Accounting: “Just Accounting”
Accounting is the making sense of cash flows through time and the assignment of that cash flow to income through processes that assign permanence and recurrence to these cash flows. We do not want to see large volatility in accounting that can be accounted for through accounting reasons alone. So we use methods to smooth the income to reflect an operating business model that does not really have that volatility. So accounting can be said to be just a way of removing meaningless volatility from cash flows to define what we call earnings. Accounting is also reflected on the balance sheet by items that may be linked in book value to other metrics that keep changing and we want to make sure the book values don’t jump inordinately because of some accounting gimmick. So we look at how dependencies flow through to book value on the balance sheet. Accounting is also reflected in the statement of cash flows which tells you how much cash is being exchanged from various activities. This would be akin to the carry on a bond desk and can tell you if you are negative convexity as you probably are if you are short bonds even if duration hedged and basically the cash flow number just better be positive or you get a situation where every move your business makes leads to more disaster or everything you do at work leads your boss to yell at you. Fortunately, there is an auto stabilization in business that accounting reflects. Particularly there is a business cycle of making some money, losing some, and then making some again and accounting is in a way motivated by a correction of this business cycle in a way to make permanent income attribution that could otherwise be attributed to the vagaries of the business cycle. For example, the United States is sometimes successful in its economic pursuits and sometimes not but we can’t have the economy in fits and starts based on something as unreliable as people’s quality of ideas. So we use accounting to pay people and make people happy and in that process we find out what we thought was our income from successes was really just from the vagaries of the business cycle but some of our income is real according to accounting and that is what we did for childhood friends who we grew up with long after we thought we weren’t children anymore at Harvard. And that is accounting isn’t it? Turning something unviable into something explainable and viable as I am glad Harvard checks my power and accounting checks the power of corporate titans to manage earnings as when I get that kind of feeling when I want to make up another stream of earnings that doesn’t exist, I get thrown out of polite circles and it is all explained to me at the end as Apollo sees everything, and he asked Achilles to return the temple maiden so I did. But as Shelley wrote, this too shall be yours, Titan, life, empire and victory. Prometheus would tell me that she was sad when she followed orders of my company to leave me be. For what looks chaotic from far away is organized up close. And that is why accounting is best seen as what brings chaos into order not vice versa so that there is room for a business to operate because operations require chaos to understand what’s wrong and fix all the technology problems. When Achilles took the beaches of Troy with fifty men, he solved an accounting problem and didn’t make a trade. He realized that to demoralize the Trojans he needed to demonstrate some Greeks were vastly superior but Greeks as a whole merely were of uneven quality. Just like earnings can be high quality or low quality but it all looks like cash until you understand the repeatability by studying accounting for one full business cycle of your business, mine was trading.