Basic Accounting Terms Business Owners Should Know

Accounts payable refers to money that your company owes to another party. In accounting terms, the entity that the money is owed to is known as a creditor. For example, if your company hired a freelancer to perform a job for $100, your company would have an accounts payable expense of $100 to that freelancer. Accounts payable includes virtually all expenses accrued by a company, from payroll to material acquisition, and specifically encompasses expenses that will be paid in the immediate future.

Accounts receivable is the inverse of accounts payable and refers to money that another party owes your company. For example, if another company hired your company for a job worth $1,000, you would have an accounts receivable of $1,000 for that company. Like accounts payable, accounts receivable are due to your company in the immediate future. A company or party with whom you have an accounts receivable is known as a debtor.

Accrued expenses represent amounts owed for expenses that have been recorded, but have not yet been paid. Examples include interest, salaries and wages and potentially income taxes.

Assets are the economic resources of an entity. They could be anything from a building that a company owns to an office chair. The value of a company’s assets is reported on balance sheets to help accurately visualize the value of the company.

A balance sheet contains a high level picture of a company's assets and liabilities. The goal of a balance sheet is to provide a complete picture of an entity's finances. In situations where a company is owned by multiple parties or publicly traded, it also reports the equity of the company's shareholders.

Cash flow is the total (net) amount of cash being moved into and out of a business. A cash flow statement helps track the cash inflows and outflows, but unlike a balance sheet it does not include owned assets, only cash and cash equivalents.

Commonly referred to as CPAs, certified public accountants are accounting professionals who have passed the CPA certification exam and met the licensing requirements established by the AICPA. They provide financial advice to companies and individuals to help them reach their goals.

This number identifies the cost of producing or purchasing the goods or merchandise you have sold. It includes only direct expenses (such as labor and material procurement) and not indirect expenses (such as marketing and distribution costs). For example, for a company that builds wooden toys, if it costs $1 for the wood to produce one toy and it takes a worker (paid at a rate of $20 per hour) six minutes to make the toy, the cost of goods sold would be $3 per toy.

A credit increases liability, equity and revenue, and decreases assets and expenses. The credits in your accounting ledger should balance out the debits when properly tracked.

Debit is the inverse of credit. Assets and expenses are increased by debit entries while liabilities, equity and revenue are decreased by debits. Using our $500 computer example from the definition of credit, the computer would show up as +$500 in the debit column under assets.

Depreciation is a method of tracking the cost of an asset over its lifetime of use. Accountants use depreciation to account for the use of an asset and decline in its value over time. For instance, if you bought a $1,000 TV for your conference room in 2020, it would not be worth that same amount in 2025. The loss of value for depreciable assets results in tax savings because the depreciation amount each year can be treated as an expense. For example, if that $1,000 TV is worth $920 in 2021, that would count as an expense of $80.

Dividends are any company earnings that are paid out to shareholders or investors. In the case of publicly traded companies, this number is determined by a board of directors.

Equity is the amount of value that an investor or shareholder would receive if the company liquidated all assets and paid off all debts. For example if a company had assets of $1 million and debts of $500,000, they would have equity of $500,000. If you had a 20% stake in the company, you would have $100,000.

Expenses are the cost of operations incurred by a company while attempting to generate revenue. Expenses can include anything from payroll to material costs and utilities.

A one-year period over which a company's finances are measured. This period of time does not necessarily line up with a calendar year, but can refer to any consecutive 12-month period of time. For most private companies, this lines up with the tax deadline of their country, but it may be based on other factors, such as busy seasons. For instance, a school's fiscal year typically begins and ends in mid-summer so that they can start the new school year under a new fiscal year.

Fixed costs are costs that do not change based on any other factors. For instance, rent is a fixed cost as it does not increase or decrease based on any outside factors related to the business.

A general ledger is the cornerstone of a company's accounting system. It contains each account used in the business, which tracks the transactions for that account.

Gross profit refers to the total revenue minus the cost of goods sold. Using the example of wooden toys from our COGS definition, if you sold a toy for $5, you would have a gross profit of $2.

An income statement is one of the key financial statements used by a company. IT shows revenues and expenses over a period of time and provides information on how revenues turn into net income and net profit.

Interest is the cost of money borrowed. In general, it accrues based on a percentage of the amount borrowed or of the value of the asset borrowed. For a simple example, if your business takes a one-year loan for $10,000 at 10% interest, you would have to pay back $11,000 by the end of the year.

Inventory refers to the cost of the goods the company intends to sell to its customers. Common things that contribute to inventory are raw materials used for production and produced goods that have yet to be sold.

A liability, in the simplest terms, is anything owed to another company or person. Liability can also refer to a regulatory or legal risk, but more commonly is associated with what your company owes to another entity.

An asset's liquidity refers to how fast it can be bought or sold at a fair price. Highly liquid assets sell faster and have an easier time being turned into currency.

Net income (also known as net earnings) is the total sales (or revenue for service-based businesses) minus the cost of goods sold and any indirect sales expenses. It is used as an indicator of a company's profitability.

Overhead refers to any business expenses that are ongoing and not directly related to the creation of goods or the providing of services. Understanding this number helps a company budget and set prices for goods and services.

Payroll is the total cost of all employee compensation. A majority of payroll is made up of employee wages but also includes the cost of employee benefits and payroll taxes.

A P&L statement provides a summary of the revenue, expenses and costs that a company incurs over a period of time. This is also known as an income statement.

Most often called ROI, a return on investment is a measurement of how profitable an investment is for a company or entity. A high ROI indicates a highly successful investment while a low ROI indicates a less successful investment.

Revenue refers to the total income generated by goods sold or services rendered by a company or entity. This may also be referred as gross sales, or top line, because revenue is shown on the top line of an income statement.

Stockholders' equity, also known as owners' equity or shareholders' equity, is the amount of value and assets that a stockholder is entitled to after a company pays all its debts and liquidates all its assets.

A trial balance is a bookkeeping worksheet where the total balance of all ledgers is kept. The trial balance contains three columns, one that names the account, a debit column and a credit column. The debit and credit columns must balance one another when the sheet is completed.

Variable costs are any costs that change based on how much a company is doing business. For instance, raw materials are a variable cost because the more goods a company sells, the more raw materials they need to purchase.