Understanding Accounting is the key to success.
Management runs the company. Accounting keeps track of the business. Accounting is keeping track of the elements of business.
Now, what are the elements of business?
In water, there are two elements one is hydrogen, the other is oxygen. If any of these two is missing, there’s no water.
In business, there are three elements. Customer. Product, Cash. If any of these are absent, there’s no business.
Suppose when you open a shop and nobody walks in, no customers. How long will that shop go? Not very long.
What the customer wants is a product.
Now, if I come up to you and say ‘excuse me what are you selling? you say, Oh, I don’t know what I’m selling just give me your money. How long do you think you would go? No product. There’s no business.
Customers want a product. Every business person desires to have the customers money.
Why does anybody establish a business? The purpose of starting your own business is to make money. A customer wants a product, a business person wants money. If it fulfills the customers’ needs, he gives us money.
This is a very, very, interesting relationship. To keep the customer happy. This is a long term business approach.
Now, out of the three elements in business, only two moves. How do they move?
These elements move between the customer and you.
When you buy and sell, a product goes out to the customer and money comes in.
When you purchase, product comes in from the supplier and money goes out.
So, looking at the three elements, just two elements move.
When a product enters, we call it buy.
We call it sell, if a product goes out.
When you buy, product comes in, money goes out. This is Pay. You have to pay when you buy.
Sell is when a product leaves and cash enters. You sell and you collect cash.
As you notice, product and money, move in opposite directions.
Product is to the right and cash is to the left. Product and cash should always go in opposite directions.
You’re in serious trouble if your money and product move in the same direction.
When you sell a product, it leaves. You do not collect cash.
You’re committing a financial suicide if you sell without any collection.
All sales should be accompanied with cash.
Let us look at this. When you buy and sell.
When you buy, accountant calls this expenses, when you sell accountant calls this income.
Product moves directly into the profit and loss account.
Profit and loss account determines the movement of product, it measures the performance of the business.
Income and expenses equals profit or loss. If income is more than the expenses, we have a profit. If an income is less than expenses, there is a loss.
The movement of cash is recorded in the cash flow statement. Here you see very easily: cash comes in accountant calls it inflow.
Cash goes out accountant calls it outflow.
If inflow is more than outflow you have a positive balance, a positive net cash flow.
If outflow is more than inflow then you have a negative balance, a negative net cash flow, or a bank overdraft.
How simple is this for starting your own business? Profit and loss account, determines the movement of product.
Cash flow is determined by the cash flow statement.
Therefore, we can tell that profit and loss account has nothing to do with cash.
Even if the movement of products are expressed in dollars and cents, it has nothing to do with cash.
Now, to help you memorize. I have a little song for you to sing, to the tune of Mary had a little lamb.
“Profit and loss is performance, performance, performance.
Profit and loss is performance has nothing to do with cash.”
Profit and Loss only determines the performance of the business.
Accounting is simply keeping track of the elements of a business.
let me quickly summarize of these good business ideas, when we say accounting is keeping track of the elements of the business. What are the elements of business?
- Customer
- Product
- Cash
How many elements only move?
Two: Product and Cash.
How do they move?
In and out in opposite direction.
Buy must be accompanied by pay.
Sell must be accompanied by collect.
Product goes straight into the profit and loss account.
Movement of cash goes straight into the cash flow.
The key to success is learning that Profit and loss account has got nothing to do with cash.
Colin Burr has been in the field of key to success for a long time and have a site about small business plan where you can get answers to the rest of your questions.