Double Entry Bookkeeping, Trial Balance, Financial Statements, Financial Ratios, Italian City-States and Capitalism

Posted by PITHOCRATES - January 8th, 2013

History 101

The Government Finances are a Train Wreck because they have the Power to Tax and to Print Money

President Obama averaged a deficit of $1.3 trillion for each of his first 4 years in office.  Bringing the national debt up to $16.4 trillion at the end of 2012.  And there will be another drop-down, drag-out fight to raise the debt limit in a couple of months.  Why does the government spend this kind of money?  Because they can.  And because they can they can buy a lot of votes by giving stuff away.  Stuff paid for with all of that spending.

When the government implemented Social Security and Medicare there was still an expanding birthrate.  More people were entering the workforce than were leaving it.  Providing an ever expanding tax base.  And a rising level of tax revenue.  Without ever having to increase tax rates.  And the smart government planners thought the good times would just keep rolling.  But they didn’t.  Thanks to birth control and abortion.  Which reversed the equation.  The population growth rate slowed down.  Fewer people entered the workforce than left it.  Resulting in a declining tax base.  And falling tax revenue.  Pushing Social Security and Medicare to the brink of bankruptcy.

The government finances are a train wreck.  And they keep digging their hole deeper.  Because they can.  For they have the power to tax.  And to print money.  Something private businesses can’t do.  Which is why few corporations’ finances are train wrecks.  Except those with unionized workforces with defined-benefit pension plans.  Something long discontinued by most in the private sector.  As it’s a failed economic model.  Just like Social Security.  And Medicare.  Over time more people move from being contributors to being beneficiaries.  Pushing defined-benefit pension plans, too, to the brink of bankruptcy.

At the End of each Accounting Period they run a Trial Balance to Verify the Total of Debits Equals the Total of Credits

The difference between private sector businesses and the federal government is that private sector businesses have to be responsible while the federal government does not.  The federal government focuses on what’s politically expedient.  While private sector businesses must focus on the bottom line.  Spending only the money they have.  Because they can’t tax or print money to fix their messes.  Like the government can.  And does.  A lot.  So they have to avoid making messes in the first place.  They can’t kick the can down the road.  Because in the private sector there is accountability.  And that accountability begins with getting their hands around their business numbers.  So they can understand what their businesses are doing.  And when it’s time to take appropriate actions.  To prevent a financial train wreck.  And it all begins with double-entry bookkeeping.

Double-entry bookkeeping includes debits and credits.  Each transaction is posted to the accounting records with at least one debit and at least one credit.  The dollar amount of debits equals the dollar amounts of credits.  If they don’t equal after recording a transaction they were posted incorrectly.  For example, when someone pays cash for something at a retail store there are two debits and two credits to post.  First we debit cash $20 and credit sales revenue $20.  Then we debit cost of goods sold $18 (the cost of the item sold) and credit inventory $18 (the cost of the item in inventory).   If posted correctly the total debits equal $38.  And the total credits equal $38.  If, for example, someone debited sales revenue instead of crediting sales revenue the total debits would equal $58 while the total credits would equal $18.  Because they don’t balance we know something was posted incorrectly.  And can go back, find the error and correct it.

A business accounts for every penny that flows through their business.  Each accounting period will have thousands of such entries.  And at the end of each accounting period they will run a trial balance to verify that the total of debits equals the total of credits.  When they do they can be pretty sure that the financial information they recorded fairly represent the financial activity of the business at the end of that accounting period.  Then they prepare the financial statements (the income statement, the balance sheet, the statement of cash flows and the statement of retained earnings and stockholders’ equity).  Businesses study these statements to assess the health of their businesses.  They calculate financial ratios to assess the liquidity, long-term debt-paying ability and profitability of the business.  As well as calculate ratios for investor analysis.  To make sure they are satisfying the owners of the company.  The stockholders.

The First Use of Double-Entry Bookkeeping dates back to the Italian City-States of Florence, Genoa and Venice

This is a lot of valuable information.  Courtesy of that double-entry bookkeeping.  Something that can be so mundane and mind-numbing at the data entry point.  Especially if you’re trying to figure out why your trial balance doesn’t balance.  But when it does balance.  And the financial information is fairly represented.  Business owners and managers can make informed decisions to avoid doing what our federal government does.  Including making the hard decisions that permit these businesses stay in business for a decade or more.  Even a century or more.  Thanks to merchant banking.  And the Italian city-states.

For those of you who hate bookkeeping blame the Italians.  Some of the Florentines were using it as early as the 13th century.  The Genoese were using it shortly thereafter.  Soon Florence, Genoa and Venice were using double-entry bookkeeping.  This mastering of economic data made these city-states the dominant economic powers of the Mediterranean.  Making them masters of trade.  And merchant banking.  To manage that trade.  This system of accounting even made it into textbooks in the late 1400s.  Helping to spread good business practices.  Where they were picked up by other great traders.  The Europeans.

With double-entry bookkeeping businesses were able to grow.  First with the help of government.  Mercantilism.  Then without.  Free market capitalism.  Which created the British Empire.  And gave us the Industrial Revolution.  Then the United States came into their own in the late 19th century.  And surpassed the British Empire.  Economic activity exploded in the United States.  Because they were able to get their hands around all of those financial numbers.  And thanks to free market capitalism they focused on the bottom line.  And made the necessary decisions.  No matter how painful they were.  Something that the federal government just can’t do.  Because those decisions aren’t politically expedient.

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LESSONS LEARNED #36: “Politicians oppose across the board tax cuts because they are not politically expedient.” -Old Pithy

Posted by PITHOCRATES - October 21st, 2010

No King Ever Ruled Without the Consent of Money

There were kings.  And there were wealthy landowners.  Kings may have been sovereign.  But the wealth lies with, as you may guess, the wealthy landowners.  Kings needed money.  Because doing king ‘things’ got expensive.  War, armies, navies, festivals, feasts, castles, palaces, churches, etc., were very expensive.  So kings taxed their subjects to raise the money they needed to be king.  And when it came to money, the vast majority (i.e., the peasants) had little.  It was the peasants’ landlords who had the money.  And it was they who paid the bulk of the taxes.

But it was a two-way street.  Because it was their money, they, the wealthy landowners, had a say in how the king spent that money.  This was a restraint on the king’s power.  There were laws to protect the property rights of these landlords.  Now.  And in the future.  Property owners could pass their property on to their heirs.  As well as their political standing with the king.  Thus the rich and landed aristocracy passed on both their property and their nobility through inheritance.  Thus kings and Nobility lived by the consent of the other.  And they each lived by the consent of money.

The Roman emperors spent so much money near the end of the Roman Empire that they brought their advanced civilization to an end.  The landed aristocracy survived, though.  They just served a different sovereign.  The masses (i.e., the poor peasants) still worked the land.  The landlords still held the wealth.  Kings would come and go but this way of life (feudalism) remained.  Kings ruled as long as the landed aristocracy didn’t object too much.  Which they did in England in 1215.  The landed aristocracy met King John on the field of Runnymede.  Seeing his power was not absolute, the king reluctantly set his seal to the Magna Charter.  Constitutional monarchy would reign in England.  And England would reign supreme in the Old World.  And in the New World.

No Taxation Without Representation

The constitutional monarchy that developed consisted of the Crown and a bicameral Parliament.  The two houses of Parliament represented the needs of the few (the House of Lords) and the many (the House of Commons).  Thus the needs of the one (the sovereign), the few (the rich) and the many (the not rich) were balanced against each other.  It was a pretty good system.  The best in its time.  An English citizen had a better and more comfortable life with greater liberty than citizens of most other countries.

This liberalism unleashed a flurry of economic activity.  It created an empire.  International trade exploded.  England became a leader in farming and agriculture.  This knowhow spread throughout her empire.  As did her representative government.  Which they established in their North American colonies.  Perhaps a bit too firmly.  With the costs of world war came the need for higher taxes.  The British had just defeated the French and took possession of all their possessions in North America.  Her English subjects there were now free from French aggression.  And Parliament wanted these subjects to pick up a large part of that war tab.

Well, this didn’t go over well in the colonies.  For they had no representation in Parliament.  They had their own representative governing bodies in the colonies.  But they were subject to royal governors appointed by Parliament.  Without a vote in Parliament, they had no say in matters of taxation.  This was very un-English.  For the English nobility consented to taxation in exchange for having a say in how the king would spend those taxes.  As the landed aristocracy protested in 1215, the Americans protested this taxation without representation.  Eight war years later and America left the mother country.  Another few years later they ratified the Constitution and created the United States of America.  Which came to be because a governing body violated the sacred covenant between a king and his subjects.  A king may only rule as those who pay the kingdom’s taxes approve.

Universal Suffrage Increases Our Suffering

Because the new American government taxed property owners, property ownership was a requirement to vote.  In other words, those with the most to lose (those paying the taxes) had a say in how the government spent their taxes.  It kept the government honest.   By limiting the vote to those who had ‘skin in the game’ it made it hard for government to build palaces for themselves.  Because there was a direct connection between the source of funding and what that funding was used for.  The government may persuade the tax-paying voter for the need for a national postal system.  But a palatial palace was a much harder sell to the one footing the bill.  Especially when that person would never enjoy its benefit.

Such a system led to responsible government.  It minimized political corruption.  And if there is anything a politician doesn’t like it’s this.  They like corruption.  They thrive on it.  It’s their raison d’être.  And this responsibility thing just didn’t cut it.  They need people to vote who have no skin in the game.  People they can buy.  So they can live the good life.  Like in days of old.  Enter universal suffrage.  Where a politician can promise people other people’s money.

Wait a minute, you mean I can have a say in how other people spend their money?  Sweet.  Gimme gimme gimme.  I me mine.  Tax the rich.  Health care is an entitlement.  I mean, as long as someone else is paying, I’m for sale.  Promise me whatever I want and I will vote for you.  And forget what Benjamin Franklin warned us about: 

When the people find they can vote themselves money, that will herald the end of the republic.

Money Talks; Egalitarianism Walks

It probably started with Martin Van Buren.  Creator of the Democrat Party.  He created the party machine.  Patronage.  Payoffs.  And buying votes.  Dirty, filthy politics began with him.  And the Democrat Party.  Beginning with the campaign for Andrew Jackson, politics have gotten worse ever since.

It’s about the money now more than ever.  With the power to tax, government has a near unlimited source of money.  And with it they can get power.  By promising money to people that don’t have money.  Lots of it.  Thanks to universal suffrage, they can bus as many poor, indigent and government-depended people to the polls as possible.  And the more of them the better.  For they will vote for whoever promises to give them the most free stuff.  And why not?  They have no skin in the game.

And by voting themselves a permanent entitlement, they will make themselves a permanent underclass.  Where they will remain poor, indigent and government-depended.  As government spending continues to grow unchecked, it will push people down the economic ladder until the middle class disappears.  There will be only the rich (the government and the government-connected).  And the poor.  Just like in days of old.  Which is the goal of our tax policy.  You see, across the board tax cuts do not enhance the dependency-power relationship.  But targeted tax cuts do.  That’s why Big Government favors a complicated tax code.  It enhances the dependency-power relationship.  That empowers Big Government.  Throws egalitarianism out the window.  And makes life good for the ruling elite.

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