12 Basic Financial Accounting Terms Defined

August 25, 2023
Accounting blog: 12 Basic Financial Accounting Terms Defined

Financial Accounting Terms

If you own a business, or are beginning your own start-up, there are many financial decisions and choices to make. You also will have to keep track of monetary amounts, and understand where they go, and what they mean.

For many new business owners, the jargon of the accounting world is new and understandably confusing.

Here is a list of 12 basic financial accounting terms, and their definitions, that we hope you find useful.

1. What is Cash Flow?

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Cash flow is the total amount of money being transferred in and out of a business.

Cash comes in from clients or customers who are buying your services or products.

It flows out of your business in the form of payments for expenses, for example, monthly loan payments or rent.

Often referred to as ‘Positive’ or ‘Negative’, it refers to the difference in cash at the beginning of a period compared to the end of a period.

If the ending balance is higher, the business is considered to have a Positive Cash Flow.

Some cash flow also comes from accounts receivable collection.

So what are accounts receivable?

2. What is Accounts Receivable?

Accounts receivable refers to the outstanding invoices a company has, or money clients owe.

You may be wondering why a company would ever allow a client to have an outstanding invoice.

It is common for businesses to operate by letting a portion of their sales be on credit.

This is typically given to frequent customers who a periodically invoiced. It allows the customer to avoid frequently making physical payments.

Another reason is that a company that provides a service doesn’t expect to be paid until after that service is complete.

For example, an electric company bills their clients after they have received electricity.

During the time in between when the electricity is being used, and when the electric company waits for the customer to pay the bill, the unpaid bill is considered accounts receivable.

Accounts receivable is entirely different from another common accounting term, accounts payable.

3. What is Accounts Payable?

Accounts Payable is the money a company owes its creditors, a short-term debt. The money is usually used for the purchase of goods and services.

For example, a marketing company pays $1200 for new office chairs. Until the invoice is received and paid, the $1200 spent for new office chairs would be an accounts payable.

4. What is a Balance Sheet?

small business accounting

A balance sheet is one of the most important financial statements that illustrates the financial health of a business.

It states the liabilities, assets, and owners’ equity, aka your business’s net worth, at a specific point in time.

One of the most important tasks that often gets overlooked in setting up your business is the balance sheet; properly allocating your startup costs and funding can literally save you thousands at tax time, make the difference between receiving a bank loan or not, and give you a solid and accurate foundation from which to build.

In order to understand a balance sheet, you need to know what each aspect of it means.

5. What are Liabilities?

Liabilities are obligations a company, amounts owed to creditors for a past transaction. They often include the word “payable” in them.

Sound a little familiar? Account payable, number 3 on the list, is an example of a liability. Other examples include wages payable, interest payable, and salaries payable.

Liabilities can either be long-term liabilities or short-term liabilities.

small business accounting

Long term liabilities are those that you will have on the books for a longer period of time, such as bank loans to start the business, etc.

Short term liabilities arise from normal business operations and recurring expenses that is expected to be satisfied within one year, such as unearned revenue, vendor invoices, etc.

Think of liabilities as a source of the company’s assets, or a claim against a company’s assets.

Which leads us into our next term, assets.

6. What are Assets?

Assets are resources owned by a company, that has future economic value that is measurable and expressed in dollars.

Number 2 from our list, accounts receivable, is an example of an asset.

Other examples include cash, investments, inventory, buildings, and vehicles.

These are examples of ‘tangible assets’, because they represent something real or ‘tangible’ that you can physically touch.

But there is another type of asset.

Intangible assets, assets that basically are not physical in nature, such as goodwill, non-compete agreements (if you are buying an existing business you will encounter these), intellectual property, brand recognition, etc.

These are all important to list and quantify, because each type of asset had its own method of depreciation, which can be very beneficial at tax time.

7. What is Owner’s Equity?

Owner’s equity represents an owner’s investment in a business, minus the owner’s withdrawals from the business, plus the net income since the start of the business.

Let’s simplify.

In mathematical terms, owner’s equity is the amount of assets minus the amount of liabilities.

It does not represent the current fair market value of a business. If a company is a sole proprietorship, the term “owner’s equity” is used on the balance sheet.

Note, if a company is a corporation, the term stockholders’ equity is used instead.

8. What is Net Income?

Most businesses are created to make money, and net income is that money. It is the residual amount of earnings after all expenses have been deducted from sales.

Another definition of net income is the net increase in shareholders’ equity, that comes from a company’s operation.

Net income is an important measure of how profitable a company is over a period of time.

A type of expense that affects net income, is cost of goods sold.

9. What are Cost of Goods Sold (COGS)?

small business accounting

This one is easy, the name says it all.

COGS are exactly what you think, the direct costs attributable to production of the goods sold by a company. It includes the costs of the materials used to create goods, as well as the direct labor costs used to produce the goods.

COGS exclude indirect expenses such as sales force costs and distribution costs and other costs of operation, called general and administrative, or G & A expenses.

For example, take an automaker. His COGS would include the cost of materials used to build the car, as well as the labor costs.

His COGS wouldn’t include the costs of sending his cars to a dealership, or the labor costs to sell the car, or myriad other expenses such as office supplies, repairs and maintenance, or utilities.

10. What is a General Ledger?

Accounting involves many different numbers, and it’s important to make sure those numbers are put in the right place. But how do you keep track of it all?

A general ledger.

A general ledger is a company’s set of numbered accounts for its accounting records. Ledgers provide a complete record of financial transactions, and hold account information that is needed to prepare financial statements. It includes assets, liabilities, owners’ equity, revenues, expenses, etc.

A general ledger needs to be thorough and understood, and it is done so with a trial balance.

11. What is a Trial Balance?

A trial balance is an accounting report that lists the balances in each of a company’s general ledger accounts. A trial balance was previously the way to make sure there were no mathematical errors were made, and that the debit balances equaled the credit balances.

Now, we advanced accounting and bookkeeping technology, like QuickBooks Online Service and Training, that does this.

A trial balance is still important though. Accountants and auditors can use it to show the general ledger account balances before proposed adjustments, and the account balances after the proposed adjustments.

It is important to have a basic knowledge of accounting, especially if you own a business.

Luckily, there are people who can help make sense of all these terms, certified public accountants.

12. What is a Certified Public Accountant (CPA)?

A CPA is someone who has passed a standardized CPA exam, and met government mandated work experience and education requirements to become a CPA. CPAs are there to help individuals and companies with financial planning, taxes, investments, mergers and acquisitions, and much more.

Generally, it is not required for a small business to have a CPA, but the benefits are numerous. A CPA can help a small business evaluate accounting software, review internal controls, obtain tax advice, etc.

Outsourcing Bookkeeping for Small to Medium Businesses

If either part-time or in-house bookkeeping is not the ideal solution, outsourcing can offers many benefits that you can’t get with an in-house bookkeeper.

Today, there are different outsourcing companies, ranging from project only outsourcing, hourly rates, flat monthly service fees, and a la carte packages to fit each business’s unique needs.

Outsourcing can provide a better and cheaper bookkeeping service than a typical in-house bookkeeper while giving you the ability to customize to your bookkeeping needs.

If your business is looking for accounting or consulting, you can contact Volpe Consulting and Accounting. We offer full service accounting, bookkeeping, payroll, tax planning and preparation, as well as full financial consulting services.

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