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There are two primary ways that corporations report profitability, including accounting and economic earnings. Much of the difference between these two processes involve the way and time that items are disclosed on a financial statement. The accounting earnings approach essentially incorporates any changes to liabilities at the soonest possible moment. Anticipated fluctuations in cash flow, however, do not usually come to surface until later. In economic earnings, any projected change in direction for cash flow is more readily accepted and revealed in the current financial results.
The parameters for the items that are included in economic earnings are broader than those components that financial analysts and accountants typically refer to in accounting profits. Nonetheless, the ability to report profits in a more flexible fashion provides corporate executives and market participants with some context for a company's anticipated access to cash in the future. Third-party analysis is often linked to the current value of a corporation, which can be determined through accounting earnings results. Although this method offers guidance on a business's future profitability, there are often many factors that can influence a change in those predictions. The anticipated cash flow expressed in economic earnings can similarly be amended, but this often reflects income that will be earned only if current conditions continue.
A firm's productivity capacity, or its ability and resources to operate the business, is one of the items that is considered in economic profit results. Some alteration in a company's output for the goods and services that are being offered could have a significant impact on future cash flow, which in turn influences economic earnings. Subsequently, this approach to reporting profitability assumes that production will continue at the current or projected pace without ceasing.
In business, it is not unusual for accounting changes in the value of assets or liabilities to be recognized in the future. Even when a major deal is underway, the amount of money that is involved in the transaction may only exist on paper until the proper shareholder and regulatory approvals are completed. A business that is reporting income using the economic standard is more likely to include the financial impact from a deal before the financing is complete or any payment exchanges hands. Subsequently, these results could appear to be more generous in comparison with the accounting method because economic profits encompasses income that has yet to materialize.
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