Basic Accounting Terms for Small Business Owners
Are you looking to start your own small business? Before you can take on bookkeeping and start keeping the books for your small business, the first things you must get a handle on are key accounting terms. The following is a list of accounting terms that all bookkeepers use on a daily basis.
Accounts for the balance sheet
Here are a few basic accounting terms you’ll want to know:
- Balance sheet: The financial statement that presents a snapshot of the company’s financial position (assets, liabilities, and equity) as of a particular date in time. It’s called a balance sheet because the things owned by the company (assets) must equal the claims against those assets (liabilities and equity).
On an ideal balance sheet, the total assets should equal the total liabilities plus the total equity. If your numbers fit this formula, the company’s books are in balance. (Flip to Chapter 3 in Book 3 for more about the balance sheet.)
- Assets: All the things a company owns in order to successfully run its business, such as cash, buildings, land, tools, equipment, vehicles, and furniture.
- Liabilities: All the debts the company owes, such as bonds, loans, and unpaid bills.
- Equity: All the money invested in the company by its owners. In a small business owned by one person or a group of people, the owner’s equity is shown in a Capital account. In a larger business that’s incorporated, owner’s equity is shown in shares of stock. Another key Equity account is Retained Earnings, which tracks all company profits that have been reinvested in the company rather than paid out to the company’s owners. Small, unincorporated businesses track money paid out to owners in a Drawing account, whereas incorporated businesses dole out money to owners by paying dividends (a portion of the company’s profits paid by share of common stock for the quarter or year).
Accounts for the income statement
Here are a few accounting terms related to the income statement that you’ll want to know:
- Income statement: The financial statement that presents a summary of the company’s financial activity over a certain period of time, such as a month, quarter, or year. The statement starts with Revenue earned, subtracts out the Costs of Goods Sold and the Expenses, and ends with the bottom line — Net Profit or Loss. (See Chapter 2 in Book 3 for more about the income statement.)
- Revenue: All money collected in the process of selling the company’s goods and services. Some companies also collect revenue through other means, such as selling assets the business no longer needs or earning interest by offering short-term loans to employees or other businesses.
- Costs of goods sold: All money spent to purchase or make the products or services a company plans to sell to its customers.
- Expenses: All money spent to operate the company that’s not directly related to the sale of individual goods or services.
Other common accounting terms
Some other common accounting terms include the following:
- Accounting period: The time for which financial information is being tracked. Most businesses track their financial results on a monthly basis, so each accounting period equals one month. Some businesses choose to do financial reports on a quarterly basis, so the accounting periods are 3 months. Other businesses only look at their results on a yearly basis, so their accounting periods are 12 months. Businesses that track their financial activities monthly usually also create quarterly and annual reports (a year-end summary of the company’s activities and financial results) based on the information they gather.
- Accounts Receivable: The account used to track all customer sales that are made by store credit. Store credit refers not to credit card sales but rather to sales in which the customer is given credit directly by the store and the store needs to collect payment from the customer at a later date.
- Accounts Payable: The account used to track all outstanding bills from vendors, contractors, consultants, and any other companies or individuals from whom the company buys goods or services.
- Depreciation: An accounting method used to track the aging and use of assets. For example, if you own a car, you know that each year you use the car its value is reduced (unless you own one of those classic cars that goes up in value). Every major asset a business owns ages and eventually needs replacement, including buildings, factories, equipment, and other key assets.
- General Ledger: Where all the company’s accounts are summarized. The General Ledger is the granddaddy of the bookkeeping system.
- Interest: The money a company needs to pay if it borrows money from a bank or other company. For example, when you buy a car using a car loan, you must pay not only the amount you borrowed but also additional money, or interest, based on a percent of the amount you borrowed.
- Inventory: The account that tracks all products that will be sold to customers.
- Journals: Where bookkeepers keep records (in chronological order) of daily company transactions. Each of the most active accounts, including cash, Accounts Payable, and Accounts Receivable, has its own journal.
- Payroll: The way a company pays its employees. Managing payroll is a key function of the bookkeeper and involves reporting many aspects of payroll to the government, including taxes to be paid on behalf of the employee, unemployment taxes, and workers’ compensation.
- Trial balance: How you test to be sure the books are in balance before pulling together information for the financial reports and closing the books for the accounting period.
Check here to see a short list of important financial documents for your small business.