Profit is something else. It is a number that is arrived at subjectively. I’ll give you a few examples below. There are more, but I’ll stick to the usual targets for manipulation. You may well ask why anyone would want to manipulate the profit figure. It happens when, for example, management wishes to have a lower or higher profit to meet the budget. There are also other reasons.
Here are the usual suspects:
If management does not write down inventory that has become obsolete they are overstating profit. If they make unnecessary write downs they reduce the profit figure.
Debtors (Account Receivable)
To reduce profits management can make provisions for bad debts that are too high. On the other hand, if they fail to make the necessary provisions profit will be overstated.
Fixed assets lose value due to market forces (second-hand assets are worth less) or wear and tear due to usage – or a combination of both. This loss in value (depreciation) should be reflected in the financials by charging the depreciation to the Income Statement and reducing the value of the assets on the Balance Sheet by the same amount.
The amount of depreciation is determined by deciding on the estimated useful life of the assets. A longer estimate of the useful life will result in higher profits – and a lower estimate will result in lower profits.
It is therefore important to remember that profit is just a number written on a piece of paper, appearing on a computer screen or in an annual report. It is not in itself money that can be used to pay the salaries.
Here’s an old one:
CEO goes into the financial director’s office and asks, “What is our profit this month?”
The financial director replies, “I don’t know. You haven’t told me what you want it to be.”