Accounting terms every business owner should know

As a business owner, you’re likely juggling a million things – from crafting the perfect product to nurturing customer relationships and strategising for growth. While the intricacies of accounting might seem like the domain of CPAs and bookkeepers, a fundamental understanding of key accounting terms is crucial for making informed decisions, managing your finances effectively, and ultimately driving your business towards success.

Ignoring accounting is akin to sailing a ship without a compass. You might drift for a while, but eventually, you’ll lose your way. This comprehensive guide will demystify essential accounting terms, empowering you to navigate the financial landscape of your business with confidence.

Whether you’re a long-term business owner or a brand-new start-up, it is always a good idea to freshen up on your accounting basics. Even if you hire a professional accountant to help and assist with money matters, there is still a lot of value in understanding accounting terms and knowing a thing or two yourself.

It’s important to be familiar with common accounting and bookkeeping terms and phrases to manage your business‘s financial and market position. Here are seven terms every business owner should know, even if you outsource to an accountant.

Assets

Business assets are the things your business owns. Assets can be tangible items such as vehicles, computers, and petty cash, as well as no physical items such as intellectual property, reputation, and goodwill.

Assets are reported on the balance sheet. They are divided into two sections- current assets and non-current assets. Current assets are assets that will be sold, consumed, or exhausted and converted into cash within one financial year. Current assets include cash, inventory, and supplies.

Non-current assets are long-term assets that a company does not intend on selling and are expected to provide business value for more than one year. Non-current assets include property, plant, and equipment.

Balance sheet

A balance sheet shows an accurate and quick insight into your business’s current financial position. It is a financial statement that reports business assets, liabilities, and equity. This sheet is updated to report what a company owns and owes and is a core part of understanding and evaluating a business.

At any time, a balance sheet should provide an accurate and clear analysis of a business and how much it is worth. A balance sheet is commonly analysed to improve financial standing and spending.

Liabilities

Liabilities are everything your business owes to creditors. They include loans, taxes, and mortgages. It is common for businesses to take on liabilities to operate and grow but it is important to keep track of the debt your company owes.

Business liabilities will be displayed on the balance sheet and are often referred to as ‘payables’. Liabilities are legal financial debts that are often paid with assets.

Equity

Equity is the difference between the total assets and the total liabilities on the balance sheet of a business. Often referred to as shareholder equity or net worth, equity is the value amount that shareholders or business owners have left over after liabilities have been deducted or paid.

Income

Income is the money your business receives for the exchange of investment, services, or labour. Accounting income is the revenue your business earns for fulfilling business operations.

It is important to ensure your business has a steady and regular income to maintain operations and grow. Your business needs to make money to pay liabilities. Your income is displayed on an income statement which provides an in-depth record of business performance and level of financial security.

Expenses

Expenses are the costs your business incurs during the running of everyday operations. Some business expenses are allowable expenses which are tax deductible and can be claimed back.

Business expenses include office costs, such as rent and energy bills, travel costs, such as fuel and parking, and staff-related costs, such as payroll, salaries, and insurance.

Profit and loss statement

A profit and loss statement shows and summarises your company’s revenue minus expenses for a transparent view of company cash flow and spending. This statement considers and calculates revenue, cost of goods, expenses, taxes, and net income to determine a business’s profit or loss.

By analysing a profit and loss statement organisations can make informed business decisions to generate profit.

Why is it important for businesses to know accountancy terms?

It is critically important for business owners to know accounting terms for a multitude of reasons that directly impact their ability to manage, grow, and sustain their business. Here’s a breakdown of why financial literacy, specifically understanding accounting terms, is essential for business owners:

Informed Decision-Making:

Understanding Financial Health: Accounting terms are the language used to describe a company’s financial health. Knowing terms like “assets,” “liabilities,” “equity,” “revenue,” and “expenses” allows owners to interpret financial statements (balance sheet, income statement, and cash flow statement) accurately. This understanding provides a clear picture of the company’s current financial standing.

Strategic Planning: Without understanding financial terms, it’s impossible to make informed decisions about pricing, cost management, investments, and expansion. For instance, knowing the “gross profit margin” helps determine the profitability of products or services and informs pricing strategies.

Identifying Trends and Issues: Familiarity with accounting terms enables owners to analyse financial data over time, spot trends, and identify potential financial problems early on, such as declining profitability or increasing debt.

 Effective Communication:

With Accountants and Financial Professionals: Business owners need to communicate effectively with their accountants, bookkeepers, and financial advisors. Understanding accounting terms ensures clear and productive conversations, leading to better advice and support.

With Investors and Lenders: When seeking funding, owners must be able to discuss their company’s financial position and performance using appropriate accounting terminology. Investors and lenders rely on financial statements and ratios to assess risk and potential returns.

With Employees: In some cases, especially with profit-sharing or performance-based compensation, owners need to explain financial concepts to their employees.

Financial Control and Management:

Budgeting and Forecasting: Understanding terms like “fixed costs,” “variable costs,” and “break-even point” is crucial for creating realistic budgets and accurate financial forecasts. This helps in managing cash flow and planning for the future.

Cash Flow Management: Knowing the difference between “profit” and “cash flow” is vital for day-to-day operations. A profitable business can still face difficulties if it doesn’t manage its cash flow effectively. The cash flow statement, understood through its specific terms, provides insights into the movement of cash.

Cost Control: Understanding different types of expenses and how they impact profitability allows owners to identify areas where costs can be reduced.

Compliance and Legal Requirements:

Taxation: Understanding basic accounting terms is necessary for comprehending tax obligations and ensuring compliance with tax laws.

Financial Reporting: Businesses are often required to prepare financial statements according to specific accounting standards. Owners need to understand the basics to ensure accuracy and compliance.

Risk Assessment: Financial ratios and statement analysis can help identify potential financial risks, such as high debt levels or low liquidity.

React Accountancy offer a range of accounting services led by accountants with a wealth of industry knowledge and experience. For more information about accounting terms, or if you need an accountant, get in touch today.

We provide our services across Manchester, Stockport, London, Birmingham, Cardiff, Bristol, Glasgow, Leeds, Nottingham, Leicester, Edinburgh, Sheffield, Bradford, Coventry, Liverpool and Belfast.

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