What's the difference between an accountant and a bookkeeper? What are accounting ratios, accounts receivables and accounts payables? And what exactly does your accountant mean when she says your financial statements need to follow GAAP standards?
Whether you do your own accounting, have an in-house accountant or hire a third party accounting firm, having a grasp on accounting speak can help your business tremendously. Not only will it allow you to understand your numbers better, but it will also help you make wiser business decisions. To help you get started, here are some basic accounting terms small business owners need to know, followed by our reference guides.
1. Accounts payable
Often abbreviated with AP, this is a term used to describe all of your unpaid expenses. It should be recorded (and thought of) as bills that are due to the business. It is a common liability.
2. Accounts receivable
This is the inverse of accounts payable. Accounts receivable (AR) is money owed to the business that has not yet been paid. It can be considered an asset.
This is the practice of spreading the cost of an expense across multiple accounting periods on your balance sheet. A common example is depreciation. Suppose you purchase manufacturing equipment for your business. You can spread the cost of that equipment over several years.
Anything the company owns that has a determined monetary value is an asset. This can include cash, real estate, equipment and inventory. Assets can have varying degrees of liquidity, which is another way of saying some assets are easy to spend, like cash, while others are hard to spend, like property, which first has to be sold (or liquidated).
5. Balance sheet
This is the master record of a business's finances. It reports the assets, liabilities and equity, and it follows a set equation: Assets = Liabilities + Equity.
Capital is the money that your company can use for operations and investment. It is calculated by subtracting liabilities from assets. It can include cash, but it can include non-cash assets that can be leveraged or liquidated for spending. Capital is not the measure of how much the company is spending, but rather the amount the company could spend.
7. Cash flow
This is the amount of cash the company is expected to receive over a select time period. Monthly cash flow is how much cash you anticipate receiving in a month.
A certified public accountant is a designation conferred by The American Institute of Certified Public Accountants. CPAs pass a uniform certified accountant exam and are licensed in their home state. The designation denotes a certain level of mastery in accounting to verify that an individual is properly qualified to work in this field.
Credit is an accounting entry that can either increase a company's liabilities or decrease its assets. A credit owed to the business decreases assets. A credit owed by the business will increase liability.
A debit is the inverse of a credit. A debit paid to a business increases its assets. A debit paid by the business decreases its liabilities. The double-entry accounting method pairs every debit and credit in the ledger.
Depreciation measures how much value an asset loses over time. A classic example is the depreciation of a company vehicle. Each year, the vehicle decreases in value. The process of lowering an asset value is depreciation.
Diversification is the process of spreading investments into varied assets. The goal is to minimize risk by reducing the percentage of assets that can lose value resulting from a single event or transaction.
Expenses are what your company pays. Generally, they are categorized as fixed, accrued, variable or operation.
- Fixed expenses (FE) are payments that are the same each period, like rent or mortgage.
- Variable expenses (VE) change regularly. Labor or inventory replenishment are common examples.
- Accrued expenses (AE) are expenses that have yet to be paid.
- Operation expenses (OE) are indirect costs, such as advertising or taxes.
On a balance sheet, equity is determined by subtracting liabilities from assets. Owner's equity is a different concept that describes how much of something is owned by a person or business. Property equity demonstrates how much of a mortgage is paid, while stock equity describes the percentage of a company that is owned via stock.
15. General ledger
This is the complete record of a company's financial transactions.
16. Gross profit
This is the company's profit excluding overhead expenses. It is often used as part of the calculation to evaluate a company's value. Determining such value will be necessary to secure a business loan or pitch to investors.
Insolvency is what occurs when a company or individual cannot pay its debts. Insolvency is often projected by comparing all expenses to revenue. If revenue is insufficient to cover expenses, insolvency becomes inevitable.
Inventory is the list of sellable goods owned by a company. Inventory is usually classified as finished goods (which are ready for sale), work-in progress goods (that require assembly) and raw materials (that will become other goods in time).
A liability is money the business owes. Accounts payable, taxes and accrued expenses are different types of liability (but not a complete list of liabilities that exist).
A limited liability company (LLC) is a business structure in which the owners are not personally accountable for company debts or liabilities.
21. Net profit and loss
Net profit is how much money the business has made after subtracting every single expense. Net loss is how much money the company lost after this same calculation if profit is negative.
This is the general cost of doing business, but it does not include the cost of goods that are sold. Utility payments, printing costs and property taxes are examples of overhead.
Return on investment (ROI) is a calculation that demonstrates how much money is made from an investment relative to its cost. This calculation is not limited to asset accumulation. An ROI can be calculated for money spent on advertising, for example.
Revenue is the total amount of money earned by the business. It is used to calculate gross and net profit.
A subchapter S corporation (S-Corp) is a legal structure that passes income, losses and deduction on to the company's shareholders.
To learn more about these accounting terms and what they mean for your business, check out our reference guides:
- What Is Accounting?
- Accountant vs. Bookkeeper: What Do They Do for a Business?
- Accounts Receivable: What Small Businesses Need to Know
- Accounts Payable and Your Business: What You Need to Know
- GAAP: Standards & Rules for Accountants
- Finding the Right Accountant for Your Small Business
For information on choosing the best accounting software for your business, check out our buyer's guide: How to Choose an Accounting Software. To see our top picks and a comprehensive list of accounting software providers, check out our roundup, Best Accounting Software for Small Business. Ready to choose accounting software? Here's a breakdown of our review coverage: