We said before that accountancy is a bit like driving a car. Good drivers use the dashboard to monitor their progress – and in just the same way good business managers use their accounts to monitor their business progress.
So accounts are, in a sense, your business dashboard. The two key instruments on your car’s dashboard are probably the speedometer and mileometer. These are equivalent to the two key elements in any set of accounts: the profit and loss account and the balance sheet.
Speedometer = Profit & Loss Account
In a car the speedometer shows you how fast you are going and how quickly you are getting to where you want to go.
This is equivalent to the profit and loss account, which shows how fast your business is accumulating profits.
Both the speedometer and the profit and loss account only make sense when viewed over a period of time:
The speedometer shows miles per hour
The profit and loss account shows profits per year.
Milometer = Balance sheet
The balance sheet, on the other hand, is like the milometer. A milometer records how far the car has travelled and is often used as an important factor in deciding how much a car is worth.
In the same way, your balance sheet measures how far your business has travelled. It is a snapshot of where the business has got to and gives some indication of how much it might be worth (but like the milometer it tells us little or nothing about how, or how quickly, it has got to where it is).
You may have heard about, and been terrified at the thought of, double entry bookkeeping. If so, relax. We don’t usually recommend double-entry bookkeeping to our small business clients. But it is useful to have an idea of what it means.
In fact, the dashboard on your car, and your accounts are both examples of double entry at work:
On a car, for every extra mph on the speedo, an extra mile is added to the milometer.
In business every extra money on the profit and loss account adds an extra money to the balance sheet.
In both cases only one thing happens (either you travel a mile or your earn a USD). But in both cases there are two effects – the mile changes both the speedo and the milometer – the USD changes the profit and loss account and the balance sheet. There are two effects (or “entries”), and so for hundreds of years accountants have referred to it as double-entry. That is really all there is to it.