When an accountant or treasurer finishes their report, are you left with the question, “Was that good or bad news?” In its quest for precision and accuracy, the language of accountants can start to sound like jargon to the untrained ear. Some accountants are very good at using plain language, while others are blissfully ignorant that their message is not being understood by their audience.
The internet is full of accounting glossaries and there are countless books with titles like “Accounting for Non-Financial Managers,” but most resources do not answer your fundamental questions:
- Is this important?
- What should I do about it?
Sworn to secrecy as I am, I am not in a position to give away the secret handshake or the decoder ring, but here is a short list of common terms you will hear in financial analysis, along with warnings about what action(s) you should take when you hear them.
Accrue / Accrual
This term simply means that the paperwork has not caught up to the transaction. For example, if your lawyer has done work for the organization and has not yet submitted an invoice, the accountant will accrue the legal fees. This also works for revenue as well. If we have shipped a product to a customer but have not yet sent out the invoice, we will accrue the revenue and any associated costs.
Action Required? No. This is just the accountant attempting to capture all of the transactions that happened in the period.
However – If the word keeps showing up repeatedly, you should ask why the paperwork is taking so long to catch up to the transaction.
Defer / Deferral
When the organization has received money for a particular purpose and it has not fulfilled its end of the bargain, the money cannot be recognized as income, so it is deferred. When the organization has performed its obligation, the money is included in income. This is a confusing concept and can lead to disputes between the revenue generation staff and the financial staff.
Let’s say that an organization sells a 12 month membership to Ms. Jones for $1,200. In return for the money, Ms. Jones has access to the resources for a year. At the beginning of the year, the organization has done nothing for Ms. Jones, so the whole amount is deferred. With the passing of each month, the organization can bring $100 (a twelfth of the annual amount) into income.
Action Required? Yes. Deferrals can cause issues between the revenue generation team and the finance team unless the differences are understood. In the simplistic example above, let’s assume that the membership sale happened at the end of the year. The revenue generation team may think it has met its objective because it brought in the membership, but the finance team will argue that the money belongs in the next year, not this year.
Amortize / Depreciate
This is the simple idea of spreading the cost of something over its useful life, with the added wrinkle that if the something is a mortgage, the payments are divided into principal and interest. Only the interest becomes an expense.
Action Required? None, except that if the amortization amounts are high, they can obscure other results. If you have a lot of amortization, especially when both revenues and expenses are affected, you should pay careful attention to the cash flow statement to be sure that more cash is coming into the organization than you are paying out.
The difference between the actual amount and the budgeted amount is referred to as a variance. The budget represents the organization’s plan at the beginning of the year. The variance analysis is a way to identify the changes that have occurred, such as unexpected expenses or events that happened later than planned.
Action Required? Yes. It’s too easy for a financial analysis to get lost in the detail and miss the overall message. The prime concern of any financial statement reader is the future of the organization. Is it sustainable and on the right course? Does management understand the situation and know what to do? The pluses and minuses of individual lines on the financial statement need to be placed in an overall context.
In addition, make sure the accountant designs the formulas so that a negative variance is “bad” and a positive one is “good,” otherwise they can be confusing to read.