Key Terms in Finance

A business is defined in the Merriam Webster’s Collegiate Dictionary Tenth Addition as: “A conducting of affairs or action by the authority of a person or group for the purpose of earning a profit.” A business can be either for-profit or non-profit organisations that conduct business to meet a social or charitable purpose or further an environmental cause. The concept of a business has been around for centuries and is usually described as a separate unit apart from the owner that carries on business activities for the profit of others.

It is the objective of any business to earn a profit and pay its expenses. A firm’s profit or gain is the value of all the net profits at the end of a period of time. A business’ income or gain is the value of all the net revenue or profits at the end of a period of time that excludes the cost of the operations and the gain of interest and dividends. The total revenue element of a business will include the fair market value of the property or assets used in the business (goods, chattels, accounts, supplies, etc.) and the depreciated value of capital assets held by the business, paid to employees, and any other similar charges.

Businesses have different ways to earn profits. Selling products is one way to earn profits. The amount of profit earned by a firm depends on the price at which the product is sold and the amount of revenue produced by such sale. Revenue per head or revenue per sale is the usual measurement of profit in the accounting literature. Other measures of profit are profit margin, cost of goods sold, gross margin, and net profit or the difference between gross revenue and the cost of goods sold.

Profits are calculated in terms of the present value of the purchases of the firm’s existing resources plus the present value of its future claims on its capital stock. Present value is the price that would be received or paid for an identical asset today, whether it is sold or not. The firm’s equity may be used as a basis for calculating future profits but it must be calculated using appropriate discount rates. A firm can capitalize its equity but it cannot reduce the capital stock unless and until all the shares of the firm are sold.

To maximize profits and use the financial method of profit determination, a firm can use a financial formula known as the underlying cost principle. The underlying cost principle tells how much profit can be generated from selling a particular investment if the present value of the firm’s total revenue is less than the total cost of production over a period of time. A financial formula may be used to minimize or maximize the profits of a firm. Usually, the managers of the firm use mathematical formsulae to solve the equations for them. It involves the employment of various mathematical forms in order to solve for a particular problem and then solve for another particular equation to arrive at a solution for another problem.

The main goal of management is the generation of profit. Profit is calculated by subtracting costs from the expected sales. Other factors such as the size of the enterprise, the number of stakeholders and the ability to innovate contribute to the calculation of profit. One of the key terms that are usually used in economics is the key terms principle which deals with the distribution of profits and their distribution according to the contributions of the key stakeholders to the economic value added of the enterprise.

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