An accountant tracks all your company’s finances prepares a series of financial statements and helps you get through tax season. But sometimes, talking to your accountant can feel like they’re speaking another language.
Here are 15 terms that all business owners should know to discuss your business’s financial health and make educated financial decisions with your accountant:
Accounts receivables refer to the rights your company has to receive payment. That is, once you have sold your goods or provided your service, you issue an invoice or a request for payment. An account receivable is an asset because you have a right to payment, even if the cash has not been received. If you have a high level of accounts receivables, it may spell potential cash flow problems because you have not received cash for the goods or services rendered.
Revenues accrue (are recognized even if no one has been paid yet) when earned, whereas expenses incur (are recognized only once they are paid). The accrual method recognizes and calls for the recording of the transaction even though no cash or payment exchanges hands. In other words, the event happens when the right or obligation arises. This stands in contrast to the cash method, in which you recognize a sale only when you receive the money.
The accrual method allows owners to better match expenses with revenues each month. Tax laws require for-profit businesses that sell on credit or have revenues over a certain amount of use accrual rather than cash.
An item of value your venture owns is an asset, and can be increased in value, used, or sold. Assets include land, buildings, fixtures, vehicles, equipment, and invisible property. The intangible, or unseen, assets include copyrights, trademarks, patents, other intellectual properties, and contract rights.
A balance sheet shows the financial condition of your enterprise. On the left side, an accountant lists the assets. The right side shows the liabilities and owners’ equity and earnings.
This statement gets the name “balance” from the rule that the assets should equal the liabilities and equity, which you calculate from the difference between your assets and liabilities. If you close the business, equity represents what the owners will receive upon selling all of the assets and pay all debts.
Depreciation is the method by which an accountant determines and assigns the cost of equipment used in manufacturing. Through depreciation, a CPA can write off the cost of the equipment over time, rather than all at once. This method recognizes that equipment undergoes wear and tear over time and loses value.
Corporations pay shareholders the equity and profits (or a portion of them) in the form of dividends. These payments come either as cash or stock. As they are payments from equity and earnings, dividends reduce the capital, or equity, side of a balance sheet.
Shareholders do not have an entitlement to a dividend. Such benefits are declared at the discretion of the board of directors of the corporation. By contrast, bondholders, lenders, and other creditors have a legal right to payment per the loan, bond, vendor or other agreement.
Expenses are the costs you incur to generate revenues. A CPA will categorize expenses into the cost of goods sold and operational costs. In the latter category, you find the wages for labor used in manufacturing or providing the service, depreciation, and production overhead. Operational costs have an indirect relationship to the goods or services sold and include building rent, administrative staff salaries, and costs, advertising and interest on the debt.
A fiscal year is 12 months for the recording and reporting of financial transactions. Businesses and governments may use a period different from the calendar year of January 1 to December 31. For example, a fiscal year that starts on October 1, 2020, will end on September 30, 2021.
The traditional calendar year offers simplicity, especially if you operate as a sole proprietor or otherwise include income from your venture as part of your income. Businesses may find a different fiscal year more appropriate for seasonal enterprises or those where the greatest activity carries over across calendar years. These may include professionals that prepare tax returns and ski resorts that operate in cold weather months, say from November to March.
Planning for your venture’s future requires forecasting. In this process, accountants use past and present financial data to project future sales, costs, and profits. Forecasting relies upon statistical analysis, projecting trends and assumptions on management, economic conditions, and the relevant market.
GAAP stands for “generally accepted accounting principles.” The GAAP guides how accountants recognize revenues, expenses, and liabilities; and prepare statements and records of the finances for companies, non-profit entities, and the government.
In a journal, you record daily financial transactions. From this information, a CPA prepares balance sheets, cash flow statements, profit and loss statements, and other financial documents or statements. Some enterprises may have separate journals showing cash transactions, purchases and sales.
In accounting, a liability consists of financial debt or obligation. Liabilities include invoices for goods or services received, loans, taxes, and wages or salaries due to employees. Many balance sheets will have a category of accounts payable, which represent outstanding debts. On balance sheets, liabilities can appear as current or long-term. The latter usually mature, or are scheduled to be satisfied generally within a year. Within the category of long-term liabilities usually lie mortgages or debt that lasts multiple years.
This term refers to the price at which a willing buyer and seller exchange goods, services, or some other asset. Market value assumes that the parties act equally and with full knowledge of the relevant facts. If you are liquidating an asset or even the enterprise, the market value will take into account the costs of removal of the asset
Profit and Loss Statement
With a profit and loss statement, accountants show the revenues, expenses, taxes and ultimately the profit for the month, quarter, year or another period. Otherwise known as an income statement, this financial document lists revenues at the top of the line. As such, if you seek “top-line growth,” you wish to increase the level of sales or proceeds from sales, rents or interest, as the case may be. Below the revenues come the expenses. Ultimately, a profit and loss statement reveals your profits and helps you measure how efficiently you generate revenues and operate the enterprise.
Revenue consists of income or proceeds resulting from sales of goods, services, and other normal operations of your enterprise. If you’re a landlord, revenue means the rents you collect. Interest and the gains on the sale of an asset also count as items of revenue.
When you count a sale as a revenue turns on the type of accounting. In the cash version, your sale becomes a revenue only when you receive payment. The accrual method allows the recognition of revenue when the sale or service is complete, i.e., when you have the right to receive payment.