Understanding basic accounting terms is an essential skill when starting a business. Accounting is the language of business, and when you can speak it fluently, you’ll be able to have important conversations with your accountant or bookkeeper that allow you to make better decisions for your company.
Below are some common accounting terms that every entrepreneur should understand. Read more here.
Any valuable resource that can be used in the operation of a business is considered an asset, including cash, equipment, property, inventory, accounts receivable etc. Assets are reported on a company’s balance sheet.
When debt or expenses are associated with assets being purchased they must usually be capitalized on the balance sheet instead of treating them as regular operating costs. This means an initial amount is put onto the balance sheet and future expenses and revenues associated with this asset must be accounted for against that initial cost.
A method of accounting where revenue and expenses are recognized when cash is transferred into or out of a company’s bank account. Under a cash-basis system, there is no recognition made for income taxes, interest payments, depreciation expenses etc. Cash-basis companies use accrual-basis accounts to record these items but aren’t required by law to do so [please cite sources].
A principle of accounting that espouses the reporting of financial information in a way that minimizes arbitrary gains and losses and results in financial reports that are probably more “real” than they would be if reported differently. Conservatism is an accounting principle that attempts to avoid overstating assets, earnings, and the like.
The costs of doing business that reduce profit or increase loss are considered expenses. Expenses decrease assets or increase liabilities on the balance sheet.
Financial Accounting Standards Board (FASB)
The organization is responsible for establishing accounting standards in the U.S., primarily for publicly traded companies . Financial statements are prepared using Generally Accepted Accounting Principles (GAAP), which are established by the FASB. These principles may also be referred to as US GAAP, or International Financial Reporting Standards (IFRS).
The money that is used to purchase assets or pay operating expenses. Funds can be obtained by borrowing from lenders, issuing stock, having owners invest in the business, receiving payments for services performed etc.
A financial statement that provides a snapshot of a company’s profitability over a specific period (quarterly or yearly). It lists all revenue and expense items and calculates net income. All companies must follow GAAP when preparing their statements and they are often compared to analysts’ forecasts as well as previous years’ statements to ensure consistency and accuracy.
Any claim against an organization such as debt, unpaid salaries and accounts payable etc. Liabilities reduce equity and assets on the balance sheet.
The calculation is used to measure a company’s profitability after all expenses and revenues have been accounted for. This number is often called net profit, net earnings or a net loss. It is found by taking revenues minus all expenses, including interest expenses and taxes. Operating costs are costs that contribute directly to the revenue-producing process and are not considered part of the cost of sales.
All income is generated from a business’ operations. When trying to determine a company’s operating cash flow, only actual revenue items should be used instead of estimates.
The cumulative amount of net income that has not been distributed to shareholders as dividends. This is also considered equity on the balance sheet.
Expenses paid to federal, state or foreign governments in return for being allowed to operate. Taxes are recognized at the time they are incurred and affect both assets and equity.
Last In, First Out (LIFO)
An asset valuation method that assumes the most recently acquired inventory is sold first. It can result in distorted financial statements if tax rates change or market conditions significantly alter the ratio of current inventory to older prices . Unlike FIFO, LIFO values lower current earnings by increasing the reported cost of goods sold. However, due to the difference in tax treatment between LIFO and FIFO, many companies switch back-and-forth between the two valuation methods over time.
A negative net income figure. When applied to an individual’s finances, it would be the amount of money that is owed after all assets have been sold to cover liabilities plus any additional fees or interest.
Net Working Capital
The total sum of cash, accounts receivable, inventory, and other operating assets minus accounts payable. It represents the liquidity of a business meaning how easily it can meet its financial obligations with cash or its credit.
Amounts that are owed by customers or clients that have not yet been paid.
Statement of Cash Flows
A financial document is used to summarize cash sources and uses within a specific period by operating, investing and financing activities.
The process of finding the present worth of an asset or liability using current market prices