Profits Have Quality: "The Nature of Profit" #191

■ Corporate Report Cards: "Financial Statements"

Financial statements are indicators used to measure a company's performance and can be thought of as a report card.
Specifically, these are the Profit and Loss Statement (PL), Balance Sheet (BS), and Cash Flow Statement (CF), which is why they are also referred to as the three financial statements.

Corporate accounting, which deals with financial statements, is broadly divided into institutional accounting and management accounting.

Institutional accounting is accounting that must be carried out in accordance with some system, such as laws, and is classified into financial accounting and tax accounting.

In contrast, management accounting is highly valuable for a company's management and decision-making.
Basically, it is used only within the company, so there are no restrictions whatsoever on how it is created.

■ Utilizing Management Accounting: "MQ Accounting"

Although both are forms of corporate accounting, the essence of institutional accounting and management accounting is completely different.
For example, financial accounting, particularly the profit and loss statement, takes a sales-centric approach focused on taxation. In other words, there is a tendency to analyze the profit and loss structure with a focus on the ratio of each item to sales.
In that case, the ways to increase profit are:
1. Increase sales
2. Reduce fixed costs
3. Increase profit margins
It is one of these.
Of course, this is not wrong. However, if market conditions are tough, it should not be easy to increase sales. As a result, you fall into price competition with competitors, so even if you increase sales, you may end up in a dilemma where you are not increasing profit margins but rather lowering them through high-volume, low-margin sales, and consequently, profit does not increase even if sales do.

Of course, you cannot ignore sales due to cash flow concerns.
However, from a management perspective, I believe an accounting theory is needed to generate profit and, furthermore, to increase cash.

In that sense, I have adopted the concept of MQ accounting as management accounting.
MQ accounting is a profit-centric approach.
MQ (Margin × Quantity) is gross profit, which signifies added value.
In other words, it is what remains after subtracting variable costs from sales.
If that sales ratio (MQ/Sales) is high, it can be said that the product or service has high added value.

■ Combinations of Profit-Making Elements

For example, high-volume, low-margin sales mean selling products or services by lowering their added value.
Also, if you force an increase in sales, fixed costs, which should be fixed, may also rise.
Fixed costs are expenses assumed to occur in advance regardless of whether the business is doing well or poorly, starting with employee salaries, as well as electricity and water.
Naturally, if fixed costs exceed gross profit, the company will be in the red.
There is no way to make a profit this way.

■ What is Profit?

In Japan, there is a tendency to view corporate profit-making with skepticism.
However, the fundamental purpose of a company is the "creation of customers."
To that end, each company provides products or services that contribute to customers and society.
And if that is recognized, it can be said that the company can earn its reason for existence in society.
In other words, I believe that profit is proof of being recognized by society and customers.

What is profit in the first place?
The renowned management expert, Mr. Drucker, wrote the following in his book:

1. Profit is the criterion for judging results.
2. Profit is insurance against the risk of uncertainty.
3. Profit is the source of funds for creating a better working environment.
4. Profit is the source of funds that brings medical care, national defense, education, and social services and satisfaction.

In other words, profit is essential for a company to continue providing added value to customers and society.

■ Increasing Cash Generation Power

Also, no matter how much of a surplus there is on the Profit and Loss Statement (PL), a company will go bankrupt if it does not have cash.
For that reason, it must continue to generate cash.
Here too, there is a tendency to focus only on increasing sales.
However, even if sales increase, if profit decreases, cash will not remain.

Therefore, what becomes important is building a mechanism to increase cash with less capital.
Specifically, it is to improve the MQ (gross profit) rate while increasing the turnover speed of inventory.

■ Profits Have Quality—Profit Accompanied by Cash

The MQ (gross profit) rate here is not against sales, but against variable costs.
Also, the turnover speed of inventory means efficiently reducing inventory against variable costs.
Note that variable costs are costs such as material costs and outsourcing costs that occur in conjunction with sales.
In other words, cash generation power is about how much MQ (gross profit) you increase relative to inventory.
Sales are irrelevant here.
Of course, one must also understand that MQ (gross profit) is a component of sales, so it cannot be completely ignored.

Profits have quality. Low-quality profit lacks the backing of a Cash Flow Statement (CF).
Such falsified, superficial profit that is not accompanied by cash has no value at all.
I want to pursue meaningful profit after being recognized by customers and society.