Understand Accounting is a story:
It is about Andrew, who is setting up a new business and needs to prepare a five-year plan. He asks a friend, Richard, to help him and he learns that recording his plans is as easy as 1=1.
Andrew asks many questions and perseveres until he is sure that he really understands WHY the system works.
He learns how to interpret the balance sheet, the income statement and the cash flow one.He finds that each has a story to tell, but each from a different angle.
Then he learns how ratios will help him to see how his business will perform if it keeps to plan.
It is a flexible plan and, by using the model he has built, he can flex his estimates to see which of them affect his business most.
That’s what it’s all about isn’t it? Is the company going to perform well, creating cash and profits?
You will learn how easy accounting is as you progress through the book.
It really is as easy as 1=1; and it can be fun too!
‘Understand Accounting’ explains the logic first and you do not even meet debits and credits until you reach chapter ten, by which time you will understand the system well.
In that chapter we go back in time and eavesdrop on Luca Pacioli, the Father of Accounting, as he explains to his friend Leonardo da Vinci – yes, they really were friends – the logical basis of the double entry system.
Here are some extracts from the book:
‘ Never ask of money spent
where the spender thinks it went.
Nobody was ever meant
to remember, or invent,
what he did with every cent.’
It seems that this distinguished American poet, was a more than a little out of touch with the world of business; his attitude was likely to result in the sentiments summed up by Richard Armour in this poem:
That money talks,
I’ll not deny.
I heard it once -
It said – ‘Goodbye’.
Not a result that businesses want! They need complete records of ‘What they did with every cent’ in order to be in control and to comply with legal requirements, including those set by the tax authorities who would otherwise be likely to query their figures; again a situation in which no business wants to find itself.
Andrew asks for help with developing his business plan
“Look, Richard, I know we haven’t talked about financial things before, but something has come up and, all of a sudden, I need to put a business plan together. Do you think we could break that unwritten rule and talk about it?”
Naturally, I agreed to help in any way that I could…….. Looking over his shoulder, I could see his car in the car park. It was a real ‘I don’t care what state it’s in, provided it can get me from A to B’ job, if ever there was one.
“Are you planning to get another car?” I asked him.
Andrew saw where I was looking and grinned. “Given the state of this one, I reckon I need to, and Joe has offered to sell me his, which is just a year old, for the extremely reasonable sum, I think, of £18,000, and to introduce me to his contract clients as well.”
“Well, that’s an excellent start, Andrew. What else can you tell me about your plans?”
“Joe has a parking space on the concourse outside our local railway station…… Joe told me that I should achieve revenues of about £60,000 in the first year…… As I will be driving back to base between fares, this will mean that I will be driving about 48,000 miles in all. He gave me lots of other information too.”………I was impressed.
“OK, so that will get your new car on the road, but have you estimated its running costs, maintenance and so on?”
“Well, I’ve already mentioned the fuel costs” ……… I ought to allow £8,000 to cover the combined maintenance costs and wear and tear on tyres for the whole of the first year……..I should allow for telephone costs. I will use a mobile phone, which will cost me about £2,400 during the first year, I should think.”
This was quite a comprehensive list, involving…… variable costs (and) fixed costs………
How much money Andrew could invest in this new venture?……….It looked as if he would have to approach his bank for some additional funds…….
“Don’t forget I shall need to take money out of the business to cover our living costs too” said Andrew, looking a bit worried.
The Separate Business Entity
“I’m going to call it Andycabs Ltd”
All the transactions Andycabs will make will be made in its name……..you can think of it as being your robot, because………all the extra money it makes it will owe to you and Joan, its shareholders.”
Not surprisingly, Andrew liked that idea
The first transaction
“So what is the next thing that you will be doing Andrew?”
“Well, I’ll be going to see our bank manager to open a new Andycabs Ltd. business account. in!”
So this was going to be the first financial transaction to affect the new business. The idea of a transaction is quite straightforward. It literally means a movement across; a trans – action, and that is exactly what is happening here. The £12,000 will be moving across from Andrew’s and Joan’s joint personal account into Andycabs Ltd’s business account.
Assets and Liabilities
“The £12,000 that Andycabs now has is called an asset, and the share capital is called a liability. This can be expressed as an equation like this:”
A N D Y C A B S LTD
Assets = Liabilities
Cash = Share Capital
12,000 = 12,000
”Hmm” commented Andrew “I think you need to explain how the words asset and liability are used in business a bit more. I don’t want to get it wrong as this seems essential to me”
From chapter Two: The Transaction Spreadsheet
Now, let’s just think about the £10,000 loan for the moment. How should we record that in the transaction equation?”………
“Well, I can’t add it to the share capital column, because it’s not an issue of new shares. I’ll follow your tip and head up a new column. Bank Loan, I’ll call it.”
“Fine, if in doubt, open a new column” I agreed.
…………………………………………Cash = Capital + Bank loan
Share Capital 12,000 = 12,000
Bank Loan 10,000 = 10,000
Now Andycabs has a total of (£12,000 + £10,000 =) £22,000 cash; £12,000 of this is share capital, and the other £10,000 is a bank loan. We can see how much money there is, and also see where it came from.
Andrew continues to build up the spreadsheet as he enters his budget figures. When it is completed he extracts his financial statements from it and sees how they tell him different stories about his business. Then he prepares five year plans and analyses them using ratios. Finally, now that he understands how the financial system works, we go back to meet Pacioli in 1494 and learn how the debit credit system came about.
So, if you want to be able to prepare business plans, and understand your bank manager – or your accountant – when they use financial language, then this eBook (or print on demand book) is for you.
When you have read it, visit this website and tackle the case studies, which are based on a variety of businesses, to increase your proficiency at building models and on becoming a financial detective!