a positive figure on the |
| framework for budgeting profit. It is always | | | | balance sheet, is of course the aim of every |
| a good idea to look ahead to the coming year. | | | | business. It is what our economy and society |
| If nothing else, at least plug the numbers in | | | | are built on. It does not always work out |
| your profit report for sales volume, sales | | | | that way. Economic trends and consumer |
| prices, product costs and other expense and | | | | behaviors change and it is not always |
| see how your projected profit looks for the | | | | possible to predict these and what income |
| coming year. | | | | they will have on a company's performance. |
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