Income differs from earnings.
Income differs from earnings. Income means receiving cash. Expenditure means paying cash. On the other hand, earnings means value received by providing some goods. And the thinking that evaluates economic activities in a certain period of time based on earnings is called the principle of periodic profit and loss. Corporate management is conducted based on the principle of profit and loss. After the sources of fundamental funds, i.e., liabilities, capital and periodic earnings (the funds used as the basis of business activities) are first classified, the principle of periodical profit and loss is applied to measure asset value (the actual levels of liability and capital) and expenses (the effect as a basis of earnings of a certain period) based on earnings. The index is profit.
When a profit is gained, it means that the effects of profits and expenses are in balance. On the other hand, when a loss is incurred, it means that profits and expenses are not in balance. When profits and expenses are not in balance, the sum total of liabilities and capital, i.e., the total capital, will increase.
Profit is an index. Although it is not good to be unable to make a profit and only incur a loss, it is not good to make excessive profits, either. The balance of profit and loss is important.
The problem with public finance and household budgets is that a profit is considered to be negative. That’s why there is an institutional gap between public institutions, household budgets and markets.
In the principle of periodic profit-and-loss, earnings are used as the base.
One should not make a mistake about this fact: liabilities and capital constitute the base.
When looking at periodic profit and loss, the key points are depreciation and reinvestment, liabilities and capital.
Cash raised in the form of liabilities, capital and profit is stored in financial assets at first, and is then allocated for payments. Property and expenses are formed through the payment of funds.
Liabilities and capital form debts while property forms credits.
Credit is something used to back up a debt and indicates the long-term effect of funds. One must pay attention to the fact that credit and debt move asymmetrically. And, the direction of the flow of funds is decided by the balance of credit and debt.
One should note that earnings form the basis of corporate management.
Property consists of financial assets, depreciable assets and nondepreciable assets.
Many people are biased by a preconceived notion that they must pay off borrowed money because they are mixing up borrowed money with liabilities.
In the principle of periodical profit and loss, however, liabilities are not necessarily premised on full repayment. As an example of this, the earnings of financial institutions are not based on the principal but on interest. Moreover, on the corporate side, expense means interest and payment of the principal is not allocated as an expense. This point is the critical difference between cash basis accounting and periodical profit and loss accounting.
This means that liabilities are not necessarily premised on full repayment in terms of periodical profit and loss accounting. And this is shown in the status of capital. Capital is a kind of debt, as are liabilities. But capital is not premised on repayment. In essence, dividends and interest share the same effect. Both interest and dividends are a factor which forms the time value of money.
The time value of money controls the turnover volume of currency. When a time value arises, a time lag is derived. And time lags have the effect of promoting the flow of funds.
The real advantage of interest and dividends lies in the time value. Dividends are based on profit, while interest is based on the principal. The difference lies in whether the basis is an entrance or an exit. To put it in an extreme way, although both liabilities and capital must be repaid, they are not the funds that must be repaid. They are funds for business.
When looking at this from the standpoint of financial institutions, it means they lose the basis for interest when the borrowed money has been fully repaid. In brief, it is optimal to continue generating profits appropriate to the amount of expenses while keeping the level of borrowing constant.
It is important to maintain the nominal values of liabilities and capital at constant levels. That is why profits need to be made. When a profit is lost, liabilities will increase. In this regard, periodical profit and loss should be set not only from the viewpoint of corporate profit and loss but also from those of public finance and household budgets.
In a sense, one can say that periodical profit and loss as well as the mechanisms of accounting and bookkeeping that form the basis for it are designed to keep the levels of liabilities and capital constant. It is not as simple as saying that one should stop borrowing money. Both borrowed money and capital have an effect as business funds. It is the thinking based on cash basis accounting that borrowed money must be repaid. In a capitalist society, public finance, household budgets and companies should be operated based on the principle of periodical profit and loss. The problem lies in a mechanism (structure) in which they cannot control liabilities and this results in the further accumulation of liabilities.
Depreciable assets are allocated to expenses because they are premised on reinvestment. Depreciable assets are set to balance the cost and effectiveness.
The funds to repay nondepreciable assets will be accumulated by gaining profits or be supplemented by the increase of asset values.
For a country, companies and households, the question is whether or not they can generate earnings appropriate to their expenses. When a change occurs in their structures, they should take action to make a profit. If they do not do so but hasten to collect funds, the whole economic structure will collapse from the bottom up.
In order to generate appropriate earnings, one needs to keep expenses at an appropriate level.
On the other hand, earnings are comprised of various prices. In other words, realizing appropriate earnings means maintaining appropriate prices.
The meaning of maintaining appropriate profits is that one becomes able to secure appropriate expenses. Eventually, expenses are transformed into personal income. Personal income is the source of consumption. When prices and income are in balance, the market functions effectively. If the balance of prices is lost or a change in income arises, the economy will get out of control.
Commodity prices are comprised of various prices. Commodity prices are the averages of the prices of various goods. Such prices, however, do not rise or fall uniformly. A given price is a specific value of each good. Not all the prices comprising the commodity prices move uniformly. In addition, there may be regional differences in the movement. A price is a value decided by market transactions. Market transactions vary by the conditions surrounding the market, i.e., a situation or an environment. Market prices change hour by hour.
Commodity prices are formed not only by a situation or environment but are also dependent on cultural factors such as values, manners and customs as well as social backgrounds and fundamentals.
Commodity prices depend on conditions, geographical characteristics, life styles, living standards and religions specific to a local area.
Economic and social fundamentals make incomes fluctuate. Financial institutions play the role of a smoother that equalizes such fluctuations. It is necessary for financial institutions to smooth the flow of funds with a long-term viewpoint.
Investments don’t become a profit unless they are converted into earnings. And, earnings cannot be converted into assets or liabilities unless they are converted into capital.
Investments are transformed into assets by the investors and into earnings by the parties who receive the money. Earnings become expenses and then expenses are transformed into earnings and personal income. Expenses are transformed into personal income in stages.
Funds used as the source of investment are raised in the form of liabilities and capital.
The invested funds are allocated to earnings by the party who receives the money. Earnings are transformed into expenses there. Expenses are transformed into the earnings of other management entities and personal income.
After being distributed to the government, owners, and investors, periodic income is capitalized and invested altogether. The invested capital becomes property.
Liabilities are reduced when profits are accumulated. Then, reinvestment in property becomes possible. Additionally, the balance of earnings is transformed into public income in the form of taxes, which then reduces the liabilities of the public sector. When returned to investors as dividends, earnings drive new investments and enhance capital. While profit is an index, it plays these foregoing roles as well. That is, liabilities and capital are converted into assets, assets are transformed into earnings, earnings are transformed into expenses, the balance of earnings becomes profits, profits are transformed into capital, and capital reduces liabilities or becomes funds for reinvestment. This is the mechanism of a money economy which circulates funds and produces goods through such successive actions. And accounting systems are the grammar of the money economy.
First, profits are distributed to managerial resources such as funds for repayment of liabilities and for reinvestments. Second, profits are distributed to the public sector in the form of taxes. Third, profits are distributed to investors. Fourth, profits are distributed to financial institutions as repayments of long-term borrowing. Fifth, profits are distributed to top management as remuneration. The ratio of this distribution significantly affects the economy.
Taxes become the income of a country and this income becomes funds to repay national bonds. Since public finance is based on cash basis accounting, income can be neither transformed into earnings nor distributed to assets, liabilities or expenses.
Public investment is converted into earnings through transactions. The funds for public investment are borrowing and taxation. However, since public finance is based on cash basis accounting, liabilities, capital and earnings on the revenue side and assets and expenses on the expenditure side are not classified.
After being converted into earnings through transactions, a portion of the funds is released as expenses, and the balance after expenses are deducted is allocated to profits. The portion allocated to profits is distributed to dividends, taxes and compensation. The balance left after such distribution becomes funds for repayment of the principal of liabilities and for reinvestment.
Expenses are allocated to earnings and personal income.
The biggest problem of cash basis accounting is the fact that the classification of investment and expenses, liabilities, capital and earnings is unclear. The principle of periodic profit and loss has developed in a way that complements the problem. Public finance and household budgets based on cash basis accounting still have ambiguity regarding the classification of investment and expenses, liabilities, capital and earnings. As a result, since it is difficult for them to measure the effects of the long-term and short-term actions of funds, they cannot clearly identify how to effectively deal with funds.
In a negative economy, negative control holds the key. The extent to which the level of liabilities is maintained means much to public finance, household budgets, companies and commerce.
And time plays a critical role in negative control.
What matters are the boundaries separating investment and expenses, liabilities, capital and profits. Depreciation expenses and repayment of the principal of long-term liabilities are such boundaries.
In a negative economy, liabilities are an index for the money supply. In short, the question is whether or not liabilities can be maintained at a constant level.
In today’s market economy, people are only trying to improve production efficiency.
But when it comes to efficiency, production efficiency is not the only element that one should try to improve. The elements of efficiency that should be improved include not only production but also distribution and consumption.
And another element is income, for example. Income has aspects such as expenses, remuneration and living expenses.
And the function of each element is not necessarily directed in the same way as other elements.
The aspect of expenses in income is connected with earnings and related to production. Remuneration is connected with labor and related to distribution. Living expenses are converted into consumption through expenditures.
Production efficiency depends on how much expenses can be controlled. To that end, improvements of the facility operation ratio, work standardization and equalization of labor costs hold the key. This leads to mass production and mechanization.
If one company with 100 people makes a profit of 100 million yen while another with 1000 people makes the same profit, for example, which one is more efficient? The answer will be the former when considered from the viewpoint of productivity. It will be the latter, however, when considered from the viewpoint of distribution. It is wrong to consider economic efficiency simply from the viewpoint of productivity.
The efficiency of distribution depends on how to efficiently distribute income to many people and how to promote exchange of income for goods. Liquidity also matters here.
Distribution of income is also an issue related to the circulation of goods and currency. It does not mean that income should be distributed equally and uniformly. However, if the distribution of income becomes excessively uneven, it will cause a decline in labor efficiency. Distribution of income is also an issue of self-realization, i.e., the evaluation of one’s labor.
Improvement of the efficiency of consumption is also an issue related to people’s lives. The issue of production and consumption can be also considered to be issues of supply and demand and issues of income and expenditure.
When looking at economic efficiency from the viewpoint of consumption, economy and savings are at the core. That is, from the viewpoint of consumption efficiency, what matters is how to efficiently utilize less resources. It is also an issue of quality.
Using good things carefully for a long time will increase consumption efficiency. When that happens, high quality and high prices will be able to coexist. It is not as simple as saying that low prices and standardization are the only indexes of efficiency. Throwing things away does not necessarily increase consumption efficiency.
Mass consumption is brought about by the demand to increase the efficiency of mass production.
It is not necessarily aimed at improving consumption efficiency. Rather, when it comes to increasing consumption efficiency from the viewpoint of preserving resources and the environment, it is more efficient to apply a system of high-mix, low-volume manufacturing.
As such, production efficiency, distribution efficiency and consumption efficiency do not share the same direction. And it is the imbalance among production, income and consumption efficiency that serves as the driving force for circulating currency.
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