Accounting vs. ERP: Sticks and carrots

When referring to their ERP systems, it is pretty common that customers refer to it as accounting software. While it is true that every ERP system embeds some accounting functionality, there is a major difference between these two categories of software. It starts with two things: what computers are good at, and the goal of accounting as a discipline.

Ever since ENIAC, computers were good at what people, unless they are severely autistic, are generally very bad at: high speed calculations and persisting information. While persisting information is something that can be addressed using, well, analog methods such as paper and pencil, or a typewriter, or a stylus and a wax tablet, what fancy you, there is an important issue with human-aided information persistence. It is called human error. And it is ubiquitous.

The goal of accounting as a discipline is fairly simple. If you are an accountant, please forgive my ignorance, since I am not, but I will try to put it simply. Accounting is keeping track of business events and financial activity. The goal of accounting is to provide an accurate track of everything that happened to an entity (usually a company) from financial perspective. The list of reason why accuracy is important is endless, and it includes knowing how much we owe others, how much others owe us, how much taxes we need to pay, where do we stand financially in general, etc.

While being accurate is important, being creative is also very important, and here comes another issue with human-aided information persistence. It is called, well, creativity. I would otherwise put it as tendency to be biased toward one’s own interest. Combine these three, information persistence, human error and creativity, you can easily see that there might be kind of a problem with the goal to provide accurate track of financial activity. People were smart, and devised ways to mitigate these issues very early on, and it doesn’t come surprising that the very principles of accounting as it is mostly used today (double-entry accounting) is centuries old, and it in fact might be much older than we think it is. However, it alone mitigates but a fraction of all the problems of accounting itself.

When accounting was done manually, the biggest problem wasn’t the accuracy. Mostly, it was volume of information. The sheer amounts of data big companies had to enter into their books, and then consolidate across the books (because yes, there are many books serving many different purposes to be filled out, and accurately) was frightening. Computers came as deus ex machina and brought along true revolution, because it wasn’t long before people figured that this new stuff can really make a difference and bring accounting to completely another level. As the matter of fact, since computers started serving general public, and before computer games were invented and before Internet porn came along, what computers in general mostly did, and where most of overall worldwide processor time went into was probably accounting of a sort.

However, the first accounting software wasn’t very smart, in fact, it only lifted human chore to another productivity level, but having the biggest problem completely unaddressed. The problem with bookkeeping, and accounting in general, is not just to track the events accurately, but to consolidate this information across various books, or ledgers as accountants call them. There is not just one place where information is tracked, there are many of them, each serving a specific purpose. While General Ledger is at the heart of all accounting, information usually doesn’t come into general ledger out of a blue. There are usually some documents, such as invoices, which result in information being recorded elsewhere. An invoice is an excellent example, because an invoice may actually result in entries being written into a bunch of ledgers simultaneously. An invoice usually contains the list of goods sold, which a customer must pay for, so we need to keep an accurate track of this information in Customer Ledger so that we know how much this customer owes us. The fact that we now do not have hold of these goods sold must be tracked in Item Ledger or Inventory Ledger, so that we know the exact quantity of items available for future transactions. And so forth. Accountants had to do all this integration manually, entering information into one ledger, then another, then another. You see where I am heading to? This information had to be exact and accurate, however it could easily happen that the information wasn’t always recorded consistently across the ledgers.

First accounting software applications didn’t bring any new brains to the game, so they simply helped accountants do more work in the same amount of time, but most of accounting software, even today, have all these ledgers as separate systems, into which information must be entered separately, therefore not addressing the problem of error, which could still occur as much as it could when all the work was done manually.

Of course, people soon realized that if computers can help keep books, they can probably help keep them consistent as well. It only took a little extra effort to make integrated accounting systems, which would take care that when an invoice was recorded, or posted in accounting lingo, it gets recorded in all relevant ledgers. Now this simple feature brought biggest value an accounting system could bring until then. With this feature, accounting systems fulfilled their goal of keeping accurate track of financial activity across all relevant books.

With this, there comes an important question: why do we need all of this information anyway? Well, obviously, all of the reasons I listed earlier apply here, but if we approach this information passively, in the way that it only helps us know exactly what has happened, its value is pretty low. Of course, the price of not having this information is probably high (just wait for the tax people to come to you), but the value of having it can not be really expressed in financial terms, at least not today, when having computers do accounting chores is the norm.

So, why then do we really need all of this information? Or better yet, why do we really need the software to do most of the work for us? Ultimately, this is a question about motivation. Motivation is pretty easy, and has been known since dinosaurs to distill down to sticks or carrots. Either you catch hell, or you get reward. So, if companies don’t keep track, or don’t keep accurate track, ultimately they will catch hell. But keeping track, and keeping accurate track alone, won’t really bring many carrots to you, or at least won’t bring as many carrots as it would bring sticks if you didn’t do it. So, it is out of balance, and it is out of balance on the opposite side of where businesses usually like it to be. Businesses are quite OK to play with possibility of getting sticks, as long as possibility of getting carrots is either bigger, or the balance of carrots versus sticks goes in favor of carrots. It’s in the very core of the business to risk something to get something better, or bigger, or preferably both.

So, with the balance going in favor of sticks in this case, what is the true value of an accounting software? Where can this kind of software really bring measurable, justifiable value to a company using it? Knowing your financial situation, balances of your customers and suppliers, knowing the amount of inventory you have, making good-looking P&L statement for your shareholders, well, is it the real value you can get from the system?

Accounting is the very basic need, and having a good accounting software is paramount, but companies soon get to another level, where they don’t just need software to keep track of financial or business activity, they want to manage it. There is a long way from being aware that something happened, and being able to react, or better yet, to proact based on information kept in the system. This is something accounting software normally can’t handle, and it is also not something that it is made for. In order to manage business activity with the help of software, there is completely another category of software, called ERP, and while it does include accounting functionality, it goes way beyond.

What is the true difference between ERP and accounting software. Well, you must know me well by now, I’m not revealing it all at once. Come back soon for the second part of Accounting vs. ERP topic.

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