Developed by Luca Pacioli, an Italian monk and mathematician, double-entry book keeping is the foundation of accounting. Pacioli established any transaction as a set of two transactions. If you're not yet bored, keep reading. This is a basic T-account, a favorite for accountants.
On the left of the T is the debit, on the right is the credit. Note: debit is not universally negative as many use it. A debit increases an asset; a debit decreases a liability and owners' equity. A = L + OE, to remember, think of the cold green gel that cools sunburned skin. Assets = Liabilities + Owners' Equity.
Assets are defined by SFAC 6 (Statement of Financial Accounting Concepts) as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." A liability is "probable future sacrifices of economic benefits arising from present obligations or a particular entity to transfer assets or to provide services to other entities in the future as a result of past transactions or events." This seems fun enough. An asset is usually good; a liability is usually bad. We'll spare the accounting details here.
Owners' equity, we'll just call it equity for our purposes, is the net of assets and liabilities. This is simple. The goal of companies is to consistently increase the equity piece of the pie, and the market value of the stock (again, we'll spare the accounting lesson of book value and market value details). Berkshire Hathaway has increased it's equity per share (book value per share) from single digits to tens of thousands. A compound annual growth rate north of 20%.
The personal finance jungle
Financial planning advice, outside estate and tax issues, is usually pretty bad. So though this is more qualitative in it's approach, Faro ventures to be one of the few to add valuable personal financial advice: treat your life as a balance sheet.
It goes something like this. And you can break this down however you'd like. Every period, be it a day or a month, has a series of debit and credit transactions. I'm getting into accounting terms; don't be too scared. Good sleep is a debit to assets--it has a positive future benefit. It also increases the equity in the long-term health account. Smoking would do just the opposite.
Time, and how it is spent, is a trickier one to estimate. Rest and fun are good, but in excess are a liability and decrease the equity in your quality of life account. Don't get lost with this.
How we spend our time becomes critical to our equity account. And anyone with competing interests--families, "careers", hobbies, reality TV schedules, and others--knows this. If in a day, you take out the uncontrollable factors, (sleep, work, etc) your time to have a material impact on your equity account is limited. It may be as few as 4-6 hours per day. So if you spend most of your time worrying about how cool your car is, what to watch on TV tonight, or planning the next credit-funded vacation, you'll discover your equity account is small.
The average American who watches four hours per day of television should feel this. The difficulty is in realizing and changing this. But treating your life as a balance sheet is a great way to open your eyes. It also helps establish the mindset for analyzing companies' decisions.
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