Common accounting terms every business owner should know
If you're a business owner, you're probably somewhat familiar with basic accounting concepts. However, effectively managing your company's finances depends on your ability to understand common accounting terms. Accounting is the process of recording, collecting and examining financial activities in order to gain knowledge about the financial situation of a company. In this post, we'll go over some of the most commonly used accounting jargon that every business owner should be familiar with.
Assets and liabilities
Assets are resources that a company owns or controls that have value and can be converted into money. Examples of assets include cash, accounts receivable, inventory, and property. Liabilities, on the other hand, are obligations that a company owes to others, such as loans or accounts payable.
Equity is the difference between a company's assets and liabilities. In other words, it is the part of the company that belongs to the owners. Equity can be divided into two categories: equity and retained earnings. Equity is the owner's initial investment, while retained earnings are profits that have been reinvested in the business.
Revenue is the total amount of money a company earns from the sale of goods or services. Revenue is usually the primary source of revenue for most businesses.
Expenses are expenses that a company incurs in order to generate revenue. Costs can be divided into two categories: direct costs and indirect costs. Direct costs are costs that can be directly attributed to the production of goods or services, while indirect costs are costs that are not directly related to production, but are necessary for the company's operations.
Cost of Goods Sold (COGS)
Cost of goods sold (COGS) is the direct cost of producing the goods or services that a company sells. COGS includes the cost of materials, labor, and overhead required to produce goods or services.
Gross profit is the amount of revenue earned by the company minus the cost of goods sold. It represents the profit that the company makes before the deduction of operating expenses.
Net income is the total profit a company earns after deducting all of its expenses, including operating expenses, interest and taxes.
Accounts receivable is money owed by customers to a company for goods or services sold on credit. Accounts receivable represent money that the company expects to receive in the future.
Commitments towards suppliers
Accounts payable are money owed by a company to its suppliers for goods or services purchased on credit. Accounts payable represent money that the company expects to pay in the future.
Cash flow is the movement of money in and out of a company. Positive cash flow means the company has more money coming in than going out, while negative cash flow means the company has more money going out than coming in.
Financial statements are documents that provide a summary of a company's financial transactions. The three primary financial statements are the balance sheet, the income statement, and the cash flow statement.
A balance sheet is a financial statement that shows a company's assets, liabilities and capital at a certain point in time. It provides a snapshot of the company's financial position.
Profit and loss account
An income statement is a financial statement that shows a company's income and expenses over a specific period of time, usually a month, quarter, or year. It provides a summary of the company's profitability.
Cash flow statement
A cash flow statement is a financial report that shows the movement of money in and out of a business over a period of time. It provides insight into a company's ability to generate cash and pay its bills.
Accrual accounting is an accounting method that recognizes revenues and expenses when they are earned or incurred, regardless of when cash is exchanged. This method provides a more accurate picture of the company's financial situation by comparing revenues and expenses in the period in which they were incurred.
Accounting on a cash basis
Cash basis accounting is an accounting method that recognizes revenues and expenses when cash is received or paid. This method is simpler than accrual accounting, but it can result in distorted financial statements because income and expenses may not be reconciled in the period in which they were incurred.
Depreciation is the process of allocating the cost of a fixed asset over its useful life. Fixed assets, such as equipment or buildings, lose value over time due to wear and tear and obsolescence. Depreciation costs reduce the company's net income, but do not affect its cash flow.
Profit margin is the percentage of revenue that a company keeps as profit after deducting all of its costs. Profit margin is a key metric for measuring a company's profitability and is often used to compare companies in the same industry.
Return on Investment (ROI)
Return on investment (ROI) is a measure of the profitability of an investment. ROI is calculated by dividing the net profit of an investment by its cost. A high ROI indicates that the investment is profitable, while a low ROI indicates that the investment is not worth investing.
The level of sales at which the company's revenues and total costs are equal is known as the break-even point. The company is operating at a loss below the break-even point, while the company is profitable above the break-even point. Understanding the minimum amount of sales required for a business to break even depends on knowing the break even point.
Understanding these basic accounting concepts is essential if you want to effectively manage your company's funds. A basic understanding of accounting jargon is essential whether you are preparing financial statements, evaluating financial success or choosing investments. You can make better decisions and guarantee the long-term success of your company if you take the time to learn these terms.
- AccountingCoach.com, “Introduction to Accounting Basics”
- Investopedia, “Accounting Basics: Introduction”
- AccountingTools.com, “Accounting Glossary”