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What Is Business Profit?

It is clear that every business operate in order to earn profit. In most cases the main goal of a business is making profit. A business may have other goals but if they do not make profit in the business then they will have to end the business. In this essay I will analyse what is the meaning of profit and how it is obtained. What is business profit? The easiest way to explain profit is the income a company earned in a certain period of time. There are two types of profit namely gross profit and net profit. Gross profit is not the actual profit of a business and it is found by deducting the cost of goods sold from net sales. Thus, net profit is considered as the actual profit retained by a business and it is actually the difference between the revenue earned by the company and the expenses incurred.

For example, on Oct 1 a company provided legal services for a customer and received $2000 cash and on Oct 31 the company paid $500 for the rent of the premises, if we are asked to calculate the net profit for the month you should find the difference

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between the cash received and the rent paid, i.e., $2000 – $500, which gives us the value of the net profit of $1500. We have to find the profit in order to see whether a business is profitable or not. Net profit will increase the equity of the business. It is recorded in the financial statement which summarizes the overall performance of a business during a particular financial period. Now, we shall analyse what is actually considered as revenue to a company. According to Cunningham, Nikolai and Bazley (2000: 132) “Revenues are the prices a company charged to its customers for goods or services it provided during a specific time period”. For example, a lawyer firm provided legal services to its customer on 1 June and received $5000 cash. In the example above the $5000 is the revenue earned by the company and it is called the service revenue.

A company selling furniture sold a drawing table on 15 May and received $300 cash and on 18 June the company sold the motor vehicle for $8000 cash. The $300 cash obtained from the sales of drawing table can be treated as sales revenue but the $8000 from the sales of the motor vehicle cannot be considered as revenue because drawing table is the goods of the company (the thing which the business sell) whereas the motor vehicle is an asset of the company (the thing which the business own). Similarly we shall now analyse the definition of expenses to a business. According to Horngreen (2004 4th Ed.: 17) expenses are the cost incurred in the running of a business and will result in a decrease in the owner’s equity. Expenses include the rent of premises, wages, salaries, insurance, electricity and interest paid. For example, on 31 Nov we pay $400 for electricity, $30000 for wages and purchases $500 worth of supplies. To calculate the expense incurred for the month we add only the electricity and wages which gives us a total of $30400. We did not add the amount paid for supplies because we have not use the supplies yet and it is still considered as the asset of the company.

We shall move on to discuss what is meant by ‘Matching Principle’. Matching principle is actually a rule which states that we should only show the revenues and the expenses for the financial period only. It means all expenses should match with the revenues earned in the time period to calculate the net profit or loss for that period. Similarly, accrual basis accounting states accountant should only recognised the expenses and profit for the financial period. However accrual accounting is actually the method we applied and matching principle is the rule. The main purpose for using this technique is to determine an accurate profit or loss for the period so that we will not overstate or understate our profit.

For example, Tum Enterprise earned service revenue of $3000 in May but they will only perform the service in June, the office rent for June will be $2000 but will only be paid in July, the company bought insurance in January worth $1200 which will last for a year and it expired in June and legal service of $1000 had been performed but it will not be received until July. In the example above we will have to record the rent expense, insurance expense and the revenue earned but not the revenue which have not been performed. In conclusion, the major aim of a business organization is obviously to earn profit. This is how you estimate the advancement of your business. By making more income means that you have more money to create more money.

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