As a new business owner, you likely find yourself taking on a lot of different responsibilities. You may be dealing with investors in the morning and your marketing team in the afternoon. To be successful in these situations, you must speak the language of those around you. An analysis from Harvard University states, “Jargon makes communication efficient within a group, but difficult between groups.”
As the owner of a start-up, you must know how to communicate with all members of your team. You serve as the common link between different teams. Understanding business jargon can help you increase communication efficiency in your firm.
To help get you started, we’ve provided a list of basic accounting terms. Studying up on the definition and correct usage of accounting terminology will allow you to communicate more efficiently with your financial team and appear more credible, thus preventing jargon from becoming a stumbling block. Consider these 21 accounting terms that every small business owner should know.
1. Accounts receivable
Accounts receivable includes money owed by customers as payment for goods or services. A company’s balance sheet will reflect accounts receivable as a creditable asset because there is an understanding that the clients are legally obligated to pay this amount.
For instance, if you sell $10,000 of goods to a company and provide them with a line of credit, and the company promises to repay you in 30 days, you’ll credit your accounts receivable $10,000. Upon receiving payment, you’ll debit $10,000 from accounts receivable and credit $10,000 to your cash accounts.
This is a list of expenses that you incurred but have not yet paid or a list of sales that have been completed but not yet billed. Accruals can be either positive or negative, impacting both the income statement and the balance sheet. You would use accrual accounts to mark funds that will hit your accounts but haven’t yet, typically because of the time it takes to complete the accounting process.
An excellent example of accruals is a year-end bonus. Imagine you give out bonuses at the end of 2018 to employees. However, you don’t process the payments until a later time period — say, the end of January 2019. Your year-end financial reports will need to indicate the bonuses that you gave. You would demonstrate this in your chart of accounts by crediting an adjusting entry accrual account and debiting your expense account.
3. Accrual-basis accounting method
Small business owners should abide by the generally accepted accounting principles (GAAP — more on that below). One of the most critical components of GAAP is the accrual-basis accounting method, which states that companies should recognize revenues and expenses at the time of a sale. This is different from the cash basis method, which says that you should realize sales when you receive payment.
The accrual basis accounting method is efficient and provides you with a better indicator of your financial position, as it shows the present value of sales revenue. It also requires the double-entry method of accounting. When you enter an accrued transaction, you enter a matching transaction in a different account.
So, let’s say that you sell $10,000 in raw materials and that the buyer agrees to pay $2,500 for four months. These sales take place in November. Under the cash basis method, you would need to create a journal entry each time you receive payment, which means your financial reporting will take place throughout two accounting periods — the end of year one and the beginning of year two. Under the accrual bookkeeping system, you’d log the sales in your receivables account and debit inventory.
As cash flow came in, you’d debit your cash account and credit your receivables account. Doing so would impact current assets, but it would not impact total assets from a financial accounting perspective.
Assets are everything that a company owns. In most cases, the company’s assets from an accounting perspective are tangible. Tangible assets include things like:
5. Bad debt expense
If you make a sale on credit, there’s a chance that you won’t receive payment. This accounts receivable entry on the income statement allows you to write off the money that you did not receive. Marking bad debt expenses can give you a more accurate look at your bottom line. Your cash flow statement will be more accurate, as will your net income.
6. Balance sheet
A balance sheet is an overview of a company’s financial status, including assets, liabilities, and equity. The accounting equation that you’ll want to keep in mind when it comes to your balance sheet is
Assets = Equity + Liabilities
A typical balance sheet has three sections: assets, liabilities, and equity. GAAP calls for the balance sheet to always match in what’s known as double-entry accounting. Every account entry requires a corresponding entry into a different account to ensure the balance sheet equation remains valid.
7. Cash-basis accounting
Cash-basis accounting is a straightforward accounting method. Under the cash-basis accounting system, you record payments when they’re received or processed. Accounts receivable do not come into play under the cash-basis system.
For instance, let’s say you perform work for a client on March 1 and submit an invoice due in 45 days. The client pays the balance in full on April 15. Under cash-basis accounting, you’ll record the income in April since this is when you received the cash in hand.
If you don’t maintain inventory, you may find cash-basis accounting more useful than accrual-basis accounting. It could also be particularly helpful for service-based businesses. However, it does not meet GAAP standards, which can be problematic if your business grows. Certified public accountants may recommend that you don’t use cash-basis accounting for this reason.
Defined as the recovery of an item’s cost over time, depreciation is especially crucial for tax purposes. You can write off and depreciate larger pieces of equipment on your tax returns. Depreciation calls for you to allocate the cost of a tangible asset throughout the entirety of its life, instead of all at once. Depreciation most impacts the cost of long-term assets.
Dividends are company earnings that are distributed to shareholders. A corporation’s board of directors typically determine the dividend amounts or percentages. They can be issued as cash, stock market shares, or other property.
Expenses are the costs of acquiring something. You can expense everything from raw materials to services. There are typically four types of costs: fixed, variable, accrued, and operational.
Fixed expenses stay consistent from month-to-month and year-to-year. Expenses like salaries, rent, and so forth are considered fixed. These costs are not affected by fluctuations in sales, production, inflation, or the market.
Variable expenses are tied to the company’s production. Variable costs can go up or down based on increases and decreases in production or sales. These can change from purchase to purchase. For instance, you may need to buy more materials to complete a large order, which will drive up your variable expenses for the month. These are the total costs associated with bringing a product to the end-user.
Accrued expenses are single accounting expenses that are reported but aren’t yet paid. Operating expenses are costs that are necessary for a company to conduct business. These are the costs not directly associated with producing goods or services. For instance, the rent that you pay for an office building is not an operating expense.
11. Fiscal year
A fiscal year is the measured period of time that a company uses for accounting purposes. The fiscal year can coincide with the calendar year, but it doesn’t necessarily have to. For example, fiscal years can run from October to September or July to June. The company is responsible for choosing the fiscal year start and end dates.
Forecasting is the process of using a company’s historical financial data to predict future business trends. Businesses typically use it to estimate budgets for a specific period, but they can also use it to predict things like sales, gross profits, the value of an asset, or how long it will take to pay off long-term debt. Forecasts often include supply and demand figures, sales records, and expenses.
13. General ledger
This is the complete recording of a company’s financial transactions over the lifetime of the organization. The ledger tracks owner’s capital, assets, revenues, and expenses. Business owners must be diligent when recording transactions in the general ledger.
14. Generally accepted accounting principles (GAAP)
Generally accepted accounting principles are the rules, standards, and principles that certified public accountants and businesses use when accounting. These principles are a combination of authoritative standards and accepted practices. Failing to follow GAAP could prove troublesome for businesses because it can make it harder to secure funds from investors and potentially expose owners to federal fines.
Journals are also referred to as accounts. This is where transactions are recorded as they occur and before they are transferred to the official accounting record, or the general ledger. While the general ledger records broader things like liabilities, things like accounts payable would show up in the journal.
Liabilities are debts that a company is responsible for paying in the short or long term. Things like mortgages and credit card balances are liabilities.
17. Market value
Market value is a measure of how much investors think a firm is worth. Looking at financial documents is an excellent way to measure market value. But market value can also account for intangible things, like intellectual property. For example, if your business plan includes a revolutionary idea but you haven’t started selling goods yet, your market value could be high even though your net income is low.
18. Profit and loss statement
Commonly referred to as “P&L,” or the “income statement,” a profit and loss statement is a report that lists earnings, expenses and net profits for a given period.
Revenue is the total amount of money collected for goods or services sold before subtracting any expenses. It also includes any credits or discounts for returned merchandise.
20. Trial balance
Trial balance is an exercise used to confirm final figures before generating financial statements. It requires placing debits and credits on a worksheet to ensure that any current balances are correct. Accounting software can perform trial balances automatically.
21. Working capital
Working capital is the amount of money a company has to invest or spend on necessary items for the business. Essentially, it’s a measure of operating liquidity and can help business owners determine how much they can allocate toward operating expenses. If you combine working capital with fixed assets, like office buildings or equipment, you will have “operating capital.” Capital is different from net worth, which also accounts for assets like buildings and equipment.
Brush up on accounting terminology
Taking the time to understand business terms is well worth your while and can set you up for future success. These terms are relevant to the owners of all business entities, whether you run a large corporation or a sole proprietorship. Once you have a good understanding of our glossary of business terms, take time to learn the seven accounting formulas every business owner should know.