Running a business means wearing many different hats in the course of a day. Even if there are elements of your company’s operations that you outsource, you still need to understand how they work. That includes accounting.
At Cook Martin Poulson, we have a lot of clients who are business owners. And while we hold ourselves to a high standard and make sure our clients are always informed of what’s going on with their businesses, we still encourage them to understand the basics of accounting.
Knowing the basics is a little bit like learning to read. If you don’t understand accounting terminology, acronyms, and abbreviations, you may miss important information about your business. With that in mind, here are 19 accounting terms that you should know.
1. Accounts Receivable
Accounts receivable are outstanding invoices that you have sent to your customers. The term “receivable” may be used as a synonym for invoice. A related term, Accounts Receivable Aging, replies to a usually-chronological list of your outstanding invoices, starting with those that are the oldest. Accounts Receivable are often abbreviated as AR.
2. Accounts Payable
Accounts payable (abbreviated as AP) are invoices that your vendors and suppliers have sent to you for payment. They are the opposite of accounts receivable. One thing that confuses business owners sometimes is that if they want to collect on an invoice, they must call accounts payable at their customer’s office. In other words, your receivable is somebody else’s payable, and vice versa.
3. Accruals or Accrued Expenses
At times in the course of doing business, you will take on financial obligations that take a while to appear on your books. These are future expenses that are referred to as Accruals or Accrued Expenses, such as interest on loans. It’s important to be mindful of accruals since they have a direct impact on your bottom line.
An asset is anything of value that your business owns. Sometimes business owners make the mistake of considering only tangible assets, things like cash, accounts receivable, inventory, and equipment. However, it’s important to consider other things of value, including patents, trademarks, copyrights, and stock. All of these things can affect the value of your company.
5. Balance Sheet
A balance sheet is a financial report that lists your company’s assets, liabilities, and equity. In other words, it’s a snapshot of your business as it stands as of the time of the report. It’s an important document to have on hand.
6. Capital/Working Capital
Capital is the money that you have on hand and are able to spend on necessary business expenses, including inventory, payroll, and equipment. It’s important to differentiate capital – which is also sometimes called working capital – from money that is invested in inventory or stock. The only money that counts as capital is money that you can access.
If you own a car, you may be familiar with this term. Depreciation is when an item loses value over time. In business, depreciation has a different definition. Depreciation is spreading out the cost of an asset that lasts for more than one year. If you purchase a machine that will last for 10 years you would expense the cost of that machine over the 10 year period. For each purchase of long term assets such as office equipment, factory equipment, and company cars you would estimate the useful life of each type of asset and systematically expense the cost of the asset for as long as it is useful in the business. In some cases, you may be able to deduct depreciation expenses on your tax returns. Knowing how to depreciate your assets, on what timetable, and consistently throughout your company is an easy place to make mistakes, so it’s good to take care.
Equity is part of the accounting formula. (Assets-Liabilites=Equity) The balance sheet will balance because of the Equity part of the formula. It often is the capital that you and other owners (or outside investors) have invested in your company. If your company is worth a million dollars and you invested $500,000 of your own money to get it off the ground, you would have 50% equity in your company.
9. Fixed Expenses
A fixed expense is a financial obligation that stays the same (or close to the same) from month to month and year to year. A fixed expense is something you pay even if you are not actually operating or conducting business. Some of the most common fixed expenses businesses have include rent, insurance, utilities or equipment rentals.
10. Variable Expenses
A variable expense is the opposite of a fixed expense. It’s an expense that fluctuates depending on a variety of factors, and it can vary quickly and often. For example, a company that pays commission to its sales people would consider the commission to be a variable expense. A salesperson’s commission might vary greatly from month to month depending on how many sales they make.
11. Operational Expenses
An operational expense is any expense that is necessary in order for a company to do business. Operational expenses may be fixed (like rent) or variable (like commissions.) They would not include discretionary expenses like the cost of your holiday office party.
12. Fiscal Year
A fiscal year is an accounting year. It is a period of one year that may begin and end on a date of your choosing, and it’s what you’ll use to determine your company’s profitability. Many companies choose to align their fiscal year with the calendar year. Sometimes, certain industries choose a common date – for example, many school districts use September 1st as the start of their fiscal year.
13. Profit and Loss Statement
A profit and loss statement, also known as a P & L, is a report that may be generated by your accounting. It shows the operating results of your business. The P & L reflects your revenues less your expenses to report your net income for a particular time period. Some companies issue P & L reports once a quarter or even once a month. They’re a good way to understand what’s happening with your company.
Your journal is the place where all of your company’s transactions are entered before they are transferred to the general ledger. Logging journal entries is a task that business owners sometimes take on. If you do, it’s important to make them promptly, so you know where your company stands financially.
15. General Ledger
The general ledger, or GL, is a complete record of all of your company’s financial transactions over your entire history. If handled properly, your GL should provide a complete history of your organization’s finances and accounting.
GAAP stands for Generally Accepted Accounting Principles. They are the guidelines for proper financial reporting and accounting. Publicly traded companies are required to be GAAP-compliant but adhering to GAAP standards is a good idea for every business.
A business liability is a business debt or financial obligation that you will eventually need to pay. An invoice would be a liability, as would a business loan or a factoring fee. Any money that you owe is considered a liability.
Revenue is any money that your company collects in return for goods or services sold before any expenses are deducted. Sometimes called income, revenue can show up on your financial statements at different times or in different ways, an being aware of the complexity here is worthwhile. However, you must enter credits and discounts taken for returned merchandise.
19. Trial Balance
A trial balance is a like a test run for a full financial statement. The person who does it places assets and liabilities into columns to see if everything balances. It’s designed to give you (or your accountant) an opportunity to correct mistakes and get your accounts in order before you generate official reports.
It’s important for every business owner to understand basic accounting terminology. It will enable you to discuss your financial reports knowledgeably and do a good job of running your business.
If you have any more questions about these terms or accounting in general, the experienced staff at Cook Martin Poulson are ready to help. Call us today at (801) 467-4450 or send us an email online and we will follow up soon. We look forward to working with you.