In the world of accounting, there are many terms that may seem confusing, but when broken down are actually very simple. If you’re left scrambling to find exactly what your accountant means, you are not alone.
According to Quickbooks 2015 Small Business Accounting Report, only 40% of business owners surveyed considered themselves to be “extremely” or “very knowledgeable” in the areas of accounting and finance.
Accounting is a profession heavily reliant on jargon and unfamiliar terms, which is possibly one reason why large numbers of business owners lack confidence when it comes to bookkeeping.
In this article, we’ve broken down some of the most common accountancy terms you may come across, to help you better deal with your business finances.
Accounting Terms You Need to Know:
- Accounts Receivable
These are considered to be an asset to your business. Accounts receivables are any monies owed to you by clients that they are legally obliged to pay.
Accruals are a list of expenses that have been incurred but are not yet paid. This can also be referred to as “accounts payable”.
- Accrual Basis
This is an accounting method whereby you record income as it is invoiced (not yet received) and expenses as bills are received (not yet paid). The other method to be aware of is “Cash Basis”, where you record income only when you receive money and expenses only when you pay the bills.
- Acid Test
This term is frequently used in all countries other than North America, and is a stringent measure of a company’s ability to pay its short-term debts. It may also be referred to as “quick ratio” and refers to the ratio of liquid assets (so no shares included) to current liabilities. (Liquid assets = cash on hand, or assets which can readily be converted to cash).
Assets are the physical items you own that have value. These could include current assets, which are things like stock, cash and accounts receivable, or fix assets, which include items such as buildings, vehicles, equipment or property.
- Bad Debt
This refers to any accounts receivables that you are not able to collect. For example, if the client is unresponsive or they have been declared bankrupt. In some parts of the world, these may be tax deductible.
- Balance Sheet
A balance sheet is a snapshot in time showing your assets, liabilities and equity. It can be used to figure out calculations, such as your gearing (ratio of debt to equity).
This may also be referred to as “working capital,” and is the term for the money that you have readily accessible to invest or spend on necessary business items. For example, as a digital business owner, you may have capital set aside just in case you need to purchase a new laptop or equipment, such as stationery or printer ink.
- Cashflow Statement
Your cashflow statement shows the movement and availability of cash through and to the business over a finite period of time. This statement is extremely important because you can use it to monitor and predict the availability of cash for things like paying any suppliers or staff you have.
If your company owns large assets in order to run your business (such as any equipment), then depreciation may be a relevant term for you. Depreciation measures the decrease in value of an item over time. This can often be used as a write-off on tax returns, depending on the country you file your taxes in.
Equity refers to the amount of money invested in a business by its owners. This may be referred to as “owner equity” when there is only one or a few owners, or shareholder equity if it has come from stock options.
Expenses are divided into different types for accounting purposes:
Fixed expenses – Costs that do not vary with changing sales or production; for example, rent, wages or utility bills.
Variable expenses – Those that do vary according to conditions, such as number of sales; for example, if you are an eCommerce store, your postage costs will increase with increased sales.
Accrued expenses – Single expenses that are reported for accounting purposes but have not yet been paid.
Operational expenses – Expenses that are necessary for you to conduct business; for example; insurance, legal fees, office supplies, depreciation, repair costs, accounting fees and software subscriptions.
- Fiscal Year
Fiscal year refers to the time period a company uses for preparing financial statements and for accounting purposes. Companies nominate their own fiscal year, which may coincide with whatever their particular federal tax year is. For example, in the US, the tax year is the same as the calendar year, in New Zealand, the tax year is April until March of the following year. It is important to note that your business may be happy to coincide with your federal tax year if your bookkeeping is relatively simple, but larger companies sometimes nominate time periods based on how long it takes them to close out their books for federal tax return requirements.
Forecasting is the process of using your business’ past financial data to predict future trends. For example, you may notice that you increase sales by an average of 3% per month, so this data could be used to predict what your sales might look like in six month’s time.
- General Ledger
The general ledger is a complete recording of your business’ financial transactions over its lifetime.
Any debts you are responsible for paying in the short or long term.
- Net Profit
The word net refers to “after all deductions”, so net profit is generally taken to mean what is left over after expenses are deducted from revenue. This figure is generally before tax is taken out, so you may also hear “net profit before tax.”
- Profit and Loss Statement
This is another important accounting document for your business. It gives an overall picture of how well your business has performed in its trading activities and includes: earnings, expenses, gross profits and net profits. The profit and loss is often referred to as one of the “most important” accounting documents along with your balance sheet and cashflow statement.
Revenue is total amount of money the company brought in from the sales of goods or services, before any expenses are subtracted. Revenue may also include any credits or discounts you have for returning products to suppliers.
- Working Capital
This is the amount you have available to run your business after current liabilities are subtracted from current assets. It may be more or less than what is actually required to fund the business.
International Accounting Terms:
Additionally, if you’re a digital business owner selling across country borders, you’ve got even more things to know about. Taxes such as VAT, GST or other sales taxes are not limited to your own borders, so you find yourself having to become familiar with the accounting systems and terms of other nations too. One thing you should understand, especially if you do business worldwide, is that there are not many differences in the GAAPs (Generally Accepted Accounting Practices) of each country; however, sometimes terms and interpretations vary.
While most of the world now uses International Financial Reporting Standards (IFRS), the USA does not require their use and still uses its own GAAPs. IFRS have been developed by the International Accounting Standards Board (IASB), a multi-national board based in London. Overall, you simply need to know that the different countries you deal with may have adopted different standard practices and different terms (for example, a profit forecast in Europe may be referred to as a revenue forecast in the USA).
As a business owner, it is vital to be educated in the terms that you will commonly hear when dealing with your company’s finances. Next time you’re in a conversation with your accountant, we hope you’re better placed to understand and ask a few questions. Being properly involved with the accounting side of your business can help you develop better strategies to stay in business going forward.
Need help simplifying your small business accounting? Contact us today!