The way in which a company uses the cash and profit generated through doing business, are recorded through cash flow sheets, profit and loss accounts and balance sheets. These documents show the numerical data which is vital for determining how successful the operations of the business are, indicating amounts of revenue, profit, cash and liabilities generated. Taking record of all company expenditure allows the business to manage the financial accounts and produce predictions for where they are heading.

Any type of business, no matter the size, will treat cash and profitability as the core reason for operating; carefully managing both as the lifeblood of the firm, meaning that calculations produced can be used as an early warning system to detect troubling financial situations (Haskins, Higgs & Ketz, 1987). In order for data sheets to be cross examined the entity must adopt a system of consistency, enabling comparisons to be made between financial periods (Gillespie & Lewis & Hamilton, 1997. pp 11). The concept of money measurement regulates what business can classify as wealth of the business; only items which can be measured in monetary terms can be included in the financial accounts, this withholding the right for business owners to regard excellent management or employee relations as assets (Chadwick, 1996).

The figures shown in a cash flow sheet emphasises the level of liquidity and amounts of cash spent by a business within a given time period (Alexander, Britton & Jorissen. 2009). Due to the complex nature of tracing where money has been spent and received from, business's produce regular cash flow sheets in order to keep track of how it has financed its operations and to determine where funds have originated from i.e. revenue, capital or investment, as well as where they have been used i.e. purchasing of assets or stocks. Analysing cash flow sheets in this way, the user can clearly see that the figures shown are a detailed breakdown of information contained within the balance sheet and the profit and loss account.

Haskins, Higgs & Ketz (1987, p 39) believe that “Firms with excellent products, new equipment, and creative marketing efforts have gone out of business because they mistook income-statement profitability for cash solvency.” The accounting concepts involved in calculating such figures like profit and loss and gross profit can prove to be complex as many problems could arise while trying to record where money has come from and where it has gone. The use of a principle known as Duality helps to keep track of where money has come from and where the money has gone. It states that every transaction within a business has a dual effect on the accounts. i.e. the source of wealth and the application of said wealth (Alexander, Britton & Jorissen. 2009)

The acquisition of new or the improvement of existing assets is known as capital expenditure, whereby such investment in business can result in increased earning capacity by lowering the cost of production or increasing output. All assets acquired come with a historic cost, this is the price paid for the item when purchased. It is said that “no expense arises because of the ownership of the asset; an expense arises when the asset is used up in earning revenue.”  (Gillespie & Lewis & Hamilton, 1997. pp 74). This meaning that items owned are assigned a depreciation value, showing in the accounting sheets that it will not last forever and that its value decreases over time. All moneys expelled by the business in terms of running or essential costs are recorded as revenue expenditure. The amount of revenue available to be spent in this way is governed by an accounting concept known as going concern, this assuming that a company will indefinitely be able to stay operational due to its ability to generate enough cash to stay out of liquidation (Alexander & Britton & Jorissen. 2009).

A profit and loss account compares the amount by which the expenses of a business have exceeded their revenue, thus revealing the net profit gained. The equation for this is demonstrated by ‘Profit = Revenue - Expenses'. The revenue referring to the income of cash generated by the business's activities and expenses referring to all moneys paid by the company in order to create the said revenues. This in comparison with to a balance sheet which shows, “The increase in equity caused by making a profit” (Gillespie & Lewis & Hamilton, 1997. pp 65) which allows a user to easily determine figures such as working capital and on to ratios to find out whether or not a company is highly geared. It has been argued that profit accounts may not always provide an accurate or meaningful projection of a company's financial operations, unless based upon its future cash flow rather than past incomes. (Purr, 2004)

The amount of profit and loss earned by a business during an accounting period is measured on a profit and loss account; however, they do not specify what has happened to the funds, allowing them to be in their current condition (Chadwick, 1996). The differences in the data entered into a profit and loss account and a balance sheet show the user key individual figures. The data entered must be accrued, recognising that figures are input when the transaction takes place, not when the actual funds are received or paid; the aims of this accounting principle are to align the costs and revenues in the period to which they relate, allowing for comparisons to be made. This part of accounting is known as matching which helps to giving an accurate picture of the company's current inflow and outflow of cash as well as a record of when transactions have taken place (Chadwick, 1996).

A balance sheet is a financial statement which informs the user of the business's status in regards to the amount of assets it employs, including anything it owns or has paid for that is connected with the operations of the business, for example, land, stock, materials and cash in the bank. While also taking into account the amount of liabilities a business has, this including all money which is owed to creditors. A balance sheet is a summary of where all the money has come into the business has come from and where and how it has been distributed at the beginning and end of an accounting period (Chadwick, 1996). The figures displayed in a standard balance sheet enable the user to calculate the amount of profit gained additionally a detailed list of assets, fixed i.e. items bought for the use of the business and current i.e. any moneys which are due to be earned by the firm, for example, debtors and stocks . The assets are deducted from the total amount of liabilities employed; these can be classified as anything which results in an outflow of resources and is something which the company owes. The equation employed on a balance sheet is shown as ‘Assets - Liabilities = Capital'. The figure produced will show the reader the financial differences between everything the business owns and everything it owes. However, under further investigations, the limitations of a balance sheet can be seen as they cannot show the movements in capital, long-term debt and assets or liabilities. (Chadwick, 1996).

The relevance of profit and cash can be disputed, depending on the financial accounts of the business at that time. While businesses are eager for long term profits within their company, careful account managing must be adopted to insure that there is enough short term cash or working capital at their expense, enabling them to stay afloat, ensuring that sudden unexpected outgoings can be subsidised. “It represents the difference between the current assets and the current liabilities. In effect it keeps the wheels of the business turning by financing the everyday type of operating transactions” (Chadwick, 1996. pp 59). The importance of having an abundance of day-today cash has been duly noted, although business's must carefully manage the levels of finance, as cash sitting in the bank could be better spent elsewhere, improving assets which would in turn would produce more long term profits.

Source: Essay UK - http://turkiyegoz.com/free-essays/finance/profit-is-a-misleading-concept.php


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