with current issues Northwest Arkansas Business Journal Focusing on accounting and finance – two subjects that are very important to me as someone who teaches in business school – I thought I’d write about numbers and how they are the language of business.
I don’t think many of our readers would disagree with me that numbers are the language of business. Unfortunately, for many of those same small and medium business owners, it can also be a foreign language. I mean, even the most basic concepts like what a profit and loss statement and a balance sheet are — and what is the difference between cash and accrual accounting — aren’t understood. This hurts the ability of these owners to manage the business.
When I teach my students about income statements, I try to get them to think about their situation. How much do they make each month from their job or their parents? How much do they spend each month on rent, utilities, food, etc.? The difference is positive or negative.
In a business, this is profit or loss. You can go for a week, a month, a quarter or a year for any period of time. The income statement covers a period of time. Most people can quickly understand what an income statement is.
Balance sheets are another matter. To teach this concept, I found out that someone owns a vehicle that they are paying on time. I asked them how much the car was worth and how much they owed. The difference is their rights. This is the balance sheet of a business. Add the value of all assets and subtract the value of any debt or obligation. That’s owner’s equity or net worth. That was at a specific point in time. This is a snapshot view of the company’s financials. If it’s positive, they’re solvents. If it’s negative, they’re broke. If I asked the same question a month later, they might have a different answer.
Accrual versus cash basis accounting is another issue that people struggle with. Accrual accounting looks at when income and expenses occur and when money comes in or pays those expenses. Accrual accounting provides a better understanding of how a business is performing in any given period and is a generally accepted accounting principle.
For example, if a service business does something and then sends a bill to their client or clients and it takes 90 days for them to get paid, they get paid when they do the work and 90 when they actually get paid God for it. The same price as labor. The time to complete the labor and the time to pay for the labor will be calculated – for example, it could be a week later. I’ve dealt with senior business owners who didn’t understand this.
Financial accounting seems to be really complicated, as it is usually taught. Debits, lenders, T-accounts – people struggle with these things. But if you first explain the big picture – how to use this information to measure a business by creating a profit and loss statement, a balance sheet and drawing a cash flow statement – and why cash and accrual accounting are two different things – the details of this information Information comes from more meaningful.
Mark Zweig is the founder of two Fayetteville-based companies. 500/5000 companies. He is also the Entrepreneur-in-Residence Professor and Entrepreneurship Team Chair at the Sam M. Walton School of Business at the University of Arkansas. Northwest Arkansas Chapter of Vistage International. The views expressed are those of the author.