Statement of Affairs (Net Worth) Method — Ascertaining Profit

Since a trader keeping incomplete records has no full ledger, profit for a period cannot be worked out directly through a Trading and Profit and Loss Account the way it would be under Double Entry Book-Keeping. Instead, the method MSBSHSE prescribes — the Statement of Affairs Method, also called the Net Worth Method — infers profit indirectly, by comparing how much the trader's OWN net worth (capital) has genuinely grown or shrunk over the year, after allowing for whatever capital the trader introduced or withdrew along the way.

A Statement of Affairs is a list of a trader's estimated assets and estimated outside liabilities as on a given date, laid out exactly like a Balance Sheet, with the balancing figure representing the trader's own Capital (Net Worth) rather than a liability owed to an outsider:

Statement of Affairs as on [date]

Capital (Net Worth) = Total Assets − Total Outside Liabilities.

Two such statements are prepared — one as at the START of the accounting year and one as at its END — and profit is then inferred by comparing the two capital figures, adjusted for any capital the trader introduced or withdrew during the year:

Profit (before further adjustments) = Capital at the end + Drawings during the year − Additional Capital introduced during the year − Capital at the beginning

Additional capital introduced during the year is DEDUCTED, because it swells the closing capital for a reason that has nothing to do with genuine trading profit; drawings during the year — whether in cash or in the form of goods taken for personal use — are ADDED BACK, because they shrink the closing capital for a reason that also has nothing to do with trading performance: the trader simply took resources out for personal use. …