Going Broke While Making Millions

Accounting is numbers, right? And numbers are solid, concrete, unambiguous, the one thing in the world we can count on—right? Then why is accounting so hard to understand? As I’ve noted here before, it’s because it is backward.

Think about it. Money that you don’t actually have (money that isn’t in your pocket or in your bank account), money that other people owe you, is–according to standard accounting praxis–an asset. Money that’s not yours is a plus. Go figure.

On the other hand, money that you actually do have in your possession is a liability—when you owe it to others. Once again, one is asked to go figure.

Now don’t even get me started on accrual accounting, a method that allows you to make millions of dollars and go broke at the same time. It’s a beautiful, backward thing (which may partially explain our economic downturn).

While cash accounting is very straightforward (i.e., What have you got in your wallet?), the accrual method (which most companies use) has more than its share of mysteries. In accrual you match expenses and revenue at the time the transaction is made rather than when payment is made. If you are not careful, this can bite you at both ends—the production side and the sales side.

Let’s talk publishing, then. Suppose you have (or think you have) a big bestseller. You bring in big printings so you don’t run out of stock. Now you owe printers money—lots of money. But you don’t have the money to pay them because you haven’t sold the books yet, or at least not all of them. (This is the bite from the production side.)

When you do sell a book, that is the moment of the transaction. That’s when accrual accounting says you are rich because people owe you money and the cost of the individual book sold–not the whole print run, mind you–is lodged on the debit side only at that moment.

But often your biggest customers (wholesalers, distributors, etc.) may take thirty, sixty, ninety days or more to pay. (That’s the bite from the sales side I’ve mentioned here.)

So you’re selling lots of books, and lots of people owe you money. According to backward accounting, that means you are rich. But keep this cycle going for a year or two, and banks won’t loan you money anymore to make up the gap between what you owe (to suppliers) and what people owe you (for the product they bought). So even though you are stinkin’ rich, your [cash flow](http://www.investopedia.com/terms/c/cashflow.asp) stinketh also. You see, there’s more than one way to look at “going for broke.”

The moral of this story: Pray for success, but not too much success.

Author: Andy Le Peau

I've been an editor and writer for over forty years. I am passionate about ideas and how we can express them clearly, beautifully, and persuasively. I love reading good books, talking about them, and recommending them. I thoroughly enjoy my family who help me continue on the path of a lifelong learner.

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