They say knowledge is power, especially when it comes to your finances. Gaining the knowledge you need to manager your finances can be difficult, though, especially if you’re not the one working on them. We’ve compiled some accounting terms that are commonly used in the industry, but may not be common knowledge to those outside the industry. While you don’t need to be an expert in accounting, you should know what your books and accountant are telling you. It all starts with breaking down some of the key terms. If you run into a term you are unfamiliar with when learning about your finances, always ask your accountant.
Debits vs. Credits
A debit is an accounting entry that either increases an asset or expense account. A debit can also decrease a liability or equity account. A credit is an accounting entry that either increases a liability or equity account. A credit can also decrease an asset or expense account.
Gross Income vs. Net Income
Gross income (also referred to as “gross profit”) is the total amount of income earned. Net income on the other hand, is the actual profit after expenses, taxes and other necessary deductions are taken out.
Accounts Payable vs. Accounts Receivable
Accounts payable includes all the expenses a business has incurred but not yet paid. This is recorded as a liability on your balance sheet, since it is not a debt owned by the company. Accounts receivable includes all of the revenue/sales that a business has made but has not yet collected payments for. This is recorded as an asset on the balance sheet since it will likely convert to cash in the short-term.
A balance sheet is an important aspect of business. This is a financial statement that reports all a company’s assets, liabilities and equity. You can look at it as this basic equation: Assets= Liabilities + Equity.
Assets are what a business owns and holds value. This can be cash, land, vehicles, buildings, etc. These can be things that can depreciate over time or be goods sold to customers.
Liabilities are the debts a business still owes. This is usually in the form of payroll, loans, or accounts payable.
Equity refers to the value of shares issued by a company. Equity is measured by liabilities subtracted from assets.
This contains the balance sheet and income statement accounts. This is where all business transactions are recorded like sales, credit purchases, office expenses and income losses.
Receipts are the total amount of cash collected in business transactions over the course of a single day. It does not include other revenue collected.
Income and revenue are interchangeable, comprising the total amount of all income collected at one point. It can include cash sales, credit purchases, subscription fees and interest income. It differs from receipts, as it can include monies that are not collected at the delivery time.
Cash flow looks at the ins and outs of where a company’s cash goes. Positive cash flow clearly means there is more cash flowing into the business than out. Negative cash flow means there is more cash going out of the business, rather than into the business.
Now that you know some of the general terms, let’s put it all together:
- Accounts are divided into assets and liabilities. An asset is what the business owns and has cash value. Liabilities are the money owed from the business to creditors.
- Debits and credits are used to represent the money that comes in and goes out of a business. When an asset is increased, it is debited; when an asset is decreased, it is credited. For example, when a customer makes a payment on an account, the asset accounts receivable is debited. When the customer comes back and pays off the account, the asset accounts receivable is credited. For liabilities, the process is reversed. When a liability is increased it is credited; when it is decreased, it is debited. When a business gets a loan, the accounts payable is credited. When the business makes a payment on the account, the accounts payable balance is debited.
The easiest way to understand accounting terms is remembering the basic equation: Assets= Liabilities + Equity. Business owners don’t have to be an accountant, but understanding these terms can be beneficial to understanding accounts and what all those words and numbers mean. Remember, if you don’t understand a term or have questions about your books, just ask! When you choose a professional CPA like those at Hayes & Associates, you’ll have expert guidance through the world of finances.