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Accounting is one of those fields that’s really hard to understand, but is still important to know. Like it or not, the accountant is the backbone to your business. Whether you’re a small business owner or an individual, it’s important to understand the basics of accounting – and how to work with the numbers. So, we’ve created a simple, but in-depth guide on some of the most important accounting terms.
Balance sheet terminologies
If you hired an accountant, one of the two most common financial statements you might have already received is the balance sheet. To better understand it, here’s a set of terminologies that may help you.
Accounts Payable (AP)
This refers to the total expenses a business has acquired that still remains unpaid. Since this is technically a debt still owed by the business, this is filed under liability.
Accounts Receivable (AR)
Accounts Receivable pertains to the total sales or revenue the business has provided but remains to be uncollected. This is filed under asset since this is money to be received by the company in the future.
Any expense acquired but not yet paid is called an Accrued Expense.
An asset is anything the business has ownership on which holds monetary value. Assets are listed in liquidity order, from cash being the most liquid and to land being the least.
Balance Sheet (BS)
A balance sheet is a financial report about the company’s assets, liabilities, and equity. This is done or “balanced” by using the equation <Assets = Liabilities + Equity>.
Book Value (BV)
Depreciation is when an Asset decreases in value. The original value of an asset is shown by the Book Value.
Equity is the value that remains after eliminating the liabilities. Going back to the equation, if you subtract your Liabilities from your Assets, you are left with Equity. This is the part of the business under the investors’ and owners’ ownership.
An inventory is a list that serves to classify all the unsold assets of the company. As these items are sold, the inventory count decreases.
Liabilities contain all the unpaid debts the company has at the moment. Some examples of entries under this are loans, payroll, and accounts payable.
Income Statement Terms
This is also known as the Profit and Loss Statement style=”font-weight: 400;”> and is the other common financial statement made by accountants.
Cost of Goods Sold (COGS)
This includes all the expenses spent to produce the product or service offered by the company. However, keep in mind that this does not include the cost to operate the business. One example of COGS is the cost of the materials needed for the production.
Depreciation refers to the asset’s decrease in value as time passes by. Some examples are equipment and automobiles that wear out over time. In the Income Statement, deprecation is listed as an expense and is classified as a “Non-Cash Expense.” The reason for this is because while it serves as a loss, it still has no effect on the company’s liquid assets.
Any cost incurred by the business is filed under Expense.
Gross Margin (GM)
Gross Margin is the Gross Profit divided by the Revenue in the same period. Gross Margin pertains to the profitability of a business after the COGS is taken away.
Gross Profit (GP)
This pertains to the profitability of a company without including the overhead expenses. This is expressed in dollars and is calculated by taking the Revenue and subtracting the COGS for the same period of time.
Income Statement or Profit and Loss (IS or P&L)
This is a common financial statement made by accountants that showcases the expenses, profits, and revenue within a certain period of time. At the top of the statement is the revenue acquired and the expenses are subtracted from it. The difference is then labeled as the Net Income.
Net Income (NI)
This is the total amount earned in profits and is calculated by subtracting all the Expenses from the Revenue in a certain period of time. The Expenses include the Taxes, Depreciation, Overhead, and COGS.
This is basically the profit relative to the Revenue and is computed by dividing the Revenue from the Net Income within a certain period.
Revenue or Sales (Rev)
This is any cash earned by the company by providing its services or products.
Now, let’s move to the terminologies that do not necessarily show up in financial statements.
All Financial Statements are done according to a given Accounting Period which is the span of time in which the report is generated from.
Designating funds to different accounts or periods is termed as Allocation. For instance, a certain amount of money can be Allocated for either different departments or for a certain amount of time.
Business (or Legal) Entity
This is a classification that identifies the type of business with each type having a unique set of laws, tax responsibilities, and requirements. Examples are Sole Proprietorship, Partnership, Limited Liability Corp (LLCC), S-Corp, and C-Corp.
Cash Flow (CF)
Cash Flow is basically just what the name implies: any flow of cash, be it in or out. The Net Cash Flow is calculated by subtraction the Ending Cash Balance from the Beginning Cash Balance. If the difference is a positive value, this indicates that more cash flowed in than out, and vice versa.
Certified Public Accountant (CPA)
This any accountant that has passed the CPA exam and has fulfilled all requirements to practice the profession.
A credit is a decrease in asset or expense account and increase in liability or equity account.
This is the exact opposite of credit wherein there is a decrease in a liability or equity account and increase in an asset or expense account.
This is a means of decreasing risk by allocating capital for different assets. This is so failure of one asset does not dictate the performance of the whole.
Enrolled Agent (EA)
This is a designation given to individuals who were able to pass required tests and prove their expertise in taxation and business. Enrolled Agents accomplish business tax filings in compliance with the IRS.
Fixed Cost (FC)
These are entities that do not change even with changes in the sales volume such as salaries and rent.
General Ledger (GL)
A General Ledger is where the complete record of the business’ financial transactions are kept and is used in preparing the Financial Statements.
Generally Accepted Accounting Principles (GAAP)
The GAAP is a set of rules by which accountants withhold whenever a job is being done.
Interest is the amount to be paid by the loaner in excess of the true cost of the loaned product or service.
Journal Entry (JE)
Updates and changes in the business books are made in the form of Journal Entries. A viable Journal Entry should have a unique identifier or label, date, debit/credit, amount, and account code.
Liquidity refers to how fast a certain asset can be converted into cash. To give you an example, stocks hold more liquidity than a house because the former is easier to sell than the latter.
This is a term utilized to pertain to whether information affects business decisions. If a company holds a revenue in millions of dollars, a small amount of $1 is almost not material. All Material should be disclosed as per the GAAP.
On Credit/On Account
On Credit or On Account purchases are purchases that are yet to be paid in the future while the buyer already holds that service or product on hand.
This is a term used to refer to any Expenses spent in operating the business. But, Expenses that create and deliver the product or service are not filed under this. Overhead are typically the Rent and Executive Salaries.
Payroll is the account where payments to staff, such as wages, salaries, and bonus, are kept. This is filed under Liability on the Balance Sheet.
Present Value (PV)
Present Value, as the term implies, is the Asset’s value as of present time. This is derived due to the concept of inflation in which it is believed that cash today is more valuable than cash tomorrow.
A business gives out receipts as proof that payment has been made. A business can also receive receipts for anything it avails to run the business. All received receipts should be properly kept and classified to cross check accuracy of expenses.
Return on Investment (ROI)
To calculate Return on Investment, take the profit or the return of the company and divide it by the investment required. To make this simpler, if a company spent $2,000 on marketing purposes and earned $4,000 in profit, the company’s marketing ROI then is 50%.
Trial Balance (TB)
Trial Balance is a document that enumerates all accounts found in the General Ledger together with their balance amount, whether debit or credit. To have a balanced report, the total debits must be equivalent to the total credits.
Variable Cost (VC)
Variable Cost is the opposite of Fixed Cost. The more sales the company makes, the more Variable Costs there will be since these are expenses required to successfully deliver the company’s products or services. Let’s say if a product is selling like hot cakes, the company will need more of the raw materials needed to produce more of that product in an attempt to meet the demand.