Basic Accounting Terms for Small Businesses

Accounting is something you’ll have to handle as a small business owner. Unless you hire a professional for the tasks, it’s important to understand accounting terms that you’ll come across in the course of doing business. This knowledge helps make your accounting process less overwhelming. Learn accounting terms for your financial statements and more in this guide.

 

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Methods of accounting terms

There are two main methods of accounting to be aware of so you can decide which makes the most sense for your business. Consider hiring an accountant so they can suggest which accounting method to use. The two main methods are as follows:

 

Accrual basis accounting method

The accrual basis accounting method is most commonly used by businesses in the United States. The accrual basis involves recording revenue when it’s earned and expenses when they’re billed, meaning you’re recording the entire sale at the time of sale, even without payment from your customer or client. This is the preferred method for many business owners because it will give you a clearer picture of your company’s financial health.

 

Cash basis accounting method

The cash basis accounting method is more common among sole proprietors, freelancers who have some expenses and small businesses that don’t carry an inventory. Unlike the accrual basis method, the cash basis method records revenue only when the customer pays in full, regardless of when the invoice is first sent out and if there are payments made.

 

Different financial statements

As a small business owner, you need to become familiar with your financial statements, including:

  • Balance sheet: A balance sheet is one of the most common financial statements, and it serves as an overview of the company’s finances. The balance sheet shows assets, liabilities and equity using the accounting equation of Assets = Equity + Liabilities.
  • Cash flow statement: This statement shows the amount of cash moving in and out of your business. 
  • General ledger: A general ledger is the recording of the company’s transactions over the lifetime of the business. It’ll include assets, revenues, capital and expenses.
  • Profit and loss statement: Also called the income statement, the profit and loss statement showcases your business’s expenses, income and revenue within a certain accounting period. 

 

Accounting terms on financial statements

These are the accounting terms you may find on your financial statements:

  • Accounts payable (AP): Accounts payable are amounts you owe to the people you do business with, such as vendors, service providers and a landlord for rental of your office space. These amounts are ones that you have not yet paid.
  • Accounts receivable (AR): Accounts receivable are amounts that others owe to your business. This could be for products and services you’ve provided. You should record these figures as assets on your balance sheet.
  • Accruals: This refers to revenue that your business has earned but not yet put down in the books or expenses that you haven’t received.
  • Assets: Assets are items that the business owns that have value. This can include machinery and other equipment, cash, buildings and company vehicles. 
  • Capital: There are two different definitions for capital. Working capital is the amount of money you have available to spend on business needs and operating expenses. Operating capital refers to working capital that also includes fixed assets such as office equipment.
  • Equity: Equity is the company’s value after deducting liabilities. This is the part of the company owned by yourself as the owner and any investors.
  • Liability: Liability refers to company debts that are unpaid.
  • Revenue: Revenue is any money earned by the company.

 

General accounting terms

Learn these general accounting terms to navigate through this part of your business:

  • Allocation: You would allocate funds if you’re assigning them to certain accounts or periods of time.
  • Cash flow: Cash flow is the amount of money that is moving into and out of the business through expenses and income. A positive cash flow is enticing to investors because it shows financial health.
  • Depreciation: Depreciation is the loss in value of an asset.
  • Expense: This is any cost incurred by the business.
  • Fiscal year: This is a period of time that a business uses for accounting purposes. The fiscal year can vary between companies.
  • Generally Accepted Accounting Principles (GAAP): These are the rules and standards that you or your accountant should follow when performing any business accounting. 
  • Inventory: Inventory consists of the unsold items that a company owns. For example, if you sell body soaps, your inventory would be the soaps you have in stock and available for purchase.

 

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