The 30 Day MBA (4 page)

You should draw up a timetable spread over the time period allocated for your 30-day MBA, say 12, 24 or 36 weeks. Then mark out the hours allocated for each subject, not forgetting to leave an hour or so to review each area. You will also need to build in a couple of days for revision before you take your final exam.

The subject areas within each chapter correspond to what you would find in the syllabus at major business schools in terms of theoretical underpinning and the practical application of that theory that you would pick up from fellow students.

You can find an appendix online (details below). You should visit this on a regular basis to ensure you have all the advantages that an MBA would hope for in terms of career progression. Here you will find out how to update your skills and knowledge by taking short courses at top business schools around the globe. The cost of these ranges from a few hundred pounds to several thousand and, by attending, you may well get onto the school's alumni list, plugging into a valuable business network in the process.

Tracking your progress

You will find a dozen short tests on the Kogan Page website (
www.koganpage.com/30DayMBA
). Use these to check your understanding of each subject. If there is anything you are not clear on, go back over the relevant chapters.

As a rough guide you should be aiming to get six out of every ten questions right. MBAs, unlike undergraduate degrees, don't come with grades. You either pass or fail. Also the ‘pass' mark can vary with the quality of those taking the exams. Read up on the normal distribution curve to see how this works.

1

Accounting

• Accounting conventions and principles
  
• The bookkeeping process
  
• Cash-flow forecasts and statements
  
• Calculating profit
  
• Balancing the books
  
• Finding financial facts
  
• Business ratios
  

S
ince the advent of the recent banking crisis, it has become evident that a key aspect of the catastrophic implosion of Lehman Brothers had, in part at least, been brought about by an accounting trick known in the trade as Repo 105. With the approval of their auditors, Ernst & Young (E&Y), Lehman managed to make US $50 billion (£32bn/€66bn) of debt invisible and in effect disappear from its balance sheet. This creative use of accounting is more or less the opposite of how the whole subject of accounting came into being.

Sometime before 3000
BC
the people of Uruk and other sister-cities of Mesopotamia began to use pictographic tablets of clay to record economic transactions. The script for the tablets evolved from symbols and provides evidence of an ancient financial system that was growing to accommodate the needs of the Uruk economy. There is detailed evidence that almost every country had some form of record keeping, from China to ancient Rome, where the heads of families maintained daily entry of household receipts and payments in an
adversaria
or daybook, and monthly postings were made to a cashbook known as a
codex accepti et expensi
. Accounting is the process of recording and analysing transactions that involve events that can be assigned a monetary value. By definition, financial information can be only a partial picture of the performance of an enterprise. People, arguably a business's
most valuable asset, don't appear anywhere in the accounts, except for football clubs and the like where people are the subject of a transaction.

Although accounting has become more complex, involving ever more regulations, and has moved from visible records written in books to key strokes in a software program, the purpose is the same:

• to establish what a business owns by way of assets;
  
• to establish what a business owes by way of liabilities;
  
• to establish the profitability, or otherwise, at certain time intervals, and how that profit was achieved.
  

Pacioli, about whom we will hear more in the bookkeeping section below, claimed wisely that ‘frequent accounting makes for long friendship'. But accounts must not only be timely, but should be reliable too, and no matter where accounting is studied you can be certain that the general principles will be universally applied.

An MBA is unlikely to be required to perform the recording side of the accounting process. But it is only by knowing how accounts are prepared and the rules governing the categorizing of assets and liabilities that you can gain a good understanding of what the figures really mean. For example, it is not obvious to the uninitiated that a company's shares are classed as a liability and that there is not the remotest possibility that the assets as recorded will realize anything like the figures shown in the accounts.

The rules of the game

Accounting is certainly not an exact science. Even the most enthusiastic member of the profession would not make that claim. There is considerable scope for interpretation and educated guesswork as all the facts are rarely available when the accounts are drawn up. For example, we may not know for certain that a particular customer will actually pay up, yet unless we have firm evidence that they won't, for example if the business is failing, then the value of the money owed will appear in the accounts.

Obviously, if accountants and managers had complete freedom to interpret events as they wished, no one inside or outside the business would place any reliance on the figures, so certain ground rules have been laid down by the profession to help get a level of consistency into accounting information.

Fundamental conventions

These are the enduring principles that govern the way in which the accounting profession assembles and presents financial information.

Money measurement

In accounting, a record is kept only of the facts that can be expressed in money terms. For example, the state of the managing director's health and the news that your main competitor is opening up right opposite in a more attractive outlet are important business facts. No accounting record of them is made, however, and they do not show up on the balance sheet, simply because no objective monetary value can be assigned to these facts.

Expressing business facts in money terms has the great advantage of providing a common denominator. Just imagine trying to add computer equipment and vehicles, together with a 4,000 sq m office, and then arriving at a total. You need a common term to be able to carry out the basic arithmetical functions, and to compare one set of accounts with another.

Business entity

The accounts are kept for the business itself, rather than for the owner(s), bankers, or anyone else associated with the firm. The concept states that assets and liabilities are always defined from the business's viewpoint. So, for example, were a business owner to lend his business money it would appear in the accounts as a liability, though in effect he might see it as his own money. Anything done with that money, say buying equipment, would appear in the accounts as an asset of the business. The owner's stake is accounted for only by the increase or decrease in net worth of the enterprise as a whole.

Cost concept

Assets are usually entered into the accounts as the cost at date of purchase. For a variety of reasons, the real ‘worth' of an asset will probably change over time. The worth, or value, of an asset is a subjective estimate on which no two people are likely to agree. This is made even more complex, and artificial, because the assets themselves are usually not for sale.

So in the search for objectivity, the accountants have settled for cost as the figure to record. It does mean that a balance sheet does not show the current worth or value of a business. That is not its intention. Nor does it mean that the ‘cost' figure remains unchanged forever. For example, a motor vehicle costing US $/£/€6,000 may end up looking like
Table 1.1
after two years.

TABLE 1.1
  
Example of the changing ‘worth' of an asset

The depreciation is how we show the asset being ‘consumed' over its working life. It is simply a bookkeeping record to allow us to allocate some of the cost of an asset to the appropriate time period.

The time period will be determined by factors such as the working life of the asset. The tax authorities do not allow depreciation as a business expense, so this figure can't be manipulated to reduce tax liability, for example. A tax relief on the capital expenditure, known as ‘writing down', is allowed, using a formula set by government that varies from time to time dependent on current economic goals, for example to stimulate capital expenditure.

Other assets, such as freehold land and buildings, will be revalued from time to time, and stock will be entered at cost, or market value, whichever is the lower, in line with the principle of conservatism (see later in this chapter).

Other methods for recording assets

While cost at date of purchase is the norm for accounting for assets in conventional enterprises, there are certain types of businesses and certain situations when other methods of recording a monetary figure are used:

• Market value: This is usually used when an asset is actually to be sold and there is an established market for that particular type of asset. This could arise when a business or part of a business is to be closed down.
  
• Fair value: This is described as the estimated price at which an asset could be exchanged between knowledgeable but unrelated willing parties who have not, and may not, actually exchange. This basis is often used in the due diligence process, where, because of particular synergies, a price higher than market value (resulting in goodwill) could reasonably be set.
  
• Market to market: This is where market value is calculated on a daily basis, usually by financial institutions such as banks and stockbrokers. This can result in dramatic changes in value in turbulent market conditions, requiring additional assets, including cash, to be found to cover a fall in market price. This approach is blamed for helping to create liquidity ‘black holes' by forcing banks to sell assets to meet liquidity targets, which in turn forces prices lower, requiring yet more assets to be sold.
  

Going concern

Accounting reports always assume that a business will continue trading indefinitely into the future – unless there is good evidence to the contrary. This means that the assets of the business are looked at simply as profit generators and not as being available for sale. Look again at the motor vehicle example above. In year 2, the net asset figure in the accounts, prepared on a ‘going concern' basis, is US $/£/€3,000. If we knew that the business was to close down in a few weeks, then we would be more interested in the car's resale value than its ‘book' value: the car might fetch only £2,000, which is quite a different figure.

Once a business stops trading, we cannot realistically look at the assets in the same way. They are no longer being used in the business to help generate sales and profits. The most objective figure is what they might realize in the marketplace.

Dual aspect

To keep a complete record of any business transaction we need to know both where money came from and what has been done with it. It is not enough simply to say, for example, that a bank has lent a business £1m; we have to show how that money has been used, for example to buy a property, increase stock levels, or in some other way. You can think of it as the accounting equivalent of Newton's third law: ‘For every force there is an equal and opposite reaction.' Dual aspect is the basis of double-entry bookkeeping (see below).

The realization concept

A particularly prudent sales manager once said that an order was not an order until the customer's cheque had cleared, he or she had consumed the product, had not died as a result, and, finally, had shown every indication of wanting to buy again. Most of us know quite different salespeople who can ‘anticipate' the most unlikely volume of sales. In accounting, income is usually recognized as having been earned when the goods (or services) are dispatched and the invoice sent out. This has nothing to do with when an order is received, how firm an order is or how likely a customer is to pay up promptly. It is also possible that some of the products dispatched may be returned at some later date – perhaps for quality reasons. This means that income, and consequently profit, can be brought into the business in one period and has to be removed later on.

Obviously, if these returns can be estimated accurately, then an adjustment can be made to income at the time. So the ‘sales income' figure that is seen at the top of a profit and loss account is the value of the goods dispatched and invoiced to customers in the period in question.

The accrual concept

The profit and loss account sets out to ‘match' income and expenditure to the appropriate time period. It is only in this way that the profit for the period can be realistically calculated. Suppose, for example, that you are calculating one month's profits when the quarterly telephone bill comes in. The picture might look like
Table 1.2
.

TABLE 1.2
  
Example of a badly matched profit and loss account

This is clearly wrong. In the first place, three months' telephone charges have been ‘matched' against one month's sales. Equally wrong is charging anything other than January's telephone bill against January's income. Unfortunately, bills such as this are rarely to hand when you want the accounts, so in practice the telephone bill is ‘accrued' for. The figure (which may even be absolutely correct if you have a meter) is put in as a provision to meet this liability when it becomes due.

Accounting conventions

These concepts provide a useful set of ground rules, but they are open to a range of possible interpretations. Over time, a generally accepted approach to how the concepts are applied has been arrived at. This approach hinges on the use of three conventions: conservatism, materiality and consistency.

Conservatism

Accountants are often viewed as merchants of gloom, always prone to take a pessimistic point of view. The fact that a point of view has to be taken at all is the root of the problem. The convention of conservatism means that, given a choice, the accountant takes the figure that will result in a lower end profit. This might mean, for example, taking the higher of two possible
expense figures. Few people are upset if the profit figure at the end of the day is higher than earlier estimates. The converse is never true.

Materiality

A strict interpretation of depreciation (see above) could lead to all sorts of trivial paperwork. For example, pencil sharpeners, staplers and paperclips, all theoretically items of fixed assets, should be depreciated over their working lives. This is obviously a useless exercise and in practice these items are written-off when they are bought.