Decisions (CT2, Chapter 7, Section 1.1)

[Vorplex]

CT2, Chapter 7, Section 1.1, next to 'employees':

"Employees are interested in the enterprise's ability to pay salaries and also to offer job security. Accounting information is, however, of limited value for such decisions."

What decisions?

 

[kartik_newpro]

CT2, Chapter 7, Section 1.1, next to 'employees':

"Employees are interested in the enterprise's ability to pay salaries and also to offer job security. Accounting information is, however, of limited value for such decisions."

What decisions?

Decisions regarding salaries. For eg, either to give increments or not. I think the point here is that the Accounting information (P/L account and Balance Sheets) are indicators of the financial position (or value) of the Company (or enterprise) rather than its profitability. If you are an employee, you are more concerned about the profits because more profit would mean the Company can pay you more. You wont care about the financial position.

 

[Vorplex]

Thanks Kartik. Not sure I completely understand your point though - isn't 'profit' precisely what is shown in the income statement?

 

[kartik_newpro]

Thanks Kartik. Not sure I completely understand your point though - isn't 'profit' precisely what is shown in the income statement?

Yes it is.

But how much of that profit is in cash?

Lets say you manufacture notebooks. You purchased paper(raw material) worth $100,000 and sell the notebooks(finished goods) at $120,000 on CREDIT. So you have made a profit of $20,000 but haven't yet received it.

So your income statement will show a profit of $20,000 but since you haven't received it you cannot use that to pay off other expenses (eg, higher salaries).

I think you can also consider an example of "appreciation" of a non-current asset (eg, real estate). The increased value can be considered profit but not in terms of cash.

Companies prepare cashflow statements to show how much cash it holds i.e. its liquidity position. (You will come across all this in the 8th chapter)

 

[freddie]

I suppose it's also worth noting that the accounts are historical records rather than projections, showing what has been, rather than what's to come. Job security and pay partly depend on market conditions now and in the future.

 

[Vorplex]

Thanks you two.