The Quick Guide To Accounting Terms And Concepts
When I first began learning about accounting software, everything I heard or read seemed garbled and incoherent, like the parents in the Peanuts comics. Each accounting word, or term, or 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. Unfortunately, as a small business owner your time is money, and you can’t afford to waste it reading hundreds of Google search results or sifting through dozens of accounting books to get the information you need.
For that reason, I present to you the guide I wish I had when I started out. What follows is a collection of some of the most common accounting terms and their definitions. You will encounter these basic terms again and again when researching accounting software or studying accounting concepts, and my hope is that this quick guide will clear up muddy waters and help keep the Peanuts voices at bay.
Table of Contents
Believe it or not, there are many definitions for accounting. But all you need to know is that accounting is basically a fancy word for understanding, recording, and analyzing the financial state of your business.
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.).
The costs to run your business.
Any debts owed by the business.
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 how much his or her investment is worth using the basic accounting equation: assets = equity + liabilities or assets – liabilities = equity.
Profit earned by your company (usaully through sales).
A business records income when products/services are paid for. If you send an invoice on May 10th, get paid June 10th, and count that money for June, then you’re using cash-based accounting.
A business records income when products/services are incurred or agreed upon. If you send an invoice on May 10th, get paid on June 10th, but count it as payment for May still, you are using accrual-based accounting. (Example borrowed from fellow Merchant Maverick writer Katherine Miller’s fantastic article, “How To Choose Accounting Software”.)
When your business has delivered a product or service, but your buyer has not paid for it yet, it is recorded under accounts receivable.
When your business buys a product or service on credit and has not paid for it yet, the expense is recorded under accounts payable.
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.
A type of accounting where every transaction it recorded twice, once as credit and once as debit. This type of accounting is preferred 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 once as a debit and once 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 very simple example of course, so if you still find this concept confusing, check out this video for another explanation.
An accounting report that calculates assets, liabilities, and equity to make sure both sides of the accounting equation match.
Cost of goods sold
Your business’s income from sales, minus COGS.
Your business’s gross profit minus taxes and interest; the true profit of your business.
Return on investment. ROI is calculated with this equation: ROI = (gain of investment – cost of investment)/ cost of investment. This formula lets your business know how successful your investment was by showing the profit gained or lost.
Profit & Loss Report
An accounting report that calculates a business’s profit by subtracting COGS from income.
Base for all accounting reports. Tracks of all financial transactions.
These definitions and their examples are just a place to start—a few brief explanations to help you along your way in your accounting search. If you have any further questions or wish to see a term added to the list, please feel free to comment below!