The Accounting Equation for the Rest of Us

Posted on February 1, 2021April 24, 2021 by John Cattanach

One of the first things you are taught when studying bookkeeping or accounting is the accounting equation which is Assets = Liabilities + Equity. I had such a hard time getting this straight in my head because most people don’t ask what is the value of my assets? They ask how much is my company worth? Using some basic algebra, the accounting equation can answer this question as Equity = Assets – Liabilities. This equation makes so much more sense to me and I would think to many business owners.

In an earlier blog, I talked about breaking accounting rules. In that post, I cautioned that you need to understand and respect a rule before you can break it. So, let’s accept that the accounting equation is A=L+E. However, in my practice, I am going to turn that around when presenting information to my clients, so the equation is expressed as Equity (how much your company is worth) equals your Assets (what you materially own) less any liabilities (what you owe to others). Doesn’t that make more sense?

Admittedly I have not done a ton of research on why the equation is expressed as A=L+E, but I am sure the reason is along the same lines as to why debits and credits seem to be backwards from a client’s perspective. It may be as simple as this is the way the balance sheet is setup. In example, the traditional balance sheet might show $5,000 in Assets and $5,000 in Liabilities and Equity. Great the equation is in balance and all is good. Except, wouldn’t it be more informative to show the report as Equity is $-3,000 because your Assets are $8,000 but your Liabilities are $11,000. The net worth of the company is negative due to such high liabilities. This story does not come through on a condensed balance sheet.

What I am promoting is that we should understand the accounting basics, but we need to transform those principles into a form and language that makes sense to those we work for. So, for me, the accounting equation will be E=A-L so that I and my clients can better grasp the concept. However, I will be ready and willing to translate it back to A=L+E if you really need me to.

Creative Accounting

Posted on February 1, 2021April 24, 2021 by John Cattanach

Creative Accounting. Sounds suspicious doesn’t it. In many contexts it is a phrase to be weary of, but it can also refer to the creative side of accounting. Most people think of accounting as cut and dry, boring, and unimaginative. Well, it can be if you want it to be, but how you setup your finances, processes, and reporting tells a lot about your business. It is essential that your financial story matches what you are selling.

There are standards and good practices to follow in bookkeeping and accounting, but there are also a lot of choices and interpretations to be made. Setting up your Chart of Accounts and how you use those accounts should follow basic and accepted practices, such as how they are numbered, but what accounts you use and how you label them should match how you understand your business and how you want others to understand your business.

A big reason that people don’t like working with money or have trouble understanding their money is that they are using systems and terminology that they have been told use. These people have never had the opportunity work with someone that is not afraid to bend the rules and break the mold a bit. Your financial statements need to be accepted and understood by those outside your organization, but they do not need to be standardized. Having clear financial reports that mean something and connect with what you are doing will go a long way towards convincing others that you know what you are doing and that you have it together.

Money is not the end goal of many organizations, but money is the fuel that feeds the goals and mission of an organization. It is important to make sure your funding is truly going towards your priorities and not meandering in areas that are less important and less effective. Setting up your accounting correctly will help with using your money intentionally and see areas where money is drifting off course and could be used better elsewhere.

Don’t be afraid to have books that you, your staff, your donors, and grant administrators understand and reflect the true nature of your organization. However, a word of caution that all trained artists understand, you must know and respect the rule before you can break the rule. Be sure you understand the accounting rules you are breaking or work with someone that can help you break them.

Are you ready to break some rules today?

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Pre-9/11, taking a flight, especially a domestic flight, was a fairly enjoyable experience. There were some security measures in place but generally it was an open and casual experience for those traveling and those meeting travelers at the gate. (Yes, you used to be able to meet someone at the gate as they came […]