For many people, just looking at a column of numbers, dealing with a tax return or even balancing a checkbook brings on immediate and significant stress. Numbers, accounting and finance—egads! Even the thought of all of these numbers gives me flashbacks to the classroom and trying to comprehend word problems and the foreign language of algebra, calculus, percentages and fractions. I hated math!
On top of the intimidation of dealing with numbers, as a business person I am often asked to add in the mysterious and strange conventions, rules and practices of accountants and financial managers. These people don’t even speak a normal language but talk in debits and credits, accruals, budgets and forecasts, ratios and balance sheets, cash flow and income statements. The language of business and financial numbers also comes with accents and dialects. You may be asked to deal with financial accounting for taxes or reporting; you may deal with non-profit, cost, throughput, activity-based or governmental, and so on and so on. The variations in the language of the numbers can be mind boggling not only for the “non-financial” person but also for those trained or educated in a particular segment of accounting. For instance,- a graduate of financial accounting may have little or no exposure to governmental or cost accounting. Someone versed in not-for-profit accounting may find tax accounting for a for profit entity confusing. Conversely, those working for a bank in which cash is a liability and a loan is an asset may find the world of accounting a mirror image of their experience.
Understanding the Context
Setting aside the math and the lingo, the numbers of the business are the messengers of how the business (or organization) is performing. When we look behind the jargon and think about the business as game, whether it is a sporting event, a card game or board game, enables us to add context to the world of numbers.
The Numbers Game
In any game, there is competition and an objective (usually to win), there are rules to follow and there is a score. Accounting and finance provide the game’s structure and ability to keep score. These two functional processes translate the people, processes, and activities into numeric representations of how the business is doing in the “game” of competition and profitability.
The Players and Rules
Each manager leads a team. The team competes for organizational resources and is expected to take those resources and “win.” In other words, each person on the team (e.g. a department, business unit) is given a role and paid for their services (i.e., salaries and wages).
In addition, each person needs equipment and somewhere to play the game (in accounting, these are known as assets and facilities). They may also need resources from people outside the team (other departments or companies providing goods and services). So the teams use assets (consume existing resources) and future resources (debt and equity), and in return for using current resources, the teams are expected to generate sources of funds in the form of sales/revenues, invested dollars and financing (other people’s money). How these new funds are used is defined as expenses and new assets (used to generate more funds).
Financial Statements: The Score Card
If you look at any set of financial statements, generally thought of as the balance sheet (what you own, what you owe, who owes you and who benefits from the business) and the income statement (what you’ve sold, what it cost and how much money it takes to be in business and what you will have to pay the government), you have the “score” of your business.
Who’s On Third? You Better Know …
Much like the venerable Abbot and Costello comedy routine “Who’s on First?”, if you don’t know who (what) is on your third financial statement, you may find that your business is unlikely to make it to home base profitability AND positive cash flows. The third and often most overlooked and misunderstood score card is the statement of cash position. People may buy from and sell to you, ”scoring” a profit, but without cash coming in adequate amounts at the right time, you may find you can’t pay your bills. All the sales and profits in the world will not matter if you aren’t realizing cash. Cash is the connection point between the statements and determines how your business will be able to function and grow. Revenues and profits without cash cannot ultimately be utilized for business transactions; regardless of the ability to use debt, every day someone will expect to be paid in cash.
So as non-financial managers, how do you translate and transform your organizations into financially savvy operations? How do you cut through the intimidation factor of accounting and financial lingo and the residual intimidation from years of dreading math class? The answer lies in understanding the real world, practical meaning and implications of the financial results and accounting lingo.
I have to share a joke that may be as old as the accounting profession itself:
There was a highly successful accountant who built a large and quite impressive company providing accounting services. Even as a young man, however, he had one idiosyncrasy: The first thing he did every morning was to unlock his top desk drawer, which he always kept locked. As his company grew, everyone knew the first thing (let’s call him Fred) would do was unlock and open that top drawer, shake his head and relock the drawer. He did this every day for 30 years. One day Fred died. While everyone began to grieve, they also began looking at each other wondering what was in Fred’s top desk drawer. What could be so important that he had to look at it every day? With some measure of guilt, his office team pried open Fred’s top desk drawer.
They found one thing. Taped to the bottom of an empty drawer was a note that simply said, “debits on the left and credits on the right.”
The punch line means even an experienced, trained accountant needed help keeping the jargon straight.
The concepts and jargon of accounting and finance tend to make the numbers intimidating. There are many complexities to both accounting and finance that are best left to the experts, including topics in taxes, capital structuresand valuations. However, the day-to-day transactions and financial statements have a critical impact on the business and how it is run, so understanding core concepts and the balance sheet, income statement and cash position of the company is not something to overlook.
From Debits and Credits to Increases and Decreases, Sources and Uses
Beginning with the terminology, some of the “mystery” can be revealed to operational managers. For instance, the term “debit” doesn’t mean increase or decrease, and neither does the term “credit”; they can actually mean both. What? No wonder you are confused. Yes, a debit or credit can increase or decrease an account—it just depends upon the account. The double-entry bookkeeping requirement and the “accounting equation” are two more concepts to understand that further peel back the curtain on the mystery of financial numbers. The accounting equation states that “assets equal the sum of liabilities and owners equity.” Double-entry bookkeeping means that you have to make an entry on each side of the accounting equation to keep the equation in balance. This means that if you spend cash (asset) you are decreasing the account, which in this particular account would be considered a use or a credit. If you are spending cash you are getting something in return. Whatever you receive will be increased by the same amount; if it is another asset, you increase (debit) the asset account. If it is an expense you again increase that account, which is again a debit.
It’s important to know that the accounting equation must stay in balance the value of the increases must equal the value of the decreases. Debits must equal credits. Sources must equal uses.
We’ll investigate this more in an upcoming article.
Copyright © 2010 Lea A. Strickland, F.O.C.U.S. Resource Inc.
All Rights Reserved.