Accounting and bookkeeping are filled with terms and reports the average business owner has little experience using. Understanding accounting terms is the best way to understand your business's finances and gives you an edge in future planning.
The following are 12 of the most common accounting terms that business owners should know.
1. Accounting Equation - This is the basic equation that underlies accounting. It states that the total of a company's assets must equal its liabilities plus its shareholders' equity. This equation ensures that accounting accurately reflects a company's financial position (assets=liabilities+Owner's Capital).
2. Accrual Accounting - This type of accounting measures revenue when it is earned instead of when it is received. Sales are recorded whether or not cash has been exchanged, which can make the balance sheet look different than the actual cash position.
3. Cash Basis Accounting - This is the most basic form of accounting. It simply records cash transactions as they occur. This form of accounting can be helpful for businesses that are just starting out or have a lot of seasonal variability in their income and expenses.
4. Cash Flow - The term "cash flow" usually refers to your company's cash inflow and outflow. It can refer to net income or to a specific amount you bring in over a set period of time. If you focus on forecasting, managing, and tracking your cash flow, you'll keep much closer track of how your business is doing.
5. Cash Flow forecast - A cash flow forecast projects how much money your company will have in and out over a certain period of time. This is especially important if you're looking to finance a new venture or take on more debt.
6. Burn Rate - This term is used when discussing a company's spending rate. It measures how quickly a company is using up its cash reserves. If your burn rate is high, it can be an indicator that you're in danger of running out of money.
7. Financial Statement - A financial statement is a paper or electronic document that contains your company's income and expenses over time. This report will help you keep track of your business's money and look back to see how it has changed.
8. Balance Sheet - The balance sheet is one of the most critical financial statements and gives a snapshot of what your company owns (assets) and owes (liabilities). It's like a quick look at how much money you have left over after paying off all your bills.
9. Income Statement ( P&L)- The income statement, also known as the profit and loss statement, details how much money your business has earned (revenue) and spent (expenses) over a set period of time. This is a good indicator of whether your business is making money or not.
10. Owner's Equity - Owner's equity is simply the amount of money that belongs to the owner(s). The owner's equity can go up or down depending on how much the company makes (or loses) in any given year.
11. Gross and Net Profit - Gross profit is the total amount of money your company has made after subtracting the cost of goods sold. On the other hand, net profit is what is left after all expenses have been paid, including rent, salaries, and advertising.
12. Profit Margin - The profit margin is the percentage of revenue left over after paying for all the costs associated with running a business (materials, supplies, labor, equipment). If your profit margin is 20%, that means that you're making $1 for every $5 spent.
These are just a few of the most important accounting terms. By becoming familiar with them, you'll be able to understand your business's financial health better and make more informed decisions about its future.
By becoming familiar with these standard accounting terms, business owners can begin to understand their company's financial health and make more informed decisions about its future.
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