Adding Some Realism

Chapter 14: About Business Numbers - Page 14.7

Adding Some Realism

Now go back a step and make the situation more realistic. For example, most sales of products to businesses are on terms, with the money generally due in 30 days. So if you sold that widget on credit you don't have $150 in the bank. You still have $50 in your bottom line, but now you have nothing in the bank. Instead, a customer owes you $150, which is what we call "Accounts Receivable."

Compare the One Widget Sold illustration on the previous page to the Selling on Credit illustration below. This is what really happens to the huge number of businesses that sell to other businesses.

Selling on Credit

Sales and profits are the same, but now there's no money.

Knowing you can buy a widget for $100 and sell it for $150, you get your widget supplier to sell to you on the same terms you sell, net 30, instead of for cash. Now you have $100 that you owe to suppliers, which is called "Accounts Payable." You also have $100 worth of widgets in inventory. This gives you the case in the following illustration, Buying on Credit, in which you are now poised to sell another widget and make more profit. You have an extra $100 in assets (the widget in inventory) and an extra $100 as liabilities (Accounts Payable), so you are still in balance. Also, you still have no money.

Buying on Credit

Business looked good, so you borrowed the money to buy another widget and continue.

The Buying On Credit illustration shows the financial picture with sales to businesses on credit and purchase of inventory on credit as a short-term debt.

Now the case is more like what you have with real business numbers, in which you have to manage your cash very carefully, and the amounts sitting in inventory and accounts receivable are significant.

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