An implication of the flow principle is that you are always better off moving information in the direction of your net flow, even when that means reversing the direction of your flow.
As an example, suppose you are a new business with no money, sitting at home making something you can sell on eBay. If someone offers to buy it for $100, but they want to pay you next year, this might tempt you to take the deal. But if by taking the deal you lose your chance to sell it for $200 next month, then your net flow is reduced by $100, and it makes more sense to wait.
To keep track of your net flow in situations like these, it helps to keep an account payable for money coming in and an account receivable for money going out. Think of this as like a ledger (a kind of book) — each transaction gets entered in one column or another. You start out by entering $0 in both columns.
The difference between having an account payable and having no debt at all is like the difference between paying interest on a loan and not paying interest. The interest rate is the cost (in terms of lost opportunity) of delaying payment; if there is no interest involved then there is no cost.
There aren’t many tools as useful as a well-designed spreadsheet. But even if you make good use of them, you can still get in trouble. An accounting clerk I once knew had a whole drawer full of spreadsheets he had made for his manager, which had been rejected for one reason or another.
My favorite rejection was for a sheet that calculated the profitability of the company’s product lines. The clerk had found that some lines were making a lot more money than others, and wanted to know why. His manager rejected the sheet because it didn’t include anything from accounting. Since the purpose of the sheet was to help figure out how to make more money, this didn’t seem like a good reason for rejecting it.
What his manager really wanted was a sheet that would calculate how much money they could make by dropping some lines and expanding others. That isn’t what he said he wanted, but that’s what he meant. He had information going in one direction—sales figures—and was looking for information coming back from somewhere else—how to increase sales—and was looking to the spreadsheets to provide it. But those numbers weren’t there, and no number-crunching trick could produce them.
How to manage a company’s money is a matter of keeping track of what’s coming in and what’s going out, a process called bookkeeping. No business can survive long without it.
But the question of how to manage a company’s money is different from the question of how to manage a company. Bookkeeping is just something you have to do, like taking out the garbage or changing the oil in your car. It’s not an important business strategy.
And yet, even though bookkeeping is a necessary but boring task, doing it badly can destroy a business. This happens for two reasons: one, accounting systems seem complicated and mysterious, and two, there are lots of myths that tell you accounting doesn’t matter much.
The result is a huge disconnect between the importance of accounting and how much attention most people pay to it. Your health matters more than your bookkeeping does, but you probably spend more time choosing a doctor than picking an accounting system.
We all know the basic principle of accounting: every transaction should be recorded, and an entry to one side of the ledger must balance an entry to the other. The only way to keep your books balanced is to make sure that every debit has a corresponding credit, and vice versa.
By itself, that’s not much advice. We’re talking about accounting here, not origami. But it turns out that an accurate picture of your business is different from a simple set of financial reports. It requires a bunch of nonfinancial information as well as financial data. It can’t be reduced to numbers alone. And it doesn’t just balance; it also flows, with money moving through it rather than merely piling up on one side or the other. This accounting system is called “accounts payable.”
A company’s accounts payable is the list of things the company owes. It is mostly made up of money it has spent on outside services: raw materials, but also rent, utilities, payroll services, legal services—everything the company needs to run smoothly but doesn’t produce itself. Companies also owe money to their own staff.
The accounts payable is one of the most important lists in a company. Because AP is a list of things the company owes, it tells you who influences what the company does. Every item on it can be interpreted as a kind of vote for or against doing something—to produce an item, to sell an item, to use some piece of technology or software, to open an office in some new location, etc. If you want to influence what a company does, you want your vote on the list.
The first principle of accounts payable management is that you never want your name on this list if you don’t have to. You especially don’t want your name on it if you’re not getting paid for it.
Business is like a river: it flows. And like a river, business tends to flow in certain directions and not others.
You may think of your business as something that happens at your place of business: you make things there, and then sell them. But what you do at your place of business is really just the tail end of a much longer chain that stretches back into the past and forward into the future.
One end of that chain is the end customers buy from you. That’s where they are now, but it is not where they will be in the future. They may be happy with what you are selling them today, or they may be dissatisfied; either way, their needs will change over time. The other end of the chain leads into the past: it consists mainly of all the things you need to make your product or service. Not only all the components you purchase to assemble your final product, but also all the things needed to make those components, or make something else that you can use as an input instead.
In a firm, money either flows toward the customer or it flows toward the owner. If it flows toward the owner, we call it profit. If it flows toward the customer, we call it revenue.
If revenue exceeds expenses, we have a profit. So what is an expense? An expense is anything that moves money away from the customer and toward either the owner or some other company. If we sell a product, the cost of making that product is an expense. If we buy something for our own use, such as a new building or a machine, that cost is an expense too.
And most importantly, if we pay someone else to do work for us, and they don’t work for themselves (because they are employees) and they don’t work for you (because you are not their customer) then what they do isn’t part of your business and therefore doesn’t contribute to your profits; it’s an expense.
Emil is a contributor at Accountant Log. We are committed to providing well-researched, accurate, and valuable content to our readers.
