Basic Accounting Terminologies
Are you baffled by accounting terminology? If you know what a balance sheet is but don’t know what it means, we got you covered.
As a business owner, it’s essential to be familiar with fundamental accounting terms. After all, you’ll likely need to work with an accountant.
If you want to learn commonly used accounting words, this blog post is for you! We’ll provide an overview of some of the most conventional accounting terms and explain what they mean in plain English. By the end, you’ll be able to sound like a pro when discussing your company’s finances!
Let’s start with the basic accounting equation, which is
Assets-Liabilities= Owner’s Equity.
This equation is represented on the balance sheet.
Balance Sheet 101:
The balance sheet is a financial statement for evaluating the health of a company. It provides a snapshot, displaying what assets and liabilities are owned by each party involved. It also provides insight into when financial circumstances changed abruptly without warning.
What is an Asset?
An asset is anything that can provide future economic benefits to its owner. They can be tangible (such as property or equipment) or intangible (like patents or copyright). Assets are important for businesses because they provide a source of revenue and can help reduce risk.
What is a Liability?
A liability is an obligation or responsibility that a business has to others. It can be financial, such as unpaid taxes or outstanding loans, or it can be the result of legal actions, such as a personal injury lawsuit.
What is Owner’s Equity?
Owner’s equity is one of the most critical concepts in business. It is the portion of a company’s assets that belongs to the owners, and it can be used to measure a company’s overall value.
The owner’s equity is the amount owned by each partner. This is the owner’s adjusted basis. Usually, it’s the initial investment minus owners’ withdrawals. In publicly held companies, it is called Shareholder’s equity. Shareholder’s equity is the amount owned by shareholders from initial investments and any withdrawals made between time.
Now that that’s out the way, let’s get into key Accounting and bookkeeping definitions.
The accounting period is the time frame associated with your financial reporting. Most accounting periods run for 12 months; however, they can be shorter. For example, your accounting period can run on a calendar year, which runs from January 1st – December 31st. Or a short year which is October 15th- January 1st.
An Accounts Payable is money you owe to vendors, clients, banks, or any outside entity on a credit basis. (This is money that the company owes and must pay).
Accounts receivable is money that is owed to YOU or YOUR business. This is the income that you anticipate receiving.
In the world of finance, allocation is assigning funds for a particular purpose or project. In other words, you are moving a set amount towards a specific task.
This is the inflows and outflows of your business, which are cash or cash equivalents. Simply put, it is the amount that comes in as revenue and the amount of money going out.
Cash Flow Forecast/Projections:
Cash flow forecasting is your business’s cash projection. It’ll help you keep track and understand the dynamics so that when things are looking good or bad financially, you know what’s going on and how to avoid losses.
Chart Of Accounts:
The Chart of Accounts is a list of accounts when posting transactions in your business. It helps organize your books and provides details needed for reporting accurate financials. These accounts are posted on the general ledger.
Cost Of Goods Sold (COGS):
Cost of goods sold is the total amount your business paid as a direct cost related to the sale of products. Depending on what you sell, that may include purchase for resale or raw materials used in production and packaging costs, among others.
A credit in the accounting space is an entry made to decrease an asset account or increase a liability account. For example, if you received cash for selling a wine bottle, you will credit your inventory account and debit cash.
Current assets are any property that can be converted to cash within a year. That includes your bank account, stocks owned by the business, mutual funds, inventory, and so forth. If the company can sell an asset within 12 months, it is considered a current asset.
Current liabilities are all the bills and expenses that a business owes or will owe within 12 months. It can include accounts payables, rent, office expenses such as supplies & utilities. They also contain short-term loans interest owed on any borrowing instrument, including credit card balances. If the business owes a debt or expense within the year, it is considered a current liability.
Debit is the opposite of credit. It is an entry made to increase an asset account and decrease a liability account. For example, expenses are liability accounts, whereas revenue is an asset account. You would debit cash as it is received and credit expenses paid.
Depreciation is an asset’s value that has been used over a period of time. It represents an accounting method that allocates cost over its useful life or expectancy. You can depreciate tangible assets like machines or equipment and physical assets like buildings.
Direct Operating Expenses:
Direct costs can be directly attributed to an individual product, department, or project. These are expenses that can easily connect to one specific item. This includes software licenses down to raw materials like fuel for vehicles used in production processes.
Equity capital is funds put into a company by shareholders in exchange for stock and given preference (also known as Preferred Stock) when it comes time to be paid back.
Financial statements are reports designed to see the performance and health of the company. Auditors, creditors (like banks), and investors use them to decide whether or not they want to provide money towards financing businesses’.
The three main types of Financial Statements include:
- A balance sheet that shows assets and liabilities during an accounting period
- An income statement showing how much revenue came into the business over time this can be profit margins plus other factors like taxes collected vs. earnings per share
- Lastly, the cash flow statement itemizes how much money is coming into an organization compared against expenses like paying off debts or purchasing.
A general ledger is the list of accounting data. This is where your accounts receivable, accounts payable, Assets, Revenue, equity, and others are posted in the chart of accounts.
Gross margin measures the difference between revenue and costs to produce goods or services. This is a percentage, and the higher the margin, the more capital you have leftover after directly related expenses.
A business’s Gross Profit (GP) is the total amount after deducting all expenses and revenue. Gross Profits are listed on the income statement. It displays profits/losses for individual periods and their overall change over time by province or country in question; it’s used to determine how much profit has been made relative to last year’s results.
Indirect Operating Expenses:
This is the company’s operating expenses that don’t directly contribute to the production of products but rather are the selling, general, and administration costs
Inventory is a set of items that a company holds to resale. It can also be items that are purchased to produce a finished product.
A journal entry is a process of manually inputting a transaction or multiple transactions into your accounting software. It is the process of debiting and crediting a transaction creating a double entry. Double-entry records transactions in at least two accounts to create a 0 balance at the end of the entry.
Long Term Asset:
Long-term assets are assets that companies possess with a useful life of more than one year. An example would be fixed assets such as property or equipment. Selling a property or equipment usually takes time and can’t be converted into cash quickly.
Long Term Liability:
Long-term liabilities are debt that the company pays beyond 12 months. For example, a long-term loan that must be paid over an (X) amount of years (more than 1 year and a day) is considered a long-term liability.
Net Margin is the difference between revenue and expenses in a percentage or decimal form.
Net profit measures how much your business has earned after deducting all operating, interest, and tax expenses from its gross profit over that period. If you generated more losses than profits, then it’s called “net loss.”
Operating income is a measure of how much profit you make from your business’s operations after deducting all the costs that go into running it. These include wages, depreciation, and cost-of-goods sold (COGS).
Profit & Loss (P&L):
The P&L statement (also known as the Income Statement) is a financial report that summarizes the company’s revenue, expenses, and profit or loss to provide an overview of its ability to grow.
Raw materials are the essential ingredients that a company needs to produce products. Some examples include wood, steel, lumber, gas, coal, etc.
Retained earnings are a company’s historical profits, minus any dividends it paid in the past. These funds are found in corporations, and retaining funds means they will be available for future growth and development of the business.
Return On Investment (ROI):
ROI measures how profitable an investment is relative to its cost. It’s often used by companies who want to make intelligent decisions about what they spent money on and how much they got back from that investment.
Revenue is the total amount earned selling goods or services.
One of the most critical tasks for any business owner or manager is to ensure that their books are balanced. A trial balance ensures this by checking which accounts have been credited and debited from each ledger in your company’s account setup, ensuring everything adds up correctly.
Variable costs change in proportion to how much a company produces or sells. These expenses increase when production increases, but they also fall as more products leave the shelves and go into storage.
Understanding the language of accounting is a vital part of running your own business. By understanding these commonly used accounting terminologies, you can speak confidently with your accountant and even get involved in financial decisions for your company.
To help start your journey in clearly using Accounting terms, we’ve provided an overview of generally used words that may come up during conversations about your company’s finances.
If any other words or phrases have been confusing to you as a small business owner, please let us know by filling out our contact form on our service page. We would love to provide additional information tailored specifically for your needs here at Pro Accounting Srvcs.