Basic Accounting Terms you Should Know
Accounting is critical to the success of small businesses. However, not all small business owners can afford to get formal financial training.
This guide’s terms and concepts were chosen for their significance to new entrepreneurs. This blog post discusses Accounting concepts that are critical for businesses and business owners.
Accounting terms like “accounts payable,” “accounts receivable,” “cash flow,” “revenue,” and “equity” are examples.
Frequently Asked Questions
What is the most Basic definition of Accounting?
Accounting, in its most basic form, describes the process of tracking an individual’s or company’s monetary transactions. Accountants document and analyze these transactions in order to create a clear picture of their employer’s financial health.
What are the Basics of accounting?
Revenues, expenses, assets, and liabilities are the four basic accounting concepts used in business. Documents such as balance sheets, income statements, and cash flow statements track and record these elements.
What are some good examples of Accounting concepts?
In most accounting textbooks, the three fundamental concepts are identified as Assets, Liabilities, and Capital. Assets are the financial holdings of an individual or company. Debts and unpaid expenses are examples of liabilities. The term ‘Capital’ refers to the money that an entity has on hand.
What are the different types of accountants?
Certified public accountants and management accountants are two of the profession’s most common specializations. Management accountants are also known as cost accountants. Auditors and forensic accountants are other important branches of the field.
Accounting Terms and Definitions in Plain English
A lot of important Accounting terms are included in this post. Accounting Terms definitions, alternative word uses, explanations of related terms and the significance of specific words or concepts to the accounting profession as a whole are all included in this guide.
We also provide resources for further exploring accounting terminology and explaining relevant meanings or histories of some words.
An accounting period is the length of time that a financial statement or operation covers. Accounting periods that are commonly used include fiscal years, calendar years, and three-month calendar quarters. Some businesses also use monthly periods. Each accounting period corresponds to one full accounting cycle. An accounting cycle is an eight-step system used by accountants to track transactions over a specific time period.
Accounts payable (AP) keeps track of funds owed to creditors. Bank loans, unpaid bills and invoices, supplier or vendor debts, and a credit card or line of credit debts are all examples. In some cases, the term “trade payables” is used instead of “accounts payable.” Accounts payable are part of the larger category of accounting entries known as liabilities.
This is the amount of money owed to a person or business by its debtors. Accounts payable is the functional opposite.
Accounts receivable are also known as “trade receivables” in some cases. They are typically generated by products or services provided on credit or without an upfront payment. Accountants keep track of receivables as assets.
Accrual basis accounting (simplified “accrual accounting”) records revenue and expense items as they occur. For instance, suppose a customer purchases a N20,000 product on credit. Accrual accounting records that N20,000 in revenue on the purchase date.
In contrast, cash basis accounting would record the N20,000 in revenue only after it was actually received. Large corporations and publicly traded companies, in general, prefer accrual accounting. Small businesses and individuals commonly use Cash basis accounting.
These are revenues and expenses recognized by a company but not yet recorded in its accounts. Accruals occur before a monetary exchange resolves the transaction.
A company that hires an external consultant, for example, would accrue the cost of that consultation. Regardless of whether the consultant had invoiced the company for their services, that cost would be recognized.
Accounts payable and receivable are both accrual types. Others are accrued costs and accrued expenses (costs incurred but not resolved during a specific accounting period) (expenses or liabilities incurred but not resolved during a particular accounting period).
Assets are valuable items or resources that a company owns or controls. Technical and precise definitions specify two details: First, assets are the result of previous business activities. Second, they will or should generate future economic value.
There are numerous types and classes of assets.
Types of Assets Include Current and noncurrent, operating and nonoperating, physical and intangible.
Classes of Assets include Cash and equivalents, equities, commodities, real estate, intellectual property, and fixed income.
A balance sheet (also known as a “statement of financial position”) is a type of financial statement. It describes the current state of the company’s assets, liabilities, and owners’ equity. Some sources shorten the term to “BAL SH”.
Accountants create balance sheets in a variety of formats, including classified, common size, comparative, and vertical balance sheets. Each format presents information in the form of line items that combine to provide a snapshot of the company’s financial position.
Capital (abbreviated “CAP.”) refers to any asset or resource that a company can use to generate revenue.
A second definition considers capital to be the amount of capital invested in the business by the owner.
The latter sense of the term accounts for any gains or losses that the owner(s) have already realized.
Accountants distinguish between different types of capital.
The amount left over after deducting current liabilities from current assets is called Working Capital. Equity Capital refers to the money paid into a business by investors in exchange for stock in the company. Debt capital refers to funds obtained via credit instruments such as loans.
Cash Basis Accounting
When the money involved in each transaction officially changes hands, cash basis accounting records revenues and expenses. It is in contrast to accrual accounting. Accrual accounting records revenues and expenses as they occur, regardless of whether or not the associated funds have been exchanged.
The balance of cash that moves into and out of a company during a given accounting period is referred to as cash flow (CF). Accountants track CF on the cash flow statement.
Certified Public Accountant
A certified public accountant (CPA) is a licensed accounting professional who specializes in auditing, taxation, accounting, and consulting. CPAs work with both businesses and individuals.
To obtain CPA certification, a candidate must meet eligibility requirements and pass a rigorous four-part standardized exam. Eligibility requirements include at least 150 hours of related higher education.
Chart of Accounts
Accountants keep track of financial transactions in a system known as a general ledger. A chart of accounts (COA) is a comprehensive list of all accounts in a company’s general ledger. A COA contains five types of accounts: assets, equity, expenses, liabilities, and revenues.
Closing the Books
The informal phrase “closing the books” refers to an accountant’s finalization and approval of bookkeeping data for a specific accounting period. When an accountant “closes the books,” they give their approval to the relevant financial records. These records can then be used to generate official financial reports like balance sheets and income statements.
Cost of Goods Sold
The total costs incurred by a company in creating a product or providing a service are referred to as the cost of goods sold (COGS). The costs associated with products are divided into three categories: Materials, Labor, and Overhead.
Costs associated with services include employee compensation, materials, and equipment. Accountants occasionally use the term “cost of sales.” Accountants calculate COGS over a specific accounting period using the following basic formula: Purchases + Initial Inventory = Ending Inventory
Credits are accounting entries that increase or decrease liabilities or assets. They are the functional inverse of debits and appear on the right side of accounting documents.
Debits are accounting entries that serve to increase assets or decrease liabilities. They are the functional opposite of credits and are located on the left side of accounting documents.
Fixed assets are subject to depreciation (DEPR). Fixed assets may lose value. Accountants refer to these decreases as depreciation. Fixed assets are long-term owned economic resources that an organization uses to generate income or wealth. Real estate, equipment, and machinery are common examples of fixed assets
This term refers to a risk-management strategy that seeks to avoid overexposure to a particular industry or asset class. Diversification occurs when individuals and organizations spread their capital across a variety of financial holdings and economic sectors. The term is also commonly used in finance and investing.
In corporate accounting, dividends are portions of a company’s profits that are voluntarily paid out to investors. Typically, Investors are paid in cash, but they may also be given stock, real estate, or liquidation proceeds. Dividend payments are typically made on a monthly, quarterly, or annual basis. They can, however, be offered as exceptional one-time bonuses.
Double Entry Bookkeeping
In Double-entry systems, each financial transaction is recorded twice: once as a credit and once as a debit. The accounting books are considered “balanced” when the total of all recorded debits and credits equals zero.
Double-entry accounting is another name for this system. It is a more comprehensive and accurate alternative to single-entry accounting, in which transactions are only recorded once.
Revenues and expenses are the only things that single-entry systems account for. Double-entry systems add assets, liabilities, and equity to the financial tracking of an organization.
At its most basic, equity is the amount of money that would remain if a company sold all of its assets and paid off all of its debts. As a result, it defines the collective ownership stake in a company held by its owner(s) and any investors.
The term “owner’s equity” refers to the ownership stake in a privately held company. Shareholders of publicly traded companies own the company collectively. Their ownership stake is described by the term “shareholder’s equity.”
A fixed cost (or fixed expense) is a cost that remains constant regardless of changes in a company’s output or revenues. Rent, employee compensation, and property taxes are some examples. The term is sometimes used in conjunction with “operating cost” or “operating expense”(OPEX). OPEXs are costs incurred as a result of a company’s daily operations. These costs, however, can either be fixed or variable. Variable costs shift as output or revenue shifts.
Gross profit (or gross income) is the value of a company’s products and services before subtracting the cost of goods sold. If the gross profit is negative, it is referred to as a gross loss. In contrast, “net profit” describes the actual profit earned after deducting those costs. The value of the organization’s net sales less the cost of goods sold is referred to as the gross margin. Net sales are calculated by deducting adjustments such as discounts and allowances from gross sales.
An income statement is a type of financial document produced by businesses. It shows the total revenue earned by the company during a given accounting period, minus all expenses incurred during the same period. Other terms used to describe income statements are:
- Earnings statement
- Profit and Loss Statement
- Financial results statement
- Statement of purpose
Income statements are one of three types of standard financial statements that businesses issue. The balance sheet and cash flow statement are the other two.
Inventory is an accounting term used to describe assets that a business intends to liquidate through sales operations. It includes assets that are for sale, assets that are being manufactured, and the materials used to manufacture them.
When an individual or business owes money to another person or organization, the term “liability” is used. Liabilities include things like bank loans and credit card debts.
Accountants distinguish between current liabilities and long-term liabilities.
Current liabilities are liabilities that are due within one year of the date of the financial statement. Long-term liabilities have maturity dates that are more than a year away.
The accounting term is also used to describe a business structure known as a limited liability company (LLC). LLC structures enable business owners to separate their personal finances from the finances of their company. As a result, owners cannot be held personally liable for company-incurred debts.
Liquidity in accounting terms refers to the ease with which an asset can be sold for cash. Liquid assets are assets that can be easily converted into cash. Therefore, common examples of liquid assets include accounts receivable, securities, and money market instruments.
Net Profit is the amount of money left over after deducting the cost of taxes and goods sold from the total value of all products or services sold during a given accounting period.
It is also known as net income. If the net profit is negative, it is referred to as a net loss. The related term “net margin” refers to describing net profit as a percentage of total revenues for a company.
Net profit differs from gross profit. Gross profit is simply the total value of sales in a given accounting period before deducting costs.
Accountants use the term “on credit” or “on account” to track partial payments on debts and liabilities. Both definitions of the term refer to goods or services sold to customers without receiving payment in advance.
Overhead (O/H) costs are expenses that are required to sustain business operations but do not directly contribute to the company’s products or services. Rent, marketing, advertising costs, insurance, and administrative costs are some examples.
Businesses must carefully account for overhead because it has a significant impact on price-point decisions for a company’s products and services. Overhead expenses must be covered by revenue.
Payroll accounting refers to the tracking operations that record, administer, and analyze employee compensation. Payroll also includes employee extra benefits and income taxes withheld from their paychecks.
A receipt is a written record of an official purchase or financial transaction. Receipts serve as proof of the transaction and enable those transactions to be processed for tax purposes.
A receipt is typically issued following the receipt of an invoice and the completion of payment.
ROI (Return on Investment)
Return on investment (ROI), usually expressed as a percentage, describes the amount of profit or loss generated by an investment.
Accountants calculate ROI by dividing an investment’s net profit by its cost, then multiplying by 100 to get a percentage. Consider a person who invests N100,000 in a company’s stock and then sells it for N120,000. The exchange would yield a 20% return on investment. When an investor loses money, their ROI is expressed as a negative number.
Revenue (REV) is the amount of money earned by a company from the sale of goods and/or services related to its primary operations. For example, A restaurant’s revenue includes all food and beverage sales. It would not cover additional sources of income, such as the sale of the company’s equipment or real estate.
The terms “revenue” and “sales” can be used interchangeably. For example, revenue is used to determine the data point that constitutes the “sales” component of a price-to-sales calculation.
A trial balance is a report that shows the current balances of all general ledger accounts. Accountants create or prepare trial balances at the end of a reporting period to ensure that all accounts and balances add up correctly. Trial balances serve as test runs for an official balance sheet in professional practice.
Variable costs are expenses that change depending on how much a company produces or sells. A manufacturer, for example, would incur higher costs if it doubled its product output. As sales and profits increase, companies may face higher tax rates. Both of these are examples of variable costs. Fixed costs, on the other hand, remain constant regardless of production output or sales volume. Rent, wages, and salaries are examples of fixed costs.
As a small business owner, you may be unable to afford an accountant; however, you must be familiar with these accounting terms so that you are not puzzled when confronted with them.
Furthermore, who needs an accountant when you can easily build your business and handle all of your accounting needs from a single app?
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