If you’re a small business owner, your expertise is likely in your business, not understanding basic accounting principles.
The fundamental & important thing in accounts is analyzing, summarizing, and reporting the particulars about every economic transaction involved in the business. Accounting for small business owners is a major part of every company, whether for small business owners or large business owners.
To manage your business and your finances properly, it’s important to understand these basic accounting terms.
Accounting Terms All Business Owners Should Know
Accounting software applications have made it easier than ever for small business owners to manage their finances without a lot of accounting knowledge.
It’s in your best interest to have a working understanding of these basic accounting and business terms and what they mean.
An accounting period refers to the span of time in which a set of financial statements are released. Businesses and investors analyze financial performance over time by comparing different accounting periods. Accounting cycles track accounting events from when the transactions first occur when they end, all within given accounting periods.
An accounting period can be one month, one quarter, or one year, depending on the business.
Accounts payable (A/P)
Everything that you owe to vendors, contractors, consultants, etc., is tracked in this account.
An example of accounts payable includes when a restaurant receives a beverage order on credit from an outside supplier. Accounts payable acts as an IOU to another company
Accounts receivable (A/R)
Account receivable is created to track income/amount that hasn’t been realized yet by your organization. It’s more like the amount of money owed to your business, typically by your customers, for goods and services that you have provided. E.g., Outstanding invoices.
An example of account receivable includes; if you sell electronics on credit to a customer of yours. While your customer record that transaction as accounts payable, your organization records it as account receivable.
Knowing your accounts receivable amount is integral to calculating your receivable turnover, which is good for forecasting and gaining deep business insights.
This is the process of recording transactions as they occur rather than when payment is made or received. I.e., you record income as invoiced, not when it’s actually received, and record expenses like bills when you receive them.
Most regular businesses use accrual accounting. If you have employees, you must use the accrual accounting method.
Accruals affect businesses’ net income in the long run and, as such, must be documented before financial statements are issued.
An asset is defined as any physical item with economic value that your company owns. This could be cash; office equipment, real estate (Office building), and vehicles are all considered assets.
An asset can reduce expenses, generate cash flow, or improve sales for businesses. Companies report assets on their balance sheets.
These Asset types include fixed, current, liquid, and prepaid expenses. Assets may include long-term resources like buildings and equipment. Current assets include all assets a company expects to use or sell within one year. Liquid assets can easily convert to cash in a short timeframe.
It’s the process of making sure your records and those of your financial institutions agree for a specific month.
Bank reconciliation should be done each month for all active bank accounts.
Capital, or business capital, is the financial assets that a business needs to produce the goods and services it sells. Capital may include funds in deposit accounts or money from financing sources.
Cost of goods sold (COGS)
The total cost of producing the goods sold by a business is called the cost of goods sold. This can include anything from materials and labor to the cost of a product you purchase for resale.
It’s important to keep track of your COGS to calculate your gross and net profit properly.
This is the system that QuickBooks uses – that all legitimate small business accounting software uses. Every transaction must show where the funds came from and where they went. Each has a Credit (decreases asset and expense accounts) and Debit (decreases liability and income accounts), which must balance out (other types of accounts can be affected).
Depreciation represents how much of a particular asset has been used over a period of time.
There are different types of depreciation, and the most basic method is straight-line depreciation. It allows you to report equal depreciation expense each year until the asset has been fully depreciated.
Other depreciation methods include declining balance, double-declining balance, and sum-of-the-year’s digits.
Expenses refer to costs of conducting business. Expenses pay for items or services and are a necessity to earn revenue.
Types of expenses include fixed, variable, accrued, and operation expenses. Fixed expenses do not change from month to month, including rent, salaries, and insurance payments. Variable expenses do change monthly, and they may include discretionary or unpredictable but necessary costs.
Accountants recognize accrued expenses when companies incur them, not when companies pay for them. Primarily necessary and unavoidable, businesses incur operating expenses (often abbreviated as OPEX), like rent, marketing, and payroll, through their normal operations.
Equity is the owner’s stake in a business. It’s the difference between your assets and liabilities.
The difference represents the value of your business, which can be a positive or negative number. If your equity is a negative number, your business loses value.
Financial statements are designed to report your company’s financial performance and are used by investors, auditors, and creditors to determine the business’s financial health. The basic three financial statements are:
General ledger (G/L)
A general ledger (G/L) is a complete record of all your financial transactions and data.
Whether you use accounting software or handle your accounting manually, you will use a G/L to prepare financial reports and understand your financial performance and health over time.
Gross profit, also called gross income or sales profit, is the profit businesses make after subtracting the costs of supplying their services or making and selling their products.
To calculate gross profit, take your revenue and subtract the cost of goods sold. Gross profit considers variable costs, not fixed costs.
Inventory refers to a company’s goods and raw materials used for making the goods it sells. It appears on a balance sheet as an asset. Inventory includes finished goods, raw materials, and works-in-progress.
If you sell products, you must manage your inventory properly, including receipt of goods or materials and sales of completed goods, to maintain an accurate inventory valuation.
A journal entry refers to a business transaction recorded in a business’s general ledger. Common with manual bookkeeping systems, journal entries are still used today to record financial transactions. All journal entries should have a date and the account to be debited and the account to be credited.
A liability reflects a financial obligation your business owes to another entity. Accounts payable, accrued expenses, and payroll are all considered liabilities.
Net profit reflects the profit or loss of a business after all expenses are calculated.
Like gross income, net income subtracts any cost of goods sold from revenue received. However, to determine your net profit or loss, you will also have to subtract all expenses from the revenue total.
Revenue, also called sales, is the gross income a business makes through normal business operations. To calculate sales revenue, multiply sales price by the number of units sold. Whether that activity is selling products or providing services, you receive revenue when your customers pay for those goods or services.
Receipts are written notices acknowledging that one party received something of value from another. An acknowledgment of ownership, receipts are proof of a financial transaction.
Except for employees, It’s referred to anyone you pay as a part of your business operations.
The top 22 is a good start.
While you’ll likely continue to run into various unfamiliar accounting words, getting acquainted with these top 22 accounting terms can go a long way towards making you much more comfortable with the accounting process.