Profit – the difference between costs and revenue – is the engine driving capitalist economies.
It determines dividend pay-outs and a high proportion of the market valuation of companies.
They can’t survive without it. If there’s no profit, there’s no dividend and the chances of investors securing a capital gain are jeopardised.
And without profit, corporate managers won’t get bonuses and pay rises.
Anyone working for a business will know profit is the ultimate objective. Often, it’s seen as the only one.
The need to secure profit plays an important role in political debate. The justification for corporate taxation and pay is often based on a view of the capacity of companies to make one.
When we’re told wages and tax can’t rise, it’s not because there isn’t the money.
It’s because higher wages and taxes will reduce profitability and discourage investment.
Profit may be good or bad, but that’s irrelevant. What matters is that it’s essential for the system to work.
But as accountant and academic Richard Murphy explains today, profit for a growing number companies is not a fact but a fantasy. It’s conjured out of thin air by accountants working with corporate managers and reflects what’s wanted rather than what exists or is possible.
When the economy was based on tangible good manufacturing, the moment costs were incurred was fixed by physical facts. They were incurred at each stage of manufacture when capital, labour and material were combined to produce a thing.
Revenue came when the thing that had been made was transferred physically to the buyer.
There was some flexibility about when costs and revenues were booked, but not much.
That utterly changes when an economy is dominated by intangibles. By definition, they have no physical characteristics. Not only can’t you scientifically specify when they’re made. You can’t say where they’re made either.
Of course, people create intangibles and they live in real time. But when their wages are connected to services, these can be booked before and after they’ve actually been incurred.
Accountants can often deem them to have been incurred in the present financial year, a previous one or a future one. Murphy refers to an article in today’s Financial times which reports that banks offering interest-free credit cards can defer some of the costs associated with them.
“But several bank chief executives and analysts have told the Financial Times that the practice is extremely risky as it is based on the assumption that customers will still have the debt on the card when the deal ends and start to pay a high interest rate,” Murphy says.
What that means is that profitability this year is being systematically overstated by banks offering interest-free credit cards. Costs, including those associated with people that pay off their credit card debt when the interest-free period ends, are not being counted.
This can be seen as imprudent, dishonest or both.
Murphy favours much closer regulation of accountants and companies to ensure any deferment in costs associated with a transaction is accurately reported.
He’s right.
But those wanting an end to such practices – which are now standard across every company creating services – need to focus on the underlying reason why company accounts are closer to fiction than fact.
That’s the supremacy of intangible commodity production in advanced economies and the challenge it presents to corporate managers, the accountants they employ, regulators and governments.