As a small business owner, you know that keeping track of finances is essential. However, understanding bookkeeping terminology can often be confusing. This guide breaks down essential bookkeeping terms in clear, straightforward language, making it easier for you to grasp the basics of financial management and make informed decisions for your business.

Core Bookkeeping Terms For Small Business Owners

1. Assets

Assets are what your business owns and are expected to provide future economic benefits. They’re divided into:

• Current Assets: Items like cash, inventory, and accounts receivable that you expect to convert to cash within a year.
• Fixed Assets: Long-term resources, such as land, buildings, and equipment, used over several years.

Example: The computer and furniture in your office are fixed assets, while cash in the bank is a current asset.

2. Liabilities

Liabilities are what your business owes to others. Liabilities can be:

• Current Liabilities: Short-term obligations due within a year, like accounts payable.
• Long-Term Liabilities: Debts due over a period longer than one year, such as loans.

Example: Money owed to suppliers is a current liability, while a loan for equipment payable over several years is a long-term liability.

3. Equity

Equity represents the owner’s share of the business after all liabilities have been deducted from assets. It’s also known as owner’s equity or shareholder’s equity.

Example: If your business assets are worth $150,000 and your liabilities are $50,000, your equity is $100,000.

4. Revenue

Revenue is the total income generated from selling products or services before deducting any expenses.

Example: If you own a landscaping business, the income earned from providing lawn care and gardening services is your revenue.

5. Expenses

Expenses are the costs your business incurs in order to operate and generate revenue. They include rent, utilities, and payroll.

Example: Monthly rent for your storefront and salaries paid to employees are considered business expenses.

6. Cash Flow

Cash Flow is the net amount of cash coming in and going out of your business over a period. Positive cash flow means more cash is coming in than going out, essential for covering expenses and reinvesting.

Example: If you receive $5,000 from sales but pay $3,000 in expenses, your cash flow for the period is $2,000.

7. Accounts Receivable

Accounts Receivable (AR) is money owed to your business by customers who have received goods or services but have not yet paid.

Example: If you provide consulting services and send an invoice to a client for payment within 30 days, that amount is recorded as accounts receivable.

8. Accounts Payable

Accounts Payable (AP) is the amount your business owes to suppliers or vendors for products or services received.

Example: If you purchase inventory on credit and agree to pay the supplier within 30 days, that amount is recorded as accounts payable.

9. General Ledger

The General Ledger is the main accounting record for a company, summarizing all financial transactions.

Example: Entries like sales revenue, office supplies purchases, and payroll expenses are recorded in the general ledger.

10. Trial Balance

A Trial Balance is a report that lists the balances of all ledger accounts and ensures that debits equal credits. It’s a tool for verifying that accounts are balanced.

Example: At month-end, your accountant prepares a trial balance to confirm that all entries are correct.

11. Debit and Credit

Debit and Credit entries are the two main sides in double-entry bookkeeping:

• Debit entries increase assets and expenses.
• Credit entries increase liabilities, equity, and revenue.

Example: When you make a sale, you credit revenue and debit cash or accounts receivable.

12. Accruals

Accruals represent revenues earned or expenses incurred that haven’t been recorded yet. This method aligns income and expenses to the period in which they occur.

Example: If you perform a service in December but don’t receive payment until January, the revenue is recorded in December.

13. Depreciation

Depreciation allocates the cost of a fixed asset over its useful life, reducing its book value each year.

Example: If you buy a $10,000 vehicle with a useful life of 5 years, you could depreciate $2,000 per year.

14. Retained Earnings

Retained Earnings are the cumulative net earnings retained in the business instead of being distributed to shareholders.

Example: Profits from the past three years kept within the company for growth are retained earnings.

15. Bad Debts

Bad Debts are amounts owed to your business that you don’t expect to collect, often written off as a loss.

Example: If a customer cannot pay an outstanding invoice, that amount becomes a bad debt.

16. Credit Note

A Credit Note is issued to a customer to correct or reverse part or all of an invoice, usually due to returns or billing errors.

Example: If a customer returns damaged goods, you issue a credit note to adjust the total due.

17. Chart of Accounts

The Chart of Accounts (COA) is a list of all accounts used in the general ledger to organize financial information.

Example: The COA includes accounts like “Rent Expense,” “Revenue,” and “Accounts Payable.”

18. Inventory

Inventory is the stock of goods held by your business for the purpose of resale.

Example: A clothing store’s unsold items are inventory until they’re sold to customers.

19. Payroll

Payroll refers to the total wages and benefits paid to employees. It’s often a large expense for businesses.

Example: Monthly salary, bonuses, and benefits for employees make up your payroll.

20. Fiscal Year

The Fiscal Year is a 12-month period used for accounting purposes, which doesn’t have to align with the calendar year.

Example: If your fiscal year starts on April 1 and ends on March 31, that is your reporting period for accounting.

Advanced Bookkeeping Terms For Small Business Owners

To deepen your understanding of bookkeeping terminology, here are additional terms that can help you maintain organized and accurate financial records:

21. Amortization

Amortization is similar to depreciation but applies to intangible assets like patents or trademarks, spreading the cost over the asset’s useful life.

Example: A patent purchased for $20,000 with a 10-year lifespan would be amortized at $2,000 per year.

22. Prepaid Expenses

Prepaid Expenses are expenses paid in advance, such as insurance or rent, which provide benefits over time.

Example: Paying $12,000 in January for a year-long insurance policy would show as a prepaid expense, and $1,000 would be recorded each month.

23. Working Capital

Working Capital is the difference between current assets and current liabilities, indicating your business’s short-term financial health.

Example: If your current assets are $50,000 and current liabilities are $30,000, your working capital is $20,000.

24. Gross Profit

Gross Profit is the revenue left after subtracting the cost of goods sold (COGS), giving insight into profitability before expenses.

Example: If you earn $100,000 in sales and COGS is $40,000, your gross profit is $60,000.

25. Net Profit

Net Profit is the amount remaining after all expenses, including taxes and interest, are subtracted from revenue.

Example: If gross profit is $60,000 and total expenses are $30,000, net profit would be $30,000.

26. Fixed Costs

Fixed Costs remain constant regardless of production or sales levels, like rent or insurance.

Example: Monthly rent of $2,000 is a fixed cost that doesn’t vary with sales.

27. Variable Costs

Variable Costs change in direct proportion to production volume, like raw materials or production labor.

Example: If it costs $5 in materials to make a product, variable costs rise with each additional item produced.

28. Overhead

Overhead includes ongoing business expenses that aren’t directly tied to producing goods or services, like office supplies or utilities.

Example: Utilities for the office space are part of overhead costs.

29. Profit and Loss Statement (P&L)

The Profit and Loss Statement (P&L) summarizes revenue, costs, and expenses over a period, providing an overview of your bookkeeping terminology in action.

Example: A monthly P&L shows whether the business made a profit or incurred a loss during that time.

30. Balance Sheet

The Balance Sheet provides a snapshot of your business’s financial position by listing assets, liabilities, and equity at a specific date.

Example: A balance sheet at year-end shows total assets, total liabilities, and equity.

31. Interest Payable

Interest Payable is the interest that has accrued on loans or credit but has not yet been paid.

Example: Monthly interest on a $50,000 loan that accrues but isn’t paid until the end of the year is considered interest payable.

32. Dividends

Dividends are payments made to shareholders from profits. They represent a portion of earnings distributed to investors.

Example: After a profitable quarter, the board may declare dividends of $2 per share for shareholders.

33. Capital Expenditure (CapEx)

Capital Expenditure (CapEx) refers to funds used to acquire or upgrade physical assets like property or equipment, typically with a useful life of more than one year.

Example: Buying a new warehouse for business operations is a capital expenditure.

34. Income Tax Payable

Income Tax Payable is the amount of income tax that your business owes but hasn’t yet paid.

Example: After filing annual taxes, the outstanding tax liability recorded on your balance sheet is income tax payable.

35. Owner’s Draw

Owner’s Draw is the amount of money taken out of the business by the owner for personal use. This is common in sole proprietorships.

Example: If you’re a sole proprietor and withdraw $2,000 for personal expenses, it’s recorded as an owner’s draw.

Grasping this essential bookkeeping terminology equips you to handle the financial side of your business with confidence. By familiarizing yourself with these terms, you’ll find it easier to keep accurate records, communicate effectively with your accountant, and make informed financial decisions.

Need help understanding your finances? Contact our team at A Cloud Above Accounting for the support you need in achieving organized, accurate bookkeeping. We’re dedicated to helping you gain clarity and confidence in your financials with our cloud bookkeeping services and bookkeeping catch-up services, empowering you to make informed decisions for your business.

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