FinanceLiteracyForAll

Getting into an accountant's shoes

2007-10-10T21:18:30+02:00

If one took a bird eye’s view of all financial transactions, one would realize that eventually all transactions can be classified into four types viz. expenses, incomes, liabilities and assets. And therefore, if somebody who had no accounting knowledge, wished to prepare a balance sheet, all he had to do was, to take a look at the transaction that had taken place, examine it, classify it into one of the above – mentioned four types, and transfer it to the appropriate quadrant in either the profit and loss account or the balance sheet.
I mean, how does an accountant prepare these statements? He starts with the transactions that have taken place, takes them through a series of processes, and eventually prepares a profit and a loss account and a balance sheet (which between them contain expenses and incomes and liabilities and assets). All I am suggesting is that, as a layman, what you don’t understand is the process. Therefore by-pass the process.
By-pass the accounting system. Examine the transaction at the root itself and directly transfer it to either the relevant side of the concerned statement. Believe me, it really is as simple as this.
The reason I’m emphasizing so much on the fact that you don’t need to be a rocket scientist to make these financial statements is that in my experience a number of people carry a mental block that since they will not understand how to make financial statements they will not understand how to read financial statements. Which, of course, is absolutely untrue. However, for those who do suffer from this delusion, what I’m trying to convey is that, if you think an inability to make financial statements is hindering your understanding, then let me show you a simple way in which to make them.
What is important is that every entrepreneur, every CEO, every key executive, must learn how to read, appreciate, understand and interpret numbers. Because on this depends the growth, prosperity, welfare and the very survival of your business. If you understand numbers, you can lead your business to great heights and if you don’t, it can well spell your undoing.
But before I proceed further, I think it will be time, (or rather, space) well spent if I devote some discussion towards clarifying two very commonly used but often misunderstood words. These are accounting words which have become entrenched in our daily language. Everybody uses them but if you ask any two people what these words mean, chances are you will receive contradictory answers. These two words are: debit and credit, written in abbreviated form as DR and CR(Please don’t ask me why is debit written as DR i.e. with an R. I have no clue whatsoever.)
Common perception about these words is that they represent loss and gain, good and bad and probably are the counterparts in accountancy of the words plus and minus in arithmetic. To the question about what represents loss and gain, the commonly received answers are debit is equivalent to loss and credit gain; debit connotes minus and credit plus.
First, let us see where do these words come from. Are these English words or accounting words? Answer is, these are accounting words. And what is an account. An account is the name given to a T-shaped thing, with figures appearing either on the left of the T or to the right or on both sides. For example if you sell goods, then in your books there will be a T-shaped ‘Sales Account’, if you pay salaries, there will be a ‘Salaries Account’ and so on. And, conventionally, debits are written to the left of the T and credits written on the right. So, if I ask you to debit Salaries A/C with 10,000, what I’m asking of you is to write 10,000 on the left side and if you are told to credit Sales A/C BY Rs. 20,000 on the right hand side of the Sales A/C.
Now it is important that, even though you may not be an accountant or may know nothing about accounting, nevertheless accounts must make sense for you. You may be browsing through somebody’s or your own books of accounts, you should be able to make sense of what you see. So suppose you are checking the books on my company Lamcon, and you come across two accounts one named Rita and the other John. And you
Find an amount of Rs. 5000 appearing on the debit or the left side of Rita’s account and 10,000 on the credit or the right side of John’s account. How would you interpret this? It will, of course, be apparent to even a novice that whatever relationship John and Rita have with Lamcon must be opposite of each other. One must be a customer of and the other a vendor to Lamcon. To one person Lamcon owes money and the other person owes money to Lamcon. One must be Lamcon’s debtor and the other creditor. My question is, can you tell me who’s who?
Now, again when I ask this question to an audience attending a seminar on finance, I never get an uniform answer. To find out who is the debtor and who the creditor, we must go to the genesis of these two words, i.e. why is a debtor called a debtor and also where does the word creditor come from. Most people think that a debtor is so called because he is in debt and the word creditor can be attributed to the fact that something was purchased on credit. It is necessary to remove this illusion. The word ‘debt’ is in no way connected to the word ‘debtor’, nor the fact that there has been a credit transaction is in any way responsible for the word ‘creditor’. Then why is a ‘debtor’ called a ‘debtor’? The answer is so simple, you are going to laugh. A ‘debtor’ is so called because while making the accounting entry the figure was written on the debit side, debit for debtor. In case of a creditor the entry appears on the credit side.
Thus, in the above case Rita is the debtor and John is the creditor. There is no scope for ambiguity any more. This is what I meant. Accounts should be user- friendly and not intimidating. Everybody should be able to make sense out of accounts.
Similarly, most people think that debits denote ‘minus’ or negative and credits the counterpart of ‘plus’. The reason for this impression can, perhaps, be traced to their first interaction with these two words. I think, most of us, for the first time in our lives hear of these words when we open our first bank account. The banker gives you a bank statement or a pass book, and each time you deposit money the figure is written on the credit side and withdrawals appear on the debit side, and therefore one has a clear picture in one’s mind that credits indicate gain and debits loss, credits plus and debit minus.
But what you also have to understand is that, in the above referred example, wher Lamcon shows Rita as it debtor, if one goes across to Rita’s accounts would be mirror images of each other.
Therefore, when you look at a pass book and reach a conclusion that credit is plus and debit minus, what you must understand is that the pass book is an extract of accounts maintained by the banker and not by you. Therefore all your conclusions have been arrived at by looking into the mirror. So tell me which is plus and which minus.
You will now be thinking that debit should be plus and credit the negative one. Even this is also not entirely true.

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DO AWAY WITH THE FEAR OF FINANCE

2007-09-26T23:21:27+02:00

Financial statements put off most people and that’s where the trouble lies

Good finance management practices, which, if followed, can be extremely rewarding, and if neglected or violated, can extract a great price in terms of health of organizations, and can even be fatal. These articles will dwell upon demystifying financial statements, will deal with how to make sense out of your MIS and how to read balance sheets.
My observation, based on my interaction with corporations in the capacity of a practicing chartered accountant, and also years of experience imparting training to thousands of executives and CEOs (of large and medium scale companies) and owners (of SMEs) spread across several countries, is, that most people suffer from a tremendous sense of insecurity when it comes to understanding numbers. Financial statements do not make sense to a vast majority of these executives. They don’t know how to read balance sheets. And it is precisely these individuals who can ill afford to be ignorant of this subject.
It is an established fact that financial mismanagement is the single biggest factor responsible for industrial sickness. Not technological obsolescence, not marketing inability, not labour trouble or strikes and lockouts, but financial mismanagement. Which means a majority of companies go sick due to an avoidable reason of sickness. That is to say, is the owners, CEOs and executives of these companies had armed themselves, in addition to their technical and selling skills, also with finance management skills, their organizations need not have shut down.
It is my belief that in any organization there are no non- finance contrary to common understanding. Let me explain what I mean. Usually for the people dubbed as ‘non-finance’ a more appropriate tag would be ‘non-accounting’. In every organization there are several ‘non- accounting’ but no ‘non- finance’ persons. No production, marketing, stores or any other manager can say that he is a non- finance manager. Because, what is finance management? Again, contrary to popular perception, ‘finance’ is not the collecting, recording, and presenting of financial data on the form of various financial statements. All this comes under the realm of accounting. Finance management, in my opinion, is the ability of every individual in the organization to understand the financial implications of his/her actions on the organization’s bottom-line; whether these actions are going to hurt the bottom-line, or strengthen it; so that they do more of those actions which benefit and avoid doing those that harm.
For instance, a sales executive out on the field meets a potential customer, who asks him for a quotation for his product. The salesman quotes, say Rs. 1,00,000 per unit. The customer responds that he can buy maybe a 100 pieces, if the price can be reduced to Rs. 75,000. Now this sales fellow has to take a call to say yes or no to this offer. Whether he decided to say ’yes’ or to say ‘no’, has he taken a marketing decision or it is a financial decision? He may call it a marketing decision, but he has no right to take it without understanding the financial implication of this decision. If, by taking this order, the bottom-line of the company is going to be hurt, he will have committed a crime against the organization by saying yes, and if the bottom-line would have been inflated, it would be a crime to say no.
Therefore, I repeat, finance management is the ability of every individual in the organization to understand the impact of every decision on the organization’s bottom-line. And if this is what finance management is, then all those persons in the organization whose actions have the power to impact the bottom-line are finance persons. Viewed from this angle, the only non- finance persons then would be the so- called finance persons, because they are the only one whose actions do not affect the bottom-line. They merely do a post- mortem and tell you whether the actions of all the so- called non- finance fellows have resulted in a profit or a loss. Isn’t it ironical that the persons who calculate profit are called finance persons and not those whose actions actually bring the profits?
Yet again I repeat. There are no non- finance persons. Forthwith start calling yourselves finance executives. Because in doing so, you will assume financial responsibility for your actions. And it is only when all the key people in an organization take responsibility for the financial outcomes of their actions, that the organization as a whole, makes profits.
Next, what’s the whole mystery about profit and loss statements and balance sheets you may ask? Every organization is expected to maintain a record of all financial transactions that take place. These records are collectively called ‘accounts’. Every now and then, accounts are summarized, and the summarized picture is presented in the form of two financial statements viz. the profit and loss account (P/L A/C) and the balance sheet(B/S).
This fact reveals something very interesting to the layman who thinks accounting is very complex and making of a P/L statement and the B/S is not his glass of juice. This tells him that if all transactions eventually land up on the face of either the profit and loss account or the balance sheet, which between them record expenses and incomes and liabilities and assets, then he realizes that nothing can happen in an organization which will not be one of these four. This understanding will not only enable one to understand and appreciate financial statements, but if one wishes one can also make a P/L A/C and a B/S with no understanding of accounting except what I have said above.
How, you may ask, can one make these financial statements just by understanding this much?
Let me show you how. Imagine your organization decides that they will not record the transactions that take place in books of accounts, but will instead record them on chits of paper and put them in a cardboard box kept in the middle of the lobby. So when the next day the organization pays salaries to the staff, this fact is written on a chit and dropped in the box. Similarly the following day when rent is paid, this is also written on a piece of paper and put in the box. And so on, slips recording sale of goods, hardware purchased, raw material purchased, interest paid etc. are also dropped into the box. And, now I bring this box to you, which may contain a thousand chits, a hundred thousand chits or a million chits, and ask you to make a B/S and P/L A/C. Can you do it? Of course you can. All you have to do is, put your hand in the box, take out one chit after another, read what is written on it, and you will discover that whatever is written on that chit will either be an expense, then show it on the expense side of the P/L A/C, or it will be an income, then put it on the income side, or it will be a liability, then show it according on the B/S. A nd if it is neither of these three then think you can blindly record it on the asset side of the B/S (as there isn’t a fifth option). And your profit and loss account and balance sheet are ready.

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Introduction..... Your own finance space!

2007-07-16T17:52:48+02:00

Dr Anil Lamba is a practising chartered accountant holding degrees in commerce and law and a doctorate in taxation. He is a prolific writer and has contributed close to a thousand articles to leading newspapers and magazines on topics ranging from finance to taxation, investments and company law.

He is also the founder director of Lamcon School of Management, a renowned
business school located at Pune, India. He has done pioneering work in distance education and is the author of a series of audio visual products (capable of delivery across diverse media), on finance management, titled “figure out the world of figures”™.

Dr Lamba is a trainer of international repute. He teaches extensively and his clients comprise several hundred large and medium sized corporations across different countries of the world.

He has also initiated the Lamcon India ‘Finance Literacy For All’ campaign which aims at reaching not only students and top businessmen but also the under privileged, the rickshaw – wallas , wholesalers to ensure effective finance literacy education is made available to all adults.He wants to take the programme ahead by the Lamcon Reach initiative by training people in finance and involving them in carrying this message to different parts of the country.

Watch out for this blog as your journey towards a finance literacy has just begun!!

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