Comment by jacques_chester | Hacker News Reader

Comment by jacques_chester | Hacker News Reader

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jacques_chester

Two observations.

First, coming from computer science, introductory accounting - the bookkeeping mechanics - is quite easy. I took a 101 class and was surrounded by future Lords of The Universe who complained about how "hard" it was to add and subtract numbers according to a small system of rules.

Accounting is a system of metrics. The system under measurement is your business. Its purpose is to give an accurate readout of business performance. The nice thing is that accountants produce lots of metrics and these can be used to probe the behaviour of different parts of the system.

Secondly,

> One thing to watch out for: profit doesn’t say anything about your bank account ... That’s why it’s possible for a company to be profitable but still run out of money!

This is why accountants produce a third document, the cashflow statement. It shows how cash is coming in and going out. This is different from the P&L statement, which deals with revenues and expenses, both of which may include future events as opposed to actual cash changing hands in the period covered by the report.

If there's one thing you absolutely must learn from accounting, it is that positive cashflow and profits are not the same thing. But if you run a business without both of them, that business is doomed.

I agree with observations and comments.

Well you can live without profits for sometime, if you run out of working cash, your stuffed. This is why loans, and factoring come in and is why even profitable business require loans because of bad cashflow.

One easy way to try avoid this, is to always try to get in flow payments coming in faster, and outgoings slower. Even if the net total is the same in end, it allows more flexibility with cash flow.

Accounting is obvious to me, but we probably haven't encountered the hard problems yet.

Yep. When you're out of cash, the game is up, no matter what the P&L says.

A different way to look at it is this: cashflow tells you the health of the company right now, P&L in the long run. You need to watch both.

For example, you've booked $100 million of sales for the period. According to the P&L you're profitable by $20 million. A bill arrives from a supplier for $10 million.

But supposing you only had $5 million cash on hand. Unless those customers begin paying you money for the booked sales, you are in trouble. Time to take corrective action.

Likewise. Consider that you're in a business where customers pay on purchase (most retail industries). Your cashflow might be excellent in that you have plenty moving across your books. However costs are rising and you are making a loss on the P&L. Eventually this will deplete your cash and you will be out of business. Time to take corrective action.

Used properly, P&Ls and cashflows are a monitoring tool, a kind of standard Nagios/munin/zenoss for your business.

Most of the hard problems are to do with depreciation, and the legalities of how you classify them.

For example, Police departments have dogs. Dogs are assets. If all government departments are told to use accrual (rather than cashflow), they need to depreciate assets.

So the account needs to figure out how dogs depreciate. Should you assume that a dog has a useful life of 10 years, and loses 10% of its initial value every year? Or that it exponentially decays, as it gets older and less able to sniff bad guys? Or should it only be 5 years? What do you do if a dog ends up working long past its expiry date?

It can be tricky to come up with sensible numbers. Especially when accountants don't have domain knowledge, and people who do don't like speaking to them.

> Most of the hard problems are to do with depreciation, and the legalities of how you classify them.

I would generalise that to say that all the hard problems in accounting are ones of classification.

Does sale X fall in 2010 or 2011?

Do we book the inventory when we order it, when it is delivered to our warehouse, when it is delivered to our shop, or all three? And if we use some combo, how do we combine them in LIFO calculations?

We've just donated $100,000 to Fashionable Cause, a charitable foundation founded by Irish rockstar Nobo and in exchange he will wear our platform shoes exclusively. Do we book this under philanthropy or marketing? If philanthropy, do we consider it part of the overhead cost for the shoes sold?

And so on and so on.

Most of the big bucks in accounting comes from coming up for clever excuses as to why something should be categorised in a certain way.

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