Ever look at a financial statement and throw your hands up exclaiming, “What do all these numbers mean?” After all, you’re a small business owner, not an accountant. Yet it’s those numbers that help you keep score, financially speaking. Here’s an explanation of some basic accounting terms to help you get started.
Accounting practices give you the tools to determine the financial health of your business. The payoff is that it helps you make more informed decisions. It answers questions like, “Am I making a profit?” It also gives you a way to communicate with investors, creditors and Uncle Sam about how you’re doing.
These are five commonly used accounting concepts:
- Assets/Liability – An asset is something your business owns that can provide future economic benefit. It might include equipment, cash, or buildings. Liabilities are debts you must pay (or services you must provide). The difference between the two represents your “equity.” It’s your right to that portion of the business assets after outsiders have exercised their rights to any outstanding claims they have. The “balance sheet” provides a snapshot-in-time look at these variables.
- Revenue/Expense – Revenue is the money you earned from the sale of a good you offer or service you provide. Expense is the cost you incur to produce that revenue. One expense might be employee wages. The difference between the two represents your operating profit. Both show up on a document called your “income statement.”
- Depreciation – The process of accounting for the decreasing usefulness of an asset, like a delivery van. For each year of use, an expense is recorded that accounts for its physical and functional deterioration. It’s also used to determine the amount of business expenses that can be deducted for tax purposes.
- Cash Flow – The amount of cash you generated and the amount you used during a given period. It can be a measure of your business’ financial strength. That’s because the availability of cash impacts your ability to pay expenses.
- Accounts Payable/Receivable – These are accounts used to track the bills you have yet to pay (accounts payable) and the funds you have yet to collect from customer sales (accounts receivable). Payable is a measure of your financial obligations. Receivable is an indication of cash inflow that you expect to collect from customers from recent or past sales.
For More Information
Want to learn more? The Small Business Administration offers a free online class, Introduction to Accounting, which is designed to provide a broad overview of accounting.