“Beware of little and unintelligent expenses, a small leak will sink a great ship”. Those were the words of a scientist and statesman author; Benjamin Franklin. Accounting and finance are one of those things only a few got educated in while growing up. The truth is that money is like a sixth sense – and you can’t make use of the other five without it. In business, we say that there are four factors of production: land, labour, capital and entrepreneurship. Arguably, the human capital is the most essential factor amongst these four. However, misappropriation of organizational funds may render every other factor of production irrelevant in the long run. Every business owner is required to know little things about everything, and everything about little things.
The mention of accounting and finance often sends a cold shiver down the spine of many individuals. This is quite understandable due to the technicality and delicateness of financial records. Notwithstanding, a proper understanding of basic financial terms and principles will help to prevent avoidable economic hazards in the organization.
Too many people spend money they haven’t earned, to buy things they don’t need, to impress people they don’t like. Everyday I see errors being made around financial decisions. From personal impulse spending to inefficient staffing. From not separating one’s income and expense from their businesses entity to taking out too much money by paying out what should have been either capital or retained earnings to invest back in the business directly. I see people have a budget for production with none for marketing and sales (I guess they just assume that a good product should sell itself).
It’s financial literacy to not live above your means. It’s okay to say, “I can’t afford it now”. Take pride in it. There is a saying that as most women fake orgasm, so do men fake intelligence, power and finance. That doesn’t have to be you. Everyday, I see people run out of cash from living la vida loca. I see people run into cash flow problems because they used their cash in hand for lending, or even instead, they use it to buy land too early or even do charity. In money matters and financial management, knowing what to do at the right time is gold.
Some false notions around money can also be misleading. For example, a few people will tell you they don’t borrow or take out loans because it’s bad. Well, this is not always exactly true. Rather, don’t ever borrow money for something that doesn’t further or enhance your financial goals, or the future. I have also seen people try too much. The fact that you have put money in a bad business unit doesn’t make you a loser when you quit. Quitting and counting your loss is sometimes the most intelligent to do, else you’re just a victim of the sunk cost fallacy; an idea that because we have invested so much in something, we have to keep pursuing it, even when it’s not working. It’s the principle behind why a gambler who’s down stays at the table, thinking he will win back his money, or why an investor keeps her money in a dwindling stock, waiting for it to go back up. Timing is key, and beyond intuition, let knowledge inspire it.
We all need an intermediate knowledge of accounting and finance to get by. Financial management helps an organization to keep track of the expenses and plan how much to spend. It also helps you know what you own and what you owe (the difference is your net worth). Financial management helps a business to organize its operations and strategize its funding. It also helps to take sound financial decisions that would boost the growth of the organization.
To understand it, we must start with knowing its conventions. Accounting conventions are guidelines used to help companies determine how to record business transactions. For example, it’s always advised that while recording transactions, that you “Debit the receiver, Credit the giver” (Double Entry Principle). There are several concepts and conventions guiding the understanding of accounting. They include the principles of Materiality, of Full Disclosure and Conservatism. Other accounting concepts include Accrual Concept (that transactions should be recognized at the time when the transaction occurs rather than when payment is made or received), Economic Entity Concept (a business is a separate entity), Going Concern Concept (it should be built to continue), Matching Concept, and Materiality Concept amongst others.
It’s also important for executives to know how to read and translate financial statements. Basically, there are four financial statements that are relevant to every organization:
1. Statement of Comprehensive Income (Formerly, called Profit and Loss statement)
2. Statement of Financial Position (Formerly, Balance Sheet)
3. Statement of Changes in Equity (Formerly, Statement of Retained Earnings)
4. Statement of Cash Flows
It is imperative for every business stakeholder to identify the components of each financial statement as they relate to the whole business operations.
Another branch of Accounting is Tax Accounting. Taxes are involuntary fees levied on individuals or corporations and enforced by a government entity. It is the law. Failure to comply with these regulations often attracts stiff penalties for the organization. Taxes in Nigeria are of two categories: federal taxes (FIRS) and state (in Lagos for example it’s called LIRS) taxes. Federal taxes include Companies Income Tax, Value Added Tax, Education Tax, etc. State taxes, on the other hand, include Personal Income Tax, Business Premises Tax, Development levy, etc They all have their predefined formula and percentages for calculation.
You should also be more concerned about financial accounting and cost accounting. Cost accounting helps you know your break-even point (the point where there is no profit or loss. And after which you begin to make profit) and even how best to price your goods. Two common methods are cost-based pricing and value-based pricing. When a company uses cost-based pricing, the company sets a price at a percentage above the cost it incurs to manufacture the product or to provide the service. Value-based pricing takes a different approach, considering the potential value the product or service will bring to its customers.
Beyond Cost Accounting, Financial Accounting knowledge is also key. It’s from it that we generate your income statement. It’s safe to say that what the lame man calls income is not income but just revenue. Income and revenue is not the same thing. Income is only gotten after you subtract cost of goods (production cost) from that revenue (which gives you your gross profit, and when expressed in ratio of that over revenue in percentage gives you your gross profit margin, the higher the margin, the more investors may see your business as likely profitable) and then you minus your expenses (ranging from selling cost expenses, to general expenses to admin expense) from it, and perhaps taxation. At this point you have an Income statement.
The net income at the bottom of an income statement may help advice on cash flow projections, which eventually can help you get a snapshot of the health of your finances through the balance sheet. All these are a major pointer to your overall business balance score card (the finance and first quadrant, of the 4 quadrants. The other being structure, innovation and stakeholder experiences).
In conclusion, we all need a considerable knowledge and best practice of accounting and finance to stay afloat. And they can be likened to the eyes of a business. It must be delicately cared for and diligently managed. Let’s help you seek financial and business literacy today via consulting. Your business life matters to us.
Strategy. Business StartUps and Corporate Restructuring Consulting
Uwaoma Eizu is the lead strategist at Hexavia! He is a graduate of Mathematics with two MBAs and over a decade of experience working with startups and big businesses. His core is in building startups and in corporate restructuring. He is also a certified member of the Nigerian Institute of Management, Institute of Strategic Management of Nigeria and the Project Management Institute, USA. By the side, he writes weekly for the Business Day newspaper.