10 Sep Accounting Terms Business Owners Must Know To Succeed
As a business owner, it is vital to have a basic understanding of key accounting terms. You may be asking, well isn’t that what I have an accountant for? True, but knowing these terms will result in you being a well-versed business owner, making your interactions and meetings with financial advisors, investors and lenders much easier and more productive.
A good accountant will explain to you in simple words the financial position of your business, so by no means do you need to be fluent in accounting terminology. However, you wouldn’t go to a foreign country without learning a few phrases to help you survive your stay. And so, in the same way, it is beneficial to have a basic understanding of accounting terms and principles, so you can navigate the financials of your business.
We have put together a few important accounting terms that you must know to succeed in business:
Term 1: GAAP (Generally Accepted Accounting Principles)
GAAP are the guidelines, principles or procedures that companies and their accountants must follow when compiling financial statements. It ensures the minimum level of consistency. A good bookkeeper or accountant does everything possible to make sure your financial statements are GAAP compliant.
Term 2: Accounts Receivable and Accounts Payable
Simply put, accounts receivable is money that is owed to you and accounts payable is money that you owe to others.
A helpful way to describe this concept is knowing that one individual’s receivable is another individual’s payable.
If you are enquiring about money owed to you, this is accounts receivable. If you are enquiring about money that you owe, this is accounts payable.
Term 3: Liquidity
This is the difference between your current assets and current liabilities. Cash is the most liquid asset. Your current assets are “liquid” meaning they can be converted into cash within 12 months, examples of these are bank balances, stock balances and accounts receivable balances.
Large assets like property, plant and equipment are not as easily converted into cash. These assets can take extended periods to be sold making these types of assets “less’’ liquid.
Current liabilities are amounts/debts payable within 12 months. Examples are trade creditors, accrued expenses and accrued interest.
Term 4: Chart Of Accounts
Your business chart of accounts (COA) is a filing system for all your transactions. It is the total listing of every account in your bookkeeping system.
The purpose of the chart of accounts is to keep the data in the general ledger (a record of all transactions in your business) organised in a way that makes your financial reports valuable! Due to this reason, business owners should work with the accountant or bookkeeper to develop and maintain the chart of accounts. By having a hand in this process – you can structure your accounts in such a way that useful reports that will benefit YOU, can be generated easily.
Term 5: Costs Of Goods Sold
This is an important accounting term; your business cost of goods sold (COGS) or Cost of Sales (COS) is the direct cost of producing your product or service.
Determining your cost of sales is the first step to knowing your business’s gross profit margin.
If your business produces R1 Million over the year, but your cost of sales is R900, 000. This means your business was left with R100, 000 after the deduction of production costs, resulting in your gross profit margin being a poor 10%.
Cost of sales is the first expense on your profit and loss statement, reducing this expense will automatically increase your profit without any increase in sales, so try to keep your production costs as low as possible!
Term 6: Equity
Equity refers to your ownership in the business. It is the inclusion of all money and other things of value that you have invested in your business plus the earnings the business has received over its lifetime.
Equity can also be explained as the difference between the business assets (what the business owns) and its liabilities (what the business owes).
Term 7: Profit
This is the “bottom line” and is what drives your long nights and momentum to keep going in business!
In accounting terms, profit is the difference between income, cost of sales and the operating expenses in the business as well as interest and depreciation expenses.
Depending on your tax structure, your business will be taxed on the net profit and not the amount of cash you have left after you have paid debts and distributions. For this reason, it is imperative that you regularly consult with your accountant to plan for your tax liability and set aside a portion of income to cover your tax liability.
Having a substantial net profit is excellent! But not having enough cash available to meet your tax liability is bad… So be proactive in your planning.
Term 8: Return on Investment
This is an analysis of your financial performance based on money invested and can be abbreviated as ROI.
For example, if you spend R900 on a training program, as a result of the program, you can increase your sales by 9, 000. The gross return on your spend or investment is R8, 100 (R9, 000 – R900 you spent on the cost of the program). The percentage of your ROI is 900% (the R8, 100 gross return divided by the R900 invested in the program).
You must pay attention to the ROI on significant investments of time and money to ensure that you target your resources and energy on the most profitable aspects of your business.
Term 9-Technical Insolvency
This means that a person or company has a negative net asset value. In other words, its liabilities are greater than its assets.
It is possible to be technically insolvent while still being able to repay debts as technical insolvency is based on the balance sheet and not cash flow.
Technical insolvency is dependent on circumstance and may be perfectly acceptable, or indicate serious problems that could lead to actual insolvency.
Term 10: Insolvency
Insolvency means that your business is unable to pay its debts/liabilities.
If a business or individual does not have the cash to pay its liabilities, this results in insolvency becoming a more serious matter and could lead to restructuring or liquidation.
If a company has liabilities on its balance sheet that are of greater value than its assets, this is technical insolvency. The company is still able to have a cash flow enough to pay its liabilities when they are due.
In conclusion, understanding accounting terms and principles will enable you as a business owner to make more informed decisions in your business, making your interactions with accountants, financial advisors and investors more enjoyable and productive!