The key to success is to understand accounting.
It is the management that runs the business. Accounting keeps track of the business. So simply, accounting is keeping track of the business elements.
So what are the elements of business?
Think of this, there are two elements of water, one is Hydrogen and the other one is Oxygen. If any of these two is absent, there’s no water.
Similarly, in business there are only three elements. Customer. Product, Cash. If any of these are absent, there is no business.
Imagine if opening a shop with no customers. Do you think it will go for long? It will not take very long.
What a customer wants is a product.
What 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’d go? There’s no product. There is no business.
Customer wants a product. Every business person wants is the customers money.
Why does anyone set up a business? A business person wants the money, the customer wants the product. So, we initiate business to make money. If it fulfills the customers’ needs, he gives us money.
A very interesting relationship. Isn’t it? So, to keep the customer pleased. This is one long term business approach.
Out of the three elements in business, only two moves. How do they move?
They move within the customer and you.
In the business process, product goes out to the customer and then 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.
Product comes in we call it buy.
Product leaves we call it sell.
Buy, product comes in, cash must go out – Pay. When you purchase, you must pay.
Sell is when a product leaves and money enters. You sell and you collect money.
As you see, product and money moves in opposite directions.
Product, right. Cash, left. Product and cash should always move in opposite directions.
If your product and cash are moving in the same direction, you are in serious trouble.
You sell the product, product goes out. You don’t get money.
Sales including no collection is committing a suicide.
All the sale should be accompanied with cash.
Let’s look at this. When you are buying and selling.
Buy, accountants call this expenses. Sell, accountants call this income.
Product moves right into the profit and loss account.
Profit and loss account determines the movement of product, this is the performance of the business.
Income and expenses equals profit or loss. There is a profit if the income is more than the expenses. If an income is less than expenses, then there’s a loss.
All cash movements are recorded in the cash flow statement. You can see it here, very easily that cash coming in, accountant calls it inflow.
Accountants call cash that goes out as outflow.
If inflow is more than outflow you get a positive balance, a net cash flow that is positive.
If outflow is more than inflow then you have a negative balance, a negative net cash flow, or a bank overdraft.
So how simple is this for starting your own business? Profit and loss account only measures themovement of product.
Cash flow is measured 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.
To help you rememberall these. Here’s a song for you to sing, in 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.
Therefore, accounting is merely keeping track of the elements of a business.
Here is a quick sum-up 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 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 with collect.
Product goes straight into the profit and loss account.
The movement of cash goes straight into the cash flow.
The key to success is understanding that Profit and loss account has got nothing to do with cash.
Colin Burr has been in the field of starting your own business for a long time and have a website about crazy business ideas where you can get answers to the rest of your questions.
