The Social Function of Profit and Loss Accounting

Many people seem to not grasp the concept of scarcity. For example, if a shoe factory stops expanding because the owner decides that profit has been maximized, they would say “Production for people, not profit!”. What they don’t realize is that yes, it is physically possible to produce more shoes, but that would require more resources. The more resources going into shoes, the less of those resources is going into other products. Is having more shoes worth having less of other goods that would have to be sacrificed?

Many textbooks define the economic problem as society’s decision on how to allocate scarce resources into the production of particular goods. In reality, society doesn’t decide anything; individual members of society do. Market prices are formed when individuals engage in voluntary exchanges with each other. The resulting prices in turn give entrepreneurs the ability to calculate profits and losses from various possible activities. It is what determines what goods and services get produced. When an entrepreneurial venture goes out of business, it means that consumers were not willing to spend enough money on its finished output. It is not the resource owners or the “captains of industry” who decide how your business is going to end up. It is the customers.

This is why profit & loss accounting is so important. Without it, you have no way of knowing if your business is doing well or not. It won’t tell you what the customers will do, but it guides you and tells you what they might do or want.

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