10 Accounting Terms Decoded
Staying on top of your finances as a small business owner doesn’t have to be complicated, but in order to understand what you are looking at, there are a few accounting terms that you should know to help you make sense of it all. Here are 10 accounting terms defined in plain English, so that you can start to evaluate your numbers and better understand your position.
Revenue
Revenue is the amount of money a business makes by selling products, services, or any paid activity. This is solely the money brought in from sales before accounting for anything else (like expenses).
Expenses
Expenses are the costs associated with running your business, and can be categorized into two buckets: Cost of Goods Sold (COGS) and Operating Expenses.
COGS refers to the direct costs like the materials you use to make your products.
Operating expenses are indirect costs like rent, internet, and booking software.
For example, if your business sells candles, your COGS would include paying for wax, wicks, and compensating employees for fabricating and packaging them, while your operating expenses would comprise of paying rent on your warehouse and the software you use to take online orders.
Asset
An asset is anything owned by a company that has monetary value and can be sold for cash. Examples of assets include actual cash, equipment, land. ‘Capital’ is another type of asset, that includes things that may not be physical objects - like trademarks and financial investments like stocks and bonds owned by the business.
Liability
Liabilities refer to the money or service that one business owes to another business or person. A few examples of liabilities in business could include wages owed to contractors or credit card payments owed to a bank.
Gross Profit
Gross profit is your business’ revenue minus its cost of goods sold. This number is a good measure of how efficient or profitable a business is when you take labor and supplies into consideration.
Net Profit
Net profit is your gross profit (revenue minus cost of goods sold) minus all other expenses. Other terms that are commonly used to refer to Net Profit are: Net Income, Net Earnings, or Bottom Line.
Cash Flow
Cash flow tracks the movement of money into and out of a business. The more positive or “in the green” this number is, the healthier the business!
Depreciation
Depreciation is the cost of an asset’s declining value. You’re never going to pay the same amount for the same car if it’s new versus used - the same goes for machinery and equipment. They get worn out the more they get used, and new models come out all the time, so those factors drive down the value of that asset. This isn’t always a bad thing! Business owners can expense the amount of depreciation instead of the entire cost of the asset, which will make their net income appear higher.
Cash Flow Statement
A cash flow statement accounts for the amount of cash going in and out of a business. It measures the performance of a company over a period of time and reflects how well a company can pay off its debts in that period.
Balance Sheet
A balance sheet is a great document to look at to find ways to improve your business’ financial health, as it accounts for your assets, liabilities, and shareholder's equity. It basically breaks down how much a company owns, what they owe, and where the business stands in a big picture sense.
