What’s the difference between an accountant and a bookkeeper? What are accounting ratios, accounts receivable and accounts payable? And what does your accountant mean when they say 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. It will not only allow you to understand your numbers better but also help you make wiser business decisions. To help you get started, here are some basic accounting terms that small business owners need to know, followed by our top accounting software picks.
Often abbreviated as AP, the term accounts payable describes 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.
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.
Amortization 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).
A balance sheet 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 as well as noncash 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.
This is the amount of cash the company is expected to receive or lose over a select time period. Monthly cash flow is how much cash you anticipate receiving in a month.
Certified public accountant (CPA) 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 (but can practice in other states). 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 increases 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.
Business expenses are what your company pays. Generally, they are categorized as fixed, accrued, variable or operating expenses.
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.
This is the complete record of a company’s financial transactions.
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.
Whereas insolvency is the condition of being unable to cover your expenses, bankruptcy is the court mandate detailing how you’ll fulfill your financial obligations.
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 (which require assembly) and raw materials (which 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.
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 deductions on to the company’s shareholders.
For information on choosing the best accounting software for your business, check out our buyers guide on how to choose accounting software. To see our top picks and a comprehensive list of accounting software providers, check out our roundup of the best accounting software for small business.
By using business accounting software, you’ll gain experience with the accounting terms on this list. As you use this software, you’ll get accustomed to the accounting jargon and how your business should manage its finances.
Additionally, accounting software will give you the tools you need to oversee your business’s finances. Invoicing, expense management, bill pay and tax filing are just some of the many financial needs that accounting software can easily cover.
We review accounting software every year and consistently find that these vendors rank among the best:
Between mastering key accounting vocabulary and setting up robust accounting software, you’re putting your company in a powerful financial position. You’re preparing yourself to face challenging financial times and make the most of your highest-earning periods, and all it requires is some additional education and infrastructure.
Max Freedman contributed to this article.