Accounting is a specialized field. It takes years for someone to become a professional accountant and even then, there is no limit to the further qualifications and the level of experience one can obtain.
When you are running a small business there are many accounting terms you need to become familiar with even if you are not a professional accountant. The profession of accounting certainly has its own shibboleth, but these common terms are also known to people who deal with finances on a day-to-day basis, yet they are not accountants. Knowing these terms will help you manage your finances well and when making entries, understand what you’re doing. Let’s quickly dive into them.
1. Accounts Receivable (AR)
Your customers and clients may not pay you immediately for your products and services. They may have an ongoing account with you through which they receive your products and services on a regular basis and then either by the end of the month or by the end of the agreed-upon term, they make the payments.
These may be multiple customers and clients. All the money that you are supposed to receive but haven’t received yet, is added to Accounts Receivable. On the balance sheet, AR appears as a current asset. This is the money people owe you.
You need to check your accounts receivable regularly and then send out timely reminders to all the people who owe money. This can be a great hassle especially if you have numerous customers and clients and an accounting firm can help you maintain a healthier cash flow.
2. Accounts Payable
Just as your customers and clients may owe you money, you too may owe money to your suppliers, contractors, and service providers. These are considered short-term debts and they are normally entered in your general ledger. In Accounts Payable you also add money that you owe to your creditors. In your company’s balance sheet, it is shown as the “Accounts Payable balance”. This account helps you gauge how much money you need to pay before you can calculate your net profit. In your balance sheet this amount also appears under the “current liabilities” section.
3. Balance sheet
Your balance sheet is one of the most important financial documents you are going to maintain. It represents the overall financial health of your business. A balance sheet is a financial statement that reports your assets and liabilities at a specific point in time. It gives you a snapshot of what you own and what you owe.
In a typical balance sheet, there are the following key areas
- Assets: Everything you own in the business including equipment, vehicle, property, furniture, and even cash and accounts receivables.
- Liabilities: These are the things or the money that you owe to the others. These may include unpaid bills, outstanding loan payments and other pending expenses under accounts payable.
- Equity: If you invested cash in the company, it comes here. Additional income also comes here, as well as losses, if any.
4. Working capital
When your business has positive working capital, you have more money to invest and grow your business. It is also called “net working capital”. It is the difference between your current assets that may include cash, accounts receivables, unpaid bills by the customers, raw materials, and finished goods, and your current liabilities that include accounts payable, pending bills, loan amount and other debts.
5. Bank statement
A bank statement is prepared by the bank you use for your business operations, typically every month. With the help of a bank statement, you can see all the income you have made and your spending activities. Basically, it chronicles all the transactions that you have made in a month. This can be an incoming and outgoing balance.
Through a cursory glance at the bank statement, you can find out how much money you have made in a month and how much you have spent. A bank statement is also called an “account statement”.
Depending on what option you have chosen, your bank may send you a bank statement every month with a summary of all the transactions in your account. Every single deposit and withdrawal instance is recorded in a bank statement for the month.
Through your net banking account, you can also generate bank statements for custom time ranges.
6. Cash flow
Your cash flow can be positive or negative based on the inflow and outflow of your cash. It is the movement of money in and out of your business. Ideally, your inflow must be greater than your outflow otherwise you have a negative cash flow, which means, your business is incurring losses instead of making profits.
It is a financial statement, which is also called the “cash flow statement” that gives you a bird’s eye view of your business’s sources and your consumption of cash over a period. It is one of the most important statements your accounting must generate.
7. Certified public accountant
This may not be an accounting term but if you are seeking professional accounting help you must know what a certified public accountant does. The designation of a Certified Public Accountant is one of the most recognized and prestigious professional designations one can earn as an accountant.
In the UK, a certified public accountant is an accounting and finance professional who may also be a member of the Certified Public Accountants Association. Once one is a member of this association, he or she can provide professional accounting services to individuals, small businesses, and bigger organizations.
Most of the CPAs are finance or accountancy graduates. Work experience is required to get a CPA license, and without a license, a CPA cannot perform professional duties. This ensures that the accountant who works for you has a proven track record. In many countries a CPA is also called a “chartered accountant”
A certified public accountant can help you maintain your financial records as well as optimize and file your tax returns. Many CPAs also help businesses and organizations implement their growth strategies.
8. Closing the books
Accounting is all about keeping books. Hence, basic accounting is also called bookkeeping where you add all the entries whether they are incoming transactions or outgoing. Books are the records of all your financial transactions. Closing of the books happens at the end of every month. Then grandly, it happens at the end of each year.
More than a physical, it is a procedural activity. By the end of the month, it is ensured that all the records have been entered into the books or into whatever recording system you are using for your business. The data is reconciled and double checked by your accountant. Once everything is checked, the accountant “closes the books”, which means, he or she approves the data for the month, and you can move onto the next month. Your income statement and balance sheet can be created with the closed books.
9. Fixed and variable expenses
These terms are self-explanatory. Fixed expenses don’t change frequently, and they can be automated. For example, if you need to pay for office space rent, it is a fixed expense. The weekly payroll is a fixed expense. Your equipment and business assets depreciate at a constant rate – that’s a fixed expense. Fixed expenses don’t change – in most of the cases – irrespective of the circumstances under which your business is operating. For example, during the Covid-19 outbreak, there were many fixed expenses that one’s business needed to incur no matter how the business was.
Variable expenses change. Your power consumption bill may vary. You may need to travel. There may be transportation expenses. The business credit card that you must be using may require varying fees every month. If you are paying hourly wages that will be a variable expense. The raw materials that you purchase and the sales commission that you pay, are all variable expenses. Normally it is difficult to automate variable expenses.
10. General ledger
A general ledger keeps record of a company’s total financial accounts. It may carry financial details of the business’s assets, equity, liabilities, expenses, and income (or revenue). It is a big part of the two-entry system. Whether you maintain physical books or use a digital tool to maintain your accounts, you will be maintaining a general ledger. The information for the general ledger comes from external documents such as an invoice or a bill. A general ledger plays a pivotal role when you are preparing a balance sheet or an income statement.
Conclusion
There is a large number of common accounting terms that you can learn to understand your accounting system. Accounting and bookkeeping are complete, dedicated financial realms, and it takes years of studying and practicing before one can perform professional accounting and bookkeeping services. Therefore, it is better to maintain your financial records with the help of a certified accountant as early as possible, than ruing later.