HBX Final Reflections: Financial Accounting — So Much Paperwork! Argh! (But It’s OK, Really) (#BusinessyBrunette HBX Week 11)
Welcome to #BusinessyBrunette! I am currently studying Harvard Business School’s HBX CORe, their online pre-MBA program teaching the fundamentals of financial accounting, business analytics, and economics. Every week I‘ll write up what I’ve learned — making it meaningful & accessible for artists, activists, geeks, nerds, fans, and anyone else who doesn’t fit the MBA Mould. I’m learning as I go, so feel free to critique, comment, tell me if I’ve messed up or did well, mash up, and share! [See the rest of the series here]
This is the final month of HBX CORe, so all the subjects are on their last modules. So from here on out I’ll be writing short reflections on each subject as they close out.
Financial Accounting: Final Reflection
When I first saw the subject, I groaned.
When I then saw the course outline — longer than the other two courses by two modules — I groaned louder.
ARGH! So much paperwork! So much boring paperwork! What’s with all these forms?! Cash flows? Liabilities? Profit Margins? WHAAAAA?!?!?
I was pretty certain that this would be my worst out of the three. No way was I going to be able to keep all of that organized.
I was wrong.
I was actually pretty decent in accounting when I was younger. Our Life Skills (Kemahiran Hidup) classes from around Forms 1 to 3 in secondary school (Grades 7–9) had an accounting section, and I was one of the better students at grasping what was going on with debits and credits. So much so that for our PMR exams (an annual national exam that everyone in Form 3 in Malaysia sits at the same time to progress to the next year) I ended up helping not just my direct classmates, but most of the other Form 3 students prepare for the KH exam. (I had joked that they owe half their As in KH to me.) I could have taken Accounting in Form 4, and done a pretty decent job at it too, but I was pretty dedicated to being a Humanities student and thus opted out of the opportunity.
While I came from a family of business people, and grew up around prospectuses and annual reports, I found financial statements very boring and pointless. None of the numbers really made all that much sense to me, and they weren’t as interesting as the stories about what the company planned for next year or the pictures of their work (which occasionally involved aforementioned family members).
This aversion to financial statements carried over into adulthood, which affected my ability to start projects: I’d get scared off by budgets or business plans, not understanding where to even begin with any of the financial requirements; I didn’t usually have anyone around either to help me or work on that aspect while I worked on my own strengths. How am I supposed to know what my cash flows are when I didn’t even sell anything yet? What’s my profit margin — uh, zero? WHAT EVEN!? There were probably quite a few projects that I could have gotten off the ground by now if the idea of “accounts” didn’t turn me off or scare me.
The Financial Accounting module started off by talking about the sheer amount of paperwork that goes into financial statements, and at first it seemed overwhelming. However, as we worked through each form week by week, they all started coming together in a way that made sense. Each document informs the other; information from one document gets consolidated and organized into another. It was less about trying to come up with numbers out of thin air and more about recording what is already happening in the business.
To begin with, understand the accounting equation:
Assets = Liabilities + Equity
Assets are stuff your business has that’ll help it function. Cash, inventory, equipment, employees, buildings, subscriptions, anything that’ll make your business money whether directly or indirectly.
Liabilities involve anything that involves you owing money, product, or service to someone else. Buying things on credit, bills, rent, wages, anything that costs the business money or service at some point (though note that if you’re buying things in cash, the changes tend to affect only your assets: you’re switching one asset (cash) for another (inventory or equipment).)
Equity represents the ownership of your business and the money that gets invested in and out of your business — whether from loans, selling of shares, dividends, your personal contribution, donations, or prior earnings.
Once you learn what counts as an asset, a liability, or equity, you can start categorizing what’s happening in your business into accounts — and start organizing your financial statements based on those accounts
First you have your journal entries, in double-entry style — which means each entry is a debit in one account and a credit in another. This basically means recording every exchange of value in the course of your business — selling inventory, paying employees, getting a loan, every last bit.
Then you organize all your entries into t-accounts or ledgers, where you see every debit and credit incurred in each account.
You add up all the amounts in each t-account, and then put all the amounts together to come up with a trial balance, which helps you make sure that your debits and credits are equal:
Now that you have all your transactions organized, you can move on to balance sheets and income statements! The balance sheet shows what the business has to work with at any given point in time, like a picture. How much do you have in assets, liabilities, or equity? If you looked at your inventory right now, or your bank accounts, how much do they hold?
Meanwhile, the income statement (or a profit & loss statement) shows the performance of a business over time, like a video. This document shows your revenue, which is all the money earned by the business and is now yours to do as you wish (keep or reinvest), as well as your expenses, the money you had to pay to maintain and run your business.
Once you have that, you can make the statement of cash flows, which shows where your business received or spent cash — not credit or bartering or depreciation, but actual cash— during the past month, quarter, year, or however long your accounting period is. This can often be more useful than just looking at balance sheets or income statements because you can get a sense for how much money is flowing through the business and is available for use at any time, rather than being tied up in a piece of equipment or in credit. (This is why you might hear of profitable companies with “negative cash flows” — that’s not necessarily a bad thing, they just may have a lot of their income and expenses on credit, are paying back loans, or investing in their business through property and equipment.)
Great! Now that you have all that information organized and sorted, you can start analyzing them to see how well your business (or someone else’s) is doing, or use this information to create forecasts and predictions — including budgets! — to prepare for your financial future. The formulae for them aren’t that complicated (for the most part; even tricksy-looking ones like the formula for free cash flows are just a string of different mini-sums); there’s just a ton of them, so I’ll leave it out for now.
Notice how, just by keeping track of when money, product, or services enter or leave your business while in action and putting them into the right categories, you can get a ton of information about how your business, or anyone else’s, is doing and how it will do in the future. You still need to use your judgment: these numbers can only give you so much meaning on their own. But knowing how these statements and accounts work is like learning a new language: suddenly a whole new world of information is open to you.
And indeed for me, it’s given me more confidence in my pursuit of bigger projects and potential businesses, because at least I now understand what sort of numbers people are looking for and where I can find them.
I said earlier that I had come into this course dreading it and being pretty sure that it’d be my worst out of the 3 courses in HBC CORe.
With a ~91% rate across my quizzes, it’s actually become my best.
Those As everyone else earned because of me are now paying back.
Other Financial Accounting posts in this series:
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