A financial plan is a product used for guiding people’s actions toward the accumulation of wealth. As a product a financial plan is created from a variety of sources. One source used for creating a financial plan is accounting.
What is accounting?
Google the phrase “definition of accounting” and here are some answers that will appear on the first page of Google:
- The process of keeping financial accounts.
- The process of systematically recording, measuring, and communicating information about financial transactions.
- The systematic and comprehensive recording of financial transactions pertaining to a business.
- The activity of keeping detailed records of the amounts of money a business has.
- The measurement, processing, and communication of financial information about entities.
The definitions of accounting emphasize process. We see two definitions that specifically use this word, a definition that uses a synonym of this word (systematic), and a definition that expands on this word (measurement, processing communication). When using accounting in your financial plans we should make an effort to simplify the use of accounting in a way for people to have financial plans that help them move forward.
How I simplify the use of accounting in a way for people to have financial plans that help them move forward is through the use of another definition. As a lecturer of financial accounting I like to use a textbook titled Financial and Managerial Accounting written by Jerry Weygandt, Paul Kimmel, and Donald Kieso. On page 5 in the second edition of this textbook they describe accounting as a process which focuses on economic events. Economic events is a way to describe transactions. So in my effort to simplify the use of accounting in financial plans here’s how I define accounting:
Accounting is the study of transactions.
What are transactions?
One definition of transactions is “the exchange or use of capital.” Capital exists in four forms: financial, human, intangible, and physical. Examples that apply to the exchange of capital are:
- Receiving cash from the issuance of common stock.
- Paying employees for work performed.
- Acquiring a patent by paying cash.
- Receiving cash for services provided.
- Issuing a note for the purchase of equipment.
- Selling merchandise on account.
Examples that apply to use of capital are:
- Using office supplies during the month.
- Requisitioning materials to be put into production.
- Converting materials into products through labor and overhead.
Can we simplify what transactions are?
The answer to this question may be in one of the definitions I found when googling the phrase definition of transactions which is “an instance of buying or selling something.” An instance is an occurrence and one might argue that what I described above represents an instance of buying or selling something. The instance of buying or selling something may be in the form of what I indicate as examples of the exchange or use of capital. I see this as an application of exchange but I don’t see this as an application of use which I believe is the more underrated element of transactions. Experience has taught me that the use of capital is an important part of an organization’s effort to accumulate wealth, especially in organizations that are engaged in manufacturing. Even though the use of capital is underrated by some I will not underrate this importance. Therefore my definition of transactions, in its simplest form is
The exchange or use of capital.
What should you think about when it comes to transactions?
- Raising money from debt is different than raising money from equity.
- Raising money from common stock is different than raising money from preferred stock.
- Purchasing investments in debt is different than purchasing investments in equity.
- Purchasing land is different than purchasing buildings.
- Purchasing buildings is different than purchasing equipment.
- Purchasing equipment is different than leasing equipment.
- Acquiring intangible assets, i.e. intellectual property, is different than acquiring fixed assets, e.g. land, building, and equipment.
- Selling products that are purchased is different than selling services.
- Selling products that are manufactured is different than selling products that are purchased.
- Accepting payments from debit and credit cards is different than accepting cash payments.
- Giving your customers time to pay for what they purchase is different than receiving payment when they purchase what you sell.
- Receiving cash before you provide what you sell is different than receiving cash after you provide what you sell.
- Making one payment for a one-year insurance policy is different than making twelve payments for a one-year insurance policy.
- Acquiring supplies that are stored in a cabinet is different than acquiring supplies that are immediately used.
This list is an extension of the list in my article titled “Using Economics in Your Financial Plans.” The list in that article focused on choices people face when creating their financial plans. The list is in the form of questions because answers are necessary in order to complete the financial plan. Before completing the financial plan the answers to the questions presented in my article about using economics require an understanding of how these choices will appear in the plan. The understanding begins with the list in this article
Understanding how the answers to questions in my article about using economics in financial plans is provided in accounting material. The most prominent form of material containing these answers is Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The material in GAAP and IFRS can be easy to interpret however there is content that may require assistance. People who aren’t versed in GAAP or IFRS can find assistance in order to apply this material in financial plans. Where is the assistance for applying GAAP or IFRS?
The answer is the expertise of an FP&A professional who can connect GAAP or IFRS to your financial plan. I describe financial planning as a process and this article provides insights into the second step of the process; my article about using economics is the first step of the process. An FP&A professional can assist in the second step by being a connection between the choices you make and the wealth you want to accumulate. The connection is a bridge between the choices you make and the wealth you want to accumulate.
A financial plan is about transactions. Transactions in a financial plan reflect the choices you make in order to accumulate wealth. So when you continue your process to create a financial plan you need to use an element that addresses the study of transactions and that element is accounting.