An illustration of a calculator, financial statements, and a computer, representing accounting basics.
accounting

Accounting terms: A 36-term guide to accounting terminology


What are the basics of accounting?

Accounting is the process of tracking and recording a business’s financial transactions. Accounting basics include understanding assets, liabilities, equity, revenues, and expenses, as well as relevant financial statements and accounting principles.


Whether you took an accounting class in high school or it's that gray cloud hanging over your startup, chances are you're familiar with the term. And if you're a small-business owner, it's a facet of the business you shouldn't wait to address on a rainy day.


Understanding basic accounting can provide key insights into your business’s financial health and help you to make better decisions.


But what exactly should you know about accounting for small businesses, and what are the basic principles and documents you should know about? To answer this question, we’ve simplified some accounting basics for beginner business owners.


And if you run into any trouble along the way, check out our accounting glossary at the bottom of this guide. From debits to retained earnings, you’ll find definitions for all of the accounting terminology you need to know to understand accounting basics.


Let’s get started!

Accounting 101: Business accounting explained

A graphic defines business accounting, a crucial aspect of accounting basics.

Business accounting is the practice of recording and analyzing your small business’s financial information. From tracking everyday transactions to creating financial statements to help paint a picture of the financial health of your business, a lot goes into the accounting process.

By taking the time to prioritize accounting for your small business, you can help meet legal requirements, take advantage of tax deductions, and have the data necessary to make important decisions for your business.

Before diving into important accounting principles and key accounting documents, let’s take a look at the eight steps of the accounting cycle:

  • Identify your transactions: First, you must identify every transaction that takes place in a business.
  • Record them in a journal: Second, you’ll record these transactions in chronological order, ensuring that the debits and credits are always in balance.
  • Post them to the general ledger: Next, you’ll post the transactions to a general ledger, a comprehensive list of all transactions in journals or subledgers.
  • Create the trial balance: Then, you’ll balance all of the transactions at the end of the accounting period. This helps provide the business with insight into each account balance and can help pinpoint any discrepancies or accounting errors.
  • Analyze the worksheet: After that, you’ll analyze the worksheet and identify any corrective adjustments that may be needed.
  • Adjust journal entries: Then, you’ll make any needed adjustment entries to ensure that all accounts are balanced.
  • Create your financial statements: Once everything has been analyzed and adjusted, you’ll begin generating financial statements, including the balance sheet, income statement, and cash flow statement.
  • Close the books: Lastly, you’ll close the books, both indicating that the current accounting cycle is officially over and the next one can begin.

Now that you understand these basic accounting concepts, let’s look at the differences between bookkeeping and accounting.

Bookkeeping vs. accounting: What’s the difference

While the term bookkeeping and accounting are often used interchangeably, there are key differences between the two.

The main difference between bookkeeping vs. accounting is that bookkeeping is the process of managing financial books by documenting transactions and recording financial data. Accounting is the process of using that data to assess the financial health of a business.

In addition, becoming an accountant requires a bachelor’s degree, whereas no specific credentials are required to be a bookkeeper. On top of that, accountants also help with tax planning and generating financial statements, whereas a bookkeeper does not.

Basic accounting principles to know

To make sure that no one is misled by inaccurate financial statements, all publicly-traded companies must follow Generally Accepted Accounting Principles (GAAP). 

GAAP is a set of rules issued by the Financial Accounting Standards Board (FASB) to help govern the accounting profession. Although privately held companies are not required to follow these principles, many of them do.

To help get a better understanding of GAAP, we’ve broken down each of their 10 principles.

1. Principle of regularity

The principle of regularity ensures that accountants follow GAAP rules as a standard at all times.

2. Principle of consistency

The principle of consistency refers to an accountant's commitment to applying consistent accounting standards throughout the entire process. This principle also requires accountants to clearly state any changes or updates to financial statements in the footnotes for transparency.

3. Principle of sincerity

The principle of sincerity ensures that accountants aim to provide an accurate and fair picture of the business’s financial situation. Accountants can uphold this principle by maintaining honest and unbiased financial records.

4. Principle of permanence of methods

The principle of permanence of methods confirms that all financial reporting methods remain the same over time. That way, businesses can easily compare financial reports from different accounting periods. 

5. Principle of noncompensation

The principle of noncompensation states that accountants must report both negative and positive financial information accurately without expecting performance-related compensation. This ensures that accountants don’t alter reporting to show only positive performance.

6. Principle of prudence

The principle of prudence ensures that financial data is reported based on facts rather than speculation. That way, financial statements provide a factual and realistic overview of a business's financial performance.

7. Principle of continuity

The principle of continuity states that while a business values its assets, it should do so under the impression that the business will continue to operate.

8. Principle of periodicity

The principle of periodicity states that businesses should record all transactions during their relevant period. That way, all financial information is timely and provides an accurate picture of a business’s financial health during a specific period.

9. Principle of materiality

The principle of materiality ensures that accountants fully disclose all financial data in financial reports.

10. Principle of utmost good faith

The principle of utmost good faith ensures that all parties remain honest in all transactions.

By adhering to these 10 principles, you can ensure that you’re providing an honest and unbiased look into your business’s financials. Next, let’s look at some essential accounting documents to be aware of.


Key documents for business accounting

A graphic describes the income statement, a crucial aspect of accounting basics.

With the importance of business accounting and relevant accounting principles in mind, let’s break down some key financial documents related to the accounting process.

Income statement

An income statement is a financial statement that showcases your business’s profitability. In the income statement, you’ll find your business’s revenues and expenses and how much your business has made or lost throughout the accounting period.

This information can help provide insight into your business’s efficiency and overall performance and may be used to compare with other businesses in your industry.

Balance sheet

A balance sheet provides information about your business’s assets, liabilities, and equity at the end of the accounting period. This provides you with a snapshot of the financial position of your business at a single point in time.

This financial statement can help compute rates of return for investors and provides a bird's-eye view of what a company owns and owes. Investors and other individuals may also use the balance sheet to assess a business’s ability to pay the bills and calculate financial ratios such as debt-to-equity ratio.

Cash flow statement

A cash flow statement is a financial statement that summarizes the sources and amounts of cash moving in and out of your business during an accounting period. This financial statement tracks all cash inflows and outflows involved in operations, investments, and financing. The sum of these three sections of cash flow is known as the net cash flow.

Unlike net income, the net cash flow represents whether or not a business’s cash balance increased or decreased, whereas net income represents accounting profit. The cash flow statement is an essential tool for helping determine the value of a business’s stock.

Bank reconciliation statement

A bank reconciliation statement summarizes banking and business activity used to see if the cash balance on your balance sheet matches the corresponding amount on your bank statement.

This financial statement is crucial in determining whether your records are correct and may help detect accounting errors or fraud.

How to set up accounting for your small business

After learning these financial accounting basics, you may wonder how to do accounting for your small business. Follow these seven steps to help you put your best foot forward when setting up accounting processes for your business. 

1. Open a business bank account

When setting up accounting for your small business, you’ll first want to figure out where you'll keep your money. If your small business is a partnership, LLC, or corporation, you’ll have to open a separate business bank account.

If you have a sole proprietorship, you aren’t required to open a separate bank account for your business. But it may be helpful to open a bank account for your small business as it can help keep all your business income and expenses in one place.

2. Track your expenses

Next, you’ll want to be sure you’re accurately tracking every expense your small business has. This can make the accounting process easier and ensure that you aren’t missing out on any tax breaks, as some business expenses may be tax deductible.

For example, certain expenses like business travel can be deducted from your taxes. So if you spend $600 on a plane ticket, you may be able to deduct $600 from your taxes. But that is only if you’ve kept a record of that expense.

Because of this, you’ll want to keep the following documents to help account for every expense your small business has:

  • Receipts 
  • Business bills
  • Bank and credit card statements
  • Canceled checks
  • Invoices
  • Financial statements
  • Proof of payments
  • Previous tax returns
  • W-2, W-4, W-9, 1099-MISC, and other tax forms

On top of that, here are five types of expenses that you’ll want to keep a close eye on, especially for tax deduction purposes:

  • Vehicle expenses: If you use your vehicle for work, track how often you use it for business. That way, you can ensure you have an accurate log of your business-related gas mileage when it comes time for tax deductions.
  • Business travel: From work conferences to annual retreats, this may include plane or bus tickets, hotel rooms, and rental cars.
  • Business gifts: Whether you’re gifting a client event tickets or buying a staff member a holiday gift, keep a log of these purchases in case they are eligible for tax deduction benefits.
  • Business meals and entertainment: From lunch meetings to meetups over coffee, this includes get-togethers that involve food, coffee, or any form of entertainment.
  • Home office expenses: Like vehicle expenses, you should keep track of any home office expenses. This may include Wi-Fi, mobile phone, or other work-related equipment.

As a general rule of thumb, you’ll want to track every expense and transaction your business has. By tracking everything, you’ll never have to worry about any expenses or potential tax deductions slipping through the cracks.

3. Choose an accounting method

Now that you understand the importance of tracking your expenses, you’ll want to decide on an accounting method for your small business. Many business owners may do it all using accounting software, while others may hire an accountant.

No matter which option you choose, you’ll need to decide between the cash or accrual method of accounting.

With the cash method, you’ll recognize and record revenue and expenses on the day they’re received or paid. On the other hand, the accrual method recognizes and records revenues and expenses the day the transaction takes place, even if payment has yet to be made or received.

4. Set up a payroll system

If your small business has employees, you’ll want to set up a payroll system. Fortunately, you can rely on payroll software to help make the process easier. By setting up a payroll system, you can easily set up a payroll schedule and rest easy knowing you’re taking out the proper taxes.

That way, you’ll have an accurate record of all paychecks and time tracking for each employee, helping streamline the bookkeeping process.

5. Determine your tax obligations

Another thing to consider when setting up accounting for your small business is determining your tax obligations. That way, you can set aside money to help cover these taxes come tax season.

The amount of taxes your business is obligated to pay can vary depending on a few factors, including your business’s legal structure, the number of employees you have, if you collect sales tax and your location.

6. Figure out how you’ll get paid

Now that we’ve covered how you’ll pay for expenses, your employees, and taxes, let’s talk about how your business receives payments for its goods and services. Whether your business is a brick-and-mortar location or also sells products online, you’ll want to ensure your payment system is convenient for you and your customers.

From accepting digital payments like Apple Pay to major credit and debit card providers, choosing a payment system that keeps all your transactions in one place can help simplify your bookkeeping and accounting process.

7. Regularly review your accounting processes

Like any other process within your small business, you’ll want to continually review and evaluate your accounting practices to ensure everything runs smoothly. In addition, you’ll also want to analyze the financial statements created from your accounting process to help gain insight into the financial health of your business.


Basic accounting example

A graphic showcases the recording of a journal entry, a crucial aspect of accounting basics.

Now that you understand basic accounting knowledge, its key financial statements and principles, and how you can set up accounting for your business, let’s take a look at a basic accounting example.


Let’s say you need to record $15,000 in sales revenue for your business.


  1. First, you’ll record a debit entry of $15,000 to your “Cash” account.
  2. Then, you’ll record a $15,000 credit entry of $15,000 to your “Revenue” account.


After recording both entries, you've successfully increased the value of both your "Cash" and "Revenue" accounts, accurately representing your business’s sales revenue.


Accounting basics glossary: 36 basic accounting terms to know

A graphic defines assets, an important term in accounting basics.

Scroll through these basic accounting terms and definitions to learn more about accounting for small businesses.

Accrual basis accounting

Accrual basis accounting, aka accrual accounting, is when you record all revenue and expense-related items as the transaction first occurs rather than after payment is received.

For example, if a customer buys $5,000 worth of product on credit, you’d record $5,000 in revenue immediately rather than waiting to receive payment.

Accruals

Accruals are revenues and expenses recognized by a business before being recorded in its accounts.

For example, if a company has done business with a customer but has not yet received payment, the company would mark down the expected revenue as an accrual.

Accounting period

An accounting period is the length of time in which accounting functions are recorded and analyzed. Depending on the business, an accounting period can last weeks, quarters, or a calendar or fiscal year. 

For example, if a business decided to compile its accounting data by quarter or every three months starting at the beginning of the year, its first accounting period would be January through March.

Accounts payable

Accounts payable, aka payables, is an account in the general ledger used to track money a company owes to creditors.

For example, if a company owes $4,000 on its company credit card, $4,000 would be recorded in the accounts payable account.

Accounts receivable

Opposite of accounts payable, accounts receivable is an account in the general ledger used to track money owed to a business by its customers or other debtors.

For example, if a customer has purchased $2,000 of products on credit, $2,000 would be recorded in the accounts receivable account.

Assets

Assets are any tangible or intangible item with monetary value that a business owns or controls. Cash, patents, investments, and stocks are all examples of business assets. Accountants record assets on the left side of the balance sheet.

Burn rate

Burn rate is the pace at which your company spends money. In other words, the burn rate is the amount of money your business needs to cover all expenses and commitments in a time period.

To calculate the burn rate, you’ll select a period and then subtract your on-hand cash at the end of the period from your on-hand cash at the beginning. Then, you’ll take that number and divide it by the number of months in that period. Once you’ve done that, you’ll know your company’s burn rate for that set period.

For example, if you begin a three-month period with $90,000 and end it with $30,000, your burn rate is $20,000 a month (($90,000 - $30,000) ÷ 3 = $20,000)

Capital

Capital is cash or other liquid assets a business can use to spend or make money.

In accounting, businesses split up capital into specific categories. For example, money received from investors in exchange for stock is categorized and recorded as equity capital. 

Cash basis accounting

Cash basis accounting is a form of accounting in which businesses record transactions at the time money changes hands.

For example, if customers purchase a product or service on credit, the transaction wouldn’t be recorded until they make their payment.

Cash flow

Cash flow is how money moves in and out of a business. Businesses record their cash flow in the cash flow statement.

For example, if your business has more money going out than it does coming in, it has negative cash flow. On the other hand, if your business has more money coming in than it does going out, it has positive cash flow.

Chart of accounts

The chart of accounts is a comprehensive list of all the accounts in a business’s general ledger.

A chart of accounts includes assets, liabilities, equity, revenue, expenses, and cost of goods sold. The chart of accounts will also include subaccounts. For example, subaccounts of assets may include cash and accounts receivables.

Closing the books

Closing the books is a phrase representing an accountant’s finalization of relevant accounting records during an accounting period.

For example, if an accountant finalizes and approves all accounting records for the period, the books are technically “closed.” From there, other accounting documents, such as the balance sheet and income statement, can be completed using the finalized records.

Cost of goods sold

Cost of goods sold (COGS) is the total direct costs it takes to produce the goods a business sells.

For example, accountants calculate COGS within an accounting period using the formula: (Starting inventory + purchases) - ending inventory = COGS.

Credits

Credits are accounting entries that increase a liability, revenue, or equity account and decrease the balance of an asset, loss, or expense account. These entries are recorded on the right side of the account and reflect outgoing money.

For example, if your business purchases $1,200 of office supplies on credit, it would be recorded as a credit in the accounts payable account.

Debits

Conversely, debits are accounting entries that increase an asset or expense account and decrease a liability or equity account. These entries are recorded on the left side of the account and reflect incoming money.

For example, if your company receives $2,000 in cash, it would be recorded as a debit in the cash account.

Depreciation

Depreciation is an accounting method used to determine the cost of a physical asset over time. Whenever a fixed asset decreases in value, businesses record it as depreciation.

For example, if a moving company purchases a moving truck for $60,000 and uses it for five years before selling it for $40,000, it has depreciated $4,000 a year according to the straight-line method (($60,000 - $40,000) ÷ 5).

Double-entry accounting

Double-entry accounting is a fundamental accounting concept stating that every transaction has an equal and opposite effect in at least two different accounts.

For example, if a business purchases $4,000 of office supplies on credit, it'll record a debit of $4,000 to the asset account and a credit of $4,000 to accounts payable. That way, both the increase in assets and liabilities are accounted for.

Equity

Equity refers to the difference between liabilities and assets on the balance sheet.

For example, if a company has $250,000 in total assets and $100,000 in total liabilities, it has $150,000 in equity.

Expenses

Simply put, expenses are the cost of doing business. This includes money spent and costs incurred while trying to generate revenue.

For example, business expenses include rent, equipment, and payroll.

Fiscal year

A fiscal year is a 12-month period businesses use for budgeting and financial reporting. While it may start on Jan. 1 and end on Dec. 31, it doesn’t have to.

For example, a fiscal year can be from Oct. 1 to Sept. 30.

Gross income

Gross income, aka gross profit, is the total value of products and services a business sells before accounting for COGS. If the gross income turns out to be a negative number, the business has instead faced a gross loss.

Inventory

Inventory refers to assets that a business plans to sell. This includes items ready for sale, those in production, and the materials needed to make them.

For example, a furniture business’s inventory may include lumbar, drawer handles, and dressers.

Journal entries

A journal entry records a business transaction in a business’s accounting books. A proper journal entry includes the date of the transaction, the amount to be debited and credited, a short description of the transaction, a reference number, and the general ledger accounts affected.

Liabilities

Liabilities refer to money a business owes. For example, liabilities may include payroll, taxes, credit card balances, bank loans, and accounts payable. Accountants record liabilities on the right side of the balance sheet.

Liquidity

Liquidity is a term that refers to how easily a business can sell an asset for cash. If a business can easily turn an asset into cash, then it is a liquid asset.

Accounts receivable and securities are both examples of liquid assets.

Net profit

Net profit, aka net income, refers to the money a business makes after factoring in taxes and COGS from the total value of products or services sold during a period.

If the total cost of taxes and goods sold is more than the value of products and services sold, it is known as a net loss. 

On credit

On credit, or "on account," is a term used to describe goods or services sold to customers without receiving payment upfront.

For example, a business may sell its products to customers in exchange for future payments or a series of payments. This is also known as customer credit.

Overhead

Overhead is a term that describes any expenses required to continue business operations that don’t directly affect a company's products or services.

Examples of overhead include insurance, administrative costs, and utilities.

Payroll

Payroll, aka payroll accounting, is the process of tracking and recording money paid to employees. Payroll accounting also includes tracking money withheld from each paycheck, including taxes or any benefits the employee receives.

Present value

Present value is a concept that factors future revenues, expenses, and debts for inflation to provide an accurate value of future funds with present-day dollars.

Purchases

Purchases are the exchange of money for inventory or goods during an accounting period.

Receipt

A receipt is an official record that a transaction took place.

Retained earnings

Retained earnings, aka earnings surplus, are the profits left over after a business has paid off all costs in an accounting period. If a business has positive retained earnings, then the business’s equity will increase.

Return on investment

Return on investment (ROI) is the percentage of profit or loss produced by an investment.

For example, if someone invests $1,000 in company stock and later sells the stock for $1,500, the ROI is 50%.

Revenue

Revenue is the income a business generates by selling goods and services.

For example, a clothing store would record the money made from selling clothes as revenue.

Trial balance

A trial balance is a bookkeeping report that compiles the closing balances of each account in the general ledger. Creating a trial balance is crucial in closing the books at the end of an accounting period.


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Streamline your accounting and save time 

After learning these accounting basics, you may be eager to dive headfirst into accounting for your small business. To help you streamline the accounting process and save time, consider using accounting software to track your income, expenses, and more all in one seamless place.

Accounting basics FAQ


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