A Guide To Common Accounting Terms & Why You Should Know Them
Accounting is the language of business and finances. A business cannot survive without proper accounting. Knowing the basics of accounting can be the difference between having a business that thrives for years or a business that fails within its first year.
In this blog, we’ll go over the more commonly used accounting terms and why it’s important to have an understanding of the mechanics of accounting.
Accounting Terminology Guide
Below is a list of the more common accounting terms and definitions. We also included common accounting acronyms.
The amount of money owed by clients to a business after goods or services have been delivered.
The amount of money a company owes creditors in return for goods or services delivered.
This is the process of recording revenues or expenses when they are earned or incurred, regardless of when the cash is received or paid.
These are resources owned by a company, such as cash, inventory, property, and equipment.
An examination of a company’s financial records and statements by an independent third party.
A financial report that summarizes a company’s assets, liabilities, and the owner or shareholder equity.
Cash Flow Statement
A financial statement that shows the inflows and outflows of cash in a company over some time.
An accounting entry that may either decrease assets or increase liabilities and equity on the company’s balance sheet, depending on the transaction. When using the double-entry accounting method there will be two recorded entries for every transaction: a credit and a debit.
An accounting entry where there is either an increase in assets or a decrease in liabilities on a company’s balance sheet.
The systematic allocation of the cost of an asset over its useful life.
The residual interest in the assets of a company after deducting liabilities; also known as shareholder’s equity or net worth.
These are the costs incurred by a company to generate revenue.
First-In, First-Out (FIFO)
A method of inventory valuation where the cost of the earliest acquired inventory is assigned to the first units sold.
Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles (GAAP) are a set of rules and guidelines developed by the accounting industry for companies to follow when reporting financial data.
This is the revenue minus the cost of goods sold.
A financial statement that shows a company’s revenue, expenses, and net income or loss over a set time.
An invoice is a document from a company that shows clients what they owe for goods or services provided. Clients can use an invoice to determine how much money they owe to an organization. Unlike receipts, invoices typically occur in business-to-business transactions, rather than business-to-consumer transactions.
Last-In, First-Out (LIFO)
A method of inventory evaluation where the cost of the most recently acquired inventory is assigned to the first units sold.
These are the debts or obligations a company has, such as loans, accounts payable, and accrued expenses.
The excess of revenue over expenses; also known as profit or net profit.
Profit & Loss Statement (P&L)
A P&L statement is used to summarize a company’s performance and financial position by reviewing revenues, costs, and expenses during a specific period, such as quarterly or annually.
Return on Investment (ROI)
A measure used to evaluate the financial performance compared to the amount of money that was invested. It’s calculated by dividing the net profit by the cost of the investment and the result is usually shown as a percentage.
This is the income generated from the sale of goods or services.
The trial balance is a list of all the general ledger accounts and their balances to check if debits equal credits.
Different Types of Accounting
Using the correct type of accounting is essential to your business’s success. Below are the different types and their purpose.
Auditing involves the examination and verification of financial statements and records to ensure accuracy, reliability, and compliance with laws and regulations. Auditors review financial information, internal controls, and business processes to provide an independent opinion on the fairness and integrity of financial statements.
Cost accounting determines and analyzes the costs associated with producing goods or services in an organization. It involves tracking and allocating costs to various products, services, or activities. Cost accountants provide information on the cost of production, inventory valuation, pricing decisions, and cost control measures.
Financial accounting focuses on the preparation and reporting of financial statements for external users, such as investors, creditors, and regulatory authorities. It involves recording, summarizing, and presenting financial transactions per generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS).
Forensic accounting combines accounting, investigation, and legal knowledge to detect and prevent financial fraud and misconduct. Forensic accountants analyze financial records, reconstruct transactions, and provide expert opinions in legal proceedings.
Governmental accounting refers to the accounting practices used by government entities, including federal, state, and local governments. It follows specific accounting principles and standards to track and report financial transactions and resources in the public sphere
Managerial accounting, also known as management accounting, provides financial information and analysis to managers, executives, and decision-makers within an organization. It involves budgeting, cost analysis, performance evaluation, and strategic planning to support decision-making. Also, it can help improve the organization’s efficiency and profitability.
Nonprofit accounting applies to organizations that aren’t profit-motivated, like charities, foundations, and religious organizations. It focuses on tracking and reporting financial information following nonprofit accounting standards.
Why You Should Know These Accounting Terms
Before embarking on any business journey, you should learn as much as you can. It’s never a good idea to invest money in something where you don’t understand the basics. Knowing basic accounting terms is beneficial for several reasons.
Firstly, this allows you to avoid mistakes. For example, you could mix up different principles and use one that doesn’t apply to your business. This can cost your business money by way of fines or just spending more money to correct a problem.
If you’re a nonprofit then the stakes are higher. You could endanger your nonprofit status if you don’t pay attention to your income, budget, and how you run it. By losing your nonprofit status you could be subject to paying back donor money, grant money, and even legal action.
Knowing these accounting terms also allows you to have clear communication with not only your employees but with other business owners. It gives you a foundation to have a meaningful conversation with them and, if you have any questions, be able to articulate what you want to know.
Finally, accounting brings together all the data regarding profits, which is one of the reasons for getting into business. Knowing the basic accounting terms helps you understand how to interpret them in financial statements and reports. Once you understand the data and its nuances, then you can make effective business decisions.
Finding The Right Accounting Partner
Finding an accounting partner can be an intimidating journey. You need to find someone who understands your business and can be part of your team.
When you work with one of the experts from Powered by Centri, that’s our goal, too. We want you and your business to succeed and will work with you to make sure that happens.
We have the resources and tools to help you grow your business to the next level, from selecting the right accounting software to knowing when to outsource your accounting and being supportive every step of the way.