We've all been there at some point in our lives, someone mentions a term and moves on as if the whole world knows what they are talking about. By the time they stop, they are too far along for you to comfortably ask them to go back and explain themselves in more detail. Bookkeeping and Accounting have a lot of these terms, and hopefully by the end of this post you will understand them a bit better. The accounting terms below are a sample of what you will hear from small business owners, bankers, and accountants.
Basic Accounting Terms
REVENUE - Any money earned by the business
INCOME - Inflow of revenue during a period of time
COST OF GOODS SOLD (COGS) - The expenses that directly relate to the creation of a product or service that the business sells
EXPENSES - Any cost incurred by the business that is not a Cost of Goods Sold
PROFIT - The positive difference from selling products and services for more than the cost of producing these goods
GROSS PROFIT - The profitability of a company, without considering overhead expenses
GROSS PROFIT = REVENUE - COST OF GOODS SOLD
NET INCOME - The dollar amount that is earned in profits. Calculated by taking revenue and subtracting all expenses in a given period, including COGS, overhead, depreciation, and taxes.
NET INCOME = REVENUE - COST OF GOODS SOLD - EXPENSES
ASSETS - Anything the company owns that has monetary value. These are listed in order of liquidity, from cash (the most liquid) to land (least liquid).
LIABILITIES - All debts that a company has yet to pay. Examples include: loans, taxes, bills
EQUITY - The value left over after liabilities have been removed, the portion of the company that is owned by the investors and owners.
A Balance Sheet represents the state of a company's finances at a set point in time. It will show the following: what you own, what you owe, and what is left over. These are commonly referred to as assets (what you own), liabilities (what you owe) and equity (what is left over). And guess what - they have to balance! So, the equation used is:
ASSETS = LIABILITIES - EQUITY
The Balance Sheet is always presented with Assets on the top, liabilities in the middle and finally equity at the bottom.
Notice we aren't talking about income or expenses; that will come later. The balance sheet simply shows, for one point in time, the financial position of your company.
Profit and Loss
The Profit and Loss statement presents a summary of the revenues and expenses over a period of time. So, you can see what profit (or loss) you had for the last month, quarter, year, or any other period you wish to study. You can even compare the periods to each other to see how your business is doing month to month or year to year.
The Profit and Loss is always presented with Revenue first, then Cost of Goods Sold (COGS) are deducted to give you the Gross Profit. Finally, expenses are deducted and what you are left with is the Net Income.
Statement of Cash Flows
The final of the "Big Three" financial statements is the Statement of Cash Flows. Guess what this one shows? If you said Cash Flow over a period of time, then you are correct! The Statement of Cash Flows shows how cash is flowing in and out of an organization over a period of time. The main areas that the Statement of Cash Flows considers are operating, investing, and financing activities.
Hopefully you now have a better understanding of some of the accounting terms you are going to encounter as a small business owner. If you have questions, or would like additional information, contact us at firstname.lastname@example.org.