Welcome once again, and let’s consider the aspect of business profitability and loss making today. Often times we hear people talk about business profits and losses, and we assume that everybody understands this fully, yet in reality this is not always the case. As I mentioned in my recent blog, business profit arises where the expenses (note the word expense and not expenditure) are less than the revenues or income (note the word income and not inflows) for a given period of time. In practice many enterprises do their statutory financial reporting on a yearly basis, though obviously financial reports that indicate profitability and financial position can be done on a monthly basis. As an entrepreneur you can decide how often you would like to measure your profitability, whether monthly, quarterly, half yearly or yearly. It’s up to you, isn’t it? It’s important to note though that very short-term measurements tend to be less accurate than longer term measurement – but minimum is a year.
Just to clarify a bit regarding the above section, let me say this. Expenditure usually denotes all outflows of cash whether they are expenses chargeable or deductible in arriving at profit or loss for a given year, or not. Even disbursements of funds for fixed assets that generate revenue for an enterprise for many years to come, are called expenditures. So it implies that the word expense is more appropriate to use, as these can be easily measured and related to a specific accounting period, hence better for assessing profitability. Again revenues or income need to be identified separately from inflows of cash, as some inflows are not income. Inflows arising from loans or borrowed resources for example, is not income. Similarly, receipt of receivables – or amounts already earned and expected to be collected – can no longer be treated as income. Do you get what I mean here? I hope so.
Yes – these terms need to be properly explained. Don’t you think so? I know there can arise many questions from the above – and I’m ready to address any concerns that may arise. Again, when recognizing income and expenses for a given accounting or financial period, it’s advisable to use what is called the accrual principle. Now, we are entering a bit into some accounting terminology, but nothing to worry about as these are oftentimes easy to understand when put in a simply way. The accruals principle basically requires that you recognize or account for incomes earned in a period though not yet received, and expenses incurred in that same period, whether paid for or not. The incomes earned have to be matched with the expenses incurred. Back to the point; let me say the following regarding profitability, before I go very deep into definitions and clarifications.
I candidly think we have had a very long one this time. We will catch up another time.
The Wise Entrepreneur