
Financial Statements: A Beginner's Guide - refrigerator
https://www.causal.app/blog/whats-a-financial-statement
======
mmckelvy
For those still confused about Assets, Liabilities, Equity, Credits, and
Debits, let me see if I can give you a more intuitive primer:

Assets = Money you have. Liabilities = Money you borrowed from someone else.
Equity = Money you earned.

All the money you have you either (i) borrowed from someone else or (ii)
earned. In other words:

Assets (money you have) = Liabilities (money you borrowed) + Equity (money you
earned).

When recording a transaction all you have to do is ask yourself two questions:

1\. Where did the money come from? (what is the Source) 2\. Where did the
money go? (what is the Use)

Suppose you borrow $100 from a bank:

1\. Where did the money come from? -> you borrowed it from someone else, so
increase Liabilities by $100. 2\. Where did the money go? -> to your checking
account (money you have), so increase Assets by $100.

Adjustments to Source accounts (where money comes from) are Credits,
adjustments to Use accounts (where money goes) are Debits, so we could revise
the above statement to:

1\. Credit Liabilities $100 2\. Debit Assets $100

That's basically it. The rest is just breaking things down into sub accounts
(e.g. Assets:Checking or Equity:Income).

Hope that helps.

~~~
stevievee
This is a good overview in layman's terms - but as with most things it can get
much more complex.

e.g. deferred revenue is a liability and although close, it is technically not
really money that is borrowed. (It reflects services/goods owed)

~~~
mmckelvy
Instead of "borrowed" you could say "owed" as you state. The basic idea is it
represents money you have that you're on the hook for. Could be deferred
revenue, accounts payable, bank debt, etc. I say "borrowed" because that's a
concrete term that maps to a transaction with which most people are familiar.

I'd also argue that you can work through even the most complicated accounting
transaction and build the most complex financial statements by repeatedly
asking the questions I've outlined in the above framework. Accounting was
meant to be simple and accessible for the layman, but for some reason every
Accounting 101 class teaches things like "debit means left and credit means
right," which causes most people to throw up their hands and just rely on
bookkeepers and accountants for all things money related.

~~~
stevievee
Agreed and I still think it's a good primer to debits and credits on the
balance sheet

------
calderarrow
As a student, I really started to grokk accounting when I started thinking of
double-entry accounting as the business application of Newton's law "For every
action, there is an equal and opposite reaction." Whenever a change happens to
one side of the financial statements, an exact and simultaneous change happens
to the other side. Aggregated over a period of time, the financial statements
both categorize and summarize these various changes.

The rule that Assets = Liabilities + Equity is important because Liabilities
and Equity can be viewed as opposing forces. Notwithstanding the financial
engineering and nuance around debt, liabilities in their purest sense are a
balance of how much you've taken beyond what you've earned, while equity is a
measurement of how much you've earned beyond what you've taken. The assets
show what you have, but L&E show how everything was acquired.

As I get older, I've come to appreciate how accounting also serves as a prism
through which to view the world, because the financial concepts that apply to
billion dollar businesses also apply to small mom-and-pops and individuals.
One can think of themselves as a company, of which they are the CEO and sole
employee. They earn revenue (from a job), incur expenses, and may have
physical assets (homes, cars, computers) or liabilities (student/car/home
loans). Every decision that's made is financial in nature, and thinking about
decisions as an exchange of money or time helps me prioritize what I do
personally and professionally.

Accounting is a wonderfully beautiful system and I hope it becomes more common
knowledge because it is absolutely fundamental to living in our modern time.
The largest governments and businesses are bound by the same rules of
accounting, and so are we -- whether we are aware of it or not.

~~~
contingencies
_Classical economics is based on a false analogy with Newtonian physics._ \-
George Soros (paraphrased)

Double entry bookkeeping is nothing but an inefficient process hack for poor
historic record keeping systems. I would argue that double entry bookkeeping
has been significantly responsible for setting back popular fiscal literacy.

Stop worshipping at the altar of tradition!

~~~
abdullahkhalids
What other accounting frameworks exist, that are better than double-entry
bookkeeping at promoting fiscal literacy? Or perhaps easier to deal with or
understand for a layman?

For reference, I don't understand double-entry bookkeeping.

~~~
contingencies
Thanks for asking.

In the programming world typically we would use a signed value[0] instead of
separate ledgers[1] for debit and credit (ie. +$12 and -$11.50 within one
ledger, resulting balance +$0.50).

Whereas, in the traditional double entry world, you have two ledgers, one
called 'credit' and one called 'debit', BOTH with POSITIVE balances. You don't
know where you stand until you look at both and apply appropriate signs, then
make a total. This obviously can function and does make sense if you are used
to it, but is an artifact of ancient book-keeping practices and a perfect
basis for confusion in many cases. Especially since, on different days, you
might be the person on either side of the equation (ie. then credit becomes
your debit and debit becomes your credit, should you - for example - acquire a
competitor).

You could of course store things in any way you like and present them
differently, but there's no need to TALK and THINK about them jumping through
such pointless logical hoops. (Many philosophers, writers, linguists,
mathematicians and programmers have explained the value of concise and
explicit language as a boon for clarity of thinking.)

You can model transactions between entities as a directed graph[2], allocating
each transaction a unique identifier. In this way, the 'credit' or 'debit'
nature of each transaction is no longer the property of "where you are looking
from" (subjective property), but rather objectively associated with the source
and destination nodes for that transaction in the directed graph.

I believe these approaches promote fiscal literacy because: (A) Everyone with
basic mathematical comprehension understands the meaning of + and -. (B) Using
common language instead of professional vocabulary reduces the chances for
misunderstanding and thus fraud. (C) Maintaining a common ledger for credit
and debit (positive and negative value) transactions means they are always
sorted through time which is probably our most basic intuitive sense of record
as humans. (D) We should always be suspicious of appeals to authority, and the
professional vocabularies and self-auditing professional societies in which
they congregate, which generally turn out to be the inertia-driven self-
interest groups of dynastic rent seeking. (E) Objective and explicit record
keeping is good practice. (F) The "whole picture" (all transactions) is a
clearer and more logical default intellectual scope than the "half picture"
(only credit, or only debit transactions).

Using these tools you can model transactions in any economy, whereas using
double entry bookkeeping you will encounter increasing issues when modeling
multi-party transactions, multi-hop transactions, multicurrency transactions
(traditional double entry book keeping systems utilize a single currency per
ledger), etc.

For further observations and thoughts along these lines see IFEX.[3]

[0]
[https://en.wikipedia.org/wiki/Signedness](https://en.wikipedia.org/wiki/Signedness)
[1]
[https://en.wikipedia.org/wiki/Ledger](https://en.wikipedia.org/wiki/Ledger)
[2]
[https://en.wikipedia.org/wiki/Directed_graph](https://en.wikipedia.org/wiki/Directed_graph)
[3] [https://raw.githubusercontent.com/globalcitizen/ifex-
protoco...](https://raw.githubusercontent.com/globalcitizen/ifex-
protocol/master/draft-ifex-00.txt)

~~~
hnick
I thought a major argument for double-entry bookkeeping was for error
detection and correction/auditing. Was I mistaken? It was sold to me like that
many years ago.

We have technology that will help with that (signing, hashes, parity bits,
blockchain, etc) but none of that matches the simplicity of a notepad in a
desk at a local takeaway store.

~~~
contingencies
Yes, that's the classic argument. However, it is quite irrelevant today, where
human error and time are both stupendously more expensive than precise record
keeping executed by software in the first place.

The tools you mention are tangential to this: signatures are for non-
repudiation and authenticity, hashes are for checksums, parity is for self-
repair in bad checksum cases (rarely used in application level software
today), and blockchains are for distributed trust (eg. distributed ledgers),
essentially providing the combined properties of signatures and hashes to a
shared database in a distributed system over time.

Note that all depend on the input of valid data in the first place, and none
can be efficiently applied to a manually written notepad.

------
EvanAnderson
I think at least a 100-level knowledge of bookkeeping is beneficial to nearly
every developer. Bookkeeping is, arguably, one of the oldest and longest-
practiced "data processing" disciplines. It seems arbitrary and somewhat old-
fashioned until you grok the reasoning and history behind it (double-entry
sourced from summaries of various different "journals" to facilitate
separation of duties, closing periods and rolling-up detail entries into
totals because human computational power is limited, an equation that balances
implicitly when there aren't entry errors, etc.)

Odds are that your work somehow impacts the revenue or expenses of your
business and will need to interface with accounting or finance people at some
point. I found it increased my perceived credibility when I could speak using
terminology from the accounting or finance person's area of expertise.

I also agree with other posters who would argue that everyone should have some
basic proficiency in double-entry bookkeeping. That's probably way too
optimistic, though.

------
tlcba
The double entry for purchasing raw materials would be the other way round: Dr
Materials; Cr Cash.

Cash is an asset so debiting it would increase your cash balance. Likewise,
Materials is an expense code in the P&L and debiting it will show it as a
cost. You would only credit to the P&L for income transactions.

~~~
refrigerator
(author here) Thanks for raising this — I intended for that example just to
illustrate the underlying concept of having balanced entries for a
transaction, rather than to show how double entry is practiced today.

The focus of the post is on the underlying concepts rather than the
implementation details — I didn't want to introduce the whole thing about
debiting assets vs debiting expenses etc because it's a little confusing for a
lay person.

Hope that makes sense. I've added a caption to the image explaining this.

~~~
abakker
I don't think this is a useful response. The concept of accounting is deeply
integrated with the rules of accounting. The implementation details _are_ the
concepts, really. I'd suggest making the examples conform to the actuality of
how accounting will get used.

~~~
kqr
I agree. Basic pedagogy: if you are about to introduce an example where you
think you might have to choose between being truthful or confusing, you should
not introduce that example. Or, if you have to, do it the confusing way.

Lying to beginners to shield them from confusion does not help them. Find a
way to do what you want to do while still telling the truth.

~~~
ricopags
Do you mean, if you have to, do it the truthful way?

------
kqr
To people who haven't tried keeping track of their personal finances using
double-entry bookkeeping, I strongly recommend it.

It's not just about reducing error (although it does that really well too.)
It's also about increasing transparency, for two reasons: it makes many things
explicit that would otherwise be easy to hide, perhaps by accident; it also
provides very strong support for querying your finances in various ways.

Whenever I'm budgeting for something (a project among friends, the wedding
with my wife, and so on) I always try to start out "simpler" but I also always
end up doing something like double-entry bookkeeping because all other
"simpler" solutions make it very hard to figure out where money is actually
coming from and where it is going.

This is as good a place as any to start:
[https://plaintextaccounting.org/](https://plaintextaccounting.org/)

~~~
Metus
Could you expand on the benefits of double-entry bookkeeping, beyond reducing
errors?

Personally I am looking into it, because the run-of-the-mill personal finance
software applications can't even deal with the fact that paying off a credit
card statement is not income and expense, but a mere change between assets and
liabilities. Or buying some stock is not an expense, but a change between two
types of assets. And so on.

However, the run-of-the-mill software is a bit better with categorizing things
and integrating with other applications. Currently, I am looking for

\- Connecting PDFs or images as invoices with transactions

\- Marking transactions as relevant for my tax income statement

\- Estimating my tax return in advance

and some more I can't think of off the top of my head. What weirds me out, is
that _everyone_ has to deal with personal finances, yet there isn't a single
personal finance app that deals with everyone's situation. Do I massively
underestimate the complexity of the problem domain?

~~~
jkhdigital
I think the issue is that there is only a small minority of consumers who (1)
care enough and are knowledgeable enough to want to micromanage their
finances, and (2) aren't wealthy enough to just pay a CPA to handle it.

I am definitely in that minority, and use GnuCash since I can tap directly
into the database backend and automate whatever I want. I do a lot of complex
cryptocurrency arbitrage trading, which of course requires "real" accounting
to determine profit/loss. I'm also very, ahem, "creative" with my credit cards
and like to take advantage of various offers and hacks to get low- or no-
interest liquidity. Double-entry bookkeeping is absolutely essential to
ensuring that I'm not just wasting money on all my complicated financial
maneuvers, as well as seeing where and when I need to move my cash.

~~~
kqr
I think you're missing a category (3) people who have no reason to micro-
manage their finances but rather use double entry accounting to keep track of
where things äre coming from and going to on a rather high level. That's where
I fit in.

------
Havoc
Looks pretty solid to me.

The part about brands and patents being treated as an expense is wrong though

Even stuff like website development cost can be capitalized as an asset under
some circumstances

[https://www.ifrs.org/issued-standards/list-of-
interpretation...](https://www.ifrs.org/issued-standards/list-of-
interpretations/sic-32-intangible-assets-web-site-costs/)

~~~
jsmith99
To be pedantic, although most intangible assets can be capitalised, IFRS does
not allow capitalisation of internally generated brands. If you buy a company
then you can capitalise any brands you obtain on acquisition.

Development expenditure on patents can be capitalised only in certain
circumstances.

------
strife25
"These backwards-looking representations aren't terribly useful when thinking
about the future. Financial statements now account for only 5% of the
information that investors use to evaluate companies, and key accounting
metrics, like Earnings and Assets, have stopped correlating with stock prices.
To fill these gaps, almost all companies report custom non-GAAP metrics in
their financial reports, to paint a better picture of their business. WeWork
famously defined a Community Adjusted EBITDA metric that ignored most of their
costs to suggest that they were actually, sort of, profitable. You can decide
for yourself whether WeWork's metrics made sense. But that's precisely the
problem — without consistent standards, "creative accounting" can cloud our
judgment and our economy suffers."

This has been a topic i've been curious about for a while now - if the way
business performance is measured has changed, why have the standards not
evolved as well?

~~~
iav
Accounting standards do change all the time. Enron forced a change in how
variable interest entities are treated. Rise of multi national conglomerates
added comprehensive income accounting to account for FX. Most recently, rise
of SaaS changed the way revenue and costs are accrued for multi year
contracts.

The debate is what is the point of accounting standard - is it to calculate
standardized figures like revenue and earnings in the most consistent way
possible across all industries? Or is it to splinter the accounting world by
adding a myriad of industry specific terms like “subscribers” and “churn” and
even “EBITDA” that only apply to some companies but not all? I prefer the
former but it’s a debated topic.

------
drapery
I like this and explains the basic mechanics in a simple way for me to
understand.

I want to highlight the What counts as revenue section because I think it is
the most crucial. Deferred Revenue is well explained and very necessary for
SaaS. I think it will also be good to highlight account receivables, where you
have delivered the good but haven't received the cash. Even though this rarely
occurs in a SaaS model, but it is important to state that account receivable
is not revenue, which some awkward mistake can be easily made.

~~~
kqr
> I think it will also be good to highlight account receivables, where you
> have delivered the good but haven't received the cash. Even though this
> rarely occurs in a SaaS model

Hah! You'd be surprised at how much businesses suck at paying their bills. And
it's not really customer friendly to shut them off either.

As far as I know, huge amounts in accounts receivable is industry standard.

~~~
drapery
You mean account payable?

------
rebolyte
Nice overview. Khan Academy[1] actually has some resources on the basics of
financial statements as well.

[1]: [https://www.khanacademy.org/economics-finance-domain/core-
fi...](https://www.khanacademy.org/economics-finance-domain/core-
finance/accounting-and-financial-stateme)

------
pinky07
Another good, and dynamic, introduction to accounting, with examples of
entries for all documents:
[https://www.odoo.com/documentation/functional/accounting.htm...](https://www.odoo.com/documentation/functional/accounting.html)

------
pjungwir
For another light but slightly more in-depth introduction, you might enjoy
_Financial Statements_ by Thomas Ittelson. It uses running an applesauce
factory as an ongoing example throughout the book. As a programmer with no
accounting/finance background, I found it very easy to follow.

------
injb
So if

Assets - Liabilities = Shareholders Equity

Then

Liabilities & Equity = Assets

So why are there separate totals (showing the same amount) for "Assets" and
"Liabilities & Equity", if they are by definition the same thing?

~~~
refrigerator
(author here) I think it’s just as a sanity check to make sure they’re equal
:)

~~~
jsmith99
Yes, that's why it's called a Balance Sheet because it shows that net assets =
equity, meaning it 'balances'.

------
dharma1
I really liked causal.app when I tried it briefly. Nice way to build
interactive dashboards from spreadsheets, with a range of outcomes - and they
have some excellent templates

------
every
I was thrown into the deep end of the bookkeeping pool when I began managing
an establishment owned by three CPA's. It proved to be a valuable and highly
transferable skill that served me throughout my working life...

------
victor106
Any recommendations on books/resources to learn accounting?

------
mdszy
"Every month a notable company goes public. Every week a hot startup raises
millions of dollars. And every day moms, pops, and teens check on their
stocks."

"Once the shoeshine boy and the taxi driver offer stock tips, it’s time to
sell."

