The company's profit and use - as confusion easily leads to wrong decisions.

Small introduction

As a consultant in management accounting, corporate finance and budgeting, I often come across a variety of ways to account for profits and losses and holivars in choosing one or another P & L report model, which use different theories from textbooks and references to authorities as arguments they do well to them "

Practically, experts prove the impossibility of a unified management theory and consider a great many of them, depending on the most diverse factors of their applicability and effectiveness.

But still, there are enough common grounds for assessing both our own managerial competence and the quality of the projected managerial reporting in the sense of its convenience for substantiating management decisions made.
')
And these common grounds are all the more useful, than at an earlier stage companies are recognized and consciously considered.

The difference between sources of profit and the purpose of its use

The most frequent problem leading to disputes, erroneous decisions, misunderstanding and dissatisfaction lies in a clear dilution in management accounting of costs that form a profit from an expense, making at the expense of profit, but not reducing it.

The main principle here is that the costs that form a profit cannot be reduced, without reducing the revenue received. They are closely related to the concept of "cost of production."

Without going into deep details and a variety of research, you should arm yourself with common sense and a small cheat sheet.

First of all, it is necessary to structure the report on the formation and use of profits at the highest level, so that in the future there would be no problems in ascertaining the essence of certain expenses.

Analytically, there are only four sections in our report that clarify the analysis and lead to the most informed management decisions.

Section 1. Profit (or loss) from operational commercial activities
Section 2. The use of profit to ensure the current economic activity
Section 3. Adjustment of profit (or loss) from current financial transactions
Section 4. The use of profit to ensure investment costs (company development)

The group of expenses that form the profit from operational commercial activities includes the following categories:
- Direct costs related directly to how each specific unit of output generates revenue.
- Direct costs that do not relate directly to certain units of production, but can be attributed to them on an economically sound basis
- Overhead costs that can not be assigned on an economically sound basis to groups or categories of products (mainly due to the limitations of detailed accounting), but we understand that these costs relate to the cost and we can make a decision about what share to which group of products would it be fair to attribute them

It is very important to remember that in this category we take into account only those expenses that directly determine the profit from sales, regardless of the current administrative and financial burden.

Here we can easily calculate the "unit economy", understanding the necessary grounds for decisions about the possibility of scaling a business. This is a process-oriented budget, and it focuses exclusively on the reproduction process of sold "units."

All other expenses should fall into the remaining three sections, since they, in fact, use the generated profit, and by themselves cannot form it. These are supporting processes that only support the main, but not replace it.

Failure to understand this often leads to the impossibility of quality management, since the reports mixing the main and supporting processes do not allow to make informed decisions.

However, in order for the quality of managerial decisions to be the highest, the structure of these essentially supporting sections should also be considered.

The structure of the second section should reflect first of all the managerial assessment of the effectiveness of the costs incurred, so the following categories should be highlighted here:
- The use of profits to cover business expenses recognized as effective
- The use of profits to cover business expenses, the effectiveness of which is questionable
- The use of profits to cover business expenses that are recognized as ineffective

The structure of the third section reflects changes in the profit (loss) received on the merits of the financial transactions and includes the categories:
- Increased profits through the management of non-current assets
- Using profits to cover planned financial costs
- Utilization of profits to cover forced unplanned financial costs
- Using profits to cover financial losses due to wrong decisions

Finally, the structure of the fourth section reflects how the use of profits was reflected in its reinvestment in business development and contains the following categories
- Increase (return) of profit, due to current investment operations
- Using profits to cover planned business development costs

Some theses about the important, but not mentioned above

Most often, a similar analysis is made on the basis of financial flows (i.e. cash flow or cash flow). Such an approach is justified if changes in assets and liabilities at the beginning and end of the period are insignificant. If any assets or liabilities of a business change significantly, these changes should be correctly correlated with recorded expenses (and revenues).

Such an analysis can be done continuously (i.e. on a cumulative basis from the very start of a business) or split up into various convenient for analysis periods (for a week, month, quarter, year)

Conclusions about the effectiveness of management accounting of income and expenses in the proposed structure can be made by yourself, based on the experience and satisfaction with the results. Of course, “the devil is in the details” and you may have questions about how to apply all this practically in the emerging conditions of a particular company. I promise to suggest as they occur in the comments.