CHAPTER VII

INTERRELATION BETWEEN THE ECONOMIC AND THE FINANCIAL ELEMENTS OF A BUSINESS, AND SOME INTER-RATIOS

=Various Aspects of the Temporary Proprietorship Records.=—The profit and loss statement has been explained as a summary of the temporary proprietorship records kept for the purpose of registering the changes in net worth as they occur from day-to-day, and also for the purpose of noting the source or cause of many of the changes in assets and liabilities. The temporary proprietorship records may be regarded as the chronicle or history of the economic life of the business. The efforts of the business to produce income with the least possible outgo in the form of costs or expenses, may be viewed as the work of forces or agencies striving towards that end. Every effort is offset by the cost of that endeavor, and unless the result of the effort be more than its cost, its aim, viz., the increase of net worth, is not accomplished.

=Relation between Profit and Loss and Financial Elements.=—These income-producing efforts are the agencies that bring about the changes in the values of assets and liabilities. Expenses and costs are incurred for the purpose of securing income. Every expense or cost that is settled causes a diminution of business assets, usually of the asset cash. If not settled, it causes an increase in the liabilities, usually the accounts payable, for the business becomes bound by or liable for it. Both of these conditions result in a decrease in the net worth.

On the other hand, every item of income, as when a sale of goods is made, is reflected in an increase of assets or a decrease of liabilities. The result of every sale is usually an increase in the cash or in the claims against persons, the accounts receivable. The sale may sometimes result in a lessening of liabilities through a cancellation of the claims of creditors by means of the claims against customers arising out of the sale. This would be true when goods are bought from, and sold to, the same person. Thus there is constantly a direct interrelation between the financial and the profit and loss elements of every business.

=Exchanges within the Asset and Liability Groups.=—All changes in individual assets and liabilities, however, are not always the result of business or economic forces. There may be an even exchange of one asset for another asset, as when delivery equipment is purchased for cash. The asset Delivery Equipment is increased by the same amount as the asset Cash is diminished. Or if a bill of goods is purchased on credit, an increase of assets is exactly offset by an increase in liabilities. These changes are illustrated in the second example in