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Accounting Terms – Your Jargon Buster

Accounting Terms – Your Jargon Buster

 
Developing your core management skills
In this article, we present a list of accounting terms, organized into a simple structure, with helpful, examples of how they relate to "real life."
 
Article author: Sam Carr
      Written by Sam Carr
       (8-minute read)
Finance and accounting are specialized functions and are usually best left to professionals.
But casting off the job to someone else, with no idea of what anything means, is a likely recipe for disaster. A basic understanding of accounting terms is a necessity for many managers, trainee accountants and – definitely - entrepreneurs, so in this article, we present a list of terms, organized into a logical structure, where helpful, examples of how they relate to "real life."

This structure should make it more understandable than a "dictionary" of brief definitions. We hope it acts as a reference guide to clarify and put things in order when confronted by the terminology.
When you encounter a term within a definition you don't understand, look for it elsewhere in the article: it will be explained.
We've been as informative as we can within the readable length of an article, but we cannot go too far: after all, this is a jargon buster, not a textbook…



GENERAL TERMS


Accounting period

The period relating to the management accounts and financial statements prepared.
Management accounts are those used by management to monitor financial performance, and the period can be anything – often annually, quarterly, monthly or sometimes even weekly.
Financial statements are those made to statutory bodies, with the accounting period usually determined by regulation. Major stakeholders (shareholders, volume suppliers and even major customers) may also want to see them. This is usually 12 months, although the start and end dates of the period can vary: the calendar year (January to December) and the financial year (April to March) are the most common.

Budget

A document outlining projected income and expenditure over an accounting period

Tax point

The date that a sales invoice is issued, which may not be the date that cash is received

Accounting Standards

GAAP – stands for Generally Accepted Accounting Principles, a set of accounting standards widely used by companies in the United States
IFRS – stands for International Financial Reporting Standards, a set of accounting standards widely used by companies outside the United States.

Accrual Accounting

An accounting method that recognizes revenues and expenses when they are incurred, regardless of when the cash is received or paid.
This means that if you raise a sales invoice today, its value will be classed as revenue even if you won't be paid some time in the future.
And if you receive a supplier invoice today, its value is recognized as and expense, even if you don't pay it for a while.
This is the most accurate method of accounting, but it requires adjustments in the Balance Sheet for creditors, debtors, and so on (see later).

Cash Accounting

An accounting method that only recognizes revenue and expenses when they are paid.
This is a very simple method used by sole traders and businesses – especially when payment is delayed or uncertain. But if the business grows, it doesn't give an accurate picture of events, so you must give way to accrual accounting.

Chart of Accounts

A list of all the accounts a company uses to record its transactions.
The company determines it, but an example would be:
• Asset accounts – Things the business owns
• Liability accounts – Debts the business owes
• Equity accounts – Funds introduced into the business and drawings by the owner(s)
• Revenue accounts – Money received by the business
• Expense accounts – Money paid by the business

PROFIT & LOSS (P&L) STATEMENT

A profit and loss statement (also known as an income and expenditure statement) is an accounting document that shows an organization's profitability (or otherwise).



Revenue

This is the income that a company generates from its business activities.
In the non-accounting world, it's more commonly known as Sales…

Expenses

These are the costs that a company incurs to operate.
The costs structure of a company is usually more complex than its sales, so it's broken down as follows:

Cost of Goods Sold (COGS)

This refers to the direct costs of purchasing or producing goods or services.

Gross margin

This is calculated by subtracting the cost of goods sold from the revenue.

Gross profit

This is calculated by subtracting the cost of selling (sometimes also marketing) the products and services from the gross margin.

Overheads

These are fixed costs like rent and wages costs, that need to be paid regardless of the level of sales, purchasing and marketing,

Depreciation

This is the cost of assets (e.g., computer equipment) spread over time (usually several years).
If you buy a fleet of delivery vans, you wouldn't expect to write off the total cost in the first year: it would wreck your financial performance. So you need to spread it over a longer period.
Depreciation does this. It allocates the cost of an asset over its useful life. With computer equipment, this may be three years. With, say, fittings purchased and installed with a new 10-year lease, it may be ten years. With a delivery van … well, it's your guess…

Amortization

This is similar to depreciation, but it is used to allocate the cost of intangible assets (like patents, trademarks or goodwill) over their useful lives.

Net profit

This is calculated by taking the gross profit and subtracting the cost of overheads and depreciation/amortization.

The bottom line

This is another term for net profit

CASH FLOW STATEMENT

A cash flow statement records cash spent and received in an accounting period, monitoring the ongoing balance.
Cash flow is vitally important to a business, but it is not a measure of profit because it just looks at what you have in the bank (or safe?)
So you may have half a million in the bank, but it may all be owed to suppliers who are screaming at your door.
Or looking at it the other way, you may be generating huge profits, but your customers won't pay you so you can't pay your bills...

BALANCE SHEET

A balance sheet is a document showing a company's financial health at a point in time through the assets, liabilities and equity.


There are three parts to a Balance Sheet:
  • Assets - This is the "positive" side of the balance sheet, divided into Fixed Assets and Current Assets
  • Liabilities - This is the "negative" side of the Balance Sheet and shows the company's debts.
  • Equity - This is the value of the investment made by the company's owners.
    It is calculated by subtracting liabilities from assets.
    If a company has traded profitably for some time, the equity value will likely be positive. But it is possible for unprofitable trading to produce negative equity – and here, the company will be kept going through loans and (perhaps) high trading debts.

Fixed Assets

Things that a company owns that have value.
There are two main types:
Tangible Assets - These are physical assets like vehicles, equipment and property.
Intangible Assets - These are non-physical assets like intellectual property or goodwill.

Current Assets

These assets can quickly turn into cash, usually within a year.
They include the following:
  • Cash reserves
    The amount of available cash held by a company, usually in bank accounts, but some may be in cash.
  • Debtors
    People (usually customers) who owe money to the company
  • Inventory
    Merchandise or raw materials held in stock
  • Prepayments
    Payments made in advance for goods and/or services related to a future accounting period

Current Liabilities

These are debts that a company owes with a short-term repayment (usually less than a year). These include:
  • Creditors
    People (usually suppliers) to who the company owes money
  • Accruals
    Payments due (i.e., not yet made) for goods and/or services used in the current accounting period
  • Loans
    Examples are short-term loans, overdrafts and credit card balances

Long Term Debt

Debts that a company owes with a repayment period of greater than a year.
These are usually loans from a bank or stakeholder.

DEBIT and CREDIT

Every transaction is recorded in a ledger, whether in an accounting system or an old book kept in the safe.
The ledger transaction always has two sides: Debit and Credit; the value of each must match (or balance).
So a cash sale will create a Sales entry in the Profit & Loss Account, balanced by an opposite Cash entry in the Balance Sheet.

Looking closer, the Sale is entered as a CREDIT in the Profit & Loss Account and the Cash is entered as a DEBIT in the Balance Sheet.
Don't try to understand why an increase in cash is a Debit (sounds wrong, doesn't it?) Just accept that it's how things work.

In other words, in the Profit & Loss Account, a CREDIT is GOOD, and a DEBIT is BAD.
But in the Balance Sheet, a CREDIT is BAD, and a DEBIT is GOOD.

TRIAL BALANCE

You'll post transactions into different ledger categories (or types) in your accounts.
You'll have Sales, Purchases, and so on.
You will probably break these down further, with sales split down into (say) product types or geographical regions.

A Trial Balance lists every ledger item with its associated debit or credit balance.
So if you're an accountancy firm, all transactions that record consultancy fees will go into the relevant ledger item. And those that record bookkeeping services will go into another.
In this way, you build up a profile of how the business works.

The total of debits must always equal the total of credits – so they balance.
If you use a competent accounting system (or bookkeeper…), this will always be the case.

FINANCIAL PERFORMANCE


EBITDA

Stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. In other words, it "adds back" non-operating costs to arrive at a more accurate measure of the operational profitability of a business. It is a very technical term, but showing you're familiar with it is an excellent way to drag a sniffy accountant off their pedestal.

EBIT

Stands for Earnings Before Interest and Taxes.
This is used when the effect of depreciation and amortization are considered necessary.
Other measures
Other measures, such as EBIAT, EBID, EBIDA – and more – exist, but we'll stop here…

ROUND UP

Well, that's all. As you may imagine, we could have drilled down further but in so doing we would have completely changed the nature of this article.
We've tried to be concise, and helpful, and hope that we've managed to clear away some of the mystique that can often surround the financial documents we need to understand in our different roles.

See our Accounts & Finance courses!


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