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Profit/Loss Accounting - in what term?

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Wheylous posted on Sun, Dec 2 2012 8:27 PM

I understand the social function of profit/loss accounting. My question is in what term (short or long) profit matters. It is a well-known fact that many of today's firms had negative profits originally. Judging by a rigid profit/loss criterion, they should not have existed. Yet they grew to be socially useful over time.

When, then, does the profit/loss mechanism come into play?

My tentative response is that how much money you are willing to lose before you quit is related to the relative opportunities available to whoever funds you - as in if a bank is funding you, then their decision to switch into another line of production reflects a greater opportunity for making money.

But this doesn't satisfy me. Is there a better answer?

It's all good and nice to praise profit/loss, but if there is no time horizon for cutting losses, then it's a useless criterion.

Another answer I would give is that it makes sense to incur losses only until you overcome the information problem in the economy. As in even if a computer is an awesome piece of technology, if you market it to the wrong people, you will lose money. That is why advertising exists - to spread information to whoever needs it. My proposition is that you may only incur losses until you have spread the information to the target market. If after the target market has been saturated with information you still make a loss, it is then that you should close shop.

This is more satisfactory to me. Is it correct?

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Top 200 Contributor
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well a lot of the companies operating in the red are funding through cash reserves, cash they receive from daily operations (selling their products) and when the cash runs out they fail.  Other criteria would be getting other investors to invest for shares, selling off unprofitable assets, and yes  when bank determine you are insolvent.

its all risk and no one knows who the target market is.  There cant be any fundamental way of knowing whether or not to continue to operate or not besides the owners choosing to or you have no money left.

Eat the apple, fuck the Corps. I don't work for you no more!
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Prime replied on Sun, Dec 2 2012 8:49 PM

Yes. As long as you have creditors and assets to salvage the game continues. I work for a company that the last 2 years has lost over a billion per year! I can' believe they still operate, but they do. They have been selling assets like brands, real estate, etc... to generate cash flow. As long as someone is willing to keep lending money, they will stay in business. It doesn't hurt that our owner/majority shareholder is a well-known hedge fund manager and has buddies that are the same.

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"It's all good and nice to praise profit/loss, but if there is no time horizon for cutting losses, then it's a useless criterion."

Praxeology has no necessary time criteria (which is one of its necessary shortcomings in modern macroeconomic discourse). Remember a few things:

1. Consumer demand is not static

2. The existence of your firm changes the demand for your firms goods over time

3. The firm's organization need not be fixed

4. Input prices are not static

5. What matters for current action is belief in future conditions, not the conditions which occurred in the past, although the second is certainly an indicator of the other.

Therefore inevitably I think that the point at which losses finally kick in are at that point where the entrepreneur either decides to shut down the firm (which will be at that point where he does not believe that profits or minimization of losses will occur) or at the point where the entrepreneur cannot recieve any further funds (that point at which all available captialists refuse to fund him). From here the question just becomes:

What of profits? When should they "stop counting"? I think that the answer here is clearly that they should count whenever they occur when looking at a particular time period and that they have served their "social function" for that time period. Therefore I don't believe that the criteria here are necessarily symmetrical, since profits need never be achieved but as soon as they are their "social function" has been achieved while temporary losses are necessary for any real production structure, and therefore their real role cannot be said to have occurred until profits are no longer considered by the relevant parties as realistic.

At last those coming came and they never looked back With blinding stars in their eyes but all they saw was black...
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This is my view on the subject, coloured by my (meager) experience in accounting:

The founding of a company is an investment, its duration the lifespan of the company, its size the value of the equity invested. Therefore its profitability is determined by whatever you're left with in the end (including payouts during the lifespan) adjusted for time value, minus the equity invested at the start (and other additions to equity during the lifespan)

It makes sense to incur losses as long as you believe the future cash flows of keeping the company in operation exceed the present sale value of the company or its contents. Of course if you run out of equity and no one wishes to lend any more to you, you're forced to go out of business no matter what your opinion of the future state of affairs is.

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It is the point where the owners believe that the future earnings of the entity are not worth the current expenditures.  Keep in mind that ownership can/will change over time as will the preferences to take current losses at the expense of future profits.  Also there is bankruptcy where creditors who have debt contracts demand ownership in lieu of payment.

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