Accrual accounting attempts to match revenues and expenses to the time periods in which they are accrue, as opposed to the time when they are paid. For example, a machine might be purchased in one year and have a productive life of ten years. Rather than “expense” the cost of the machine during the year of its purchase, the company will accrue the expense of the machine over its expected life. With accrual accounting, the expense of the machine is matched to the ten years of its use by expensing a fraction of the machine’s total cost each year as it slowly “depreciates.”
For the bookkeeper, accrual accounting means that a single large expense transaction, such as the purchase of a machine, is recorded not once when it occurs, but many times as fractions of the total expense are “matched” to a time periods of the machine’s life. The machine with a useful life of ten years, purchased at, let’s say, $100,000.00, could be expensed as a cost of $10,000.00 per year over its ten year life (this assumes straight-line depreciation and no salvage value). At the end of the ten years, the total expense of the machine, the $100,000.00, will have been fully expensed.
If the company only reports its expenses once a year, each year of the machine’s life will cause the bookkeeper to enter one transaction recording the $10,000.00 expense for that year’s depreciation. On the other hand, if the company wants its financial information to be more current, it might report its expenses on a quarterly basis. Since there are four quarters in a year, there would be forty quarters in the ten-year life of the machine. The bookkeeper would then have to produce forty accrual entries for the gradual depreciation of the machine, one expense entry of $2,500.00 for each quarter of the machine’s life. This quarterly reporting schedule has all of the advantages of the annual schedule in that, if someone wants to know the amount of depreciation for the whole year, they can simply ask a computer to sum all of the accrued expenses for the four quarters of the year. The arithmetic operation of addition is quite easy for a modern computer.
If we take this reporting schedule even further to provide daily reports to our information-starved executives, we need to produce accrual transactions each day of the ten-year period. This is possible with modern automation because the bookkeeping labor can be automated, allowing the entries to occur automatically each night of the machine’s life.
A daily accrual schedule offers the company the advantage of having an accurate daily expense report (and therefore, accurate daily earnings and balance sheets). In addition, the computation of the amount of accrual for a quarter or year can be accomplished by simply summing the appropriate daily accrual entries.
Most importantly, with daily accruals, a clever financial analyst could produce reports for particular weeks, months, or even sales periods without regard for any rigid fiscal reporting schedule. By having a busy executive simply enter the beginning and ending points of time, a computer program should be able to produce complete financial information about the intervening period.
Wednesday, July 30, 2008
Tuesday, July 29, 2008
13. Daily Account Balances
In the preceding post, the production of a trial balance on a daily basis was proposed. By simply using the power of the computer to add a few numbers together, a complete trial balance should be available as soon as the business transactions are recorded. It was also shown how to-date earnings and other information could be produced at little or no cost from this trial balance.
A trial balance, however, has the formality of being part of the official quarterly report preparation process and, since we are just trying to get critical information quickly to the company’s executives, we get dispense with formalities and just talk about producing real information on a real-time basis. Balance sheets, trial balances, and income statements aren’t as important as the information contained in them, and we can produce that information as easily as the dashboards in our car produce current information about speed and mileage. There is no reason why every detail of a company’s financial data could not be made available to corporate leaders on a daily basis.
The general ledger is made up of accounts; each account has entries in it that represent deposits (debits) or withdrawals (credits); and each account has a balance that represents the sum of the deposits and withdrawals. The account balances of the general ledger are really all that is needed to easily produce the information found in the formal GAAP reports.
Because this is the twenty-first century, we can assume that the general ledger is automated and that the entries in each account are recorded by a program. As easy as it is for the program to record the entry, it can also keep the running balance of the account, adding a ten dollar debit entry could automatically update the running balance ten dollars in the debit direction. An automated running balance means that the balance of every account in the General Ledger (representing all of the financial data in the company) is available to us as quickly as the data is posted.
This means that for any company large enough to have its bookkeeping on a machine of laptop power or greater, the account balances should be always available. The account balances are the details of the trail balance that was discussed in the previous post, so we are essentially where we were in the previous post, having the ability to present all of the critical GAAP quarterly report information to executives on a daily basis (see previous post).
More essentially, it can be shown that if we have the account balances available to us, it is simply a matter of grammar school arithmetic to produce totals of assets, liabilities, revenues, expenses, and earnings (revenues less expenses).
Quarterly reports can be converted into real-time dashboard information by simply performing trivial arithmetic on the ledger account balances that should be available and current at any point in time. Greater sophistication can be made real-time by making accrual entries daily (this will be the subject of a later post).
A trial balance, however, has the formality of being part of the official quarterly report preparation process and, since we are just trying to get critical information quickly to the company’s executives, we get dispense with formalities and just talk about producing real information on a real-time basis. Balance sheets, trial balances, and income statements aren’t as important as the information contained in them, and we can produce that information as easily as the dashboards in our car produce current information about speed and mileage. There is no reason why every detail of a company’s financial data could not be made available to corporate leaders on a daily basis.
The general ledger is made up of accounts; each account has entries in it that represent deposits (debits) or withdrawals (credits); and each account has a balance that represents the sum of the deposits and withdrawals. The account balances of the general ledger are really all that is needed to easily produce the information found in the formal GAAP reports.
Because this is the twenty-first century, we can assume that the general ledger is automated and that the entries in each account are recorded by a program. As easy as it is for the program to record the entry, it can also keep the running balance of the account, adding a ten dollar debit entry could automatically update the running balance ten dollars in the debit direction. An automated running balance means that the balance of every account in the General Ledger (representing all of the financial data in the company) is available to us as quickly as the data is posted.
This means that for any company large enough to have its bookkeeping on a machine of laptop power or greater, the account balances should be always available. The account balances are the details of the trail balance that was discussed in the previous post, so we are essentially where we were in the previous post, having the ability to present all of the critical GAAP quarterly report information to executives on a daily basis (see previous post).
More essentially, it can be shown that if we have the account balances available to us, it is simply a matter of grammar school arithmetic to produce totals of assets, liabilities, revenues, expenses, and earnings (revenues less expenses).
Quarterly reports can be converted into real-time dashboard information by simply performing trivial arithmetic on the ledger account balances that should be available and current at any point in time. Greater sophistication can be made real-time by making accrual entries daily (this will be the subject of a later post).
12. Daily Balance Sheet
In the preceding post, I proposed, as a thought experiment, the daily closing of the books, allowing for a computation of the earnings reports on a daily basis. Let us extends that thought experiment a little further and propose that a balance sheet, summarizing the financial position of the company, be produced on a daily basis.
With modern automation, all of the arithmetic of producing a balance sheet should take only moments and be relatively costless. It can be set to go off automatically, immediately after all of the day’s transactions are posted. To make the job easier, let us propose that we do not even have to close the books to prepare the balance sheet. We can, for example, obtain our up-do-date financial position from a daily “trial balance.”
The trial balance will give us an intact summary of critical parts of our financial position. For example, directly from the trial balance, before any accounts are closed, we can obtain the amount of the assets broken down by category. An accurate summary of all liabilities would also be available directly from the trial balance. What would be missing from the trial balance would be earnings information. For the earnings data to be directly in our balance sheet the closing operations would normally be performed, turning our trial balance into a true balance sheet.
However, our daily trial balance would include the balance of every account in the ledger and a complete and accurate earnings summary could be produced in milliseconds by simply adding the balances of the revenue and expense accounts together. Therefore, in effect, our trial balance could produce all of the information in a true balance sheet as well as the earnings data normally found in the income statement, without the closing of the books.
In summary, all of the data found in quarterly reports could be generated on a daily basis by simply summing the balance of each account and putting it into a trial balance. This, of course, could be done without closing the books. The key to producing real-time financial data in the age of automation is to simply allow a trivial computer program to perform addition on ledger accounts each night as soon as the day’s transactions are recorded.
With modern automation, all of the arithmetic of producing a balance sheet should take only moments and be relatively costless. It can be set to go off automatically, immediately after all of the day’s transactions are posted. To make the job easier, let us propose that we do not even have to close the books to prepare the balance sheet. We can, for example, obtain our up-do-date financial position from a daily “trial balance.”
The trial balance will give us an intact summary of critical parts of our financial position. For example, directly from the trial balance, before any accounts are closed, we can obtain the amount of the assets broken down by category. An accurate summary of all liabilities would also be available directly from the trial balance. What would be missing from the trial balance would be earnings information. For the earnings data to be directly in our balance sheet the closing operations would normally be performed, turning our trial balance into a true balance sheet.
However, our daily trial balance would include the balance of every account in the ledger and a complete and accurate earnings summary could be produced in milliseconds by simply adding the balances of the revenue and expense accounts together. Therefore, in effect, our trial balance could produce all of the information in a true balance sheet as well as the earnings data normally found in the income statement, without the closing of the books.
In summary, all of the data found in quarterly reports could be generated on a daily basis by simply summing the balance of each account and putting it into a trial balance. This, of course, could be done without closing the books. The key to producing real-time financial data in the age of automation is to simply allow a trivial computer program to perform addition on ledger accounts each night as soon as the day’s transactions are recorded.
Monday, July 28, 2008
11. Daily Closings
Let’s consider the idea of closing the general ledger on a daily basis. I propose this idea as a thought experiment only, intended to open minds to new ideas and perhaps provoke further discussion. This is not suggested as the optimal solution on maximizing financial information available to corporate decision-makers
The closing of the books involves summing up the so-called “temporary accounts” (revenue, expense, and dividend accounts) and transferring their balances to the retained earnings account. This is typically done at the end of a business period, allowing the bookkeeper to determine the earnings for the period and leaving these temporary accounts with a zero balance to begin the next period accumulating new earnings data.
Since most corporations use the closing operations to prepare their income statement and other periodic reports, the closing operations determines the reporting period. Valid reports are only available after the period’s closing operations and the only reported metrics available are for the period itself. It is hard to imagine how important financial information is reported in such a limited and rigid manner in today’s age of automation, but the method was designed in the middle ages when addition was done with beads and the practice has been dogmatically accepted as necessary regardless of the mounting evidence of its archaic absurdity.
If we choose to continue the process of closing the books before preparing the reports, let us now consider amplifying the amount of information available and increasing its timeliness by closing the books every day and then producing earnings reports for each day.
Since we are working with computers, the closing operations can be easily automated to kick-in at midnight each day and run at little or no cost to the company to summarize the day’s activity. This means that every day the people who run the company could have daily earnings statements as well as more detailed reports on specific types of revenues and expenses. The effects of marketing plans, weekend sales, and work interruptions could be easily gauged just as they happen, allowing the alert helmsman to adapt his company by quickly making necessary corrections and adjustments.
But, if the temporary accounts begin each day with a zero balance, how would a company ever be able to produce a quarterly earnings report? Simple, the earnings for one week is the sum of the earnings for each day of that week; the earnings for a given month is the sum of the earnings for each of its days; and the earnings for a quarter can easily be produced by summing the appropriate daily reports.
Therefore, there is no reason why account closing must await the end of a fiscal period. For the company unwilling to forego the whole wasteful process of closing the books, the process of doing daily closes is a simple way of freeing financial information from the limitations of a rigid fiscal period.
The closing of the books involves summing up the so-called “temporary accounts” (revenue, expense, and dividend accounts) and transferring their balances to the retained earnings account. This is typically done at the end of a business period, allowing the bookkeeper to determine the earnings for the period and leaving these temporary accounts with a zero balance to begin the next period accumulating new earnings data.
Since most corporations use the closing operations to prepare their income statement and other periodic reports, the closing operations determines the reporting period. Valid reports are only available after the period’s closing operations and the only reported metrics available are for the period itself. It is hard to imagine how important financial information is reported in such a limited and rigid manner in today’s age of automation, but the method was designed in the middle ages when addition was done with beads and the practice has been dogmatically accepted as necessary regardless of the mounting evidence of its archaic absurdity.
If we choose to continue the process of closing the books before preparing the reports, let us now consider amplifying the amount of information available and increasing its timeliness by closing the books every day and then producing earnings reports for each day.
Since we are working with computers, the closing operations can be easily automated to kick-in at midnight each day and run at little or no cost to the company to summarize the day’s activity. This means that every day the people who run the company could have daily earnings statements as well as more detailed reports on specific types of revenues and expenses. The effects of marketing plans, weekend sales, and work interruptions could be easily gauged just as they happen, allowing the alert helmsman to adapt his company by quickly making necessary corrections and adjustments.
But, if the temporary accounts begin each day with a zero balance, how would a company ever be able to produce a quarterly earnings report? Simple, the earnings for one week is the sum of the earnings for each day of that week; the earnings for a given month is the sum of the earnings for each of its days; and the earnings for a quarter can easily be produced by summing the appropriate daily reports.
Therefore, there is no reason why account closing must await the end of a fiscal period. For the company unwilling to forego the whole wasteful process of closing the books, the process of doing daily closes is a simple way of freeing financial information from the limitations of a rigid fiscal period.
Wednesday, July 23, 2008
10. Financial History
The financial history of a company is potentially its primary source of business information. It can easily be expanded to provide more information on a much timelier basis. It even can be used to formally measure the rates of change that are occurring in the company (true “financial calculus”).
However, before the financial history of the company can be a truly useful tool for investors and managers, it needs to be unfettered from the constraints of the traditional accounting model. Today’s accounting is limited by its attachment to the fiscal period and its inability to adapt itself to the specific informational needs of the company. Neither of these limitations is necessary in the age of the ubiquitous computer.
We need to rediscover the fundamental information of a company’s financial history – the record of simple transactions in the bookkeeper’s journal. By exploiting this information in its fundamental form, a company can use its experience of the past as a powerful analytical tool that will guide it and its investors into the future. See Banking the Past, page 218.
However, before the financial history of the company can be a truly useful tool for investors and managers, it needs to be unfettered from the constraints of the traditional accounting model. Today’s accounting is limited by its attachment to the fiscal period and its inability to adapt itself to the specific informational needs of the company. Neither of these limitations is necessary in the age of the ubiquitous computer.
We need to rediscover the fundamental information of a company’s financial history – the record of simple transactions in the bookkeeper’s journal. By exploiting this information in its fundamental form, a company can use its experience of the past as a powerful analytical tool that will guide it and its investors into the future. See Banking the Past, page 218.
Thursday, July 17, 2008
9. The Journal
The journal, the accountant’s “book of original entry,” is the chronological record of the financial events of the business. The events, referred to as transactions, are recorded in the journal as a financial quantity and the relationships that this quantity has components of the company. Within the journal, all of the data that is every used by accountants is recorded in one place. Everything other piece of data in the financial world is simply a copy or a summation of the data found in the journal.
From the primitive information found in the journal, accounting is able to generate new information that tells managers and investors:
1. The total income that was made by the business in a new given time period;
2. The total assets and liabilities of the business at a given point in time;
3. The flow of the company’s cash assets during a given time period;
4. The relative growth of the business during a given time period.
Given a journal, and no general ledger, an automated program is able to produce all of the data used in financial analysis. And, without the burden of a general ledger, the journal can produce this information for any arbitrary period of time.
See Banking the Past, page 43.
From the primitive information found in the journal, accounting is able to generate new information that tells managers and investors:
1. The total income that was made by the business in a new given time period;
2. The total assets and liabilities of the business at a given point in time;
3. The flow of the company’s cash assets during a given time period;
4. The relative growth of the business during a given time period.
Given a journal, and no general ledger, an automated program is able to produce all of the data used in financial analysis. And, without the burden of a general ledger, the journal can produce this information for any arbitrary period of time.
See Banking the Past, page 43.
8. The Virtual Fiscal Period
We measure business success by unit of time. Earnings and cash flow, for example, are a business’s most important measures of success and they can be expressed meaningfully only as amounts per quarter, month, year, or some other unit of time. Business is an activity and its failure or success can only be measured by the rate of activity through a period in time.
The activity of a business expands and contracts from year to year, quarter to quarter, and even day to day, however, the critical financial measures of a company’s activities is currently only available on a quarterly basis. This schedule of measurement does not allow the company to gain insight about the effects of sales and marketing campaigns, for example, which occurred during certain weeks of that quarter. Determining which weeks were the best during the quarter, or which days of the week brought the best revenues, or how much better revenues were during a particular campaign, are all critical pieces of business information that are typically not available to a company. Financial reporting is limited to a fixed fiscal period and the only unit of time that can be report on is the company’s official fiscal period (typically a three month quarter).
Almost important as the rigidity of measurable time unit is the delay in reporting. While decision-makers are desperate for information, they must often wait months for a report on the company’s earnings and cash flow to help guide them in allocating resources.
This critical limitation of financial reporting by time unit is simply not necessary and is a product of a reporting technique that is five-hundred years old and was designed to assist the manual bookkeeper who worked with quill and parchment and without the assistance of even a slide-rule. In today’s computer age, earnings can be speedometer on an executive’s dashboard that is providing him with a real-time view on the activity of the business and the changes that they are causing.
A company’s dependence upon a rigid quarterly report is based upon the use of database known as the general ledger that performs the simple algorithm of sorting transactions so that an ancient bookkeeper can manually perform addition upon the transactions that affect each account. This sorting can be done in seconds with the modern computer and the general ledger can now be a simple algorithm that provides, upon demand, the same information as the stored database (see the previous post where this algorithm is referred to as a Virtual General Ledger).
As a process, rather than a stored database, the virtual general ledger can produce earnings and cash flow statements for any day, month, year, or other period of time that the user is interested in (he can produce fiscal periods from deep in the past as well as to the current moment). In other words, the virtual general ledger provides the business executive with a perfectly accurate virtual fiscal period.
See Banking the Past.
The activity of a business expands and contracts from year to year, quarter to quarter, and even day to day, however, the critical financial measures of a company’s activities is currently only available on a quarterly basis. This schedule of measurement does not allow the company to gain insight about the effects of sales and marketing campaigns, for example, which occurred during certain weeks of that quarter. Determining which weeks were the best during the quarter, or which days of the week brought the best revenues, or how much better revenues were during a particular campaign, are all critical pieces of business information that are typically not available to a company. Financial reporting is limited to a fixed fiscal period and the only unit of time that can be report on is the company’s official fiscal period (typically a three month quarter).
Almost important as the rigidity of measurable time unit is the delay in reporting. While decision-makers are desperate for information, they must often wait months for a report on the company’s earnings and cash flow to help guide them in allocating resources.
This critical limitation of financial reporting by time unit is simply not necessary and is a product of a reporting technique that is five-hundred years old and was designed to assist the manual bookkeeper who worked with quill and parchment and without the assistance of even a slide-rule. In today’s computer age, earnings can be speedometer on an executive’s dashboard that is providing him with a real-time view on the activity of the business and the changes that they are causing.
A company’s dependence upon a rigid quarterly report is based upon the use of database known as the general ledger that performs the simple algorithm of sorting transactions so that an ancient bookkeeper can manually perform addition upon the transactions that affect each account. This sorting can be done in seconds with the modern computer and the general ledger can now be a simple algorithm that provides, upon demand, the same information as the stored database (see the previous post where this algorithm is referred to as a Virtual General Ledger).
As a process, rather than a stored database, the virtual general ledger can produce earnings and cash flow statements for any day, month, year, or other period of time that the user is interested in (he can produce fiscal periods from deep in the past as well as to the current moment). In other words, the virtual general ledger provides the business executive with a perfectly accurate virtual fiscal period.
See Banking the Past.
Wednesday, July 16, 2008
7. The Virtual General Ledger
Each of the Entries made in the Journal must be posted twice in the Ledger, one
to the debit and the other to the credit.
Luca Paciolo, Particularis de Computis et Sripturis
The general ledger, or just “ledger,” is made up of a set of accounts, each account representing a source or destination of resource flows within a company’s accounting system. The information in each account is a repetition of the information that has already been recorded in the accountant’s journal. The duplication of information in the general ledger allows the balances of each account to being manually computed. By copying the amounts of each transaction into the account that it is related to, the human bookkeeper needs to only go to the account to be balanced and add up the sums recorded therein.
For example, a transaction is first recorded in the journal with a note that the transaction has a credit (source) effect upon the revenue account and a debit (destination) effect upon the cash account. After this initial recording, the details of the transaction’s record is “posted” to the general ledger by copying the transaction amount to the credit column of the revenue account and then copying the same amount to the debit column of the cash account. When the bookkeeper wants to find the balance of any account, he adds up its debit column and its credit column and the difference between the two sums is the account’s balance (the net balance can be a debit balance or a credit balance, depending upon which sum was greater).
However, using the fundamental principles of software engineering, the general ledger should be an algorithm, a series of steps that are performed by a computer program, rather than a separate database containing data that is already recorded in the journal. The reasons supporting this statement include the following:
1. The general ledger helps with the manual computation of balances; it serves no similar purpose for automated computation.
2. Duplicating the same information in more than one place violates the most fundamental principles of information design (keeping backups of data on tape and other media is not relevant to this argument).
3. The finding of an account balance is a matter of first sorting and then summing data. The traditional general ledger performs the function of the sorting part of this process. Modern computers can do this sorting almost instantaneously and without cost. Therefore, to have the data in a pre-sorted state is of no economic value. Determining account balance is efficiently a simple algorithm that first sorts and then sums.
4. The maintenance of a general ledger as a separate database performs no other function on the computer than to place an artificial boundary upon the data, limiting its availability in both time and semantics. The general ledger limits the data to the time of a single fiscal period and it limits the various ways that the data can be correlated with other dimensions of the transaction, such as business units, products, customers, etc. (this will be detailed in the next post here).
The general ledger should be, by this analysis, virtual data. Modern accounting practices should use the power of the automation to make the general ledger a Virtual General Ledger, implemented as a program that sorts and sums the data already stored in a powerful database.
See Banking the Past.
Monday, July 14, 2008
6. The On-Demand Cash Flow Statement
The cash account should always have a debit balance or be equal [zero balance].
Otherwise, the account will be in error.
Luca Paciolo, Particularis de Computis et Scripturis
The Cash Flow Statement is nothing more than a summary of activity in the company’s cash account. It summarizes how the cash account was debited and credited by the company’s operating, investing, and financial activities during a particular period of time. The debits are referred to as “input” in the report while the credits are therein referred to as “output.”
Typically, a Cash Flow Statement, like an Income Statement, summarizes activity for a particular fiscal period. However, unlike the Income Statement, the Cash Flow Statement does not require that the company’s books be closed before its preparation. This means that, although the Cash Flow Statement summarizes a time period, it is not locked into the constraints of a fixed fiscal period such as the Income Statement is. A Cash Flow Statement could, theoretically, be prepared at any time without the closing of the books and the use of temporary accounts that exist only for the company’s fiscal period.
The Cash Flow Statement could be prepared on a weekly, monthly, or even daily basis. The only impediment to this powerful ability to create useful information is the intensive labor that is required to create the Cash Flow Statement and the only solution to this impediment is to store all of the financial transactions in a data warehouse. A Cash Flow Statement for any time period desired can be prepared effortlessly in seconds with a simple command to a well-designed financial data warehouse.
The use of a data warehouse to back up an accounting system (or be the accounting system) is the key to producing real-time financial statements for arbitrary time periods. This fact is most apparent in the case of the Cash Flow Statement and its growing importance within the company. See Banking the Past, p. 169.
Thursday, July 10, 2008
5. 21st Century Financial Computation
At a very early stage in human history, then, we have encountered the
fundamental currency of the capital markets: information.
William J. Bernstein, The Birth of PlentyThe computer is a tool that the accountant can use to do accounting, but it is such a powerful tool that, to use it wisely, the accountant needs to step back from his profession and take a second look at how accounting solves its problems, why it solves them that way, and how the new tool may actually change the way that problems are solved.
The computer offers the accountant brand new ways of doing the things that he has been doing basically the same way for over five hundred years, and, if these new ways of doing things are accepted, it will not only be more efficient, but will also provide businesses with new kinds of information.
Currently, the prevailing paradigm of accounting is limited by the past and the techniques that were formed by the tools of the past, but the computer expands the horizons of the adventurous thinker, removing old limitations and providing new opportunities. Rather than use a new tool to do an old solution, the accountant can use the new tool for new solutions, and, in the process, discover new opportunities for creating business intelligence.
4. Virtual Balances
The smallest operations can now afford financial control programs that
account for their finances with greater speed and sophistication that even the
largest corporations could have achieved through their production hierarchies a
few decades ago.
James Dale Davidson and Lord William Rees-MoggFinancial sums are most essentially the finished product of an arithmetic process. For example, the balance of a particular account is really the result of adding all of the deposits (debits) and subtracting all of the withdrawals (credits). It is just a matter of addition and subtraction, an operation that humans do laboriously and erratically but which is done effortlessly and flawlessly my machines.
The same can be said for the other monetary amounts that we use to determine the value of a business and its success or failure. Income is the sum of all of the revenues and expenses that occur to a business during a given period of time; the term “assets” is the sum of all of the resources available to the company; and the term “retained earnings” is the owner’s book value based upon the simple sum of the company’s assets and liabilities (liabilities are actually subtracted from the company’s assets). Financial data is basically the finished product of some very simple arithmetic operations.
The importance of this observation lies in the disparity between the computer’s ability to perform millions of arithmetic operations perfectly each second while humans must struggle to do the same in many months of effort with a paper and pencil. Because of computer’s computational power, the value of the finished product of the arithmetic approaches zero. If you can perform a million operations effortlessly and in virtually no time, you can perform those same operations again and again at no cost, making the value of sums as free as air. The sums of the operations become valueless while the value of the input data to those operations (the amounts of simple financial transactions) increases in value (since they can be reused effortlessly in many different combinations to produce unique new sums).
In the twenty-first century, only the simple data that summarizes the simple atomic financial transactions needs to be stored in the computer. The sums and balances that affect our financial markets will be produced upon demand by machines that are imbued with the intelligence of how those sums and balances can be produced from the rawest of data.
Wednesday, July 2, 2008
3. Double-Entry Bookkeeping
Double-entry bookkeeping allows merchants to categorize historical events in such a manner that they can be quantified and numerically analyzed as a dynamic process. It preserves the before-and-after character of the events in such a manner that allows a previous financial state to be completely reproduced by the analyst.
Because of the invention of double-entry bookkeeping, financial information has become time-dimensional, giving us historical snapshots that can be sorted and summed into the analytical forms that we know as financial statements – the headlines that produce a quick snapshot of a company’s financial flow of resources.
We can maintain a financial balance by making single-entries in a ledger, in a manner similar to how we keep a balance in our checkbooks. However, to be able to identify and analyze the changes to our financial state over time, such as we do when we determine earnings and income, it is necessary for us to record both the origin and destination of a financial movement. The origin is what we refer to as the “credited” account and the destination is what we refer to as the “debited” account. See p. 65, The Tao of Financial Information.
Because of the invention of double-entry bookkeeping, financial information has become time-dimensional, giving us historical snapshots that can be sorted and summed into the analytical forms that we know as financial statements – the headlines that produce a quick snapshot of a company’s financial flow of resources.
We can maintain a financial balance by making single-entries in a ledger, in a manner similar to how we keep a balance in our checkbooks. However, to be able to identify and analyze the changes to our financial state over time, such as we do when we determine earnings and income, it is necessary for us to record both the origin and destination of a financial movement. The origin is what we refer to as the “credited” account and the destination is what we refer to as the “debited” account. See p. 65, The Tao of Financial Information.
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