When Lions Chemical, Inc., entered the paint business first time, it was not successful. According to a company report, in one year it “lost” nearly $500,000 in actual cash in addition to an expected return on investment of nearly $500,000, which made a total loss of income to the company of nearly $1,000,000. Why did this report include as part of the company's loss the amount it had expected to earn – but didn't – on its investment in manufacturing paint? Explain.

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Companies make investments in new initiatives in order to obtain a return on their investment (ROI). This is true of any new business decision. Increasingly, though, companies are allocating funds to areas where they do not expect to earn a return in order to make social or charitable contributions.

Nevertheless, companies are mainly driven by profit incentive. Thus, they must report to their stakeholders how well they have performed regarding their profits goals. If they have fallen short of any goals, they must also explain this shortcoming to their stakeholders, who are often public shareholders. Shareholders have the right to understand what the company’s goals are and how the company intends to achieve these goals.

When a company makes a sizable investment in a new business unit, it needs to outline some general parameters, including its expected return on investment (ROI), the time it will take to reach break-even and then generate profits, and any expected cross-promotional or cross-support activities within the overall organization that can help create economies of scale.

In the case of Lions Chemical and its new paint initiative, the company describes two different types of “losses.” The first loss is an actual cash loss. Think of it this way: Lions had to add new personnel to manage and move its paint business forward. There was an actual cash cost associated with these new staff members. In addition, the company had to invest in materials needed to launch the paint business, including components to produce the paint and containers with which to sell the paint. These are all real costs associated with starting a new business.

At the same time, the company apparently also had anticipated some profit from the new business that it did not realize. Lions expected to produce a total profit of $1,000,000 that year, but actual income fell short of this. Lions management has to explain the reasons for the shortfall. In this case, the factors behind the shortfall include the investment in the new paints business and that the paint business failed to generate a profit. We use the following numbers to illustrate the point:

Expected Consolidated Profit

Other businesses $500,000

Paint business: $500,000

= total Lions' profit: $1,000,000

Actual Consolidated Profit

Other businesses $500,000

Paint business: ($500,000)

= total Lions' profit: $0

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