Accounting 101: The Current Equity Report
By Dr Paul E Adams | November 30, 1999
I will never forget a conversation over lunch one day with my close friend, Murray, a successful distributor of shipping materials, who, during our chat, told me he believed accounting and financial statements are fine for those who understood such matters, but in his estimation, all that he wanted to know was how much did he owe, and how much was owed to him. If he was owed more than his bills, he had made money. Simple!
What Murray was explaining to me, was a simplified accounting system a New York merchant had taught him when he first started out in business. In his view, the method told him if he made or lost money each month. To do so, at the end of each month, he added his accounts receivable, his inventory and cash, and subtracted his accounts payable. The remaining balance: His equity. If the equity at the end of the current month increased over the prior month, he made a profit. A decrease meant he loss money.
If you study the example , you will see that, from month one to month two, the total of cash, accounts receivable and inventory increased by $5,920, whereas, the liabilities increased by $1,000. The net result is a gain in equity of $4,920. Or in other words- a profit.
Murray's Equity Report: An Example
|ITEM||MONTH ONE ($)||MONTH TWO ($)||DIFFERENCE ($)|
In my courses on Entrepreneurship, I stress this approach, to those who do not have a background in accounting, as a means of quickly determining profitably. (For those of you knowledgeable in accounting, you can see that I have taken a little liberty with the term equity, as I have purposefully omitted anything beyond current assets and liabilities)
The report is easy to prepare and should be done at the end or beginning of the month. Whichever you elect, be consistent. First, total your bills. This amount must include bills from suppliers, your operating expenses such as utilities, etc. as well as taxes and any monthly payments you must make.
Next, add up you bank accounts, including all your checking and savings accounts. With that task completed, total the amount your customers owe you. Include all customers' balances; do not omit any, even though you have reservations about being paid. Your data must be consistent. I assume you have a list of customers and the balances owed to you, if not, correct the situation before you lose the money!
Now, prepare a total dollar value of your inventory. If you do not have perpetual inventory records or, if you are lacking in inventory records; now is the time to correct the problem.
Finally, total your cash, your customer balances, and your inventory value; subtract your bills and the difference is your equity. This is the amount of money remaining, after you sell all your inventory, collect all the monies owed to you by your customers, and pay your bills in full.
Remember, if the amount of your equity is increasing- you are earning a profit. Let your accountant worry about the taxes, and you worry about your business surviving. The purpose of the 'equity report' is not to replace your traditional financial statements, but to give you a simplified short cut to make sure you are immediately aware of yourprofits or losses at the end of each month.