In Part 2 we recorded the movement of 200 from Customer to Bank. We captured the most important aspects in a table called a ledger.
Five columns provide sufficient context to accurately account for any movement of value. This post expands on these columns.
#13 – Bucket
A bucket describes the source and destination which value flows to and from. The naming of these buckets is left to the accountant and the final list will depend on the nature of the business.
In addition to say Bank and Customer, a law firm may have a bucket called Revenue while an animal charity may have a similar bucket called Donations.
#14 – Event
The event reference is a unique handle for a collection of entries sharing the same business event. The example below shows two deposits received from a customer for exactly the same amount, on the same day:
Without the unique references Event-1 and Event-2, there would be no way to distinguish between similar looking deposits in the ledger.
#15 – Date
Every business event takes place on a specific date – accountants ignore hours, minutes and seconds.
You cannot have different aspects of the same event occurring on different dates. That’s why all entries with the same event reference have the same effective date.
#16 – Amount
The amount column shows the exact value of the movement as well as its direction with reference to the source and destination buckets. A positive sign indicates movement into a bucket while a negative sign indicates movement out of a bucket.
#17 – Currency
Without a unit of measure, an amount is meaningless. For accountants, the unit of measure is currency such as GBP / USD / EUR. For any given business event, all entries of a particular currency must sum to zero.
#18 – Financial Statements
Accounting is simply the recording of value movements and the reporting of these movements in useful ways. There are exactly 3 reports and these are known as Financial Statements:
- the Balance Sheet – “How much is the business worth AT a point in time?”
- the Income Statement – “How did it perform OVER a period of time?”
- the Cash Flow Statement – “Where did monies spent, come from?”
All these reports are built from the five essential columns. The only thing we have to do is aggregate.
#19 – Balance Sheet
Assume that the following movements represent the complete set of business events in the ledger:
We can derive a simple ‘Balance Sheet’ at the end of December 2018 by mechanically adding up all the entries across the entire ledger:
Here is the balance sheet as at December 2018
How much is the business worth? Zero.
Our balance sheet shows how the $400 in the bank isn’t actually ours.
The only events in our ledger are deposits, which we owe to our customer.
The point of the balance sheet is to measure the total value of the business at a point in time. Without having to inspect the nature of every business event by hand. Even if there are millions of events represented in the ledger, we can calculate this automatically with an aggregate query.
Again, the aim of accounting is to meaningfully report on business events recorded in the ledger. The balance sheet above is an example of one such report.
Any business that maps its business events more closely to reality will produce more meaningful and relevant financial reports.
In Part 4 we identify how to choose meaningful dimensions. And how to determine the appropriate value directions: positive or negative.