Question

Discuss the problem a company may have by looking at short-term profit as a measure of performance. Giving example and explain in detail

Answer 1

Performance is generally measured using long-term profit. Short-term profit is generally not an indicator as it does not provide any indicator of repetition. There is no guarantee that

a. The profit was generated from genuine business activities and not through plain luck

b. The profit is repeatable and can be earned again.

Let us take the example of a small restaurant in Russia that has earned $10,000 in a month because of the world cup in the town it is situated. This would boost its short-term profit significantly. However, the world cup is a one time even. Measuring performance based on this would misinform the analyst, since this event is unlikely to occur again. Furthermore the revenue was earned because of an external factor out of control of the restaurant management. They might be able to replicate a small part of this revenue, however they cannot replicate the entire world cup crowd. As such it is unlikely that this profit would be repeatable. Hence it would be misleading to measure performance based on short-term profit.