#SahodItaasPresyoIbaba Economics May Be Confusing Profits and Revenues

A really disastrous decision!

As I read through Facebook, the amazing foolishness and economic illiteracy are there. What do you expect from a nation that's driven by an education system where economics was only taught in either the third year or fourth year, under K+10? What do you expect from a nation where mathematics education focuses too much on theory rather than the wonderful application of the subject? I'm going to write about those who talk about FDIs, that only they will get rich because they will run away with the profits, etc. It's because I'm afraid there's really a lack of understanding of what profit really is. 

Most people in the Philippines may be operating with the typical merkado mindset. I remember reading through the arguments of someone who quotes CTTO Merkado. Who in the world is Merkado CTTO (read here)? As I was thinking about it, I heard about how people running businesses in the merkado or marketplace, whether it's the wet market or a sari-sari store, usually have a poor understanding of profits. 

A conversation about profits can go like this. For the sake of non-Cebuanos, I'll just write things down in English. I can ask, "How much is your profit for the day?" Instead of saying, "I haven't deducted my sales minus expenses yet." Instead, they equate profit with income or revenues. They may say in Cebuano, "My sales for the day is PHP 10,000.00, therefore my profit is PHP 10,000.00." That's a poor understanding of what profit is.

Malaya Business Insight

The possible reason why a considerable amount of Filipinos, fall for the lie above, is because of how they define profits. If we're going to go with the simple definition of profits, Investopedia (by the way, I'm now quoting it a lot since I don't intend to please the woke crowd) says this:

What Is Profit? 

Profit describes the financial benefit realized when revenue generated from a business activity exceeds the expenses, costs, and taxes involved in sustaining the activity in question.

Any profits earned funnel back to business owners, who choose to either pocket the cash, distribute it to shareholders as dividends, or reinvest it back into the business.

Do they even realize that MNCs are no different from the local businesses when it comes to operations? MNCs will require more money because of the size of their businesses. True, an MNC may have bigger revenues for the day. What isn't accounted for yet is the expenses that come to acquire the huge revenue. A store that's open for 24 hours may sell more goods. What's unaccounted for are the expenses, which it must pay for. Otherwise, the business can be disconnected from their utilities, have employees leave en masse (for not paying a living wage), and the like.

Now, for more definitions of the types of profits:

Gross, Operating, and Net Profit

The first level of profitability is gross profit, which is sales minus the cost of goods sold. Sales are the first line item on the income statement, and the cost of goods sold (COGS) is generally listed just below it:

Gross Profit = Revenues - COGS

For example, if Company A has $100,000 in sales and a COGS of $60,000, it means the gross profit is $40,000, or $100,000 minus $60,000. Divide gross profit by sales for the gross profit margin, which is 40%, or $40,000 divided by $100,000.

Operating profit removes operating expenses like overhead and other indirect costs as well as accounting costs like depreciation and amortization. It is sometimes referred to as earnings before interest and taxes, or EBIT.

Operating Profit = Revenue - Cost of Goods Sold (COGS) - Operating Expenses - Depreciation & Amortization

Net profit furthermore removes the costs of interest and taxes paid by the business. Because it falls at the bottom of the income statement, it is sometimes referred to as the firm's "bottom line."

Net Profit = EBIT - Interest Expense - Taxes

The bottom line tells a company how profitable it was during a period and how much it has available for dividends and retained earnings. What's retained can be used to pay off debts, fund projects, or reinvest in the company.

When one takes a look at the profits, FDIs are still bound by these rules in accounting. What FDIs leave is the net profit. People may be ignoring that the expenses include employees' pay, utility payments, raw materials payment (chances are, they are local for convenience reasons), and taxes. FDIs are still required to pay taxes in the Philippines if they want to continue doing business in the Philippines. That means even if I buy an iPad from an Apple store, eat at McDonald's instead of Jollibee, or get tea from Tealive or Chatime instead of Bo's Coffee Club, I buy all imported products for the day (since I may not need the local products due to availability at home), etc.--these are still taxable. The receipt will still put the 12% VAT. These companies will still let them pay quarterly and annual taxes. There's also an excise tax on some goods and services. 

If they knew the meaning of the word profit, they'd get that FDIs would keep 100% of the net profit (read here). That means these companies keep only what's left of their operations. If they don't pay their employees properly, they can get sick employees that will not do work properly. If they don't provide suitable working environments, they will destroy productivity. If they don't pay taxes, they can forfeit their right to do business in the Philippines. When the profits are kept, it's basically what's left from the earnings after all expenses are paid. 

Image by Sabrina Jiang © Investopedia 2020

Take a look at the sample income statement above. Let's say the monthly revenue was USD 5,000.00. That doesn't account yet for the COGS, marketing expense, administrative expresses, deprecation, interest rates, and taxes. Out of the USD 5,000.00--the company's profit of USD 1,500.00 is barely half of the revenue! 

Once again, what do you expect from people who study #SahodItaasPresyoIbaba economics instead of real economics? They still believe that one can easily raise salaries and reduce the prices of goods, like magic. It's no surprise that the same people who say that only FDIs will get rich are failing in even basic accounting. I don't need a PhD to understand that net profit is based on everything after all expenses, including interest and taxes.