Imagine a man who sells apples on the side of the road out of a cardboard box. Every morning, he buys some apples at the grocery store, then walks to his corner. He sells the apples for $1 each until he runs out, then heads home for the day.
For the apple seller, accounting is easy. If he wants to know his balance sheet, he looks down in front of him. There are some apples (his inventory) and a cardboard box (his property, plant, and equipment). If he reaches into his pocket and counts the number of dollar bills he has, that’s his cash. Together, those are all of his assets. His equity is exactly equal to his assets – he didn’t borrow any money to buy the apples or the cardboard box in the morning, so he has no liabilities. He can do this whenever he wants to get the current balance sheet of his business. His income statement is just as easy – he remembers how much money he had in his pocket before he left home this morning, and counts how much he has now. The difference is his net income for the day.
One day, a truck of workers passes by and they offer to buy his entire box of apples, but they’ll need to pay him tomorrow. For the apple seller, this is a great deal – he could go home early if he agrees and spend more time with his family, or he could use the money to buy more apples and make a lot more money today. But he would need to keep track of how much the workers owe him for the apples, so he writes a note on the side of his cardboard box. The next day, as he’s buying apples, the man at the counter in the grocery store says, “You know, you buy apples from me every day. You’re my best customer – why not just pay me once a week? That would be easier.” So he starts writing on the side of the box how many apples he buys each day, so he knows how much to pay at the end of the week.
This is an example of accounting in action. The marks on the side of that cardboard box are the beginnings of T-accounts – recording his accounts receivable and his accounts payable – and this apple seller is still running an extremely simple operation. If he opens a bank account, because he’s worried about being robbed while he stands on the side of the street, he’ll need some way to record that. If he decides to hire his son to sell apples two streets over, he’ll need to keep track of how many apples his son has sold and how much to pay him. Suddenly, he can’t generate his balance sheet just by looking in his box.
Very quickly, the benefits to accounting become apparent. Accounting gives us a standardized way to keep track of all of these things, so you can quickly and easily understand your business.
Want to learn more about accounting, economics, and analytics? Check out HBX CORe, an interactive online program from Harvard Business School!