The Proper Role of Accounting for a Just and Flourishing Business

Introduction:

As St. John Henry Newman explains in his book, The Idea of a University, solely focusing on a specific subject can narrow our view of the world, causing us to disregard all outside disciplines under the belief that our particular field can reveal all that needs to be known. Accounting is one such discipline. At its core, accounting is the recording, reporting, and analysis of measurable financial data to aid stakeholders such as businesses, investors, and creditors in making prudent decisions. If studied exclusively, one could falsely conclude that the information contained in financial statements provides a thorough understanding of all that should be known about a firm. As I will argue, there are legitimately good reasons to understand accounting to create genuine human value, but, similar to Newman’s argument, accounting insights can only reveal so much as to how relevant actors should conduct themselves.

To better illuminate this perspective, I will explore the underlying principles that make accounting possible, describing their respective limitations as well as the positive and negative effects of said principles. Firstly, exploring the notion of Creation’s fundamental intelligibility, I will explain how human beings, given our distinct nature, can comprehend the basic order of things. As such, because business transactions exist within this order, measurable results are generated, which can be attained and recorded by people. Nonetheless, the data they can record only extends so far. Secondly, because of the complex interwovenness among the relevant data, future outcomes based on how the data relate to one another can be predicted. However, there exist dimensions of knowability that supersede that which can be quantified, leading to limited applicability of predictions. Finally, because accounting can indeed reveal likely consequences, interested business parties should take the given insights into consideration. Yet still, there are goods that extend beyond strict accounting factors like profitability. In the end, these higher aspirations — goods like justice and communal bonds — should not be discarded in the name of numbers.

The Logos of Accounting:

Principle 1 — Creation contains a fundamental intelligibility, or “logos,” which can be understood by human beings and enables business activity to generate measurable financial data.

Stretching back to Ancient Greece, according to the Economic scholar Samuel Gregg, “For Plato, the world’s orderliness reflected a rational and mathematical structure that itself proceeded from an Intellect and was susceptible to human reason” (Gregg 32). In agreement with Plato, Christianity espouses a similar notion. God Himself is understood to be the fundamental order of existence. As Catholic author James Schall writes, “If a rosebush suddenly produced a rock one day, then a toad the next, then a tree the next, and this in no order, we would have chaos–that is, no order and no intelligibility” (Schall 74). The universe itself is not pure chaos — a basic truth that is knowable by the fact that certain causes lead to predictable effects.

Furthermore, as Schall continues, human beings are the only creature capable of grasping this order. We, unlike plants and animals, possess rational capacities, such as memory, that enable us to know and arrive at general ideas about the nature and properties of things around us, like the aforementioned rosebush (Schall 75). In this way, by our unique ability to understand God’s Creation, we reflect His image and likeness. Although some people mistakenly argue truth in general does not exist or is wholly unknowable, this postulation itself asserts an underlying opinion about the nature of reality. Hence, because it attempts to stipulate truth about the universe while claiming truth itself is categorically illegitimate, such a statement is oxymoronic.

Because business activities exist within the created, logical order in which truth can be known, human beings, using our intelligence, can measure and record the results thereof. To elaborate, it helps to understand the essence of business itself. A business can be thought of as an entity of one or more persons performing commercial, industrial, or professional activities to provide goods or services to others in exchange for something in return. As people perform business activities, they can notice and comprehend the measurable input and output involved in their actions. Hence, accounting is beginning to seem plausible.

To demonstrate, imagine a man named John runs a lemonade stand. To conduct operations, he must first consider what assets he wishes to invest in and his means of obtaining necessary financing. Reviewing his options, he decides to issue shares to his family and friends to purchase the necessary $15,000 lemon-squeezing machinery. Accordingly, he debits cash and credits common stock. Additionally, he takes out a loan from a bank to purchase $10,000 worth of lemons, debiting cash and crediting notes payable in the process. After purchasing the lemons by deferred payment, which requires a subsequent debit to inventory and credit to accounts payable for the same amount, John plans to begin the lemon squeezing process so he is ready to generate sales revenue next week. The metrics of such activities can be quantified because of the fundamentally ordered nature of the universe. Moreover, because John is a rational creature capable of grasping this order, he can appropriately record and report the financial data involved.

Regardless of the specific commercial circumstances, the order of creation always assigns value to business activities. John’s product, his lemonade, can be evaluated at $5 dollars per glass. Moreover, his capital expenditures and operating expenses can be quantified. If a central purpose of a business is to provide goods and services to others to receive something in return, there necessarily must exist a means of evaluation to determine the value that should be given for the product in question. Even in a barter economy in which there is no medium of exchange but only goods and services traded directly for other goods and services, values still must be assigned to determine an appropriate reciprocal interchange. Without such measurement, markets based on mutually-beneficial agreements could not persist.

Nonetheless, accounting data is limited in its ability to capture economic information. For instance, a company’s balance sheet — one of the most significant accounting documents — in providing a snapshot of a firm’s assets, liabilities, and equity, describes merely the book value of each of these items. That is, it exhibits the value of the firm and its components based on historical cost and relevant depreciation. Whereas, market value, which measures the firm’s worth based on exterior factors like the level of outside demand for what the firm can provide, reveals a new dimension. For example, John can account for the value of his machinery as $15,000 minus depreciation, but, for all he knows, market demand for lemonade may skyrocket in five years if his region faces a particularly hot summer, causing the value of his machinery to rise in tandem. Therefore, despite his innate rationality, John is incapable of weighing all factors. Because it would have been implausible for him to have accounted for this rise in demand in advance, his recorded value of the machinery would not fully explain its true economic worth.

In spite of this limitation, there is still inherent value in the work of measurement performed by people. As JP II explains in his encyclical Laborem Exercens, “Work is a good thing for man–a good thing for his humanity because through work man not only transforms nature, adapting it to his own needs, but he also achieves fulfillment as a human being and indeed, in a sense, becomes more ‘more a human being’” (John Paul II 9). Because man’s ability to plan and create according to his own subjective will, which reflects God’s image, makes him unique among all creatures, man’s work is intrinsically fulfilling to his nature. Accounting metrics, in revealing truths about the created order, can serve to direct a person’s subjectivity, thus enabling him to reflect the Image of God. For instance, through John’s accounting for the various factors he believes will affect his revenues and expenses, despite not recording all relevant data, he serves as the proper subject of his work, bestowing his activity with intrinsic value by virtue of his human dignity. Nonetheless, as described above, it should not be mistaken that the work of an accountant can paint the full picture of financial data. Assuming so would be to misconceive the proper nature of the created order, which can lead to poor decision making.

The Power of Accounting:

Principle 2 — Measurable financial data can provide insights into the likelihood of alternate future business outcomes.

Knowable data do more than simply exist as observable numbers on a balance sheet or income statement. It follows from the intelligible order of the universe that these numbers connect to one another, revealing cause-and-effect trends among the multitude of measurable information. Accountants employ their reasoning to analyze and draw conclusions from this data about likely future outcomes.

Descriptive analytics reveal merely what has happened. John, the lemonade entrepreneur, can examine his quarterly income statement and note his gross profit, defined as revenue minus cost of goods sold (COGS), was lower than last quarter. Taking things a step further, diagnostic analytics reveals not only what has occurred but seeks to explain why. John may notice his COGS increased because his lemon vendor, Paul, increased prices, decreasing John’s gross profit. Venturing further yet, predictive analytics can reveal what is likely to happen in the future. Given Paul has increased the price increase of lemons by roughly 5% per quarter for the past year or so, it is reasonable to assume John’s gross profit will be lower once again next quarter unless he increases his own price.

Such analytics can gauge more complex factors as well. For instance, given his known quarterly gross profit, John can calculate his gross profit margin by dividing this value by the total revenue. As such, he can determine how much revenue is left over as a percentage of the full amount generated. Moreover, in computing his current ratio (current assets — current liabilities), he can continue predicting future outcomes. If John buys lemons from Paul on credit, and his short-term debt increases over time compared to his resources, it may reasonably follow that he will soon be incapable of paying Paul. As such, Paul may cease doing business with John if he does not make payments. Hence, examining ratios can reveal facts about the future sustainability of business practices. Once again, this is made possible by the fact that John, as a rational creature, can apprehend the measurable output of his activity. This whole process rests on the world’s fundamental comprehensibility.

In all cases, because of people’s ability to judge cause and effect based on this grasp of order, metrics can be used to assess the likelihood of future business outcomes. Granted, an accountant may be incompetent, leading to faulty descriptions, diagnoses, and predictions, but if he accurately observes and analyzes the facts at hand, he could always draw logical conclusions. If John’s current ratio continues decreasing, he can surmise the pattern will continue if he does not alter his behavior. Again, even under a barter system, a man can take stock of the goods he has been accumulating and infer that if he acts the same way, he will continue increasing or decreasing his net value of goods or services.

Nonetheless, simply because conclusions can be drawn in light of the relevant facts at hand does not mean accounting data alone contains all relevant facts. Hence, if a prediction is logical given the known factors, it is not automatically guaranteed to come true — the key word being known. As explained above, accounting metrics only reveal limited information pertaining to complex economic conditions, with details such as market value being omitted entirely. Indeed, it may be a logically sound assertion, solely examining the books, that because John foresees his current practices rendering him incapable of paying his debts to Paul, Paul may cut business ties with him.

For all John knows, three months from now, Paul, seeking to receive immediate cash, may choose to sell John’s receivables to a third party at a discounted price. This new owner of John’s debt may be willing to accept a higher degree of bad debt. Such a turn of events could not have been predictable by John’s examining his own balance sheet and income statement. Conceivably — albeit, unlikely — John and Paul may discover their grandfathers were close childhood friends. Paul, being a sentimental person, may choose to accept a higher degree of bad debt from John just to support his grandfather’s friend’s lineage. Not only could such a dramatic turn of events not have been predictable by John’s examining his balance sheet and income statement, but abstract concepts, like sentimentality, cannot be fully measured with numbers anyway.

Such is a possible negative effect of overemphasizing the predictive capability of accounting: people may falsely try to reduce that which cannot truly be quantified to mere numbers on a spreadsheet. To briefly step away from discussing accounting, it will be helpful to examine the famous thought experiment posed by the Australian philosopher Frank Jackson about Mary the color scientist. As a brilliant researcher who has extensively studied the physical properties of color, Mary can tell you all there is to know about wavelengths, optics, neutral pathways, etc. In her mind, she has the numbers pertaining to the science of color down to a tee, but, oddly, she has lived her life in a black and white room and has never experienced color for herself. When she finally steps outside and sees red, blue, yellow, etc. for the first time, will she learn something new? Yes, because dimensions of truth exist beyond the scope of numbers.

Returning to John and Paul, Paul’s emotional reaction to the news about their grandfathers’ history together, which directly affected the outcome of John’s business practices, could not have been predicted by numbers alone, nevermind financial data specifically. Nonetheless, generally speaking, prognostications made from accounting information can still be logical and accurate; the books just fail to encompass all dimensions of predictive facts.

The Utility of Accounting:

Principle 3 — Interested parties should consider accounting data to help illuminate the best business course ahead.

It follows from the Logos of the universe that not only is truth knowable, but we can actively grasp what is good and most conducive to our flourishing as human beings. For example, by our reasoning, we can know it is good to treat others justly. We can also know that profit, generally, is a good thing. As Pope St. John Paul II explains in his encyclical Centenimus Annis, “When a firm makes a profit, this means that productive factors have been properly employed and corresponding human needs have been duly satisfied” (John Paul II 35). Because firms exist to serve human needs, such as thirst for lemonade on a hot summer’s day, profitability is an indicator that such needs are being met well. Under normal, free market circumstances, clients would not choose to consume what a firm offers if they did not see it as satisfying their needs. Thus, accounting, beyond predictive analytics, involves prescriptive analytics as well, which seeks to determine the path ahead most likely to increase monetary returns.

If John’s gross profit continues decreases, and he appropriately diagnoses the source of this issue as the rising price of lemons that will likely continue as a quarterly trend, he may explore alternative supplier options such as a new vendor or growing the lemons himself. Accounting for all expenses, such as the interest owed on his initial loan to finance his lemon squeezing machinery, can help him act prudently, considering the necessity of maintaining his desired profit margin. Furthermore, John is not the only one who could benefit from the predictive power of his accounting data. If John decides to take his lemonade stand public, Paul can access John’s records and analyze his solvency (ability to pay his debts). This could help Paul decide if he should continue accepting credit payments from John bearing in mind John’s ability to pay. Although John and Paul have a special connection, Paul cannot be too generous, or his own business will not last.

Additionally, potential investors and lenders can benefit from this data as well. If the bank decides it will no longer loan John money, he may approach his friend, George, hoping to borrow $20,000 to start his own lemon-growing facility. Sensibly, John believes it would be more cost effective to vertically integrate the lemonade production process. George, reasonably hoping to not waste money, wisely inspects John’s books to evaluate his prospects of success. Investors should do likewise. Generally, if the business would be non-finanically viable according to the metrics, this is a major factor that should inform the decisions of interested parties. This follows from the fact that certain goods, such as financial wellbeing, are knowable to the human mind.

As described at length above in previous sections, because there are more factors than those that are presented in accounting data, financial statements are limited in their ability to accurately predict the future. Notwithstanding, even if they could flawlessly reveal the path ahead that is most conducive to profit 100% of the time, should accounting metrics really be the only guiding light for businesses to inform all their decisions? Afterall, profitability, as established, is a good, noble thing. Or, are there higher goods that should also be considered?

Firstly, even from a purely economic perspective, profit maximizing itself is insufficient. Questions naturally arise, such as, “over what time horizon should profits be maximized?” Theoretically, if John’s only goal was to increase his current year’s bottom line, he could sell all his assets, making significant gains on his sales and securing very high profits. Of course, though, this would not be tenable for profitability in the long run. Maybe, the goal of his firm should be to maximize profits over the next fifty years. Doing so probably means his lemonade stand would please plenty of happy customers, contributing value to the world.

However, such a horizon cannot be prescribed by accounting itself; it must have recourse to other disciplines. Perhaps John, currently twenty five, wishes to retire when he is seventy five so he could enjoy his elder year in greater peace. This may be a good decision, but the value of living peacefully in old age cannot be measured by accounting alone. Maybe, even, John, Paul, and George will discover their latent musical talent and decide to invite their friend Ringo with them to start a rock band instead of the current businesses they run. In such a case, the ideal horizon over which to maximize the lemonade stand’s profitability will likely be shorter than 50 years, but the intrinsic value of a hit music career cannot be compared to that of the lost profits from abandoning the lemonade stand. Even if the band flops, and they make relatively money, the value of the memories they shared together and the joy they brought to their small number of fans through music is closer to a philosophical rather than accounting question.

Firstly, though, it helps to reemphasize the positives of accounting. Financial data can lead to a more affluent, prosperous society. As John Paul II also notes in Centesimus Annus, “It is precisely the ability to foresee both the needs of others and combinations of productive factors most adapted to satisfying those needs that constitutes another important source of wealth in modern society” (John Paull II 32). Without the insights provided by accounting, it would be difficult to assess the effectiveness of business ventures. As described above, accounting offers prescriptive analytics to show what avenues will create long-term, sustainable value. As businesses incorporate this knowledge into their plans, they can better meet people’s needs and produce more real community goods. Hence, societal wealth will likely increase over time as businesses act more judiciously. Even non-profit organizations, which do not primarily seek wealth for their owners, use accounting to weigh the practicality of their operations and pursue courses that create the most benefits.

However, because businesses are person-centric organizations, good practices of justice, that are not fully explained by accounting, apply to them as well. Though it is true that a people-driven market economy developing products of genuine value is a cornerstone of a flourishing society, which means accounting data should be seriously considered to orient people accordingly, financial metrics do not reveal the ultimate end of goodness itself. Treating metrics as such can have harmful effects. Other components of a healthy business, such as fair treatment of workers and positive environmental impact, can be overlooked.

As Pope Leo XIII explains in his encyclical Rerum Novarum, it is a grave injustice to deny a worker his fair wage. Self preservation is a law of nature, and labor enables men to survive. Therefore, it is wicked to withhold from a man the rightfully earned fruits of his labor (Leo XIII 44). If John, inordinately concerned with minimizing salaries expense to boost net profit, chooses to exploit the desperation of a homeless man by hiring him to operate his lemon squeezing machinery but refusing to pay him a wage sufficient to provide for his family, this would be deeply wrong. Additionally, as Pope Francis describes in his encyclical, Laudato Si, ecological problems arise when methods and aims of science and technology serve as the fundamental basis for human action (Francis 107). John may rightly observe that investing more in research and development to further mechanize his lemon growing process positively affects net income, but amidst this success on paper, his methods release much carbon dioxide into the atmosphere, harming the local surroundings. In the final analysis, this negative externality may outweigh the good of higher net income.

Finally, a hyper focus on accounting metrics can distort a business’ main purpose, causing people to lose sight of their mission. As author Jerry Muller writes in his book, The Tyranny of Metrics, “Gaming the metrics often takes the form of diverting resources away from their best long-term uses to achieve measured short-term goals” (Muller 149). Employees may be exploited for profit’s sake. Environmental beauty may be damaged. Businesses may deceive creditors or investors to pay less interest or appear more valuable for next year’s earnings report. Ultimately, accountants must not forget that knowable goods such as reputation, employee morale, loyalty, and satisfaction cannot be neatly quantified and labeled on a balance sheet; nonetheless, they are crucial to the health of a business. If people rely solely on the books to make decisions, such enduring positive forces can be neglected. As John Paul II makes clear in Centennimus Annis, fostering a genuine community as people strive together to meet their needs at the service of society as a whole must be maintained as the ultimate purpose of a business (John Paul II 35). However, focusing too narrowly on accounting metrics can distract from what is truly good in the long run.

Conclusion:

In the end, despite accounting’s grounding in the logical order of Creation, which does in fact attribute to its genuine usefulness, the discipline can only take people so far. As rational human beings, in grasping the measurable outputs of business activities, people reflect the Image of God as they employ their subjectivity to understand the Logos of Creation. However, even while doing so, there are several factors, such as a firm’s market value, that accounting information fails to capture. Additionally, even though they can make predictions based on the recorded numbers, factors that cannot be measured render their predictions ultimately incomplete — though still potentially accurate. Finally, though useful for helping increase profit and meeting other financial goals, accounting alone simply cannot encompass the full array of goods that are conducive to a flourishing business. Striving to operate ethically, respecting the rights of all parties and fostering a thriving community oriented toward justice is crucial, yet these values are not contained in financial statements. Whether they be lemonade stand owners or CFOs of large corporations, interested parties should not merely rely on recorded financial data to capture the full truth. Through growing in one’s understanding of the Logos, it becomes apparent there are several deeper factors for which to account.

Thank you for reading. It truly means a lot.

If you’d like to hear more what I have to say, check out my podcast, “A Disciple and a Doubter,” where I and my friend Jackson discuss topics of faith and doubt.

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Additionally, this essay was initially completed for the course “Work and the Interior Life” as part of the University of Notre Dame’s Business Ethics and Society program at the Mendoza College of Business — taught by Professor Jeffrey Burks.

In the meantime, please pray for me. I will pray for you as well.

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