Understanding Basic Accounting Terms and Concepts: A Guide for Small Business Owners

Hello and Welcome.

Here at Beyond the Books, we help small business owners to understand the financial health of their business so they can make better decisions.  Part of understanding the financial health of the business is understanding the basic concepts and terms that most accountants and bookkeepers use.  We understand one of the most confusing and frustrating parts of business ownership is knowing what to do with the accounting.  Even if you have already hired, or plan to hire, a bookkeeper and/or accountant, knowing what they are trying to tell you can be like trying to listen to an alien speak.  It's overwhelming and therefore, financial tasks often get pushed aside until tax time and then it becomes the biggest source of stress for the year. It doesn't have to be that way.

Over the next few weeks, on "Financial Fridays," I will publish a series of articles to help demystify the terms and concepts and give you a few tips on how you, as an entrepreneur, can better understand the financial health of your business. 

Today we are going to focus on some basic terms and concepts every small business owner should know:

• Assets:
  Assets represent everything your company owns that has value. They can be tangible, like machinery or property, or intangible, like trademarks or copyrights. There are two main types:

  • Current Assets: Items that can be converted into cash within a year, such as cash itself, inventory, or accounts receivable.

  • Fixed Assets: Long-term resources, like land, buildings, and equipment.

• Liabilities:
  In contrast to assets, liabilities represent what your company owes. Like assets, they're divided into:

  • Current Liabilities: Debts due within a year, like short-term loans or accounts payable.

  • Long-term Liabilities: Debts due over a longer period, such as mortgages or long-term loans. 

• Equity:
  Think of equity as your stake or ownership in the company. It's the residual interest in the assets of the entity after deducting liabilities. In simpler terms, Equity = Assets - Liabilities. For small businesses, equity might encompass the owner's investment and any retained earnings (lifetime profits/losses not distributed).

• Revenue:
  Revenue, often referred to as sales, is the money your business earns from its primary operations, be it selling products, providing services, or other core activities. Depending on your accounting method (cash or accrual - which will be discussed in a few weeks), your revenue may be recorded either when the cash is received or when the invoice (accounts receivable) has been created.

• Expenses:
  These are the costs incurred by the business to earn revenues. Expenses can be direct, like the cost of goods sold, or indirect, like marketing expenses, rent, or salaries.
  

• Income Statement (aka: Profit and Loss Statement or P&L)
  This crucial report shows revenues, costs, and expenses over a specific period (e.g., a month or year), helping you determine your business's profitability. The bottom line, also called Net Income, will tell you if you've made a profit (revenues exceed expenses) or a loss (expenses exceed revenues).
  

Wrapping Up

Understanding these terms is just the beginning. As you delve deeper into accounting, you'll encounter many more concepts and intricacies. However, by mastering these basics, you've taken a vital first step in managing your business's financial health.

Stay tuned for more posts on bookkeeping, tax planning, and other financial topics tailored for the ambitious small business owner. Remember, knowledge is power, especially when it comes to your company's finances!

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