The Accounting System is Fundamentally FLAWED
The existing accounting system is hundreds of years old. It is about balancing positives and negatives (double entry accounting) and providing a figure upon which tax is based. The system is driven by regulatory bodies (government) basing tax on “profit”. The P&L system only looks in the rear view mirror. In addition, the picture it provides is distorted due to what is included and excluded.
Definition of Profit
You can have profit but an empty bank account. Why? Because profit ignores several things that you actually pay for such as asset purchases, debt payments, drawings, inventory and tax.
Lots of things that burn cash don’t show up on the P&L – hence the lament, “Where’s all my profit, my bank account is empty!” It’s easy to forget that profit and cash are as different as bananas and bricks.
|
Profit |
Cash |
|
Ignores: Assets Debt Payments Drawings Inventory Tax |
Covers: Assets Debt Payments Drawings Inventory Tax |
|
Adds: Depreciation |
Ignores: Depreciation |
Trajectory
Receiving a single figure profit at the end of the financial year does not provide enough information for you to assess the health of your business. Profit alone doesn’t show our trajectory. It doesn’t tell us if we are moving towards or away from the cliff face.
Consider the example below. Business A and Business B both have a reported profit of $100,000 for the financial year ended 30 June, however this does not give the full picture. In fact, Business A is growing whereas Business B is in decline.