The Value of Accounting

Since becoming a professional accountant, I have been asked on multiple occasions whether or not I believe accounting provides value to businesses. This is a question that should be asked and should be understood by all people associated with the business world. The simple answer is "Because the decision makers and investors think its valuable." A slightly longer answer is below.

To those unfamiliar with accounting, accountants seem to be nothing more than a nuisance, an unnecessary cost to businesses. And while it is true that we are a nuisance at times and a cost to businesses always, it is not true that we are unnecessary. The leaders of all successful, long term businesses rely on information provided by accountants or accounting software to make business decisions. Accounting tells the story (hopefully non-fiction) of the business to the decision makers. How will a CEO know that they need to outsource a certain job or duty unless they have accurate accounting information regarding that activity? How will they know if they need to make lay-offs? Or to expand? How will they know how much inventory to hold? Or to get rid of inventory altogether? All this information comes from accounting.

Accounting is similar to the central nervous system in the human body. How do you know not to get any closer to a fire? How do you know when you need to take a drink of water? or when you have stepped onto a sharp object? The nerves placed all around your body "provide information" to your brain. You are the ultimate decision maker and decide when, where and how to respond to this information. But, you would be dead without it. And just like humans, businesses would die without accounting information being provided to the decision makers of that business.

There are only 2 things that cause businesses to fail: 1) There is no demand for the business' products or services; and 2) Making poor business decisions. Accounting cannot help with the first cause, but is extremely important to the second cause. A businessman or businesswoman that does not include accounting information in their decision process is basically a human without a central nervous system. Very soon, they will be walking around with rusty nails stabbed through their feet and they will not know it until they have died from loss of blood or Tetanus has paralyzed their diaphragm and they suffocate.

Hopefully, this has made it quite clear as to why business leaders and investors are willing to spend billions upon billions of dollars on their CFOs, accountants, accounting software, auditors, tax consultants, accounting consultants, etc.

List of Accounting Estimates

The following areas may require estimates:

1) Inventory valuation (Excess & Obsolescence) and inventory reserves

2) Rebate Reserves

3) Income Taxes

4) Stock Options

5) Bonus Accruals

6) Warranty Accruals

7) Bad Debt Reserve

8) Litigation

9) Carrying Value of Intangibles

10) Restructuring Reserve

The New Way to "Retire"

For many Americans, retirement is simply a number. This number represents the amount of money that they must save up in order to pay their expenses from age 65 to the time they "kick the can". Many Americans believe that only by reaching this number will they achieve retirement. Obviously, this number varies depending on the individual's lifestyle. I just looked at ING's website and their advertisements of people who have found their number. Mary found her number to be $1,006,635. This is a complete joke. No human being needs that much money to retire at any age, let alone age 65.

What if I told you that a single individual could retire at the age of 40 with only $200,000. The following is one way that this could be done.

Take your $200,000 and buy yourself 4 houses. One for yourself, and 3 to rent out. If you don't believe that you can purchase four houses/condos/apartments/townhomes for under $200,000, just check out the Arizona and Nevada real estate markets. After buying all four homes outright in cash. You will have enough money coming in each month from your rental homes to "retire." Don't believe me? Here is your new budget.

Monthly Budget (made for a single person)
Rental Income from 3 homes: $2400
Mortgage:                              $0     (You owe nothing on your houses)
HOA Fees:                            $400 (All 4 houses may have HOA fees)
Food/Necessities:                  $300
Cell Phone:                            $100
Health Insurance:                    $200
Car Payment:                          $0     (Pay off that car loan)
Gas:                                       $300  (Think Toyota Corolla)
Car Insurance:                        $100
Utilities:                                  $300
Internet/Cable:                        $100
Other                                      $300 (Includes fun money, clothing, Christmas, birthdays, unexpected items)
Profit                                      $300

*I left out income taxes. Income taxes would be minimal on this amount of income per year.

Obviously, this budget is made for a single individual and it only satisfies their most basic needs. "Retiring" at 40 with a family may require you to buy 1-2 more rental homes to make enough money to cover their basic needs.

This is the new way to "retire". Cover basic needs by saving up money to buy assets that will produce cash consistently. We no longer need to spend our entire lives saving up money just to reach a "number".