Bookkeeping is a critical business activity, whether you are a small business or a Fortune 500 company. Regardless of an organization’s size, the underlying principles of accounting and bookkeeping terms remain the same. While there is no substitute for hiring a professional bookkeeper, as a small business owner you may be able to afford to manage your own books in the initial stages. It may seem daunting at first, but accounting is a very uniform and regulated discipline, which means that once you understand the basic concepts, you can get the hang of things quickly. To help you understand the basics, we put together a list of bookkeeping terms that every small business owner should be familiar with.
Key Small Business Bookkeeping Terms:
Accounting Equation: This equation is one of the core concepts of the double entry accounting system and is a simplified representation of the relationship between assets, liabilities and the owner’s equity in the business. The assets of a business must always equal liabilities plus capital/equity, hence the accounting equation: Assets = Liabilities + Equity
Accounting Policies: These are specific principles, rules, conventions, and procedures set up by a company to help prepare and present its financial statements. An example is the use of first-in, first-out (FIFO) or last-in, first-out (LIFO) methods when processing inventory reports, in order to decrease the cost of goods sold and increase profits.
Accounts Payable: This is an accounting entry which denotes amounts owed by a company or business to its suppliers, also referred to as creditors. These amounts are recorded in the balance sheet as liabilities.
Accounts Receivable: This accounting entry includes amounts owed to the business or company by customers who have yet to pay for products or services. These amounts are recorded in the balance sheet as assets.
Assets: These are items of property or resources owned by a business, available to meet debts or commitments. Assets typically include cash, equipment, buildings, land or vehicles, and are recorded on the balance sheet in order of liquidity – starting from the most liquid, i.e., cash, and moving down to the least liquid assets, such as goodwill.
Balance Sheet: Also referred to as the ‘Statement of Financial Position’, the balance sheet is a major accounting statement that provides a snapshot of the company’s financial standing at a particular date and time. It must always be balanced in regards to the accounting equation i.e., Assets = Liabilities + Equity.
Billing: One of the simpler bookkeeping terms, this is the process of issuing invoices to customers who have purchased goods or services from the business.
Budget: This constitutes the projected income and expenditure for the business in the future and is typically estimated for one year ahead.
Capital: This denotes the amount of money or resources invested by the business owner in order to start and operate the business. In the accounting equation, this is represented by equity and is the remainder of assets minus liabilities.
Cash Flow: This is the difference between cash moving into a business and out of it. Cash Flow is different from income because the latter also includes accounts receivable (payments not yet received). Positive cash flow (more cash coming in than going out) indicates an increase in liquid assets and is a good measure of a company’s solvency.
Credits: Another basic concept of the double entry accounting system, credits are transactions recorded in the right column of a T-Account and depending on the type of account, can increase or decrease its balance. Generally, credits increase liabilities and equity and decrease assets and expenses.
Debits: As opposed to Credits, Debits are transactions which are recorded in the left column of a T-Account, and depending on its type, can increase or decrease its balance. Generally, debits increase assets and expenses and decrease liabilities and equity. A journal entry is only valid if debits are equal to credits.
Depreciation: This is one of the more technical bookkeeping terms and is used to represent the aging and consequent reduction in the value of an asset (typically vehicles, equipment and furniture) which is used for more than a year. These write-offs are regulated by the IRS and there are specific rules for the amount of time you are allowed to depreciate an asset.
Double Entry Accounting: This system of bookkeeping dictates that every business transaction should involve two or more accounts, which must be balanced via debits and credits. For instance, an increase in one account has to lead to a decrease in another. An example can be the purchase of office furniture, which would be marked by a debit entry (left column/increase) in the office equipment head, under assets, but also result in a credit entry (right column/decrease) in the cash head under assets.
Equity: This represents the original investment or ownership interest in the business and is represented via the accounting equation as the remainder after liabilities are deducted from assets, i.e., Equity = Assets – Liabilities.
Expenses: These are costs incurred by a business over the course of its activities and are generally divided into two bookkeeping terms, operating expenses and non-operating expenses. Some examples of operating expenses include utility bills, employee salaries, cost of goods sold (COGS) and rent. Non-operating expenses usually include interest payments, bank fees and so on (costs not directly related to the company’s main activities).
Financial Accounting: This refers to the preparation of financial statements intended for third-parties such as lenders, tax authorities, and investors. All business transactions are recorded, summarized and presented in accordance with standard accounting guidelines, such as the Generally Accepted Accounting Principles (GAAP).
Payroll: This refers to the entire process of calculating and distributing employee salaries and benefits along with any mandated tax deductions. These costs are all recorded under Payroll Expense.
Profit and Loss Statement: Also known as the Income Statement in popular bookkeeping terms, this is a financial report that helps ascertain a business’s profitability by summarizing the revenues, costs and expenses over an accounting period in order to determine the net profit or loss.
Revenue: This reflects the entirety of assets a business earns in exchange for the sale of goods or services. Revenue is not the same as profit, which equals the remainder of expenses subtracted from revenue.
Write-Off: This is an accounting practice that reduces the value of an asset or completely nullifies it. A write-off is generally required when a business cannot recover an account receivable (bad debts), has completely depreciated an asset, or an asset has lost market value.
While there is a lot more to accounting than the bookkeeping terms we have explained here, these should serve as a useful introduction for small business owners who want to understand the basics of bookkeeping.