What’s an accountant? Someone who solves a problem you didn’t know you had, in a way you don’t understand, at a price you can’t afford. What do accountants do to liven up their office party? Invite the funeral director. What’s the difference between an accountant and a lawyer?
The accountant knows he’s boring. Some of my best friends are accountants, but they do get such bad press, don’t they? Jokes abound about them, but accountants are the score keepers. Without them, managing a business would be like playing sport without knowing the score. But it’s a complicated scorecard they keep. Like medical doctors, engineers and computer scientists, they have a language of their own.
It’s one that mere mortals such as you and I don’t understand. And we should. After all, as managers in business our reason for existence is to win the game – that is, to make a profit. And to do this we have to know the score. A few days ago, I bumped into a young farmer I hadn’t seen for some time. “How did things go last year?”
I asked. “Not too bad,” he said, “But we have a huge fruit set this season, with nice clean fruit and it looks like we have a bumper crop coming on.” It happens again and again. When I ask a farmer, “How’s farming?” I’m immediately told about yields. These are important, but it’s not what I’m asking. I want to know about profit, about cash flow, about the accounting score.
The Big Three
As you know, there are three accounting scorecards: balance sheet, profit and loss account and cash flow statement. Every manager at every level earning a living in business needs to have some understanding of how these scorecards work and what they mean. Don’t get me wrong. Leave the detail to the accountants, but it’s essential you understand the purpose of each account and what it tells you.
- The balance sheet: It’s just like a snapshot of a moment in time. It tells you what the business owns, what it owes and what it’s owed. It’s a picture of the financial health of the business at a specific date. It’s normally drawn up on an annual basis, but can be prepared at any time.
- Profit and loss (P&L) account: Sometimes called the “income statement”, this tells you what’s happened over a period of time. It’s usually prepared monthly. And take note – it reports on all income earned and expenses incurred, whether actually received or spent or not. It also includes critical non-cash expenses, such as depreciation or written off bad debt.
- Cash flow statement: Even financial illiterates like me don’t battle too much with this one. Cash is cash. This tells you what’s come into the bank and what’s gone out.
Most confusing for me was when this statement indicated quite clearly that we had earned more cash than we had spent, but the P&L told me we had made a loss. How come? Like most things it’s easy to understand – when you know how.
Which of these three scorecards is the most important? It depends on what you’re looking for. If you’re a banker being asked for a loan, you’ll be looking for different things than a potential buyer of the business. The difference between “balances” and “flows”. The “accrual” concept, where income or expenses are recognised in the accounts despite not yet having been received or spent.
The “matching” concept synchronising income or expense with the time when it takes place. The difference between “capital” and “operating” income or expenditure. Understanding a few simple concepts used in the preparation of these three scorecards will open your eyes to the important differences between them, and help you manage the business in a way that improves the score – that is, profit.
Contact Peter Hughes at [email protected] Please state “Business” in the subject line of your email. •FW