Why Entrepreneurs Need To Understand Accounting

Entrepreneurs who don’t understand basic accounting concepts are setting themselves up for unnecessary stress and failure, says Peter Frampton of Color Accounting International; but, he adds, the good news is that everyone can learn the basic skills they need.

“Business owners often tell us they’re slightly intimidated when meeting their accountants,” says Frampton. “They end up saying nothing more than ‘tell me where to sign’ so they can get out as quickly as possible. But with just one day’s training, entrepreneurs can improve their accounting skills to the point where that dreaded quarterly meeting becomes an opportunity for intelligent, constructive conversation about the future of their business.”

“There’s a very clear correlation between accounting literacy and business success,” says Marc Johnson of Financial Literacy Express. “When you understand the basic financial architecture of your business and how funds flow through the value cycle, you can see more options and make better decisions. You might change the products you sell based on what’s most profitable, or negotiate discounts or better payment terms based on your spend with a key supplier.”

Johnson says understanding the business value cycle also enables more intelligent planning and forecasting (see diagram). “Successful planning takes a lot more than just adding a percentage to all the figures on last year’s spreadsheet,” he says. “Once you really understand the linkages between equity, income, expenses, assets and liabilities, planning becomes a much more rewarding process.”
For example, says Johnson, “if you have a profit target in mind, and know what profit margins in your industry are, that gives you a revenue target. It’s fairly easy to work out the direct cost of sales from there, but what about your indirect costs? And what will that mean for your assets? When will you need to hire a new staff member, or buy a new vehicle, or get bigger offices? And how will that new asset structure be financed?”

Seeing these linkages not only enables better planning, says Johnson, it protects entrepreneurs from bad decisions. “When we’re stressed, our vision narrows. But when we can see a system as an organic whole, we also see a lot more options. When there’s a cash flow crisis, for example, there are plenty of ways to ride it out if you can see clearly. Perhaps you could pay your taxes later and accept a penalty, or run down your inventory, or retrench a staff member. The key point is that you won’t see these options if your accounting literacy isn’t up to scratch.”

“For a rare few entrepreneurs, usually those who come from entrepreneurial families, this kind of knowledge seems to come naturally,” says Frampton. “But the rest of us have to learn it. Success is about working smarter, not necessarily harder.”

* The views expressed here are not necessarily those of the owner of Ideate.