Understanding the Mutually Exclusive Nature of Profit and Loss in Business
Profits and losses represent two opposing financial outcomes that cannot exist together for a single entity during the same period because:
- The General Definition of Profit and Loss:
Profit occurs when revenues exceed expenses, resulting in a positive Net Income.
Loss occurs when expenses exceed revenues, resulting in a negative net income.
- Profits and Losses are Mutually Exclusive
Every business either makes a profit or incurs a loss during a specific accounting period. Those who earn a profit are experiencing a positive financial outcome from their time and money invested in delivering their sales while those who don’t experience a negative financial outcome because expenses were allowed to exceed revenues. It’s this black and white.
- Fundamental Accounting Equation is True 100% of the Time
Assets = Liabilities + Owner’s Equity is only wrong when any one of the three has an accounting error. The accounting equation ensures that all financial transactions are balanced. A profit increases owner’s equity, while a loss decreases it every time.
As a result, it is impossible for a business to simultaneously experience both a Net Profit and a Net Loss during the same accounting period. Just as it is impossible for a sports team to end a game with a win and a loss. The team that out scores the other gets the win.
The only time profits and losses exist together within a business or over a given period is in Gross Profit and Operating Income. Here’s why:
- Different Products/Services: every multi-product business will have one product line generating more profits than the others with some even some knowingly offering products at a loss.
- Different Time Periods: seasonal and highly variable businesses will have a mix of profitable months mixed in with lowing months. The only way these businesses will build cash reserves is by ensuring they have more profits than losses. These means they keeping their losing months low so they have less hole to dig out of before they are back in the “black.”
- Cash vs. Accrual Accounting Methods: a business looking at their financial results via the accrual method can show a profit on paper while experiencing cash flow problems just as a business looking at their results via the cash method may actually be losing money while reporting a “cash” profit. Click here to learn more about Business CPR to learn more about solving the profit but no cash problem.
Remember. Profits and losses are two sides of the same coin. If you run your business via the “hope method” than your relying more on chance that you’ll earn a profit than those who use a management system to protect their business from failing.
A proven management system like the one here is the surest way to realize your sales, profit, and wealth creation goals.
