In this article, our quest for financial literacy takes us to Venice in Italy and a very clever monk -…
If any teacher at boarding school had asked what we associated with Italy, we would have immediately said Sophia Loren, the buxom, sultry Italian star who dominated movie screens of that era.
Then, as an afterthought, perhaps, we might have muttered something about a boot-shaped country somewhere far away that produced grapes and wine. Little did I know then how much we are indebted to the Italians for one of the world’s greatest inventions!
It all started with Giovanni Peluga and Luigi Constantine, who had a small market stall in Venice in the late 15th century.
“How much did we make, Giovanni?” asked Luigi one day.
“Two thousand florins.”
“A thousand each, then,” said Luigi.
“Not quite,” said Giovanni. “I had to pay for those two hams we haven’t sold yet. I gave Signor Capella 50 florins for each of them.”
“OK, then, then I’m owed 950 florins,” said Luigi.
“Wait a minute,” said Giovanni, “you know those cheeses I sold to Signora Rosa? She hasn’t paid for them yet. She’ll give me 90 tomorrow.”
“I see,” said Luigi. “Did you pay Signor Grimaldi for the cheeses?”
“Only 40. We still owe him another 20.”
“So, Giovanni, how much money can I have then?” asked Luigi.
“I don’t know,” said Giovanni. “I wonder if Pacioli could help us.”
The double-entry system
Luca Pacioli, a Franciscan monk with a talent for numbers, pondered the friends’ problem, and soon realised that many entrepreneurs were struggling to keep a record of what was going on in their businesses.
In an effort to help, he visited a few of the older, well-established merchants in Venice. Here he learnt that whenever they sold or bought something, they made not one entry of the transaction in their records, but two! To his astonishment, Paciola ‘discovered’ that every transaction has two sides to it.
It’s quite simple really. If, say, you buy a book for R100, two things change: you now have an ‘asset’ that you never had before and you have R100 less than you had before. This is the basis of double-entry bookkeeping, which requires that all transactions should balance out.
If they don’t, there’s a mistake somewhere. Yet, as simple as it is, it’s a concept that had been incomprehensible to me for years and still remains so to many people.
Paciola’s system, which was described in 1495, includes all the fundamental accounting principles we use today. He described journals and ledgers. He warned against going to sleep before the debits equalled the credits. He discussed assets, liabilities, capital, income and expenses.
He demonstrated year-end closing entries and described the purpose of a trial balance.
I learnt about Paciola from Philip Ramsden’s Finance for Non-Financial Managers while on my personal journey to seek some measure of financial literacy.
The first and most important Paciola accounting principle I tumbled to was the difference between flow and balance.
The former I knew about. Take the book bought for R100. I understood that if I started with R500 in my pocket, I would have R400 left after buying the book. That R100 had ‘flowed’ from my pocket into the bookshop’s cash register. What I hadn’t grasped before was that my balance had also changed. Before, I had R500; afterwards, I had R400 and a book.
Someone explained it to me by suggesting I find five snapshots of myself from my school days to the present. Each represents a personal balance sheet at a particular point in time. The flows are what happened between each of the pictures, and caused them to change – in my case, from young, trim and dark-haired, to old, portly and grey!
Next time, we’ll explore some more of the revelations I had while learning about the genius of Luca Paciola.
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