Know the top and most commonly used accounting terms to enter the inner circle of accountants. If you are a business owner and often speak with accountants, you also must learn these terms for fruitful communication.
Every industry has a unique language. It helps industry people learn who is an expert and who is not. Accounting is no different, and some of its internal industry terms are truly confusing even for business people.
If you are someone who wants to grow a career in accounting, you have come to the right place. Also, you are spot on if you are a business owner or freelance professional and need to understand those jargon-filled emails your accountant sent you for approval. Read on to learn some of the crucial accounting terms in easy-to-understand language.
- Importance of Accounting for Businesses
- Accounts Payable (AP)
- Accounts Receivable (AR)
- Balance Sheet
- Book Value
- Cash Flow
- Fixed Cost
- General Ledger
- Gross Margin
- Gross Profit
- Net Income
- Profit and Loss Statement
- Return on Investment (ROI)
Importance of Accounting for Businesses
The accounting department is an indispensable part of any business since it provides the figures you need to run a business. For example, you can calculate business expenses, employee payments, raw material purchases, tax payments, and profit through accounting.
Here are the top reasons why micro, small, medium, startup, and large businesses need a robust accounting system or team:
Financial Statements as Business Status
Accounting generates financial records and transcripts that help you understand the overall health of your business.
- Is the business making unnecessary purchases?
- Are you employing more staff than needed?
- Is the business debt growing uncontrolled?
You can get answers to all these questions by looking at account statements.
Plan a Business Budget
Any business could fail if there is no budgeting or it is over budget. To create a reasonable business budget, you need accounting data for your business. For example, previous fiscal inventory purchases, sales, employee payments, payments towards employee benefits, marketing expenditures, etc., will help you plan for the coming years.
Submitting Company Financial Statements
Countries have set up regulatory bodies to which businesses need to file financial statements on a quarterly, half-yearly, or yearly basis. Also, stock market-listed organizations must file company accounting statements to the respective stock markets. You need to furnish standardized financial statements that only an accounting team can produce.
Complying With Tax and Labor Laws
Businesses also need to furnish several other statements to the regulatory authorities, like tax collection and payment records, labor benefit payment statements, pension fund management and its statements, etc.
Again, you can not just write an amount and send it to the authorities. You need a financial statement in standard format with audit data that the accounting team can prepare.
Without further ado, let’s discuss below the accounting terms that are vital for you:
Accounts Payable (AP)
Accounts Payable or AP is a transaction account within the business’s general ledger. This account represents your company’s responsibility to repay liabilities or debts to your suppliers or creditors. Such debts are usually for the short term.
The accounts payable balance on your business’s balance sheet indicates the sum of total outstanding amounts that you owe to the vendors.
The accounting industry sometimes uses the term Accounts Payable (AP) to refer to a business department. This division is usually responsible for sending payments to the creditors, suppliers, and vendors that are owed to the business.
Accounts Receivable (AR)
Accounts receivable (AR) is the balance of funds due to a company for services or goods delivered. AR is also the money pending from your customers against goods or services they have consumed before making the payment.
An accountant usually lists accounts receivables as current assets on the company balance sheet. AR balance is a clear indication of the purchases made by your clients in credit. Hence, you should put a check on growing AR balance or speed up the collection process to avoid going into a cash crunch.
The asset represents anything that your business owns with a monetary value. Accountants list assets in their order of liquidity, like balance in the company bank account is the most liquid and factory land is the least liquid asset.
It is an accounting statement that calculates liabilities, assets, and equity to ensure both parts of the accounting formula match. After matching both credits and debits, the balance sheet should always be zero.
An asset always loses its value in the business world. Hence, an accountant calculates the actual value of an asset by deducting any depreciation (loss of value) from its original purchase price or value. It is known as the book value of an asset.
Business capital or simply capital is either money or financial assets that a company needs to run its operations—manufacture products, provide services, or host data required to provide IT services.
Usually, capital is a liquid fund obtained from own or other sources. When you source business capital from other sources, it becomes a debt because you either have a credit line or loan from a financial institution like banks and must return the principle with an interest at a mutually decided time.
Sometimes, capital can also be equity stocks of a business listed in the stock market, a brand name, a scientific patent, and even a business idea.
A cash flow statement simply shows how money or cash flows in and out of the business. Hence, cash flow explains the movement of liquid money throughout the company. When you subtract the Ending Cash Balance from the Beginning Cash Balance of your business ledger, you get the Net Cash Flow.
However, you must set a period for such calculations to get actionable data. If you see a negative figure, that means you are losing cash faster. On the contrary, seeing a positive number means your business got a huge cash boost.
You will find credit as an entry on the right-side column of your business’s balance sheet. It represents an increase in equities or liabilities or a decrease in assets on the accounting ledger.
You will always find a debit record accompanying a credit record in the double-entry accounting system to give a net zero balance.
A debit is just the opposite of a credit record. It is always available on the left-side column of the company ledger book.
Whenever there is a decrease in equity or liability account, it is a debit transaction. In another way, if you see the asset or expense account is increasing, that is also a debit record.
Depreciation gives you an idea of how a business asset loses its value over time. Only assets with a significant purchase cost may have a depreciation value. You will find depreciation value in the income statement as an expense, usually a non-cash expense. Assets like vehicles, factory machinery, etc., have a depreciation value.
Whenever you pay for something from your business’s account, that is an expense. Expenses can be fixed, like paying rent for the office. Again, there are variable expenses like recruiting daily wage construction workers whose payment varies with time.
Additionally, there could be operational expenses like insurance payments, property taxes, marketing expenditures, etc., that do not link with the production of goods.
Fixes cost is an expense that is meant to happen regularly and does not change with the revenue earning of your company.
For example, you need to pay office rent, employee wages, vehicle insurance premiums, and interests on capital loans irrespective of the volume of product sales or service provisioning. These are examples of fixed costs.
The general ledger is the overall record of all the financial transactions over a business’s lifecycle. For effortless understanding, accountants post transactions into separate sub-ledger accounts depending on the company.
Gross Margin represents your business’s profitability in a percentage figure. You can calculate the gross margin value by dividing the gross profit by revenue for the same financial period.
Companies use this figure to state their gains after subtracting the input cost for the goods or services sold to the customers.
In a nutshell, if a company tells you that its profitability is 40% for the current quarter, it means from each dollar of revenue, the company pocketed 40 cents into its account, and the rest were input costs.
Gross Profit shows us the profitability of a business in dollars. An accountant will calculate the gross profit value for the said period without taking into account the overhead expenses for that period. You can compute this value by subtracting the cost of products sold from the revenue for the same period.
A company accrues certain financial obligations or debts to run its business operations. That is known as liabilities on the accounting book of any business. Liabilities are of two types: Current Liabilities or CL and Long-Term-Liabilities or LTL.
Supplier or vendor payments are CLs since you need to pay them off in less than 12 months. On the contrary, long-term mortgage payments for a transport vehicle, factory machine, or office building are some excellent examples of LTL.
Liquidity explains how quickly a company can convert materials to cash without depreciating the material’s value. However, the financial and accounting industry expert considers a business’s liquidity positive—the more the liquidity, the easier for a company to pay its short-term liabilities or CLs.
Net Income is the monetary amount that your business earned as a profit. Your accountant should calculate this value by subtracting all of the expenditures in a given period from that period’s revenue. The expenses could be the cost of goods sold, depreciation expenses, overhead expenditures, and amounts paid in taxes.
A business does not always incur expenses to produce products or provide services to its clients. There could be other expenses, which are recorded as overhead expenses or cost in the business ledger.
Hence, any spending not related to the product or service the business sells is an overhead expense—for example, office rent, office supplies, insurance premiums, administrative staff, etc.
In accounting, an accountant uses the Payroll account to show payments released for employee wages, salaries, deductions, benefits, pension funds, and bonuses/rewards. If the payroll payments accrue like unpaid wages, unpaid bonuses, pending vacation pay, etc., then such Payroll amounts will appear on the Balance Sheet as a Liability record.
Profit is the financial gain your company receives from business proceedings like sales of products or provisioning services to new clients, etc. However, to book a profit, the business’s revenue must surpass all the input costs and expenses you must pay to the respective parties.
Profit and Loss Statement
The Profit and Loss Statement is also known as the Income Statement. It is a financial statement prepared by the accountants to summarize your business’s performance and monetary status. It includes expenses, revenues, and net profits over a while like quarterly, yearly, etc.
Return on Investment (ROI)
Return on Investment (ROI) is a metric for evaluating the performance of an investment by demonstrating the loss incurred or profit gained. You can calculate the ROI of any investment by dividing the net gain by the cost of your investment.
Revenue is the earnings that your company receives from day-to-day business operations like selling goods or provisioning services to new customers. It is the actual money that a company generates at a given point in time.
However, it would help if you subtracted the input cost and other expenses from the total revenue of that specific period to find actual profit.
Turnover is another crucial accounting concept that indicates how fast a company conducts business operations. Sometimes, accounting experts also use this term to determine how quickly a business collects cash from its credit-based clients. Hence, we also know turnover as the speed of accounts receivables (AR) operations. Additionally, turnover can also represent the pace of inventory sales by a company.
Final Words 💻
So far, you have learned the essential accounting terms in plain English. You can now confidently speak with fellow accountants in an office or school setup. If you are a business person, you can participate in meetings and calls with accountants more actively than before.
If you are looking for more knowledge on accounting to sharpen your skills, you must try any of these online accounting course platforms.
Alternatively, if you need advanced accounting tools for your business, you must read this article, Cloud-based Accounting Solution for Small to Big Business.