As a business owner, you probably tend to leave your business’s financial knowledge to your accountant. As a result, you might feel left out when it comes to understanding accounting matters. It helps to know some basic accountant terms and what they mean so that you can stay on top of your finances. Here are 17 basic accounting terms we believe that every business owner should know.
Think of a balance sheet as your company’s financial report of its assets (what your business owns), liabilities (what your business owes), total debt, and equity capital at any point in time. A balance sheet gives you a bird’ eye view of your business’s finance on any given date. On looking at a balance sheet, you will notice the assets are recorded on one side while the liabilities are on the other side.
Accounts Receivable (AR)
That is the money that is owed to your business by your clients. Since this is money that you are owed and can expect to receive, account receivables are listed as assets on a balance sheet. An AR is created when you let a customer buy your products or services on credit.
Assets are everything your company owns that has monetary value. There are two types of assets – current (short-term assets) and fixed (long-term assets). Assets are resources that help your business generate profit.
Liability includes all the debts that your company has yet to pay. Some common liabilities are payroll, accounts payable, and loans. Liabilities can also include mortgages, bank loans, and IOUs. Liabilities could also include services that are owed but not yet performed.
Equity represents all your shareholders’ stake in your company. Your current assets minus your current liabilities gives you your company’s equity.
Inventory is a form of current assets. The term is used to refer to unsold items you have purchased to sell to your customers. As you sell these items, they are removed from the inventory, making the inventory account lower.
The loss of value of any asset over time is depreciation. Assets can be depreciated only if they are of substantial value, like equipment and automobiles.
On an income statement, depreciation appears as an expense as it costs your business.
Any cost that your business incurs is an expense. Expenses are costs of operations that your company incurs so that it can generate revenue.
Gross Margin (GM)
Gross Margin or GM is the profitability of your business after deducting the cost of the goods sold. You can calculate the gross margin by dividing the gross profit by the revenue for the same period.
The profits that your company makes without taking your overhead expenses into account is your gross profit.
To calculate your gross profit, you must subtract the cost of goods sold (COGS) from the revenue for that same period.
Cost of Goods Sold (COGS)
When you refer to COGS, you refer to the expenses related to creating your product or service—for example, the cost of materials. The money that you spend to run your business is not included in COGS.
Net income is the amount of money you earn in profits. These expenses would include depreciation, over-head, COGS, and taxes.
Net income is your revenue minus all your expenses in a particular period.
Net margin is a percentage amount that tells of your company’s profit in relation to its revenue. To calculate your business’s net margin, you must divide the net income by the revenue for a given period.
Any money that your business earns is your business’s revenue. Revenue is also commonly known as gross profit or turnover.
The accounting period is a particular period reported on all financial statements (Statement of cash flows, balance sheet, income statement).
Gross Profit Margin
The difference between how much you spend to produce your products or services and the price you sell them gives you the gross profit margin. It is necessary to understand the gross profit margin to understand your company’s profitability.
Profit and Loss Statement
A profit and loss statement is a report that lists out all your earnings, expenses, and net profits, over a certain period.
If accounting isn’t your forte, you might find understanding your business accounts nerve-wracking. There are several terms associated with accounting – while you can rely on your accountant to know what those terms mean, the above list will help you better understand your business’s financial health.
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American Express. 2020. 10 Basic Accounting Terms Every Business Owner Should Know. [ONLINE] Available at: https://www.americanexpress.com/en-us/business/trends-and-insights/articles/10-basic-accounting-terms-every-business-owner-should-know/. [Accessed 13 March 2021].
PaySimple. 2021. 42 Basic Accounting Terms All Business Owners Should Know. [ONLINE] Available at: https://paysimple.com/blog/42-basic-accounting-terms-all-business-owners-should-know/. [Accessed 13 March 2021].
QuickBooks. 2021. Basic accounting terms every business owner should know. [ONLINE] Available at: https://quickbooks.intuit.com/au/resources/small-business-finance/basic-accounting-terms-every-business-owner-should-know/. [Accessed 13 March 2021].