The Yin and the Yang of Accounting

It is probably too much to say that accounting is really a haven of balance in a world of chaos.  But I honestly believe this is true.  I am going to try and explain why.

The underlying foundation of our bookkeeping and reporting system is the idea of double entry accounting or more commonly, debits and credits.

Every transaction that is recorded has a debit and a credit.  This is a brilliant concept that is simple in execution and which has proven effective over time. It is also a concept that causes no end of confusion in the world of business.

Balance is a repeating event found in nature - for every action, there is an equal and opposite reaction.  If you use cash (credit), then you must have had something else change (debit).  You must have.  No ifs, ands or buts.

Theoretically, and I actually like to ponder this from time to time, if the entire world combined their books, the answer would be zero.  If I pay cash out, you receive cash.  Net effect, zero.  If I borrow money, you lend money.  And so on.

Why is this so difficult?  Over and over, I speak with a person that manages the books at a client and I ask where a check was posted and they will look at me confused.  "It was posted at the bank."  Yes, I will say, changing my face to be a bit more understanding, but what did you buy with it?

Accounting systems have automated the double entry nature of the business, but it is still happening - it's just that you are not having to enter the transaction.  Maybe a vendor is assigned to a code which is creating the debit or maybe you just put everything in an account called "Ask My Accountant".  But whatever code you put on the check entry creates a transactional record of a debit and a credit.

At this point, I guess you might be thinking "Who cares?"  Well, if I may be bold, I would say, you should care.  If you are contemplating a business deal - it might be interesting if you paused for just a moment and thought - what is the credit here?  Does this create value?  If I move resources here, where am I moving them from?  If I use liquidity here, what is now not solvent?

Look -  I freely admit that there are great strategic thinkers in our world, ones that have truly changed things, the doers.  These people are not accountants (obviously).   They do, however, understand the concept of balance.  The fact that our world hangs on that balance.  And they have found a way to shift the world while maintaining balance.

Accountants, at their best, see the balance and report it.  And they use the reports to communicate the truth of what really happened and to make their own contribution to the events.  And, yes, this is all starting to sound a bit touchy feely for a profession that is often considered punitive, stuck in the past, and costly.

But really, if you have ever worked with an inspired accountant, one who whispers numbers, one who can show you stuff, then I guarantee you have worked with someone that feels the balance.  The debit AND the credit.  The Yin and the Yang of accounting.

Recession? Or Situation Normal?

I was interested to read in the newspaper last Monday that we are now in a recession.

Apparently, the last one ended in June 2009 and a new one has now begun.  Leaving aside the technical definition of recession, I mentioned this to several people and no one felt they had been a part of any period of economic expansion.  "What?  It ended? When?"

If we can't tell the difference between recession and expansion anymore, then what are we facing as we go forward?

It has dawned on me that this economic environment might be typical for the rest of  my working life.  And my retirement, which I now expect to take when I am 88 or so.  That the world everyone jokingly talked about "leaving for their kids" is here.

Sadly, when I mentioned this realization to a couple of people, no one disagreed.  In fact, one person supported the idea further by saying that the inequities we see with wealth are so divergent that it will likely take decades for them to wash through the system.

Another person showed me a graph of where America stands in investment in social services relevant to investment in medicine and how we are not being efficient with proactive help socially and that we need to do more of that.  (Another post, another day.)

I may be a bit of a Pollyanna, but as soon I acknowledged to myself that this is what I am going to deal with forever, my outlook went through a slight, yet significant, shift.  "Okay," I thought.  "I can work in this.  I HAVE worked in this."  Some people say that we have been contracting since the tech bubble burst in 2001.  I have been out here that whole time.

If things get better, I guess I can be pleasantly surprised.

Meanwhile, over the last four years, I have improved my personal balance sheet and the balance sheets of others.  I have reduced my reliance on leverage and I have contained my footprint.  I have become comfortable and accepting of the home that I possibly will live in forever (because it is so far underwater I can never contemplate leaving).  I have been grateful to work with the organizations I work with.  I decided that if I was going to work for another 50 years, I could slow down just a bit.  I have settled in to life and taken time for the meaningful along the way.

I know there are many who are out of work.  I know there are even more who are underemployed.  I know that I could become one of these at any moment.  For now, though, I am setting my sights on the long haul because if you have no choice, then you work with what you have.

Instant CPA - Just Add Coffee

There is nothing instant about finding a CPA that both understands your business and that, ahem, you can afford.  Well, I am going to let you in on a little secret, from the CPA side, there is also nothing instant about getting the good referrals - the clients that match your personality, your skill set and that, ahem, want to pay you.

CPA's are continually targeted by people that want to help them market - they say we need to advertise, do mailers, do monthly newsletters, etc.  I think there is value in a newsletter when there is news and we really don't need to become part of the noise that fills your inbox each day.

And ultimately, is your financial information something you generally trust to a name that shows up on a postcard in your mailbox?

I don't think so...

Well, then how do people find their perfect CPA?  And how do CPA's find their good clients?

I am not sure that there is an easy answer to that, but I would like to propose the idea that it starts with coffee.  Coffee with a friend in your industry.  Ask them who does their work and do they like them?  Coffee with a mentor, same questions.  Get a couple names from friends.  Call those names.  See who calls you back.  Meet them for coffee, pick your favorite and begin the relationship. 

I believe that financial services is still an industry that works best through personal referral.  There are good on-line matches, but one should not overlook the personal relationships.  I am not saying finding a CPA is like getting married, but I suspect that your CPA (the right one) will understand and communicate about your finances better than most spouses.

By the way, when I choose to market, and I do choose to market, I do it through community events - a table at a non-profit event; a hole on a golf course for charity, a sponsorship of a festival for kids who don't have festivals. I calculate that I get about as much return on this marketing as I would get on sending out mailers (nearly none), but at least I feel a whole lot better about where the money went.

I have written a companion piece to this called How Much Should You Pay for Bookkeeping if you would like to read more (much more - it was a tad wordy).

I Suffer From Depreciation

Some time ago, I was speaking briefly with a Board Member of an organization and he mentioned that “we don’t ever record depreciation during the year.  Do whatever you need to get the books in shape, but don’t ask or make us look at depreciation.”

“Depreciation doesn’t matter.”

“GAAP entries?  Oh, you mean like depreciation.”  (Big sigh follows.)

Depreciation is technically the recognition of a capital expense over the life of the asset.  In other words, if you buy a building for 3.6 million dollars and you believe it will last 40 years, then each year, you will have an expense of $90,000.  Ninety thousand dollars that you have to cover with support, revenues or some other offset on your way to positive net assets.  Ninety.  Thousand.  Dollars.

Oh, and you are probably paying debt service on that building in which the interest is also creating an expense.  Another expense (this time real cash) that you have to cover with support, revenues or some other offset.

Depreciation can cause confusion among non-financial Board and Leadership people in the organization.

Every good cash analysis and operational/management tool adds back depreciation in the first step.

EBITDA – Earnings BEFORE interest, taxes, depreciation and amortization.

Depreciation, depreciation, depreciation – I suffer from depreciation.

So, why do we record it?  Why do we make you look at a large number that represents money already spent?  Why do we set you up to have to explain you have a net loss, but only because of depreciation?

There are some good reasons to record depreciation:

First and foremost, it IS generally accepted accounting principles and if I know that you are handing out “board approved” interim statements for Grant applications or financing or whatever, then I am going to make sure that those interim statements are as close to accurate as possible within an accounting framework.  And that includes depreciation.  This just protects you.

Second,  it can loosely represent future capital needs and if you are covering it with your support in this year, theoretically, you are increasing your cash to meet those needs.

Third, if you are doing a tax return, depreciation is actually the law for certain listed assets.  (Note that tax depreciation and book depreciation can vary widely – one is legislated and one is based on estimated actual life).

Finally, well…  I can’t think of any other reason to record depreciation because, I also don’t like depreciation.  I also add it back at the earliest opportunity. And I also generally think it doesn’t matter.  For my clients, I often take it out of the main expenses and give a net income before depreciation – it is still there, but it is way below the operational data.

BUT, I work with service entities, arts based and community services organizations.  These organizations do not have large capital expenditures for production.  The number one cost on most of my financial statements is payroll – not inventory, not production cost, not warehousing.  There is a place for depreciation in the world of manufacturing, etc. and for those, please carry on.

In the meantime, we will keep recording it because we should and then we will add it back to find our important ratios – debt coverage, operating cash, income from operations.