Top 20 Basic Accounting Terms
Accounting is a systematic way to present financial and non-financial business information in a way that readers or “users” of that data can make important business decisions. Although seemingly boring the use of solid accounting principles can actually help elevate your new business venture towards better growth opportunities.
This data is related in the Financial Statements of the company, made up of: The Balance Sheet (aka The Statement of Position), The Income Statement (aka Profit & Loss), the Statement of Cash Flows, and The Statement of Owners’ Equity. There are other financial statements, but most privately held companies do not use these statements. The two most used Financial Statements are the Balance Sheet and Income Statement.
The whole purpose of starting any company is to grow, prosper and obtain whatever goals the CEO and Founder sets. Accounting helps to point out if these are being met and if they are not, how can your team fix that.
Below are 20 key accounting terms that every founder will need to know and have working knowledge of in order to be successful in each cycle of your business.
Process of recording financial and non-financial transaction data into the company’s ledger(s). Businesses must follow a certain set of rules and guidelines when “accounting” for these transactions, and are held accountable by governing agencies (such as the FASB and IRS)
Financial Accounting Standards Board, sets financial reporting standards that US companies must follow, called Generally Accepted Accounting Standards or GAAP. For External Reporting, US-GAAP must be followed.
3. EXTERNAL REPORTING VS. INTERNAL REPORTING
When presenting your company’s financial data in a report (called Financial Statements) to someone outside of the company this is referred to as External Reporting. Internal Reporting means that the financial data is presented through Financial Statements or other reporting tools, such as graphs, to individuals inside the company (employees, managers, senior executives or Board of Directors).
Internal Revenue Service, a US Federal agency that sets and enforces Federal taxation rules and regulations through the Internal Revenue Code (or IRC).
Process of exchanging goods or services between two or more parties, specifically in a business setting. For example, selling your new product to your customer for cash is a business transaction.
The process of actually entering in the transaction into written documents (ledgers) to use as evidence that the transaction took place. In accounting, sometimes “recording” a transaction must happen before it is realized, in order to follow GAAP or IRS rules.
Way of organizing the company’s “accounts” and the transactions that hit those accounts. So, each account will have its very own ledger, which reflects the increases, decreases, and/or balances caused by the business transactions. For example, when selling your Product to a customer for Cash, the Sales and Cash ledgers are both impacted, and both increase. This process is referred to as “posting to the Ledger”
8. CHART OF ACCOUNTS
A Chart of Accounts is a List of all accounts used for recording transactions that are used in the General Ledger. This chart is used by accounting software to pull the information in order to create financial statements. Typical accounts listed in a Chart of Accounts include Assets, Liabilities, Stockholder’s Equity, Revenue and Expenses.
An “account” is a predetermined “place” where a company records these transactions. These “places” are made up of only seven types of accounts: Assets, Liabilities, Equity, Revenue, Gains, Expenses or Losses.
When the exchange of goods/services for compensation is completed. Think of the phrase “what really happened in real life” when trying to see the difference between recording and realizing a transaction.
11. BALANCE SHEET FINANCIAL STATEMENT
Reflects the company’s assets, liabilities and owners equity account balances at a single point in time. Users refer to the balance sheet to see if the company is “liquid “solvent”, meaning that the company has the ability to pay its obligations, such as debt repayments, as they become due. This is very important to both creditors and investors. The accounts represented on the specified date will reflect what the ENDING BALANCE is on that date. Think of your bank account, if you look at your checking account today, it will show you an ENDING BALANCE as of right now. The Balance Sheet reflects the “accounting equation” which mathematically is represented by Assets = Liabilities + Equity
An individual or company that lends either goods or finances to your company in exchange for the original (principle) amount back plus a specified amount of interest. A vendor can be a creditor when it allows you to pay for supplies or inventory 30 days after you receive your goods. A bank is a creditor when it lends your company a cash loan in exchange for monthly payments made up of both principle and interest amounts. These obligations are recorded as DEBTS on the Balance Sheet Financial Statement, as either a loan or payable type of Liability account.
An individual or company that provides cash or other form of capital in exchange for partial ownership of your company (such as selling stock in your company in exchange for cash). The exchange of ownership is recorded in the Equity section of the Balance Sheet.
The account that represents what the company OWNS, such as Cash Balances, Marketable Securities in other Companies (Stocks/Bonds), or inventory. This is sometimes referred to as ” claims to Cash”.
The account that represents what the company OWES, such as credit card balances, loan balances and other obligations that company is required to pay. This is sometimes referred to as “uses of Cash”.
The amount that reflects the Net Assets that the owners of the company have a right to, or once the Total Liabilities are subtracted from the Total Assets.
17. THE INCOME STATEMENT
Reflects the company’s Revenue, Expenses Gains and Losses. Revenue (aka Sales or Income) and Expenses reflect transactions that the company incurs based on its core operations, or what the company is in business to do. This statement is for a period of time, such as one month, one quarter or one year (or any other period of time), versus the Balance Sheet that is shown as of one date in time. For example, if your company is selling widgets, both the revenue earned and expenses incurred in order to sell the widest to its end customers. Gains and Losses, however, or increases or decreases in Cash due to selling assets that the company owns but is NOT related to its core business. For example, selling a truck that the company owns for more money than the company put into the truck is a gain. However,er when the core business is selling widgets, this amount of extra cash is not revenue, but a gain. Similarly, if the truck is sold for LESS money that it has historically put into the truck, than it sold the truck at a loss. This financial statement can also be mathematically represented by Net Income, or what the company has “earned” after selling its goods, inducing expenses, and any gains or losses for the period of time.
18. ACCRUAL BASIS ACCOUNTING
This method of accounting for transactions is required by GAAP and requires businesses to record certain exchanges BEFORE they are realized. For instance, Sales Revenue is to be recorded when the selling company has a RIGHT TO COLLECT the cash or compensation, not necessary when the cash or other compensation is collected. This is often referred to as recording when the “earnings process is completed”.
19. CASH BASIS ACCOUNTING
The method of accounting (NOT Approved by GAAP for external purposes), but can be used when preparing your annual income tax return or for internal, management purposes. This method means recording transactions when they are realized, such as only recording Sales Revenue when the cash or compensation is received, not earned.
20. TAX BASIS ACCOUNTING
Using the accounting rules expressed by the IRS so that the financial and non-financial data in the company’s financial statements reflects exactly what the annual income tax return will look like. This is not a good method for making business decisions, but should be reviewed so that management understands what the tax liability will be.
Rebecca A. Casarez, CPA is the founder of ProAdvisor CPA. She is an experienced CPA with a demonstrated history of working in the accounting industry assisting business owners and accounting professionals. She is a strong leader who provides bookkeeping, financial accounting, tax planning and tax preparation services to business owners and individuals alike. She is also a Co-Founder of Green Ledger CPA. “The Grass is Greener on the side you water”. Follow her @ProAdvisorCPA.