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K_Siman
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Accounting Encyclopedia - Basic Accounting Definitions

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When you’re a small business owner, one of your strengths is being a jack of all trades. You may know a lot about accounting (or just enough), but either way, let me help you out! 

Here’s our secret not-so-secret directory to accounting terms used in QuickBooks!

A

Accrual Method Accounting

The simple definition: An accounting method that reports money from completed transactions along with pending transactions.

Textbook definition: With the accrual method, you record and report your income and expenses when it's billed, whether or not you have received it. This includes accounts payable and accounts receivable transactions (as opposed to the cash method).

Tip: When you start your business, pick one accounting method and stick to it. Changing methods will require help from your accountant. 

What’s the upside to counting money before it’s in hand? It gives small business owners a more realistic idea of their income and expenses in a given period. This can provide a better overall picture of how your business is doing now and how it will do in the future.

Since the accrual method factors income you don’t have, on hand or in the bank – your books may report large amounts of revenue based on in-progress invoices, even with an empty bank account.

Term in Use: My business is set up for Accrual Method accounting and I just received $100 from an invoice payment. I haven’t deposited it into the bank but I also have $100 in unpaid invoices. If I run a Profit and Loss Report, I will see $200 - both the money I’ve received and what I expect to receive.

Accounts Receivable (A/R)

The Simple Definition: Income owed to your business, but that you haven’t received. Often referred to as A/R. 

Textbook Definition: Accounts Receivable is the record of money owed to your business for goods or services. This refers to open invoices you haven't received payment for yet.

Note: Even though the word "accounts" is plural, QuickBooks uses one Accounts Receivable account in the Chart of Accounts to track all outstanding payments.

Term in Use: I sent 10 invoices out last week but no payments. I give my clients 15 days so these transactions are still pending. If I were to enter these transactions into QuickBooks, they'd be part of my Accounts Receivable.

Accounts Payable (A/P)

The Simple Definition: Expenses that you owe, but have not yet paid. Accounts Payable is often referred to as A/P.

Textbook Definition: Accounts Payable is the record of your business' pending/outstanding bills. It's used whenever you generate a bill or vendor/supplier credit transaction.

Term in Use: Last month, I purchased three tons of unroasted coffee beans for my shop and now have this pending bill. I’ll pay it by the end of the month, but when my accountant enters this into QuickBooks tomorrow, they’ll be part of my Accounts Payable.

Assets

The Simple Definition: Assets are tangible and intangible items you own and use for business with a cash value. They can be fixed (long-term use) or current (short-term use) assets.

Textbook Definition: An asset is a tangible resource that belongs to your business that retains value after a year or more. To categorize assets into accounts...

  • Fixed assets (e.g. tangible assets, property, equipment) – these are assets intended to be used to produce or provide goods or services. Fixed assets are not held for sale in the normal course of business. A fixed asset account is used to track purchases of tangible, depreciable property that will have a useful life longer than one year, such as equipment or furniture.
  • Current assets (a.k.a other current assets) - these are assets that are likely to be converted to cash or used up within one year. This includes assets like petty cash, notes receivable due within a year, prepaid expenses (prepayments), and security deposits. The QuickBooks Inventory Asset and the Undeposited Funds account are examples of Current Asset accounts. 
  • Other assets (non-current assets) - these are intangible assets that have a life of over one year. Assets that are not fixed or current, such as long-term notes receivable, belong to this category. 

Term in use: My business just bought a new pizza delivery truck for work. The truck is a fixed asset and so is the dough pressing machine. The cash stuffed in the desk drawer to help pay for one-off expenses (i.e, petty cash) is a current asset.

C

Cash Flow

The Simple Definition: The movement of cash in and out of your business.

Textbook Definition: Cash inflows are your sources of income while cash outflows are your expenses. Positive cash flow is the goal since you want to generate more money than you’re spending. It’s normal to go through periods of negative cash flow due to seasonality or early investment in assets for the business.

Term in use: You own a pie shop (yum!). Income from the sale of pies is cash inflow. When you buy ingredients to make the pies, these expenses create a cash outflow.

Cash on Hand/Petty Cash

The Simple Definition: Cash you use for small, “one-off” purchases for your business.

Textbook Definition: Petty cash is the convenient supply of cash you use to make immediate payments for goods and services. For example, instead of writing a check for a small $1.50 purchase for postage, you can pay the postman directly with your petty cash box.

Tip: You should designate one person at your business to control and track your petty cash. In QuickBooks, you have to “deposit” funds into your Petty Cash/Cash on Hand account before you can make a withdrawal so the account balances to $0. 

Term in use: The cash reserve I keep in the safe to pay for printer paper purchased outside of our normal order is considered Petty Cash/ Cash on Hand.

Cash Method Accounting

The Simple Definition: An accounting method that only reports money you’ve actually received or expenses you’ve already paid. This method does not report transactions in-progress (income or expenses).

Textbook Definition: With the cash basis of accounting, you record income as it’s received and expenses as they’re paid. This method does not take into account any accounts receivable or accounts payable (see above).

Many small business owners choose cash method accounting because it’s a simpler bookkeeping process. It’s easier to track money as it moves in and out of your bank accounts and there’s no need to record receivables or payables. 

One downside to the cash method is its limited view of your overall finances. Since it doesn’t account for incoming revenue or outgoing expenses, it can lead you to believe you’re having a very high or low cash-flow month.  In reality, high cash flow may be the result of last month’s work

Term in use: My business is set up for Cash Method accounting. I just received $100 from an invoice that I deposited into the bank. I have $100 worth of unpaid invoices. If I run a Profit and Loss Report, I will only see the $100 payment I received and deposited, not the pending payment. 

Cost of Goods Sold (aka COGS, Cost of Sales, or COS)

The Simple Definition: The costs associated with producing a good or service.

Textbook Definition: Costs directly related to producing a good or service for sale. There’s a direct relationship between these costs and your revenue. If your company sells a product, your cost of goods sold includes the materials, labor, and other expenses incurred to make and sell the product.

Note: While they may facilitate the production of a good or service, expenses such as rent, marketing, or advertising are considered indirect and should not be posted to the Cost of Goods Sold account.

Term in use: If you sell a ceramic cup for $5 and it costs you $2 to produce (materials and labor), the cost of goods sold is $2 and the actual revenue is $3.

(i.e. [Revenue from the sale of the cup] – [Cost to produce the cup/COGS] = actual revenue) 

D

Depreciation

The Simple Definition: The declining loss of value to an asset resulting from various factors, such as normal wear and tear and the length of ownership.

Textbook Definition: Most businesses rely on physical assets to stay operational. Computers, cars, office equipment, and machinery all lose value over time. Quantifying that loss is known as depreciation, or the portion of an asset’s cost that is “consumed.” This attributes a portion of the profits from the physical asset to the lost value due to use if the asset were to be sold.

Note: When calculating depreciation, there are many factors that must be taken into consideration, such as the current trade-in value, any down payment or outstanding fees, and so on. You'll need to consult with your accountant on how to account for these variables.

Term in use: My guitar has seen better days. I bought it 5 years ago for my side-gig playing music at a local lounge. Its value has declined significantly and I could never sell it back for the purchase price – that loss is its depreciation.

E

Equity

The Simple Definition: The total value of your business after you’ve subtracted what you owe (“liabilities”) from what you own (“assets”).

Textbook Definition: Equity is the net worth of a business. It represents the difference between your liabilities and assets. If you sold all your assets today and paid off all outstanding liabilities with the money received from the sale of your assets, the remaining money is your equity. Of course, you don't need to sell your assets to have equity. Your equity represents the value of your business, and thus, its health.

Equity comes from two primary sources: (1) money invested in your company and (2) profits and losses from the business.

An  Owner's Equity account includes capital investments and drawings. An owner can also take money out of the business. Such withdrawals, called Owner's Draws, reduce the company's overall equity.

Term in use: I have $5000 worth of assets (my equipment and everything else I use for my business) and a $2000 loan from the bank. This month I have no A/R or A/P and I’ve made $1000 in income. Right now, my total current equity is $4000 ($5000 – 2000 + 1000 = $4000). 

E

Expense

The Simple Definition: Costs associated with business operations, like bills and utilities.

Textbook Definition: Expense accounts are used to track and categorize what your company is spending. An "Other Expense" account is used for money spent on things outside normal business operations, such as corporate income taxes.

Term in use: The money you paid for your new Mac laptop is an asset, but the phone bill and energy utility used are expenses to your business.

I

Income (Revenue)

The Simple Definition: Money you earn from sales. 

Textbook Definition: Money earned from the sale of your products or services is recorded as income. You track this money using income accounts. Your company may have one or several income accounts depending on the financial data you need to track and analyze. 

Note: Another category of income is "Other Income," or income generated from the sale of a product or service outside your normal operations. Interest Income is an example of an “Other Income” account type.

Term in use: The money you collect from selling food and catering services (via invoices or sales receipts) is considered income.

L

Liabilities

The Simple Definition: The money you currently owe to others – i.e. debts.

Textbook Definition: Liabilities are your company's debt. They are the credit extended to your business. Liabilities include bills you've received, the money you owe on credit cards, sales tax you owe the government, employee withholdings, and both short-term and long-term loans. QuickBooks Online distinguishes between two types of liabilities:

  • Current liabilities (Creditors in France) - Debts your company expects to pay within a year, such as bills, sales tax, payroll taxes, accrued or deferred salaries, and short-term loans.
  • Long-term liabilities (Non-current liability, Long-term creditors) - Debts that your company expects to pay off in over one year, such as long-term loans and mortgages

Term in use: I took out a $5,000 loan to pay for new camera equipment, which I only use for my wedding photography. The loan represents a liability for my business (while camera equipment itself is an asset).

O

Owner’s Equity

The Simple Definition: The cash and other assets an owner(s) has invested in their business.

Textbook Definition: Depending on the type of ownership (sole proprietor, partnership, LLC, S-corp or C-Corp), you must account for this type of equity in very specific ways. Learn more about the different types of owner's equity on the QuickBooks Resource Center.

Term in Use: As a business owner, I check my balance sheet to look at my Owner’s equity account. Capital contributions increase the value of this account, like when I take money out of my personal bank account to use for business operations. It’s also increased by the net income I earn each year. It’s decreased by any annual net losses and by any cash that I take out of the company for personal use.

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