The Quick Guide To Accounting Terms And Concepts

When I began learning about accounting software, everything I heard or read seemed garbled and incoherent, like the parents in the Peanuts comics. Every accounting word, term, and abbreviation made my head reel and sent me straight to Google.

If you’ve spent any time researching accounting, you’ve probably run into the same problem. Of course, as a small business owner, the adage applies: time is money. You simply can’t afford to waste your hard-earned dough parsing endless Google search results or sifting through hefty accounting books.

For that reason, I present you the guide I wish was around when I started out. What follows is a collection of some of the most common accounting terms, written out with short definitions. You will encounter these basic terms again and again when researching accounting software or studying accounting concepts, and I hope that this quick guide will clear up muddy waters and keep the Peanuts voices at bay.

Accountant

Someone trained to properly keep, report, and inspect financial records and transactions. Get a full breakdown with Merchant Maverick’s comparison of accountants, bookkeepers, and CPAs.

See also: Bookkeeper, CPA.

Accounting

Believe it or not, there are many definitions for accounting. But you only need to know that accounting is basically a fancy word for understanding, recording, and analyzing your business’s financial state. For a deeper look into accounting, check out our accounting eBook for beginners.

The Accounting Equation

To minimize mistakes in your accounting, you’ll want to utilize this equation. It is merely:

assets = equity + liabilities

or

assets – liabilities = equity

The primary rule of this equation is that both sides must balance out (you’ve probably heard of “balancing the books” — this is where that phrase comes from). This means that if one half is greater or less than the other, there’s an error in your calculations.

Accounts

These are places to record specific transactions, such as those involving cash or loans. Accounts are frequently split into five categories: assets, liabilities, equity, income, or expenses.

See also: Chart of Accounts.

Accounts Payable

When your business buys a product or service on credit and has not paid for it yet, the expense is recorded under accounts payable.

See also: Accounts Receivable.

Accounts Receivable

When your business has delivered a product or service, but your buyer has not paid for it yet, it is recorded under accounts receivable.

See also: Accounts Payable.

Accrual Accounting

A business records income when products/services are incurred or agreed upon. If you send an invoice on May 10 and are paid on June 10, but count the payment for May, you are using accrual-based accounting.

See also: Cash-Basis Accounting.

Amortization

A technique utilized to gradually and periodically reduce the cost of a loan, intangible asset, or other debt.

Assets

Anything (cash, inventory, equipment) owned by your business.

Current Assets

Short-term assets made up of cash plus any other assets that will become cash during the fiscal year (like inventory or accounts receivable).

Fixed Assets

Assets with a long-term life that won’t be used up in a single fiscal year (like property, equipment, company vehicle, etc.).

See also: Equity, Liabilities.

Audit

The examination of your business’s accounting records and physical assets because you believe a mistake or discrepancy exists and needs to be verified.

Balance Sheet

An accounting report that calculates assets, liabilities, and equity to make sure both sides of the accounting equation match.

See also: The Accounting Equation.

Bookkeeper

Someone who is in charge of maintaining your business’s books. They handle the business’s finances on a day-to-day basis.

See also: Accountant, CPA.

Bookkeeping

The act of recording the accounts, financial transactions, and other information related to your business.

Capital

The financial assets your business owns, which can include monetary funds as well as physical entities such as manufacturing equipment or buildings.

See also: Liquidation, Solvency.

Cash Flow

The money that is going in and out of your business. Money that goes into your business usually comes via customer payments. Money going out usually includes payments you make, from rent to taxes to loan repayments.

See also: Cash Flow Statement.

Cash Flow Statement

This financial statement provides a summary of the in-going and out-going cash in a business during a set time period.

See also: Cash Flow.

Cash-Basis Accounting

A business records income when products/services are paid for. If you send an invoice on May 10, get paid June 10, and count that money for June, then you’re using cash-based accounting.

See also: Accrual Accounting.

Chart of Accounts

A report that lists all used accounts in a general ledger. Because this chart is made up of accounts, you’ll often see five categories: assets, liabilities, equity, income, and expenses. In many cases, the report is sorted by account number.

A chart of accounts simply offers a way to organize financial information, although it can be a bit daunting to deal with at first. If you’re wondering just how to set up your business with a chart of accounts, visit our guide.

See also: Accounts, General Ledger.

Cloud-Based

You may see this term in conjunction with cloud software. If something is “cloud-based” then it is usually accessed via the internet and hosted on remote servers.

Cloud-based accounting is becoming a popular option for small business owners because of its ease-of-use and accessibility. Find out in our in-depth article if it’s right for your business.

See also: Locally-Installed, SaaS.

COGS

Cost of goods sold. This acronym refers to any sort of cost related to making or assembling items or services you sell. Generally, the total is calculated by summing up the amount you spent on inventory and labor.

See also: Gross Profit, Profit & Loss Report.

Contra Accounts

These accounts are used in a general ledger and come with a balance opposite the normal balance for a related account. If the related account has a debit, then the contra account will record a credit. Note that your accounting software will likely handle all this behind the scenes, so you probably won’t come into contact with contra accounts in the wild.

See also: General Ledger.

CPA

Certified public accountant. Those with a CPA qualification have more credibility and expertise than regular accountants. A CPA can create audit and review reports as well as legally represent your business in front of the IRS — two things a regular accountant can’t do.

See also: Accountant, Bookkeeper.

Depreciation

This term looks at the loss of value in an asset during its time in use. You’ll often consider depreciation when looking at vehicles, manufacturing equipment, or other physical assets that decrease in value over time. Depreciation can be utilized as a tax write-off by calculating how much a specific asset has depreciated from its initial value (rather than writing off the entire expense at once).

Double-Entry Accounting

A type of accounting where every transaction is recorded at least twice, both as a credit and as a debit. This type of accounting is preferred by experts and gives a clear picture of your business’s financial health. To learn more, read our article What Is Double-Entry Booking (and Do You Need It)?.

Credits

To understand this concept, you’ll need to suspend your banking knowledge of credits and debits for a minute. In strict accounting terms, any transaction that increases liabilities (or debt) and decreases assets or expenses is called a credit. (Almost all cloud-based software does the double-entry calculations for you automatically, but the concept is still good to understand.)

Debits

On the other hand, debits increase assets or expenses and decrease liabilities. Remember the basic accounting equation assets = liabilities + equity? This equation is the basis for all double-entry accounting because each transaction is recorded as a debit and as a credit, meaning that both sides of the equation always remain balanced and equal. That, in fact, is where we get the phrase balance the books.

Here’s a good example. Let’s say you’re a baker. You buy $350 of supplies (flour, apples, salt, sugar, cinnamon) to make 35 delicious apple pies. Yum! Now, you’ve spent $350 — you’ve decreased your cash assets — so you would enter that amount on the credit side. But wait! You’ve also increased your assets in the form of inventory. Okay, put an entry on the debit side. You’ve lost $350 in one area and gained it back in another. Boom! Consider your books balanced. This is a basic example of course, so if you still find this concept confusing, check out this video for another explanation.

See also: Single-Entry Accounting.

Equity

Equity refers to a business’s worth, or the value of the owner’s investment in that business. When an owner has assets invested in the company, you can calculate the value of his or her investment using the basic accounting equation: assets = equity + liabilities or assets – liabilities = equity.

See also: Assets, Liabilities.

ERP

Enterprise resource planning. This is a process meant to help you manage and consolidate the key parts of your business. You’ll often see it attached to software that can integrate planning, human resources, and account tasks like generating reports, paying bills, or bank reconciliation.

If you’re looking into adding ERP software to your business arsenal, Merchant Maverick has a couple of reviews worth perusing:

• NetSuite
• Odoo Accounting

Curious to take a deeper dive into ERPs? We’ve got you covered there too.

Estimate

A calculation of a financial transaction where no precise value can be determined. Estimates are often made based on expert judgement, background knowledge, and historical data.

See also: Invoice, Proposal, Quote.

Expenses

The costs to run your business.

General Ledger

The basis for all accounting reports. Tracks all financial transactions.

Gross Profit

Your business’s income from sales, minus COGS. This number can be used to help determine the health of your business. You’ll usually see gross profit on your company’s income statement, as well as pretty much any business tax form.

See also: Net Profit, Revenue.

Invoice

An itemized list of rendered goods or services detailing the price and terms of sale. It is sent by the seller to the buyer.

See also: Estimate, Net 30, Proposal, Quote.

Job Costing

A method where you calculate the costs and profitability of each job performed for your customers. Job costing considers all costs associated with providing a service and is used when calculating the cost of a service or product that is unique to a customer. For more details, visit our in-depth look at job costing.

Journal Entries

You can utilize these to record business transactions and organize all related accounts affected by a transaction. You’ll make journal entries in the general ledger report; however, the journal entries themselves are not necessarily a report. The journal itself is ordered chronologically.

See also: General Ledger.

Liabilities

Any debts owed by the business.

See also: Assets, Equity.

Liquidation

The act of dissolving a business by converting assets into cash to pay off debts.

See also: Capital, Solvency.

Locally-Installed

If you have locally-installed software, then the program is installed on the hard drive of your local computer, tablet, or phone. This contrasts with a cloud-based application that you access via a web browser. Note that locally-installed software may still require internet access (such as to verify your product’s license).

See also: Cloud-Based, SaaS.

Net 30

The length of time (here, 30 days) a customer has to pay a bill before its due date. The clock starts ticking the date the invoice was sent. You may also see “Net 15” or “Net 10”, which means a customer would have to pay within 15 or 10 days, respectively.

By setting due dates on invoices, your customers may be more likely to pay up quicker. If you’re having trouble with slow-paying customers, check out Merchant Maverick’s tips to getting invoices paid faster.

See also: Invoice.

Net Profit

Your business’s gross profit minus taxes, interest, depreciation, and various other expenses. Note that net profit subtracts all operating expenses from your income via sales. It’s the true profit of your business. While gross profit measures the health of your business, net profit simply measures its profitability.

See also: Gross Profit, Revenue.

Profit & Loss Report

An accounting report that calculates a business’s profit by subtracting COGS from income.

See also: COGS.

Proposal

A submission by a potential customer or vendor proposing to buy or sell goods or services.

See also: Estimate, Invoice, Quote.

Purchase Order

A commercial document submitted by a buyer requesting a vendor/supplier to provide goods and/or services.

See also: Sales Order.

Quote

A document provided by the vendor or supplier detailing a list of proposed prices for goods or services. Quotes may be generated based on the individual needs of a particular customer.

See also: Estimate, Invoice, Proposal.

Reconciliation

The act of comparing two numbers (usually account balances or other financial records) and making sure things line up. Reconciling your accounts can help you spot errors, fraud, or other problems with your books.

Revenue

Profit earned by your company (usually through sales).

See also: Gross Profit, Net Profit.

ROI

Return on investment. ROI is expressed as a percentage and is calculated with this equation: ROI = (gain of investment – cost of investment) / cost of investment. This formula demonstrates how successful your investment was by showing the profit gained or lost.

SaaS

Software as a service. A business model where users don’t buy the software outright, but are paying a subscription to access the software service on a continuous basis. These payments are usually monthly and the software is often cloud-based.

See also: Cloud-Based, Locally-Installed.

Sales Order

A document written by a seller that is sent out after receipt of a customer’s purchase order. It essentially confirms the sale of goods or services.

See also: Purchase Order.

Single-Entry Accounting

A type of accounting that records income and expense accounts only. This is simpler than double-entry accounting but gives a less complete view of your company.

See also: Double-Entry Accounting.

Solvency

Your business’s ability to pay long-term debts and financial obligations.

See also: Capital, Liquidation.

Trial Balance

A list of all balances of all accounts found within the chart of accounts. This report also includes your total debits and total credits. Numbers within this a trial balance should match; if they don’t, then your books aren’t balanced.

See also: Balance Sheet, Chart of Accounts.

Learn More About Accounting

If you’re still keen to sharpen your accounting knowledge, our free The Beginner’s Guide To Accounting eBook is a great place to start. Or, if you’re looking for some accounting software for your business, check out one of our accounting reviews. We’ve also got a 101 guide to accounting that will give you a quick rundown on all the accounting basics you need to know.