The key issue of accounting is to provide a ‘snap-shot’ at a point in time of two items:
- How much do you have?
- How much are you making?
When I left home for school, I had to become aware of managing my expenses which were quite simple:
For example, let’s say I had saved $5,000 over the years and I owed $500 on my car that had a value of $3,000.
This answers the first question of “how much do I have?” On the surface, the accounting world seems to complicate the question by breaking it into two parts, assets and liabilities. It makes sense when you see it, and it looks like this:
- Savings $5,000
- Car $3,000
- Total $8,000
- Loan -$500
- Total -$500
So the answer to the first question of “how much do you have?” is your Net Worth, which is the sum you have at a specific point in time. In this example we will assume it is the first day of the semester.
Then the second question, “How much are you making?” is broken into 2 parts: income and expenses.
- From Odd Jobs $6,000
- Parental support $6,000
- Total $12,000
- Tuition -$5,000
- Room and Board -$7,000
- Play and Fun -$3,000
- Total -$15,000
Net – $3,000
In this example, we lost money in the amount of $3,000, which we will call a “Net Income.” We label this as a ‘budget;’ while the accounting world would call it a “pro forma.” So where does this “loss” come from? It deducts from our savings/assets, thus at the proposed end of the semester we take another snap-shot of how much we have remaining.
- Savings $2,000
- Car $3,000
- Total $5,000
- Loan -$500
Net Worth $4,500
So at the end of the period in time that we are taking our snap-shot, any gains or losses (Net income) get plugged into the Net Worth Statement.
I regularly hear from my young friends that they are challenged to discuss the topic; so was I. But I was able to learn along the way that it is these same basics of accounting which all businesses and large corporations utilize.
This is the basic information that we need to purchase a car or home which requires financing. If you are making major financial decisions or large purchases, you will need to assess your Net Worth and Net Income more frequently. This can be done weekly, monthly, or annually depending on the changes in your financial situation.
Accounting can and does become much more complicated of course, but it always comes back to these basic issues: how much did you make, and how much do you have?
Rich Meyer, Author & Blogger
P.S. Tax accounting is like living in an alternate Universe.