Whether you have an in-house accountant or have your accounting outsourced it is important that every small business owner has a fundamental understanding of basic accounting terminology. Once you have an understanding of all these basic terms, not only will this knowledge help you make smarter business decisions, but it will help you fully grasp any potential problems your accountant may present to you. Small business accounting takes a special approach, one that we’re very familiar with at BSM Accounting.
Balance Sheet Terms
One of the most important financial statements made by my accountants as it pertains to all the business’s assets, liabilities, and equity.
Accounts Payable: Expenses a business has incurred but not yet paid. The account is then recorded as a liability.
Accounts Receivable: Claims for payment held by a business for goods supplied and/or services rendered that customers/clients have ordered but not paid for.
Asset: Anything the business owns that has financial value. Usually listed in order of liquidity
Liability: All debts a business has not paid back yet.
Accrued Expense: Expense incurred, but not yet paid.
Book Value: Original Value of an asset, less any accumulated depreciation.
Inventory: Assets that a business owns that have been acquired to sell to its customers.
Equity: The net amount of funds invested in a business by it’s owners, plus any retained earnings. It is also calculated as the difference between the total of all recorded and liabilities on an entities balance sheet.
The Balance Sheet is important to understand as it essentially reflects your business’s overall financial health. You know a balance sheet was done properly if every debit on the balance sheet has a corresponding credit. Balance Sheets can help create reasonably accurate predictions on the future of your business.
Income Statement Terminology
The other most important financial statement prepared by accountants that include, expenses, revenue, and profit.
Revenue: The total amount of income generated by the sale of goods and services related to the companies primary operations. Often referred to as “The Top Line”.
Cost of Goods Sold (COGS): The direct cost attributable to the production of the goods sold in a company. COGS is deducted from revenue in order to calculate gross profit and gross margin. The value of COGS changes depending on the accounting standards used when calculating it.
Depreciation: A reduction in the value of an asset with the passage of time.
Expense: Costs incurred by the business.
Gross Margin: Represents the profitability of a business after deducting the Cost of Goods Sold.
Gross Profit: The total profit of a business without including any overhead expenses.
Net Income: The residual amount of earnings after all expenses have been deducted from sales.
Income Statements can help determine the operating performance of your business in that period of time, as well as determining if you’re properly allocating expenses. You can then modify your budget if your business is overspending or underspending on certain aspects of your business.
General Small Business Accounting Terminology
Accounting Period: Period of time where financial statements are reported.
Allocation: The process of shifting overhead costs to cost objects using a rational basis of allotment. Most commonly used to assign costs to produced goods, which then appear in the financial statements of a business in either the cost of goods sold, or the inventory asset.
Business Entity: The legal structure of a business.
ie. LLC, C-Corp, S-Corp, etc.
Cash Flow: The inflow and outflow of cash in a business.
Enrolled Agent: federally-licensed tax practitioners who may represent taxpayers before the IRS when it comes to collections, audits and appeals.
Fixed Cost: A Cost that has no effect on the volume of sales.
Variable Cost: A Cost that changes based on the volume of sales.
General Ledger: Complete record of a business’s transactions.
Trial Balance: Listing of all accounts within General Ledger.
Interest: Amount paid on a line of credit or loan that surpasses the repayment of the Original (Principal) Balance.
Overhead Costs: All costs on the income statement with the exceptions of direct labor, direct materials, and direct expenses. Overhead expenses including accounting fees, advertising, insurance, interest, legal fees, labor burden, rent, repairs, supplies, taxes, telephone bills, travel expenditure and utilities.
Payroll: Accounts showing employee salaries, wages, bonuses, and/or deductions.
We hope that these simple terms and definitions help you further understand your businesses’ financials and make more informed decisions. Stay tuned for more useful information!