Abstract
Chapter 1 introduced the two major financial statements used in accounting: the balance sheet and the profit and loss account. It also introduced the balance sheet equation:
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Notes and References
This type of valuation model forms the basis for the calculation of value in economic analysis. In that context it is usually depicted as the ‘present value of future cash flows’. This approach to value is used, for example, in the classic analysis of economic income by J. R. Hicks which is referred to again in Sect. 14.2. One of the main differences between accounting and economic measurement of profit and value is that economics uses this forward looking subjective model for measuring value, whereas accounting — which has to be more concerned with reliability and objectivity — relies on historical or market based values.
In this example and throughout the remainder of this chapter we have deliberately ignored the problem of changing prices. For example, what if in the time between the purchase and the sale of the squash racket there had been an increase in general prices (inflation) or an increase in the specific replacement cost of the squash racket? These and other problems of changing prices are dealt with in Chapter 14.
Over a short period the relationship between accounting profit and cash flow may be difficult to identify. However reference to Figures 2.4 and 2.5 show that for the five year period the profit of £80 000 is equal to the £80 000 increase in cash. It has been suggested that one of the strengths of accounting profit is that it may be an indicator of the long run cash flow of the firm.
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© 1991 Arthur Hindmarch and Mary Simpson
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Hindmarch, A., Simpson, M. (1991). Concepts of Value and Profit. In: Financial Accounting: An Introduction. Palgrave, London. https://doi.org/10.1007/978-1-349-21765-6_2
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DOI: https://doi.org/10.1007/978-1-349-21765-6_2
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