As a small business owner, you’ve got a lot on your plate. With everything going on in your world, it can be tricky to understand the financial terminology of bookkeeping. So here’s a list of terms that will help you make sense of your accounting data.
Accounting Terms You Need To Know
Accounts Payable (AP)
- AP is a liability account, which means it represents an obligation to pay someone else for goods or services that have been provided.
- AR is an asset account, which means it represents money owed by customers for goods or services previously purchased from you.
- COGS is an expense account; it tracks the costs associated with producing your products and services.
Accounts Receivable (AR)
Accounts receivable (AR) is the money your company has been owed by its customers who have purchased products or services from you. It’s important to note that an account receivable can only be “receivable” if it is a valid obligation, meaning that the debtor agreed to pay the bill and has not yet done so.
Accounts receivable are typically broken down into two components: the net amount due from credit sales (which includes discounts) and unbilled amounts. For example, let’s say Bob buys $100 worth of widgets from Joe Company on June 11th on credit; this would be considered a credit sale because Bob didn’t pay anything upfront for his widgets–he only agreed to do so at some point in the future (after he received them). In this case, Joe Company would recognize $100 in accounts receivable on its balance sheet when it receives payment from Bob.
When you receive a bill for an expense that has already happened but has not yet been paid, it is considered an accrued expense.
Accrued expenses are liabilities that have been incurred on your balance sheet, and they’re usually reported as long-term liabilities. Examples of accrued expenses include:
Contractual Liabilities – These are payments made by a business to another party in exchange for goods or services already provided by the other party. For example, if you hired someone to do some work for you and the contractor hasn’t been paid yet, this would be considered an accrued expense because your company has already received their service but hasn’t yet paid them.
Accrual accounting is the recording of revenue and expenses when the cash is earned or spent, regardless of the time period in which the money is received or paid. It’s a form of accounting that focuses on matching revenues and expenses to get a more accurate picture of your company’s financial health.
Accrual accounting differs from cash accounting, which only records revenue when your business receives it. Accrual accounting allows you to record income when you’ve fulfilled your part of the transaction (e.g., delivering goods or services), even if there isn’t any money in your bank account. This can be beneficial because it gives businesses more time to collect their receivables before they are due, rather than having all their accounts payable due immediately after each transaction has been made—which would cause them to have very high debt levels times. After all, they’re constantly borrowing money to pay back all those who’ve bought goods/services from them!
Assets are anything that an accounting business owns. When you’re learning about assets, it’s important to remember that they aren’t just physical items—they can also be intangible assets. Assets are listed on the balance sheet and divided into current, long-term, and intangible assets:
Current assets include cash or cash equivalents (such as money market funds), accounts receivable (money owed by clients who haven’t paid yet), inventory (products used in the business), and prepaid expenses (expenses that have already been paid for but haven’t been used).
Long-term assets include property and equipment such as buildings, machinery used in the business, land, furniture, vehicles, computers, software licenses, etc., or investment real estate if these items will last more than one year before they need to be replaced. The value of these types of assets is recorded at cost less depreciation expense over their useful life rather than being written down each year like current ones would be done under other accounting methods like GAAP (Generally Accepted Accounting Principles).
Intangible assets are those things that cannot physically be touched. Still, they hold great value, such as patents acquired by research laboratories working on new products or processes, Copyrights held by authors who create literary works such as books, plays, scripts, etc., and trademarks owned by companies that use them in their products packaging materials advertising campaigns, etc.
The balance sheet is a snapshot of a company’s financial position at a given time. It is divided into three sections: assets, liabilities, and equity. Assets are things that can be converted into cash or used to generate income for the company. Liabilities are debts that need to be paid off by the business; this generally includes short-term and long-term debt and any money owed to creditors and suppliers. Equity refers to the net value of all shareholders’ investments after liabilities have been subtracted from assets; it includes both common stock (purchased by investors) and retained earnings (money left over after expenses are deducted).
Cash Flow Statement
The cash flow statement is a financial statement that shows how much money your business has made and where that money went. It’s like a trial balance for your bank account—a snapshot of what was in your bank account at the end of each month.
The cash flow statement reads like a list of debits and credits, with the total added at the bottom. Each debit or credit represents either an expense (debit) or income (credit).
The term describes a potential liability that may arise in the future. For example, if your company sells services and/or products to another organization, it’s possible that you could be liable for any wrongdoing on their part. In other words, if another organization commits fraud or violates another law, they could owe money to your company—and vice versa. If these liabilities are not disclosed on your balance sheet (and they won’t be), they’re considered contingent liabilities.
Cost Of Goods Sold (COGS)
Cost of goods sold (COGS) is the total inventory cost sold during a given period. This amount is recorded as an expense on your income statement and reduces your net income for that period. The value of an inventory at any given time consists of its COGS plus any increase in value from changes in market prices and other factors, less any decrease in value due to sales or other dispositions.
COGS can be calculated using either a FIFO or LIFO method:
- FIFO stands for first-in, first-out. It assumes that goods are first purchased and then sold, regardless of when they were made or their original prices. On this basis, costs would be allocated to products based on when they were acquired rather than when they were used by the company—which may mean very old stocks are used up before newer ones (and therefore priced lower).
- LIFO stands for last-in-first-out; it says that you always sell your most recently purchased inventory items first and replace them with older stock if necessary; this method has been criticized as being unfair because it allows companies to report lower cost figures each year than if they used another way (such as FIFO).
Current Liabilities And Deferred Liabilities
Current liabilities are short-term liabilities that are due within one year. Examples include accounts payable, accrued expenses, and wages payable.
Deferred liabilities, on the other hand, are long-term obligations that haven’t been paid yet. An example would be deferred income taxes (taxes owed but not yet paid).
Current liabilities are usually listed on the balance sheet under “current assets” and “current liabilities” to show how much money a company owes within the next 12 months or so — 12 months is considered “one year.” On the other hand, deferred assets and liabilities refer to future payment obligations beyond 12 months.
Double-Entry Accounting System
Before we talk about the benefits and disadvantages of a double-entry accounting system, let’s first understand what this business tool means in simple terms.
A double-entry accounting system is an accounting method that requires two entries for every transaction. The reason for this rule is because of its ability to ensure accuracy and accountability when it comes to recording financial information.
Equity Vs. Asset Vs. Liability
Equity is the difference between your assets and liabilities. Assets are things you own that have value; liabilities are things you owe. Equity is the amount of money an investor would receive if they bought all of your company’s shares and sold its assets.
If you were starting a new accounting firm and had $100,000 in cash, to begin with, then spent $250,000 on office equipment (asset), but also borrowed $150,000 from a bank (liability), then your equity would be: ($100k + $250k) – ($150k). In this case, it would be negative because we owe more than we own. Still, since our founder wisely acquired some business insurance before opening her doors for business hours every day, she’ll survive until payday when her clients pay up!
An expense account is a record of expenses you have spent on behalf of your company. Expense accounts are typically used in companies that pay their employees a salary rather than an hourly wage since they do not need to track how many hours each employee works each month. The money you receive from your employer is deposited into your bank account, and you write checks to pay for your business-related expenses.
A fixed asset is something that has a useful life of more than one year and whose value depreciates over its lifecycle. The most common are equipment, machinery, and vehicles. These assets are often referred to as “hard” because they can’t be easily moved or sold.
Included in this category are:
- Buildings (including land)
- Machinery and equipment used in the manufacturing process (e.g., factory equipment)
- Vehicles for transporting goods or passengers between locations
The income statement is the second of four financial statements prepared for a company. It’s like a snapshot of all the sales, expenses, and other items that bring in revenue or cost money. The purpose of the income statement is to show you how much profit (or loss!) your business made over time.
The income statement has three parts:
- The top section shows revenues earned during the period (i.e., sales). This part will be called different things depending on how many types of revenue there are: if there are just two types, then it’s called Gross Revenue; if there are three types, then it’s called Total Revenue; if there are more than five types then it can be called something else entirely!
- In the middle section, you’ll see costs related to running your business—these include payroll and supplies but also interest paid on loans and other operating expenses that aren’t directly related to producing goods or services during this period.
- At the bottom is net profit (or net loss), which shows what’s left over after subtracting all those costs from all those revenues!
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