When I took my accounting classes and passed the CPA exam (the first in 1976, the second in 1977—dang, I’ve been doing this a long time!) I learned the definition of business profit as promulgated by GAAP (Generally Accepted Accounting Principles). What I didn’t learn at that time is how trying to teach business owners to understand the GAAP principle of profit was really hurting their ability to grow a highly profitable business.
The problem is with the basic accounting formula itself:
Sales – Expenses = Profit
So what is wrong with this formula?
First, it makes the business owner concentrate on the wrong thing. As humans, we normally concentrate on the first item of any list. As business owners, we concentrate on increasing sales at all costs, and then we pay all of our expenses. Finally, whatever is left over is our profit. Most business owners wait for a CPA to tell them what the GAAP profits were after they perform their “magic” and generate a financial statement.
Second, it doesn’t force us to look at every sale and expense with an eye toward profits. Is this a sale with a high profit margin after all costs? Is this a sale that leads to profits in the future, or is this just a one-off kind of a sale that just increases related costs? Does every dollar of expense lead to increased profits?
A third problem with the GAAP formula is that human nature is to spend. The more we increase sales, the more cash we bring in. The more cash we bring in, the more money we have to spend. The more money we have to spend, the more money we actually spend. We justify all this increased spending as necessary to grow our business sales. We are only concentrating on growing the top line of sales rather than the last item of profits.
Finally, the accounting formula puts profits last and makes getting to that final number so complicated that the vast majority of business owners just pretend they understand it. What is last on a list is almost always ignored. Human behaviorists call it the primacy effect. The accounting formula puts sales first, so we concentrate on sales. It puts profits last, so we barely think about it.
What is your company profit? As accountants we calculate your GAAP profits based on many estimates. What is the value of your inventory? What is the collectability of your receivables? When should a sale be recorded? When should a payable be recorded? How do we handle customer prepayments? How and when do we record profits on large, long-term contracts? How long and what method do we use to write off equipment? Many decisions go into a CPA’s calculations of your bottom line. In truth, the GAAP formula is really just an estimate of your profit for a specific time period.
Way, way too complicated if you are trying to successfully run your business!
Your definition of business profit should be much more simplistic—how much did I increase cash this year?
That’s it! Cash is all that counts. It’s great when you have it and it sucks when you don’t! The only thing you should be focusing on is cash profits.
Three things to help you out:
- Pick up Profit First by Mike Michalowicz to discover a simple system any business can implement to grow a business concentrating just on your cash balance.
- Click on this link (https://profitmasters.mykajabi.com/store/YBR9FPzq) to access a free course I have, Turn to Your Customers When You Need Cash Now!
- Click on this link (https://profitmasters.mykajabi.com/store/esox55ut) to purchase my online course Finding the Cash Hiding in Your Business! This is a low-cost option if you are serious about quickly eliminating your business cash flow problems.