If you're a business owner or manager, accounting is an essential part of your job.
However, if you're not a trained accountant, it can be easy to feel overwhelmed by the jargon and technical terms used in the field.
In this blog post, we'll break down some of the most common accounting terms in simple language, so you can better understand your business finances and communicate with your accountant more effectively.
Here are 10 common accounting terms explained in simple language:
- Balance Sheet - A report that shows how much a business owns, what it owes, and how much is left over. It's like a financial picture of a business. The balance sheet is important because it helps business owners understand their financial position and make informed decisions about their operations. It's also useful for investors and lenders who want to assess the financial health of a business before investing or lending money.
- Cash Flow - This is the money that flows in and out of a business. When more money is coming in than going out, this means the business is doing well. Cash flow management is important because it ensures that a business has enough money to pay its bills, invest in growth and pay dividends. A positive cash flow also indicates that a business is generating enough revenue to cover its expenses.
- Depreciation - This is when something a business owns loses value over time. This is important to know when calculating how much a business made or lost. Depreciation is a non-cash expense that reduces the value of an asset over time. It's important to consider depreciation when calculating the true cost of an asset and the profit or loss made from its sale. This can help businesses make informed decisions about buying, selling or leasing assets.
- Gross Profit - This is how much money a business makes after it sells its products or services, minus how much it cost to make them. Gross profit is an important measure of a business's profitability because it shows how much money is left over after the cost of producing goods or services has been accounted for. It's important to monitor gross profit because it can indicate whether a business is pricing its products or services correctly and managing its costs effectively.
- Net Profit - This is how much money a business makes after taking out all of its expenses, like salaries and taxes. Net profit is the bottom line of a business's income statement. It's the profit that remains after all expenses have been subtracted from revenue. Net profit is important because it shows whether a business is profitable or not. It's also useful for investors and lenders who want to assess the financial health of a business before investing or lending money.
- VAT - This is a tax that businesses have to pay on things they sell. It's like a sales tax. VAT is a consumption tax that is added to the price of goods and services at every stage of production and distribution. Businesses are responsible for collecting and paying VAT to the government. It's important for businesses to understand their VAT obligations and ensure that they comply with relevant regulations.
- Accruals - This is how businesses keep track of how much money they are making and spending, even if they haven't received or paid it yet. Accrual accounting is a method of accounting that recognizes revenue and expenses when they are earned or incurred, regardless of when the payment is received or made. This is different from cash accounting, which recognizes revenue and expenses only when payment is received or made. Accrual accounting is important because it provides a more accurate picture of a business's financial performance.
- Capital - This is the money that a business uses to invest in itself and grow. It can come from investors, like people who buy stocks, or from loans. Capital is a critical component of a business's financial structure. It's used to finance a business's operations, invest in growth and pay dividends to shareholders. It's important for businesses to manage their capital effectively and ensure that they have enough capital to support their operations and growth.
- Dividends - This is when a business pays some of its profits to the people who own it, like shareholders. Dividends are a way for a business to share its profits with its shareholders. They are usually paid out in cash, but can also be paid in the form of additional shares or other assets. Dividends are paid out of a business's net income after all expenses and taxes have been deducted. It's important for businesses to manage their dividends effectively and ensure that they have enough profits to pay them.
- Equity - This is how much a business is worth, minus how much it owes. It's like the value of a house after you subtract the mortgage. Equity is the residual interest in the assets of a business after all liabilities have been paid. It represents the value of a business to its owners or shareholders. Equity can come from the sale of shares or retained earnings. It's important for businesses to monitor their equity and ensure that they have a healthy balance between debt and equity.
In conclusion, accounting can be a daunting area for those without a strong financial background. However, understanding basic accounting terms can help business owners and managers better manage their finances and make informed decisions. By understanding these 10 common accounting terms, businesses can better understand their financial position, monitor profitability, and manage cash flow effectively. So whether you're a small business owner or a corporate executive, it's important to familiarise yourself with these terms and their meanings to ensure your business's financial success.
So, next time you're having a meeting with your accountant, don't be afraid to ask questions and clarify unfamiliar terms. With a little bit of knowledge, you'll be able to have more productive conversations and make better financial decisions for your business.