BONA FIDE PROFITS VERSUS ACCOUNTING PROFITS
In defining bona fide profits, the simple formula, revenue minus costs, represents a useful starting point. When calculating this kind of profit, the analyst must take care to consider only genuine revenues and deduct all relevant costs.
A nonexhaustive list of costs includes labor, materials, occupancy, services purchased, depreciation of equipment, and taxes. No matter how meticulously the analyst carries out these computations, however, no calculation of profit can be satisfactory unless it passes a litmus test:After a company earns a bona fide profit, its owners are wealthier than they were beforehand.
To underscore the point, there can be no bona fide profit without an increase in wealth. Bona fide profits are the only kind of profits that truly matter in financial analysis.
As for accounting profits, Generally Accepted Accounting Principles define voluminous rules for calculating them with extraordinary precision. For financial analysts, however, the practical definition of an accounting profit is simple:
An accounting profit is whatever the accounting rules say it is.
If, during a stated interval, a business adds nothing to its owners’ wealth, but the accounting rules state that it has earned a profit, that is good enough. An accounting profit that reflects no genuine increase in wealth is certainly sufficient for many stock market investors. They cheerfully assign a price-earnings multiple to any number that a reputable accounting firm waves its magic wand over and declares to be a profit.