Basic Accounting Terms All Business Owners Should Know
Have you ever ended a call with your accountant feeling more confused than before it started?
Mostly 95% of all business owners’ or tax individuals’ response would be “EVERY TIME”
Business owners should always possess a basic understanding of accounting terms in order to apply it effectively to their basic day to day running of their company.
The first question that pops into your head is: “Is that not what my accountant is for?
Correct, but knowing the basic terms will make you a well-versed owner, making interactions and meetings much easier and more productive.
All good accountants will explain to you in simple words the position of your company, so you do not need to be fluent in the terminology. However, knowing the basic terms and principles will make it easier to navigate the financials of your company.
Below is a few basic terms and principles:
Income Statement Terminology:
The Income Statement AKA Profit and Loss Statement are the most common basic accounting terms used.
The Income Statement is the financial statement that shows the revenues, expenses, and profits over a given time period. The Revenue/Sales earned, is shown at the top of the report and various costs (expenses) are subtracted from it until all costs are accounted for resulting in the NET Profit or Loss of the company.
Revenue is any money earned by the business.
2. Cost of Sales/Goods
Cost of Sales/Goods Sold are the expenses that directly relate to the service or goods sold.
Not included in this category are those costs that are needed to run the business. Those costs are referred to as “overhead expenses”.
3. Gross Profit
Gross Profit indicates the profitability of a company, without taking overhead expenses into account. It is calculated by subtracting the Cost of Goods Sold from Revenue.
Expenses are day to day cost incurred by the business in order to run it. For example: salaries and wages, motor vehicle expenses, telephone expenses etc.
5. Net Profit or Loss
This is the profit or loss made for the year after expenses are deducted from the Gross Profit. This is what is used when calculating taxation payable to SARS.
Balance Sheet Terminology:
A balance sheet is a financial statement that reports a company’s assets, liabilities, and shareholder equity.
It provides a snapshot of a company’s finances (what it owns and owes).
Anything the company owns that has value. These are listed in order of liquidity, from cash (the most liquid) to land (least liquid).
Accounts Receivable include all of the revenue (sales) that a company has provided less the amounts received into the financial institution you bank with. It shows you the closing balance of outstanding income still payable.
3. Book Value
As an asset depreciates, it loses value. The Book Value shows the original value of an asset, less any accumulated depreciation.
Equity denotes the value left over after liabilities have been removed. If you take your Assets and subtract your Liabilities, you are left with Equity, which is the portion of the company that is owned by the investors and owners.
All debts that a company has yet to pay are referred to as Liabilities.
6. Accounts Payable/Suppliers
Accounts Payable include all of the expenses that a business has incurred but has not yet paid.
Inventory is the term used to classify the assets that a company has purchased to sell to its customers that remain unsold. As these items are sold to customers, the inventory account will lower.
General Accounting Terminology:
Of course, there are those basic accounting terms that don’t pertain to a particular financial statement.
1. Accounting Period
An Accounting Period is designated in all Financial Statements (Income Statement, Balance Sheet, and Statement of Cash Flows). The period communicates the span of time that is reported in the statements.
This is used by bookkeepers and accountants to assign income and costs to various accounts or periods in the income statement and balance sheet.
3. Cash Flow
Cash Flow is the term that describes the inflow and outflow of cash in a business. The Net Cash Flow for a period of time is found by taking the Beginning Cash Balance and subtracting the Ending Cash Balance. A positive number indicates that more cash flowed into the business than out, where a negative number indicates the opposite.
4. General Ledger
A General Ledger is the complete record/summary of a company’s financial transactions. The GL is used in order to prepare the Financial Statements.
5. Journal Entry
Journal Entries are how updates and changes are made to a company’s books.
6. Trial Balance
This is the closing balances/summary of the Income Statement and the Balance Sheet for the financial year.
These terms might seem difficult to digest at first, but once you grasp these basic financial terms, you will feel more empowered when next you communicate with your respective bookkeeper/accountant.
For any help you may need for your businesses accounting, contact us here today!