The world of accounting is known for being a little heavy on the jargon and technical terms. According to Go Remotely’s Accounting Statistics, 60% of small business owners don’t think of themselves as being knowledgeable about finances and accounting.
Sound like you?
While you won’t need to know everything when it comes to accounting terminology, there are a few key terms that will help you out – a little knowledge of good accounting practices can make all the difference for your business.
So, here’s our list of the 16 most useful accounting terms to know as a business owner, in alphabetical order.
1. Accounts payable/accounts receivable
Accounts payable (AP) refers to all the expenses that a business has incurred but has not yet paid. In other words, AP includes all the money a business owes. This may be in the form of unpaid bills or debts to suppliers.
Accounts receivable (AR), on the other hand, refers to the value of the goods or services that a business has provided but has not yet collected payment for – i.e. the money that is owed to a business by customers.
2. Accruals
Accruals are simply a list of expenses that have been recognised by a business but are not yet recorded in their accounts. Accruals occur before an actual exchange of money has resolved the transaction.
For example, if a company had outsourced work to an external contractor, e.g. their accountant, an accrual would instantly recognise and record the cost of the work even if the contractor had not sent an invoice or received payment.
3. Assets
Assets are physical items that a business owns that have monetary value. These may be current assets like stock, cash and accounts receivable, or fixed assets such as buildings, vehicles, equipment or property.
4. Balance sheet
A balance sheet, also known as a statement of financial position, specifies the current state of the business in relation to its assets, liabilities, owner shares and business reserves. It is calculated by the equation [Assets – Liabilities = Share Capital + Reserves]
5. Capital
Capital is any asset or resource, tangible or intangible, that a business can use to generate revenue. It is used to meet upcoming expenses or invest in new assets and projects. Working capital refers to the money used by a business to pay for day-to-day operations.
It is good practice to have capital set aside in case of the need to purchase necessary business items such as IT equipment.
6. Cash flow
Cash flow is the movement and availability of cash through and to the business during a set timeframe. This information can be used to monitor and predict the availability of funds for things like paying suppliers.
7. EBITDA
EBITDA refers to your earnings before interest, taxes, depreciation, and amortisation. Banks use the EBITDA method to assess whether your business is able to pay off its debts
The Earnings usually refer to your net profit as you report it to HMRC.
Interest is what is charged when repaying your debt.
Taxes are the sums of money you pay to HMRC – they can vary from one period to the next and are subject to conditions not directly linked to your business.
Depreciation describes the decrease in value over time when you use tangible assets like machinery and vehicles.
Amortisation relates to the eventual expiring of intangible assets like patents and copyright.
EBITDA is calculated by either adding depreciation and amortisation expenses to operating profits, or adding interest, tax, depreciation and amortisation expenses back on top of net profit.
8. Equity
Equity describes the sum of money that would remain if a business sold all of its assets and paid off all of its debts. This is the portion of the business that is owned by its investors and owners.
9. Expenses
Expenses are simply any cost incurred by a business. They can be categorised into:
Fixed expenses, which do not vary according to changing sales or production – for example, rent, wages and utility bills.
Variable expenses, which do vary in line with changing sales or production – for example, increased postage costs due to increased online purchases.
Accrued expenses, which have been reported but not yet paid.
Operational expenses, which are necessary for conducting business – for example, insurance, office supplies and software subscriptions.
10. Gross profit/Net profit
Gross profit is the value of the products or services sold by a business after the cost involved in creating or providing those goods or services has been deducted. If the gross profit is a negative number, it is known as a gross loss.
Net profit is the sum of money earned after all expenses have been deducted from revenue. If this is a negative number, it is called a net loss.
11. Income statement (profit and loss account)
The income statement, also known as a profit and loss account, provides an overall picture of how well a business is performing over a given timeframe. It balances revenue, expenses and gross profit to calculate net profit.
12. Liabilities
Liabilities are any debts the business is responsible for paying in the short- or long-term – for example, accounts payable, payroll and loans.
13. Liquidity
Liquidity refers to how quickly and easily an asset can be converted into cash. Assets that can be easily converted, such as accounts receivable and stocks, are known as liquid assets. Non-liquid assets like property take much more time to sell.
14. Overheads
Overhead costs come from expenses that do not contribute directly to a business’ products or services, but that are necessary to sustain day-to-day operations. For example, rent, insurance, and marketing and advertising costs.
15. Return on investment
Return on investment, or ROI, describes the financial rewards a business receives in return for the things it invests in, and acts as a measure of efficiency for an investment. ROI is calculated as a percentage using the formula [net profit/total investment x 100]
16. Revenue
Revenue is the total amount of money generated from sales of products or services associated with a business’ main operations, before any expenses are deducted. It does not include any additional sources of income such as bank interest or government grants.
So there you have it, 16 of the most important accounting terms for you to know as a business owner, demystified. The next time you have a meeting with your accountant, you’ll be better equipped to ask questions and understand your finances.
At Benson Wood, we believe that all our clients should feel empowered to do this, so one of our promises is that we’ll communicate clearly, without jargon. You’ll get easily-understandable information and actionable plans, plain and simple. Contact us to find out how we can help you.
