Accounting Terms Made Simple
After I graduated college (we wont say how many years ago), I tried to help other wanna-be accountants begin their path to the "exciting" world of debits and credits. In doing so, I would always start with the same opening line... "You will either love accounting or hate accounting... very few people are in between." I find this to be more and more true each day. Though I love what I do, most business owners, managers and non-finance team members start to glaze over when I hit these terms and topics.
"I know that I need the information but I don't know how to understand it or use it." This is a phrase I hear often from my clients. I am going to take a little of the complexity and fogginess out of your conversations with your Accountant by explaining a few of the technical terms... (UNASHAMED PLUG NOTICE) and if you don't have an Accountant, you are welcome to get pricing here!
You will hear words like "Financials," "Financial Reports," "Month-end Reports," "Financial Package," "Statements," "Financial Statements," and the list goes on. These are normally 3-4 reports that you will get on a monthly basis. After your accountant reviews your financial records, they will pull these reports together and send them to your in a "package." It is EXTREMELY important that you, as a business owner, can review these reports with understanding. You know your business better than anyone else and can normally spot a problem quickly... if you know what you are looking at. So let's go a little deeper into these reports.
Balance Sheet - This document has different terms that I will explain below but basically it tells you the "book" value of your company. This is not what the company is worth. Balance Sheet Terms are:
Accounts Payable - Vendor Invoices not yet paid
Accounts Receivable - Customer Invoices outstanding (cash not received)
Accrued Expenses (Accruals) - Expenses that have been incurred within the period but an invoice has not been received from the Vendor.
Asset - What the business owns (include cash, vehicles, equipment, etc.) They are normally in order of most to least liquid
Book value - The book value is the original cost of the asset less any depreciation or amortization
Equity - Assets less Liabilities (The ownership book value of the company)
Inventory - Assets that are purchased for resale that have not been sold
Liability - What the company "owes" to vendors, loan holders, employees, etc.
Income Statement - "Profit & Loss," "P&L," tells a company what it has made or lost in the month, quarter or year-to-date. It is the inflow and outflow of expenses or revenue.
Accrual vs Cash Accounting - Cash accounting, the more basic and simple form of accounting, means posting the revenue and expense at the time the cash moves in or out of the company, while Accrual accounts means posting the revenue or expense at the time it is incurred or earned. Accrual accounting is more complicated and required in certain business forms or circumstances by the IRS.
Cost of Good Sold - "COGS," "Cost of Sales," "COS" are the expenses that directly relate to the revenue earned through the sales of goods or services
Depreciation - Mentioned above in Book Value, is the loss of value in a tangible fixed asset over time. The other side of this transaction is Accumulated Depreciation which nets against your fixed assets on your Balance sheet to bring you to a Book Value
Expense - Any expense incurred by the company
Gross Margin - "Top of the Line Margin," "GM," is a percentage. It is calculated by taking the Gross Profit and dividing it by the Revenue. The higher the percentage, the better.
Gross Profit - "GP," Your profit on goods or services sold before operating expenses. This is calculated by taking the Cost of Goods Sold from the Revenue.
Net Income (Loss) - Basically your overall profit or loss. Calculated by starting with your revenue and deducting all expenses for the company.
Net Margin - "Profit Margin" is the same idea as Gross Margin only you start with your Net Income or Loss and divide by your Revenue
Revenue - "Sales" "Income" - Income earned by the company
Cash Flow Statement - This statement tells you where your cash went or came from for the period or select periods. It is divided into 3 sections. Operating, Financing & Investing.
Operating - Cash that came from or went out through the day to day operations of the business
Investing - Cash that came from or went out through investing in equipment, buildings, etc. or the sale of such items
Financing - Cash that came from or went out through equity or loan related activities including funding rounds, loans, and personal investments
Statement of Equity - Normally this document is created for C-corps or those with equity shares (Private or Public). This statement includes the ins and outs of all equity activity including Stock Options and other share purchases.
There are other terms that you will hear when you talk to your Accountant, Investors or Banker. The following are some important ones to note.
Accounting Period - Normally a month, quarter, or year-long span of time, this is the period of time reflected on any reports you are given by your accountant
Allocation - This is a span of time that an expense or revenue is applied against. We can allocate costs for software systems over the life of the contract
Credit - Unlike your check register, this can increase one type of account but decrease another. For assets or expenses, a credit will DE-crease the account. For revenues, liabilities or equity, a credit will IN-crease the account.
Debit - Basically opposite of Credit. For assets or expenses, a credit will IN-crease the account. For revenues, liabilities or equity, a credit will DE-crease the account.
Fixed Cost - vs Variable Cost. This cost is one that is not affected by the increase or decrease in Revenue.
General Ledger - "GL" is the backbone of your company's financial transactions. All transactions are posted to the GL which must always balance to zero. The GL includes all Assets, Liabilities, Equity, Revenue and Expenses.
Generally Accepted Accounting Principles - "GAAP" Rules for Accountants. General standards and guidelines that accounts should adhere to when preparing the financial transactions of a company. In some cases, adherence to GAAP is required by law.
Journal Entry - "JE" is the way an accountant will enter a transaction into the General Ledger. The transaction must balance between debits and credits.
Return on Investment - "ROI" is basically how much revenue you make above any investment you put into a project, job, investment, etc.
Trial Balance - The balance at any point in time on all accounts in the General Ledger
Variable Cost - vs Fixed Cost This cost is directly affected by an increase or decrease in Revenue.
Now that you have the basics of the terms you will hear, be sure to review the financials of your company using these as a guide to learn more about your company and where it can go. It wont bring you success on it's own, but every little step counts!
Again, if you are in need of any business financial services, we will be glad to help. Fill out our questionnaire and we will get you a price. Have an amazing day and may you have great success!!!