Nowadays, owning a business takes a lot of energy, time, and money. Not only do you have to manage the day-to-day operations, you also have to be aware of the competition, new innovations, like advances in technology that disrupt the status quo, and a flood of information from all angles.
On top of that, you’re expected to be an expert in your field, while managing your sales, marketing, and accounting.
While you can hire an accountant to take care of the financial side of your business, it’s still good for you to be familiar with the basics of accounting.
In this article we go through 25 basic accounting terms that small- and medium-sized enterprise (SME) owners should know to increase their chances of success.
Accounting is vital to the financial health of a business by maintaining records. Accountants help to record and organize all the financial transactions of a business. Accountants tend to focus on the big picture and create financial statements by periodically reviewing and analyzing the financial information of a business. They also conduct audits (to see if anything is amiss) and forecast future business needs.
An accounting period encompasses certain accounting functions that are performed on a regular cycle.Some of these functions happen annually, based either on a calendar or on a fiscal year, but some also happen over a week, a month, or a quarter. Financial and cash flow statements use accounting periods.
Accounting software is beneficial for all businesses, allowing them to manage company expenses and income, send invoices, and generate financial reports. More and more small business owners are taking advantage of cloud accounting software. Cloud accounting falls into the category of Software as a Service (SaaS), meaning that instead of purchasing physical copies of software, you get access to an online site that serves as an accounting portal.
Accounts payable (AP) are all the expenses that a business still has to pay. This is the money a business owes its suppliers for goods and services that were provided. This is recorded as a liability on the balance sheet (since it’s debt a business has incurred).
Accounts receivable (AR) is the balance of money owed to a business for the goods or services they provided but have not been paid for by customers. AR is listed as a current asset on the balance sheet. For example, a phone company bills its clients after they have used their services. In this instance, the company records an AR for unpaid invoices as they wait for customers to pay their bills.
Accrual accounting is a financial accounting method that permits a business to record their revenue before they receive payment for the products or services that they sold. Basically, regardless of when cash transactions have occurred, the revenue earned is recorded officially on the business’ accounting books.
An asset is anything a business owns that has monetary value. Business assets bring value to an organization by funding operations and driving growth. Types of assets include physical items like property and inventory, and intangible items like patents and royalties.
An audit refers to a financial statement audit, meaning it’s an objective inspection and evaluation of a business’ financial statements to ensure that financial records match the transactions that are claimed. Audits can be administered internally or externally by an accounting firm.
Average Invoice Processing Cost
An average invoice processing cost approximates the average cost of bills paid to suppliers. These costs include bank charges, systems, overhead, etc. Overall processing costs can be impacted by outsourcing and the level of AP automation (technology that can expedite backend processes).
A balance sheet is a financial statement that summarizes all of a business’ assets, liabilities, and equity. Balance sheets can be used for individuals or organizations, from sole traders to limited companies.
Bookkeeping involves the daily recording of a business’ financial transactions. Bookkeepers help businesses track their day-to-day financial activities, like invoices, cost spreadsheets, and revenue. Bookkeepers are essential because they help business owners make key operating, investing, and financial decisions.
Business Credit Card
A business credit card is exactly as it sounds — a credit card intended for business purposes rather than for an individual’s personal use. Business credit cards help businesses of all sizes build a credit profile (improve future borrowing terms) and help SMEs meet short-term financing needs by providing additional cash management opportunities.
Business Credit Score
A business credit score is a number that shows whether a business is a good candidate to receive a loan or go into business with. Businesses don’t just have a single score because there are in fact several credit-reporting companies (each uses its own methods and systems). Credit scores are determined based on a business’ credit obligations and repayment histories, any legal filings, how long the company has been operating, etc.
A business plan isn’t just a lofty goal; it’s an actual document that thoroughly describes a company’s objectives and how it actually plans to achieve its goals (think of it like a roadmap). A business plan includes everything from the daily operations to the marketing and of course the financial side. As such, it is crucial for startups, who need to focus on their target market, and it also gives established business owners a sense of direction.
Business (or Legal) Entity
A business entity is the legal structure or type of business. How a business entity is organized and operates will determine how it is taxed. Types of business entities include sole trader, partnership, limited liability partnership, and limited company.
A business loan is one way to help finance your business. It’s a relatively straightforward way to borrow money and doesn’t involve giving up any business equity. Business loans are usually paid back on a monthly basis. Business loans are either unsecured, meaning they allow your business to borrow money without having to use any assets as collateral, or secured — where you use an asset as security (if you can’t pay back the loan).
Cash Basis Accounting
Cash basis accounting involves providing an instant recognition of revenue and expenses (this differs from accrual accounting which concerns anticipated revenue and expenses). In other words, when cash related to revenue and expenses is actually received, it’s recorded. This type of accounting is typically used by sole traders and very small companies.
A cash book is a financial journal used to record all cash receipts and payments. The entries are tied to receipts and payments of cash which are first recorded in the cash book then posted into the general ledger. Basically, a cash book is to keep track of a business’ cash flow (e.g. card transactions, bank transactions, and day-to-day expenditures).
Cash flow is simply the inflow and outflow of cash in a business. Having a positive cash flow means that there’s more money coming into a business than leaving it. When you have negative cash flow, it means that more money is leaving the business than coming in. Poor cash flow is actually one of the top reasons why small businesses fail.
Cash Flow Forecasting
Cash flow forecasting is the process of estimating the flow of cash that is coming in and going out of business over a particular period of time. An accurate cash flow forecast can be accomplished by using accounting software, which helps SMEs predict future cash positions, plan for future gaps in their cash flow (to avoid any shortages), and manage surplus cash.
Cash Flow Statement
A cash flow statement is a financial statement that outlines the movement of cash and cash equivalents going into and out of a business during a specific period of time. The main components of a statement of cash flow are the following: operating activities, investing activities, and financing activities of a business.
This one has two, related meanings. In double-entry bookkeeping, a credit records money going out: decreases to assets, increases to liabilities, increases in revenue and equity, etc. Additionally, credit refers to money loaned. For example, a mortgage and a line of credit are both forms of credit.
The opposite of a credit entry, a debit is an accounting entry that records money coming in: decreases to liabilities and revenue, increases to assets, increases to expense accounts, etc. Debits and credits balance each other out, because they operate in opposition to one another.
Depreciation means the loss of value in assets over time. Common examples of assets that depreciate are vehicles, equipment, and buildings (especially if they’re not maintained). On an income statement, depreciation is shown as an expense and is categorized as a “non-cash expense” since it doesn’t directly affect a business’ financial position.
Direct costs are the expenses a business incurs directly to produce a product or service (or when they purchase a wholesale product for resale). Direct costs fluctuate as production quantities and purchasing orders fluctuate. In manufacturing, direct costs are known as cost of goods sold, and in retail or wholesale businesses, they are known as cost of sales.
There’s a lot that business owners need to know when it comes to operating a company. Even if they hire an accountant to manage their business finances, they should be familiar with some basic terminology.
If you need help figuring out the basics when it comes to your financial position, you can request a free consultation right here from one of our London Chartered Accountants.