7.2

• Firms have two types of accounts:

  • Stock accounts: Measure quantities at a given point in time.
  • Flow accounts: Measure quantities over a period of time.
• Revenue: Money earned by selling goods or services.
• Cost: Money spent on production.
• Profit: Revenue minus cost.
• • R-a-P rents out workers at £10/hour but pays them £7/hour.
  • In 2019, they provided 100,000 hours of labor and earned £1,000,000.
  • Business expenses (wages, rent, advertising, etc.) totaled £900,000.
  • how much was pre tax profit
  • tax : £25,000 how much was post tax profit?


  Pre-tax profit: £100,000 = 1,0000000 - 900000

  after tax profit: £75,000.
• Unpaid Bills and Cash Flow

  • Firms often face unpaid bills at the end of a financial period, such as wages or utility bills, leading to cash flow issues (the amount of actual money received).
• • Cash flow differs from profit, as firms can be profitable but still struggle if customers pay slowly.
• cash flow is the amount of actual money received
• Physical capital: Machinery, equipment, and buildings.
• When a firm buys capital (e.g., computers), it’s not treated as an expense in the year of purchase. Instead, the depreciation (fall in value over time) is calculated. For example, a computer worth £1,000 might depreciate by £300 each year.
• Depreciation lowers the value of assets over time, affecting both profit and cash flow.
• Inventories:

  • Inventories are goods held by the firm for future sales.
• • Firms keep inventories to meet future demand. For example, a car company may produce more cars than it sells in a given year, but only the number of cars sold should count toward that year’s revenue.
• Borrowing:

  • Firms often borrow money to finance start-up or expansion costs. Interest on loans is considered a business cost.
• Balance Sheet:

  • The balance sheet lists a firm's assets (what it owns) and liabilities (what it owes) at a specific point in time.
• Pre-tax profit = Revenue - Total Costs
• Net Worth:

  • Net worth is the difference between a firm’s assets and liabilities. It represents the actual value of the business after all debts are subtracted from the total assets.
  • Example: Snark International has assets worth £540,000 and liabilities of £300,000, so its net worth is £240,000.
• Goodwill:

  • When considering a takeover, the firm's goodwill (reputation, customer loyalty, etc.) is often considered in addition to its physical and financial assets.
  • This means a sound company may be worth more than its net worth because of these intangible factors.
• • Northern Rock was a UK bank involved in property finance and heavily relied on borrowing from other banks and issuing loans (mortgages) to customers.
  • By 2007, Northern Rock could not secure enough funds to cover its obligations due to the credit crunch, leading to its collapse. The UK government had to step in to nationalize the bank.
• Earnings:

  • After paying taxes, a firm can either:

  1. Distribute dividends to shareholders.
  2. Retain the profit in the company as retained earnings to invest back into the business (buying equipment, repaying debt, etc.).
• Retained earnings: The part of after-tax profits that is kept in the business for future use.
• Opportunity cost: The value of the best alternative foregone. This is different from accounting costs, which focus only on actual payments.
• Economic vs Accounting Profits:

  • Accounting profits consider only direct costs (wages, rent, etc.).
  • Economic profits also factor in opportunity costs, such as the best alternative use of your resources (like your time or capital).
  • If economic profits are negative but accounting profits are positive, the business might be better off shifting resources elsewhere.
• Supernormal Profit:

  • This is the extra profit earned after considering all costs, including opportunity costs.
  • Firms aim for supernormal profit as it shows they are using their resources efficiently, generating more than the basic economic cost.