An entrepreneur is not just the owner of a startup, but someone who knows little about every aspect of its business. So whether you intend to do your own business bookkeeping or hire a professional you should be familiar with some of the basic accounting terms. To some entrepreneur, accounting may be a daunting task, while to others, its fun.
However, whether daunting or fun, here are the basics accounting terms you need to familiarize yourself with.
Basic Accounting Terms Used on Financial Statements
Fiscal Year: A fiscal year is the 12 month period that makeup the start and end of the annual financial records for a business. It does not necessarily match with the calendar year. For example, farmers often use a fiscal year that ends in the fall.
Assets: Assets are anything that can be owned by a company or an individual person. These are able to be sold for cash. Commonly, assets produce income or give value to the owner.
In the world of financial accounting, assets prove to be economic resources. They can be physical objects or intangible concepts that can be utilized and owned to create value. Assets are deemed to have real and positive value for their owners. Assets must also be convertible into cash, which itself is furthermore considered to be an asset. Examples include land, vehicle, building, etc.
Liabilities: Liabilities are the amounts of money that are owed by the business at any given point. This includes salaries, rents, the money owed to suppliers, tax, etc. These liabilities are displayed on the firm’s balance sheet. They are commonly listed as items payable, or simply as payables.
There are two types of liabilities. These are longer term liabilities and shorter term liabilities.
Long term liabilities turn out to be business obligations that last for greater than the period of a single year. Mortgages payable and loans payable are included in this category.
Short term liabilities represent business obligations that will be paid in less than a year. There are many different kinds of short term liabilities.
Revenue: Revenue is the sum of total of money generated by a business through the sale of goods and services, property, shares of the company, etc. before deducting expenses.
Expenses: Business Expenses are costs incurred by a company to generate revenue. It can either be fixed (rents, salaries, etc.) or variable, e.g. those that fluctuate depending on sales or production cycles.
Accounts Receivable: Accounts receivables are the amounts of money owed to the company by customers for goods and services rendered. Because the clients have a legal obligation to pay, the amounts are entered as an asset on the balance sheet.
Capital / Working Capital: Working capital is money that a company has available to pay bills or reinvest. It is equal to the value of all current assets minus liabilities and is considered a key measure of the health of a business.
Bad Debt Expense: Bad debts are incurred when customers do not pay amounts owed. They are recorded as an expense on financial statements.
Accruals: Accruals are revenues that are earned but not entered into the books (such as completed but not invoiced sales) or expenses that are incoming but not received (such as goods purchased but not yet invoiced for).
Depreciation: Depreciation occurs as business assets such as vehicles and equipment decline in value over time due to use or obsolescence. Depreciation is an important tax deduction––a percentage of the original value of the asset can be written off every year based on the rate of depreciation.
Equity / Shareholder’s Equity: Equity is the amount of money invested in the company by the owners (shareholders) minus any money taken out in the form of draws (not salary).
Dividends: Dividends are distributions of a portion of company earnings to owners (shareholders) of the company. Dividends can be issued on a regular or non-regular basis and may consist of cash or additional shares in the business. For tax purposes, a business owner may prefer dividends to salary.
The Two Main Methods of Accounting
Cash Basis Accounting: Cash basis accounting is a simple method of keeping track of revenue and expenses––revenue is recorded when the customer makes payment and expenses are recorded when paid out. It is most often used by sole proprietorships and small businesses that don't maintain inventory. If the customer pays by credit the revenue is not recorded until full payment is received, regardless of the invoice date. Similarly, if the business incurs an expense on credit, the expense is not recorded until the invoice is fully paid.
Accrual Basis Accounting: Public companies and most businesses and professionals in the United States and Canada are required by law to use accrual basis accounting, which requires revenue to be recorded when the customer is invoiced and expenses to be recorded when they are incurred, rather than when the actual payments are made. Accrual Basis accounting gives a more accurate picture of the long-term health of the business.
Basic Accounting Terms For Financial Statements
Balance Sheet: A balance sheet is a snapshot of a company’s financial status at a particular point in time. It is organized into two main columns, with assets in one column and liabilities and shareholders equity in the other.
Income Statement: The Income Statement shows your revenues, expenses, and profit for a particular period. It's a snapshot of your business that shows whether or not your business is profitable at that point in time:
Revenue - Expenses = Profit/Loss
Cash Flow Statement: The Cash Flow Statement shows the movements of cash and cash equivalents in and out of the business. Most businesses that fail do so due to chronic cash flow problems.
General Ledger: The general ledger is the complete recording of a company’s financial transactions over the lifetime of the organization, including assets, liabilities, revenue, expenses, and equity.
Conclusively, this article basic accounting terms for business owners was first published by THE BALANCESMB and featured in here. However, before publication, changes were made to the original article in some paragraphs.
Why should you pay attention to know these basic accounting terms? To avoid misconception in your finance.
further, whether you're an accountant or not, knowing these basic accounting terms will be of great help to you to understanding your business financial statement and others.