The accounting method of the Dutch guilds

About 800 years ago, the Dutch guilds devised an ingenious method to solve the problem of business losses. Although almost nobody understood how it worked, companies used it for centuries. Profitable companies paid such high salaries that they attracted employees from around the world. Despite its small size, the Netherlands became one of the richest countries in the world. However, in a changing world, the method was lost in the late 1960s.

To cover losses guilds included the general ledger for profit and loss in the company accounts. Using this method every month, at the close of accounting, the balance of the cash and bank journal would be booked against the general ledger for profit and loss. The credit balance is the loss. The debit balance of the general ledger for profit and loss is the company’s profit.

In small companies, losses amount to 2% of sales on average. When a company books 5% of its monthly added value to its general ledger for profit and loss, losses are automatically covered.

In large companies, losses may be substantially larger. In the 17th century, the method was changed a bit to allow for large companies to cover larger losses. When a company issued shares, share capital was booked to the general ledger for profit and loss, and five percent of the added value was used to pay dividends. Thus, the Dutch East India Company could cover losses that were 20 times as high as that of small companies. (The Dutch East India Company sent uninsured wooden ships to the other side of the world. Many of those ships never made it back.)

Companies that used the guild method could survive for eternity, while companies that did not use it went bankrupt within 10 to 15 years. The method was never used outside the Netherlands.

Although the guild method worked well, it had a big problem. When a company booked 5% of the added value or the share capital on the general ledger for profit and loss and made a contra entry for the balance of the cash/bank journal every month, losses “magically” disappeared; the general ledger for profit and loss always had a debit balance, except when the company was bankrupt. So entrepreneurs and directors of large companies failed to understand what problem was solved by the general ledger for profit and loss and did not understand how it worked.

The guilds used an accounting method to save the reserve, but in our fast-paced world, that is asking for accidents. The guild method didn’t work magical: As long as the reserve was big enough to cover the loss, the general ledger for profit and loss had a debit balance. If the reserve was too small, the company would go bankrupt. So the general ledger for profit and loss would always have a debit balance, except when the company went bankrupt.

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