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Dec 13Tim McLellan

Profit is Just an Opinion

Dec 13Tim McLellan

I attended a seminar a couple weeks ago titled “Cash Flow Enhancement.”  The instructor kept repeating the phrase “Profit is just an opinion, Cash Flow is a fact!”   My first reaction was very defensive.  After all, I’ve been doing accounting for 30 years, and I know that I can measure a company’s profitability pretty darn accurately on a monthly basis.  Heck, I’ve even had auditors come in and review my work and say that the company’s reported profit for the year was indeed accurate.

Then I started to think about all the assumptions that a business owner and his accountant must make to report an accurate profit.   For example:

Sales – Just about every business sells to other businesses on credit.  Businesses assume that they will get paid timely on the vast majority of credit sales.  What happens if they don’t get paid as expected?  The sale gets written off in a future accounting period.

Customer Returns – Most companies  some type of product warranty, whether documented in writing or not.  Some manufacturers may also accept returns of unsold product from their distributors or dealers.  What happens when these items get returned?  They become an expense in a future accounting period.

Inventory – A Business Owner in Albany, GA once told me his business plan was “To buy stuff and sell it to others for more than we paid for it.”   That pretty much sums up any business plan without reams of spreadsheets and data.  But when we buy stuff, do we really know we can sell it for more that it cost us?  What if we can’t?  We first start to discount the inventory to hopefully sell it at a lower price.  If the inventory sits around for a while, it may get damaged or stolen.  Someday we may have to throw the inventory in the dumpster and write off the entire cost.  A lot of these events will be recorded on the income statement in a future accounting period.

New Machinery and Equipment – Every business periodically has to purchase new equipment or a new computer system.  This is usually cost justified by saying it will save us xxx,xxx dollars over xx years if we were to purchase the new equipment.  I’ve seen cases were a company purchased equipment and actually had to hire more staff because the new equipment was very complicated to operate.  And how many of us have lived through a multiyear software conversion that didn’t quite turn out as expected?   This is another case where equipment or a project many have to be abandoned and written off in a future accounting period.

OK, so now I agree!  Profit is just an opinion.  Of course it’s very easy to compute your cash flow.  Just take your bank statements and add them up.  Then compare them to the prior month or year.  If you need a second opinion on your profits or cash flow, please call me.

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