Revisit: Basic Accounting Terms

murphy booth

2 years ago

This is from a blog post published over a year ago. As business owners it is important to understand basic accounting terms, which I hope is helpful as we enter into the 2025 tax season.

It can be overwhelming to start a business. One of the most helpful things I did when starting my business was becoming familiar with common bookkeeping practices. I wanted to make sure the financial portion of my business was done correctly before I really started networking and gaining client interest. I wrote a blog post about 4 legal steps to take when starting a business: Click here to read that article.

Before you can really dive into good bookkeeping practices it’s important to know what all the words mean and how this knowledge can actually help you financially around tax season. If you’re like me, I didn’t have much of a personal finance background. I had to use resources, ask around to people I trusted, and ultimately had to teach myself. I am so glad I have this skill set now because I can help clients with bookkeeping and keep good books on my own business.

First things first, it’s important to know what type of business entity your business should be listed under. There are a few more types than this but these are the 5 most common.

Different Types of Business Entities:

Limited liability company (LLC): An LLC is a corporate structure where members cannot be held accountable for the company’s debts or liabilities. This can shield business owners from losing their entire life savings if, for example, someone were to sue the company.
Sole Proprietorship: owned and run by one person and in which there is no legal distinction between the owner and the business entity.
Subchapter S corporation (S-CORP): A form of corporation (that meets specific IRS requirements) and has the benefit of being taxed as a partnership versus being subject to the “double taxation” of dividends with public companies.
Partnership: arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, businesses, interest-based organizations, schools, governments or combinations
Corporation: usually a group of people or a company—authorized by the state to act as a single entity and recognized as such in law for certain purposes.

Next, knowing the difference between bookkeeping and accounting will save you frustration around tax season. Bookkeeping is keeping record of all purchases and sales your business conducts. Accounting can be a subjective look at what that data means for your business, file taxes on your behalf and make sure you are following the IRS laws in regards to owning a business. Accountants can be considered bookkeepers but bookkeepers cannot be considered accountants without proper certification (businessnewsdaily).

I always recommend my bookkeeping clients hire an accountant for their business. In fact, I now require my clients to have an accountant before taking them on as clients. My job as the bookkeeper is to compile all necessary transactions throughout the year and the accountant is responsible for filing necessary taxes before April 15th.

Finally, I’ve narrowed down long lists of business terms into a list that I think will serve you well in your small business. This list is compiled of basic accounting terms you will hear bankers, accountants, and other business owners use. If you do your own bookkeeping you will also need to be familiar with these terms as most bookkeeping software programs refer to these terms often.

Common Business Terms you should know as a small business owner:

Accounts receivable (AR): The amount of money owed by customers or clients to a business after goods or services have been delivered and/or used.
Profit and loss statement (P&L): A financial statement that is used to summarize a company’s performance and financial position by reviewing revenues, costs and expenses during a specific period of time, such as quarterly or annually.
Accounts payable (AP): The amount of money a company owes creditors (suppliers, etc.) in return for goods and/or services they have delivered.
Assets (fixed and current):
- Current assets (CA) are those that will be converted to cash within one year. Typically, this could be cash, inventory or accounts receivable.
- Fixed assets (FA) are long-term and will likely provide benefits to a company for more than one year, such as real estate, land or major machinery.
Balance sheet (BS): A financial report that summarizes a company’s assets (what it owns), liabilities (what it owes) and owner or shareholder equity, at a given time.
Cash flow (CF): The revenue or expense expected to be generated through business activities (sales, manufacturing, etc.) over a period of time.
Liabilities: A company’s debts incurred during business operations.
Credits & Debits: This is really where the accountants come in handy! At times accounts will need to use a system called Journal Entries. This involves crediting one account and debiting another to make it balance. Accountants have the full understanding of this.
Net income: A company’s total earnings, also called net profit. Net income is calculated by subtracting total expenses from total revenues.
Cost of goods sold: The direct expenses related to producing the goods sold by a business.
Expenses:
- Fixed expenses (FE): payments like rent that will happen in a regularly scheduled cadence.
- Variable expenses (VE): expenses, like labor costs, that may change in a given time period.
- Accrued expense (AE):an incurred expense that hasn’t been paid yet.
- Operation expenses (OE): business expenditures not directly associated with the production of goods or services—for example, advertising costs, property taxes or insurance expenditures.