Demystifying Accounting Terms • Knecht Business Solutions

Let’s face it. The language that financial professionals use can be confusing (and intimidating)! You may not even know what to do with the expert financial advice you get for your business without fully understanding the terminology. However, understanding the jargon is key for anyone looking to run their business effectively.

Let’s demystify a few key accounting terms to help you make informed decisions and gain a clearer understanding of key concepts. Feel more confident in financial discussions with those around you!

Terms Related to Balance Sheets

A balance sheet is a snapshot of a company’s assets, liabilities and equity at a specific point in time.

Assets – Assets are what a business owns, or any item of economic value that the business or individual owner has. Assets can include cash, inventory, equipment, real estate or investments. They can also be tangible or intangible. Intangible assets aren’t physical and can include patents, trademarks or brands.
Liabilities – These are financial obligations you owe. Whether it’s a loan you’ve taken out for renovations, the credit card bill for your new equipment, or accounts payable.
Equity – This is what is left for the business owners after all debts are paid off. Also called net worth or shareholders’ equity. Your stake in the company, per se. For example, if you have $100,000 in assets and $90,000 in liabilities, you’d be left with $10,000 in equity.
Accounts Receivable – This represents money owed to a business by its customers or clients for goods or services that have been provided.
Accounts Payable – This represents the money that a business owes to its suppliers or creditors for goods or services received.
Retained Earnings – Profits that a business keeps rather than distributes to shareholders.

Terms Related to Income Statements (or P&L)

The income statement summarizes a company’s revenues, expenses and profits for a specific period (i.e. a month, quarter, year, etc.). This is also commonly called a Profit and Loss (P&L) Statement. It highlights the financial performance of your business.

Revenue – This is the total income your business earns. It comes from products or services you sell.
Expenses – This covers costs incurred by a business in day-to-day operations, such as rent, salaries, utilities, etc.
Net Income – This is what remains after you have settled all your bills. It’s the profit your business makes. Ideally, this is a positive number to show you’re on the right track.
Net Loss – A negative net profit is referred to as a net loss.
COGS (Cost of Goods Sold) – These are the direct costs tied to what you are selling. It is the cumulative cost of materials and labor required to produce a product or deliver a service.
Overhead Expenses – These are the costs that aren’t directly tied to making sales, but are still necessary to keep the business running. Think utilities, internet, interest, taxes, rent, etc. Regardless of how much you produce or sell, these are the expenses you will need to pay no matter what.
Non-Operating Expenses – These are expenses such as taxes and interest that aren’t directly tied to your business-operating activities but still need to be paid.
Gross Profit – This metric tells you how much you make on each sale minus the COGS. It’s an indicator of your business’ health and profitability. It also helps to get an accurate view of how your sales are impacted by the cost of things like raw material and labor.
Gross Margin – Also referred to as Gross Profit Margin. This is the difference between revenue and COGS, divided by revenue and is expressed as a percentage. It could also be calculated as the selling price of an item, less the COGS, than divided by the same selling price.
Net Profit – This is your total revenue minus COGS and all Operating and Non-Operating Expenses (or Gross Profit – Total Expenses). This metric tends to be a much more realistic representation of your company’s profits and potential cash flow.
Net Margin – Also referred to as Net Profit Margin. This is the calculated by taking the Net Profit and dividing it by revenue. This is expressed as a percentage. It’s a great measure of how much net income a company generates from each dollar of revenue.

Other General Accounting Terms

Statement of Cash Flows – This tracks the movement of cash in and out of a business. Positive cash flow means your business is liquid and you are in a solid position to cover bills and invest in growth.
Accrual Accounting – This method records transaction when they occur, NOT when cash changes hands. It gives a more accurate picture of the financial health of your business by matching revenue and expenses in the period they are incurred.
Cash Accounting – This method records transactions when cash is received or paid. It’s a simpler method that is more straightforward and suitable for businesses with simpler financial transactions.
Depreciation – The decline in value of an asset over time. It takes the systematic cost of an asset over its useful life and reflects the gradual wear and tear or obsolescence over time. This is done to help businesses spread out the cost of expensive assets by recording the expense on the income statement, while reducing the value of the asset on the balance sheet.
Amortization – Like depreciation, but it applies to intangible assets like patents or copyrights. It helps to accurately reflect the value of intangible assets on the balance sheet over time.
Double-Entry Bookkeeping – This is the fundamental accounting principle that every financial transaction has equal and opposite effects on at least two accounts (debit and credit). This ensures the books always balance. It is the basis for accurate financial record-keeping. Debiting and asset accounts increase their value and crediting decreases it.
General Ledger – This is the central repository of all financial transactions recorded by a company. It is the primary record of any business that uses double-entry bookkeeping. It is the foundation of your accounting and can help you prepare financial statements and analyze your data.
Trial Balance – This is a list of all the balances in the general ledger accounts, both debit and credit. It represents the balances at a specific point in time and helps to identify any errors or discrepancies in the accounting records.
MTD, QTD, YTD – Abbreviations for month-to-date, quarter-to-date and year-to-date.

Accounting terms can seem daunting if it is not something you are familiar with. Understanding some common accounting terms can help to give you a clear understanding of the financial aspects of not only your business, but your personal finances, as well. It can take some time and practice, but this knowledge will serve you well in navigating decisions you’ll need to make with confidence. Reach out to Knecht Business Solutions today for any assistance you may need in your accounting and bookkeeping questions.