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Ethics Affects the Financial Results of a Company

ethics affects the financial resultsWhen you think of Enron, WorldCom, and Arthur Anderson, what do you think? Do you think of how successful and innovative they are? Do you want to be their financial leader? Their use of questionable behavior to squeeze more margin and gain more market share has caused each of these companies to be challenged. But today, we are arguing that good ethics can affect the financial results of your company in a positive fashion.

How Ethics Affects the Financial Results of a Company

Although ethics does not have a “price tag“, we have seen the impact of questionable ethics. Stock prices take a dive, customers leave, protests occur, and other companies restrict their ability to do business together. Yet some companies survive because some consumers are willing to overlook ethics in order to get the best price.

If you’re looking to destroy the value of your company, having poor ethics is a guaranteed way to go. Click here to learn about the Top 10 Destroyers of Value and how to increase the value of your company.

ethics affects the financial results

Good Ethics Affects the Financial Results Positively

One brand that comes to mind when thinking about good ethics is Patagonia, the outdoor clothing and equipment retailer. Take a look at their mission statement: “Build the best product, cause no unnecessary harm, use business to inspire and implement solutions to the environmental crisis.” Unfortunately, we are not able assess the financial success of the company as it is a private entity. But Patagonia has gained the loyalty of customers. Now, they sell their products in 150 countries because of the ethical decisions they made.

Poor Ethics Affects the Financial Results Negatively

Regulators believe that Volkswagen may have lied about the fuel efficiency of their vehicles. Most aircrafts have banned the Samsung’s Galaxy Note 7 because it has caused multiple injuries due to its exploding batteries. But they could have prevented this recall of three million phones by adjusting the design of the product. Unfortunately, bad ethics affect the financial results and profitability of the company. Unlike companies who hold themselves accountable and obey the law, other companies fail to maintain their integrity and seek to gain every bit of profitability by cutting much needed corners.

You as the financial leader of your company need to manage the standard of ethics maintained in your company. Consequently, this means that marketing, sales, operations, finance, manufacturing, etc., all need to adhere to a strict code of ethics to gain huge value. If one leg of the company falls short of these standards, the whole company falls.

Enron: A Company Once On Top of the World No Longer Exists

“America’s Most Innovative Company,” Enron, once ruled the energy world – growing and blooming into a highly profitable company. But behind closed doors, masterminds were putting together one of the greatest accounting fraud and corruption scandals in recent history. Enron and their relationship with the Arthur Anderson accounting firm is now the perfect example of how important ethics is and how unethical decisions can disrupt thousands of lives. As executives were inflating financial records and participating in insider trading, they were in a downward spiral.They inflated the numbers and prevented themselves from being caught the first time. Thus, forcing them to repeatedly inflate the numbers to cover their tracks. Unfortunately, auditors at Arthur Anderson did not report this fraudulent behavior either.

As a financial leader, you must maintain the utmost level of integrity especially when it concerns financial records and reporting. If you are looking to sell your company or undergo a capital valuation, make sure your ethics are not destroying the value of your company. To learn about other potential destroyers of value, download our free Top 10 Destroyers of Value whitepaper.

Equifax – The Enron of 2017

As the second largest security breach in the world, Equifax is facing numerous issues – including possible insider trading, not protecting the security of customers, and not promptly responding to this breach. The Wharton School at the University of Pennsylvania discusses this Equifax issue and reports that the CFO was not informed about the breach. Equifax is struggling to maintain its discretion with Social Security Numbers, the most important number Americans have. This breach impacted over 143 million Americans.

How could Equifax have prevented this breach and improved their position?

  • Respond quicker to the situation
  • Invest is better security measures, rather than settling with a mediocre security

Even though the breach occurred in July, most Americans did not find out until early September. We currently don’t have the details about what happened during that period. But Equifax should have released information about what was going on sooner. In addition, a company that deals with highly sensitive information should have had the best possible security measures in place to prevent this type of nightmare.

ethics affects the financial resultsGood Ethics Returns Huge Value

Unfortunately, we have seen many companies forget their ethics and tumble to their inevitable demise. But there are companies that have found that good ethics return huge value. The Guardian newspaper states that “the way the values represented by the code are embedded in the organization which makes the difference. The more the values are lived, the better and more consistent the decision-making at every level, the greater the amount of trust, the more confident and motivated the employees and the less the chance of costly damage to the company’s reputation. The virtuous circle can be expected to embrace customers, suppliers and other stakeholders.”

Huge Value & Huge Profits

In a Wall Street Journal article, they conducted an experiment that measured what people would pay for an item based on ethics. They divided each testing group into three categories: highly ethical, control, and unethical. Those presented an brand of coffee beans regarded as highly ethical were willing to spend $9.71 a pound. Conversely, those presented with a brand of coffee beans considered much less ethical were only willing to spend $5.89. That’s a staggering $3.82! If you sell 1000 pounds of coffee beans, the difference in revenue is $3,820.

While that may not seem like a lot, think about this. Your cost of goods sold are $4.23. By being ethical, you have $5.83 margin whereas the less ethical brand has only $1.66. Which situation would you rather be in?

Ethics affects the financial results of your company greatly! If you want to access huge value and huge profits, it’s time to focus on your company’s ethical standards. Discuss with your sales, operations, and finance departments how you can be more ethical internally and present a high ethical standard externally. If you’re in position to sell or just want to prepare for a potential sale, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

ethics affects the financial results

ethics affects the financial results

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Sole Proprietorship

Sole Proprietorship Definition

The sole proprietorship definition is a private business owned and operated by one individual. Furthermore, a proprietorship is unincorporated and is not a legal entity separate from its owner. As a result, the owner earns all of the profits and incurs all of the losses from business operations. Therefore, the sole proprietor is legally liable for all of the activities and obligations of the business. For example, if the proprietorship defaults on debt obligations, the owner risks liquidation of personal assets.

Advantages and Disadvantages of a Sole Proprietorship

There are several advantages to the sole proprietorship. Proprietorships are easy to establish, easy to dissolve, and they give the owner a significant amount of operational freedom and flexibility. For tax purposes, the owner simply includes the profits or losses of the proprietorship with his or her individual tax filings.

There are also disadvantages. The owner has unlimited liability for the activities and obligations of the proprietorship. This puts the owner’s personal assets at risk. Also, because of the small scale of a proprietorship, it can be difficult to gain access to substantial capital resources and financing. As a result, this limits the growth potential of the enterprise.

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sole proprietorship

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sole proprietorship

See Also:
General Partnership
Limited Partnership
S Corporation
How to Run an Effective Meeting

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Profit Center

Profit Center Definition

In accounting, a profit center is a type of responsibility center. A responsibility center is an organizational subunit the manager of which is responsible for certain financial and non-financial performance measures. Furthermore, for accounting purposes, consider a responsibility center – in this case a profit center – a distinct entity within the context of the larger organization.

In a profit center, the manager is responsible for the revenues generated by the subunit. In addition, they are responsible for the costs and expenses incurred by the subunit in the course of normal business operations. As a result, the manager of a profit center is responsible for the profits of the subunit. Their primary goal is to maximize the subunit’s net income; however, the manager of a profit center is not responsible for long-term capital investment costs.

Profit Center Explanation

There are several reasons why a company would establish its business units or departments as profit centers.

A profit center is established within a corporation in order to determine the profitability of the subunit independently from other departments in the company and from the company as a whole. This could be because a large corporation has numerous divisions – the appliance division, the apparel division, the electronics division, etc. – and wants to measure the financial performance of each division to determine which are the most profitable.

A corporation can also establish an internal business unit as a profit center so as to compare profitability across organizational subunits. For example, a large lawn equipment company might establish its northeast division and its southwest division as profit centers so as to compare profitability of the two regions. In addition, a corporation could compare the profitability of two types of operational strategy and tactics employed at different profit centers.

Another reason for establishing a business department as a profit center is to promote goal or behavioral congruence among the managers of the company’s organizational subunits. By motivating and evaluating the manager’s performance in terms of profit, you can then incentivize the manager to achieve profits, which is in tune with the goals of the overall organization.

Profit Center Examples

All of the following are examples of profit centers:

  • Individual restaurants in a large restaurant chain
  • Manufacturing divisions in a large corporations
  • Individual retail stores in a large retail chain
  • Other organizational subunit deliberately established to maximize the profits the subunits

Profit Center

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Profit Center


Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.

Barfield, Jesse T., Michael R. Kinney, Cecily A. Raiborn. “Cost Accounting Traditions and Innovations,” West Publishing Company, St. Paul, MN, 1994.

See also:
Service Department Costs
Transfer Pricing
Responsibility Center
Cost Center
Cost Driver

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Labor Costs

See Also:
Absorption vs Variable Costing
Agency Costs
Operating Capital
Replacement Costs

Labor Costs Definition

The labor costs definition is the total cost of all labor used in a business. It is one of the most substantial operating costs. These are particularly important in any business which experience heavy human resource labor costs: construction, manufacturing, and other industries which have partially or non-automated operations. These costs include 2 main subcategories. The direct labor costs definition is summarized as the cost of labor which is used directly to make products. Meanwhile, the indirect labor costs definition is simply explained as the cost of labor which is used to support or make direct labor more efficient.

Labor Costs Explanation

These costs are explained by many as the most important cost a company will face, is a key factor in almost any business. This is due to the fact that employee turnover is one of the main factors which causes a business to fail. To begin, it is in the best interest of any owner that unit labor costs and inflation are minimized to maximize profits.

The importance of labor costs does not stop here. They are a variable cost. As such, they must also occur in a predictable cycle to avoid cash flow problems. If a firm is seasonal and requires additional labor at peak times, business controllers must have the cash on hand to afford this increase in cost. If a business plans properly it will avoid many cash issues associated with the cost of labor.

Labor Costs Formula

A single formula will not serve the many different needs associated. Despite this, a common and simple formula is included below:

Labor Costs = (total sales x labor %) / average hourly rate of labor

Labor Costs Calculation

To perform a simple labor costs calculation follow the process outlined below:

Total Sales = $1,000,000
Labor % = 15%
Average hourly rate of labor = $10

Labor Costs = ($1,000,000 x .15) / $10 = (150,000) / $10 = $15,000

Labor Costs Example

For example, Leann is the owner of a clothing store in the largest mall in her city. Leann, a fashion aficionado from birth, knows the popular styles better than any designer in Milan. She works diligently to make sure her store stays in pace with the trends of today as well as the future.

Leann is gearing up for her peak season. Additionally, she is concerned because her off-season sales have slumped slightly. She sees the new season as a great opportunity to move inventory and regain the ground. That is, if she has enough cash to get by.

Leann will need to increase hours for sales and backroom staff during these peak times. To balance that, she will also have to make sure she can pay for these employees. The slump in her off-peak season has made Leann plan more for the future. She now wants to calculate cost of labor for her peak period to make sure she can afford the cash needed to get by.

Example Calculation

Leann performs this simple calculation to find her cost of labor:

Total Sales = $1,000,000
Labor % = 15%
Average hourly rate of labor = $10

Labor Costs = (total sales x labor%) / average hourly rate of labor
Labor Costs = ($1,000,000 x .15) / $10 = (150,000) / $10 = $15,000

For Leann’s retail business cost of labor total $15,000 for the period she is studying. This is more than she expected and can afford. Luckily, Leann has excellent credit. Leann decides to apply for a small business loan to help her company survive the first month of peak demand. From here she will make the cash necessary to continue.

Leann also decides to pay more attention to her company finances. She was not surprised by this situation, but still wants to be able to predict the problems that her business will face better. Her drive and insight will achieve this and many future goals.

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Labor Costs, Labor Costs Definition

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Labor Costs, Labor Costs Definition


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See Also:
Dividend Yield
Capital Impairment Rule
Dividend Payout Ratio
Financial Ratios

Dividends Explained

Dividends are corporate profits distributed to shareholders. When a company makes a profit, the board of directors can decide whether to reinvest the profits in the company or to pay out a portion of the profits to shareholders as a dividend on shares. The board of directors determines the amount of the dividend on stocks, as well as the dividend payout dates.

Stockholders typically receive a certain amount of dividends per share for each share of stock they own. Tax rates on dividends, historically, have often differed from tax rates on capital gains from investments. If the dividend tax rate exceeds the capital gains tax rate, it may benefit the shareholders to avoid paying a dividend, and instead to carry out a stock repurchase.

Dividend Yield Definition

We define dividend yield as the dividend amount expressed as a percent of the current stock price. For example, if a stock will pay a $1 dividend at the end of this year, and today the stock price is $10, then that stock’s dividend yield is 10%.

10% = 1/10

Dividend yield equation

Dividend Yield = D1 / P0

D1 = Annual dividend per share amount (the dividend per share at time period one)
P0 = Current stock price (the price at time period zero)

Dividend Date Definitions

The process of distributing dividends to shareholders follows a set schedule. The board of directors announces the dividend on the dividend declaration date. Once the dividend has been declared, the company is legally obligated to pay the stated dividend to shareholders.

The next significant date is the ex dividend date. Investors who purchase the stock on or after the ex-dividend date will not receive the forthcoming dividend. Prior to the ex dividend date, the stock is considered cum dividend, or with dividend. This means that anyone buying the stock during this period will receive the forthcoming dividend.

The ex dividend day precedes the dividend record date, or the dividend date of record, by three days. Shareholders documented as owning the stock on the dividend record date will receive the dividend.

Last is the dividend payable date, or the dividend distribution date. This is the actual date on which the company pays out the dividends to its shareholders. The dividend payable date is typically about a month after the dividend date of record.

Dividend Payout Dates

• Dividend Declaration Date (stock is trading cum dividend)
• Ex-Dividend Date
• Dividend Record Date (three days after the ex-dividend date)
Payable Date for Dividend (one month after the dividend record date)

Dividend Signaling

Dividend signaling hypothesis refers to the idea that changes in a company’s dividend policy reflect management’s perceptions of the company’s future earnings outlook. Basically, it states that a change in a company’s dividend policy can be interpreted as a signal regarding future earnings. The problem is that a company can interpret the signals as contradictory messages.

Dividend Example

For example, if a company announces that it will increase its dividend yield, investors may interpret this as a positive signal. It could mean the company anticipates a profitable future and is allowing shareholders to benefit from these profits.

On the other hand, one can interpret an increase in the dividend payout rate as a negative signal. It could mean that the company has no good investment opportunities, and it has nothing better to do with its cash than to pay it out to shareholders as dividends.

Similarly, if a company announces that it will decrease its dividend payout rate, this can be interpreted as either a positive or negative signal. It could be interpreted as a positive signal because it could mean that the company has so many good investment opportunities that it needs all available cash for positive-NPV investments and projects. This could mean the company is growing and expanding.

On the other hand, if a company cuts its dividend rate, that could mean that the company anticipates lower earnings or even losses. This, of course, could be a bad sign. So as you can see, the logic behind the dividend signaling hypothesis makes sense, but because it can be interpreted in contradictory ways, the reading of the signals is not necessarily very meaningful.

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Another Way To Look At Factoring

See Also:
What is Factoring Receivables
Accounting for Factored Receivables
Journal Entries for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
History of Factoring
How Factoring Can Make or Save Money
Factoring is Not for My Company
The What, When, and Where About Factoring

Another Way To Look At Factoring

While talking to a prospect named Vicki, she told me, as I hear so often, “Factoring is just too expensive.” She continued by saying “The annual interest being charged for your services is in excess of 20%.”I let her finish, and told her that she is paying for more than just interest on the cost of money. In fact, we are actually providing you capital, not loaning you money. And, we are providing you with additional services, thus allowing you to increase your profits. In this article, we will look at the impact of factoring on profits – another way to look at factoring.

She said you have told me about the other services you provide, which are: performing daily and monthly collection activities; providing daily, weekly and monthly reports about account receivables aging and collection activity; assisting in establishing credit lines for our customers; and monitoring our customers’ financial conditions to alert us when they are in financial trouble. I just don’t understand how you are providing my company with capital, allowing my company to grow and increase our profits.

I told Vicki, capital is generated for her company by speeding up the cash received by her company for credit sales. By factoring, you will have faster access to the profits in your sales which create capital. She said that sounds great, but I would like you to further explain two things. How does my company factoring with you increase my profits? And, I want to know the return on my investment on the factoring cost I will be paying to your company.

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I asked Vicki a few more questions relating to her company’s growth opportunities and expenses she expects to incur with the growth. With her input here is the example I gave her:

Impact of Factoring on Profits

Let’s look at the impact of factoring on profits in Vicki’s example.

                      Before Factoring    After Factoring
Revenues                $500,000                  $1,000,000
Cost of Services Sold   $325,000(65%)             $650,000(65%)
Gross Profit            $175,000(35%)             $350,000(35%)
Variable cost           $50,000(10%)              $100,000(10%)
Fixed Costs             $100,000                  $100,000
Cost of Factoring       None                      $25,000(2.5%)
Net Profit              $25,000(5%)               $125,000(12.5%)

I didn’t have to say anymore. Vicki explained my example to me by saying her profit after factoring increased both dollar-wise from $25,000 to $125,000 and percentage-wise from 5% to 12.5%. She stopped a minute, and then said, are you telling me that if I invest $25,000 in factoring, the net profit increases by $100,000 making my return on investment (R.O.I.) in factoring to be 400% (R.O.I. = (100,000/25,000) X 100% = 400%).

I said yes and Vicki then looked at me and said I understand what you are saying and I am interested in your program.

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Impact of Factoring on Profits
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Impact of Factoring on Profits

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