How do we know what a company is worth?
Photo: X. Source: Pixabay
We want to base our investments on facts, not feelings. One reason Apple is worth more than GM, even though GM has twice as many employees, is that Apple earns more – five times more – than the car giant. Both companies have iconic brands with global scale. But Apple is far more profitable .
But how do we know this? We know it because of double-entry accounting: debits, credits, income, expenses, assets, liabilities, and capital. The notion of maintaining accurate books started in the trading empires of Mesopotamia, Korea, and the early Muslim Caliphates. But a formal accounting system was fully laid out in the late 15th century, in a book written by a Florentine monk who taught math to Leonardo da Vinci.
The friar, Luca Pacioli, didn’t invent accounting so much as describe it. In his textbook on mathematics, Pacioli outlines how the merchants of northern Italy kept track of their businesses, including double-entry bookkeeping, trial balances, and balance sheets. He also explains how they used barter, bills of exchange, and standardized weights and measures to manage their enterprises. By clearly and systematically explaining how the “Merchants of Venice” prospered, he indirectly helped businesses thrive across Europe. He really was the first one to tell us how to “follow the money.”
Italian postage stamp. Source: Wikipedia
Accountants rarely get the credit they deserve for business success. After all, you can’t build an enterprise if you don’t know what you have and what you’ve done. We lionize Steve Jobs and Bill Gates, but who were their CFOs?
Douglas R. Tengdin, CFA