All business owners, no matter what size their business, need to understand the language of business … accounting.
Accounting can be simply described as keeping track of money. But the real benefit of accounting comes from understanding the relationships between the profit & loss statements, the balance sheet and cashflows.
Accounting is based on double entry bookkeeping. For every transaction of entry there must be an opposite transaction. Increase sales -> increase debtors. Debtor pays invoice – Increase cash ->reduce debtors. The principle of double entry bookkeeping is relied upon every day in our forensic accounting investigations – it provides a trail for us to follow. An asset was purchased, how was it paid for, where ddid that money come from … was it cash or a journal entry.
It is one thing for expert forensic accountants to know all about accounting but why should an everyday business owner. In the first instance it provides the mechanism by which the performance of the business can be measured and therefore improved, but in a much simpler basis accounting is about keeping track of the money.
A business owner needs to know where the money is.
Let me give you an example:
We were engaged to investigate the accounts of an architect who was concerned about his bookkeeper but was also concerned that whilst the business was profitable, he was struggling for cash. We found that the bookkeeper had been systematically stealing money from the business over many years to the tune of $700,000. In fraud investigation, we look at how the stolen funds were hidden. In this case, the bookkeeper did nothing fancy just applied the stolen money directly to the architect’s loan account. As a result, his loan account got bigger and bigger, which the architect who did not understand accounting thought was a good thing … but it was getting bigger the wrong way.
If the architect had some basic understanding of accounting, he would have been able to prevent this fraud years ago.
All profits convert to excess cash. That excess cash can be used to pay dividends, buy assets or reduce liabilities. The architect should have asked himself the question – “I made these profits, now where is the cash?”
As a note, if the bookkeeper had known that the fraud would be detected, the fraud would not have occurred in the first place.
Should his accountant have found the fraud?
The architect only saw his accountant once a year for his annual tax return. The accountant had no opportunity to understand his client’s business. Our clients in the Business Wisdom Workshops meet with us twice a month so we understand our clients business.
In future posts, I will look at the language of business and what business owners need to understand about accounting and accounting reports.