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.

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.

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.

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.