Whether you’re a business owner looking to improve your accounting/bookkeeping, or simply someone wanting to better organize and understand your finances, we’ve put together a list of 10 key accounting terms you should know. Becoming familiar with these basic terms can lead to more effective tracking of financial transactions, more organized records of your most important purchases, as well as a general understanding of buzz words you may hear from your accountant when tax season arrives.
1. Assets – All resources owned by a company that are necessary for daily operations. This can include, but is not limited to, cash and investments, inventory, buildings, vehicles, FF&E (Furniture, Fixtures & Equipment), etc. Accounts receivable is also considered an asset (viewed as cash earned but not yet received).
2. Liabilities – All of the amounts owed by a company. These include amounts owed to credit cards, vendors/suppliers (i.e. accounts payable), payroll tax liabilities, business loans, etc.
3. Equity – The amount of money invested in a business by the owners plus/minus accumulated earnings/losses. In mathematical terms, it’s your total assets minus your total liabilities. You want this amount to be positive.
4. Balance Sheet – The financial statement used to report business assets, liabilities and equity that must be in “balance” with this simple equation: Assets = Liabilities + Equity.
5. Debits vs Credits – By far the most confusing concept to understand. In general terms, accounting entries (aka journal entries) must be entered using “double-entry” accounting. This means that every journal entry must have, at a minimum, 2 lines in the following format… a debit amount on the left as a positive number, and a credit amount on the right as a negative number… AND they must sum to zero. Assets, COGS/COS and Expenses carry a debit balance (i.e. positive numbers are looked at as positive numbers), while Liabilities, Equity and Revenues carry a credit balance (i.e. negative numbers are looked at as positive numbers). Did we confuse you yet? Here are some examples of journal entries that will (hopefully!) help you understand these concepts:
Accounts Receivable $1,000
An invoice is entered, and a sale is recognized
Accounts Receivable ($1,000)
Money is received for the sale above
Telephone Expense $200
Accounts Payable ($200)
A bill is entered, and an expense is recognized
Accounts Payable $200
Money is paid for the expense above
6. Cost of Goods Sold/Cost of Sales (COGS/COS) – The costs directly associated with the production of goods (manufacturer) or the purchase of goods (retailer) that were sold. Costs associated with the production of goods generally include materials and direct labor used to make/assemble them. Costs associated with the retail sale of goods generally include the wholesale purchase price plus costs to receive it (e.g., shipping). COGS/COS are also known as variable costs, since they are directly related to and tend to fluctuate with revenue.
7. Gross Margin – Sales revenue less Cost of Goods Sold/Cost of Sales. For example, if a Retailer sells a product for $1,000, with a wholesale cost of $600 plus $25 shipping, the gross margin would be $375 ($1,000 – $625).
8. Overhead Expenses – The costs necessary to run your business that are not directly associated with generating revenue (aka the “cost of doing business”). Office personnel, copiers, insurance, telephone, etc. are among some examples. Overhead expenses are also known as fixed costs, since they generally stay the same no matter how the business is performing.
9. Accrual vs Cash Method – The accrual method of accounting recognizes revenue when “earned” and expenses when “incurred”, while the cash method recognizes revenue when “received” and expenses when “paid”. If you invoice your customers through your accounting software, an accounts receivable is created and the sale is recognized as of the invoice date. This means that you are using the accrual basis of accounting, at least for “book” purposes (see next).
10. Book vs Tax – “Book” refers to how you view your financial results internally for management purposes, while “Tax” refers to how you view your financial results in your Federal income tax return. A lot of companies will prepare financial results throughout the year under the accrual basis of accounting for book purposes, then converting to the cash basis of accounting for income tax purposes (usually done by stripping out accounts receivable, accounts payable and other accruals).
While you might have heard these words before, we hope you take away a further and more in-depth understanding of what they mean for yourself and your business. If you have further questions about accounting terms or how these concepts relate to you, visit us at cpasforhire.com or call 314.381.2200.
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